Wage pressures pose a risk to economic growth in Estonia, as does weak external demand

Kaspar Oja
Kaspar Oja
Economist at Eesti Pank

The flash estimate from Statistics Estonia shows that the economy grew in the third quarter by 0.4% year-on-year and by the same amount quarter-on-quarter, returning to growth after two consecutive quarters of decline.

The main factor restricting growth is still the weak external environment and despite the gradual improvement in the euro area economy, the import forecast for Estonia's main trading partners has been lowered in recent months from what was expected in the spring. Weak demand is also confirmed by a survey from the Estonian Institute of Economic Research, which showed that at the start of the third quarter some two thirds of manufacturing companies considered demand to be the main factor limiting production.

Estonian exports decreased at a rapid rate in the third quarter, but the impact on the value-added of Estonian companies has been smaller. Exports shrank principally in low value-added products and the decline in exports is reflected in a decline in imports.

The weak external environment is offset by strong household consumption, which has been boosted by a fall in unemployment and by wage rises. However, another consequence of the rapid rises in wages is an increase in production costs, which may restrict the development of the exporting sector. This can been seen in the average rise of almost 7% in the first half of the year in the labour costs needed to produce one unit of output as wages rose faster than productivity, while in the European Union as a whole, this rise averaged 1.3% for the same period.

The fall in investment that has occurred concurrently with the strong growth in consumption has several causes. The slow recovery in external demand is holding investment back as the production capacity of manufacturing companies is being used less than usual and the need for investment is smaller. Investment is also affected by wage pressure, which has led to rapid cost growth for investments in building work. A third cause is that the one-off investment projects for energy efficiency are ending.

Although economic growth has temporarily slowed down and demand in the external environment has proven weaker than expected, there has not been any major change in expectations of recovery in the global economy. The strengthening of the economy in the USA and the euro area should contribute gradually to growth in external demand for Estonia and an acceleration in economic growth.

Eesti Pank will publish a new economic forecast on 12 December.

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