BACKGROUND INFORMATION
WHY WAS THE 1999 GROWTH FORECAST OVERESTIMATED?

The downfall or slowing down of the economic growth in transition countries in 1998-1999 has raised the issue of economic cycles in transition economies. Although nobody is denying cycles as such, the very question itself was unexpected for many an expert. Why? One reason could be the fact that only a few transition countries (eg Poland, Slovenia) have achieved or surpassed the pre-reform level. Therefore it is too early to think about the likelihood of demand-side shocks or shocks arising from economic policy mistakes. Provided that the chosen reform ideology is right and consistently pursued. In case of small open economic system cycles can be caused by external shocks.

Estonia, experiencing the economic recession at the end of 1998 and in the first half of 1999, is among the countries in which the downfall was caused by external factors, not the country's economic policy. Thus, it cannot be argued that the currency board-related response both to the Asian and Russian crises has been unexpected. Nevertheless, the economic recovery has been slower than expected and several earlier forecasts have been misleading.

Two methods combined or separately can be used for economic forecasting. One forecast uses equations and models. As a rule it yields good results in stable economic situation. The other forecast considers the so-called leading indicators. They indicate upcoming changes in trends. In case of both methods the results are corrected against expert opinions.

Estonia's macroeconomic forecasting is under way in several institutions, for example in the Ministry of Finance, Eesti Pank, commercial banks and other domestic and foreign institutions. These institutions use different methodology, combining models, leading indicator and expert opinion methods. Forecasters have also a different approach to relations between economic indicators. Thus, forecasting gross domestic product, the Ministry of Finance considers estimates on the growth of the GDP production-related components, provided on the spheres of economic activities by ministries. Whereas Eesti Pank founds its GDP estimate on the external demand forecast. The growth forecast by State Audit Office is based on industrial sales, which indirectly could be identified with export forecasts[1].

Regardless the methods used, the forecasts still have several similarities. Thus, the 1997 growth was clearly underestimated, during 1999 all growth forecasts became more and more pessimistic. The external experience has shown that forecasts made by small countries are more inaccurate compared to those made by large. Just because small countries are more open and therefore more susceptible to external development trends which is a significant source of mistakes in forecasting[2].

The main mistake made in forecasts on Estonia in 1999 was the poor evaluated pressure exercised by the external environment. The flexibility of our export sector was mostly overestimated. The east-oriented export downfall after the collapse of the Russian market was relatively accurately forecast but high expectations were laid on rapid reorientation of exports to the west. It was not taken into consideration that Russian and West European markets are not substitutable with each other for our exports and with the existing supply-side structure it is neither possible to rechannel sales flows nor to produce immediately goods compliant with the requirements of the new market. The novelty of the situation lies also in the fact that up to the second half of 1999 domestic demand was the main source of economic growth in Europe. The export-oriented production required less input than before and growth of exports to the traditional EU market slowed down significantly.

In conclusion, the discrepancy between forecasts and reality can be explained with the lack of experience as Estonia has been through only one full cycle of economy by now. Probably the further development of Estonia's economy could also be difficult to forecast. Therefore the economic policy should be more conservative. In general, the public has focused too much on the size of indicators when evaluating economic forecasts, instead of discussing prerequisites and economic policy steps.

EXPORT OF ESTONIA'S SERVICES AFTER THE CRISIS

During the transition period, the share of the services' sector against the GDP has been growing and constitutes 61% (53% in 1993). The export of services has also grown. In years 1993-1998 it grew 4.7 times (export of goods 3.5 times) and was 21% of the services' turnover in 1998. Compared to the processing in which about half of the production is exported, the share of exports in the services' sector seems to be low. It should be taken into the consideration that the services' sector is by nature linked to the domestic market and only few services can be exported extensively. Most of the export of services is comprised of travel and transport services; by classification the export is split between two major fields of activity[3] with export being responsible for about 40% of the turnover.

Businesses providing services for the external sector have survived the economic recession, which started in the fourth quarter of 1998 much better than businesses exporting goods. The growth in the export of services was both suspended and recovered earlier than that of goods (Figure 2a).

One of the reasons lies in the economic acceleration in Europe coinciding with the high season of passenger traffic and tourism, another in profits from oil transit having partly compensated the decline in transport services arising from decreasing foreign trade.

Transport Services

The export of transport services is linked to the export of goods and is dependent on Estonia's foreign trade turnover. The slowdown in the growth of trade turnover in the fourth quarter of 1998 brought along a decline in the carriage of goods.

This was offset with increasing oil prices in the first half of 1999, which increased oil export from Russia and profits of Estonian mediating transport companies. The fluctuation of oil prices in the world market, potential changes in Russia's export policies and competition with neighbouring countries in transit brokerage make this export deeply susceptible to external factors.

Similar to transit other transport services have revealed an upward trend in the post-crisis period as well. Trade revival promotes, together with the export of goods, the import, too (Figure 2b).

Travel Services

The other key component in the services' balance, ie travel services, is deeply related to seasonal fluctuations. In the third quarter of 1999 the export of travel services reached 3 billion kroons according to preliminary data and exceeded by 16% the same period a year ago. Thus, this was not only a seasonal growth but also the most rapidly recovered export industry.

As the export of travel services involves also shopping tourism and the share of goods' export born from price differences between Estonia and other European countries, already in near future the key issue would be to converge Estonia's price level with that of other European countries, first and foremost, with Finland. About 90% of the tourists visiting Estonia come from Finland, vast majority being the so-called one-day or shopping tourists. Nevertheless, the investments made in the recent years let to forecast growing traditional tourism.

Services' Balance

Throughout the transition period the export of services has exceeded import both in travel and transport services (Figure 2c). It is closely related to the foreign trade balance as in 1995-1997 the surplus of the services' balance covered about 50% of the trade deficit and was more than 10% of the GDP. The above seasonal fluctuations vary this indicator by quarters.

During the first nine months of 1999 the export of services reached about the level of the previous year (decreasing only up to 2 percentage points of the GDP).

The rapid growth of profit generated from the export of travel services took the surplus of the services' balance to 16-17% of the GDP in the third quarter (against 15% in 1998). As the investment demand has been low and travel services grew extensively due to previous investments, the surplus of the services' balance exceeded the foreign trade deficit and created a surplus in the current account. Anyway, such a relation between services and trade balance can still be only temporary.

[1] Although these two forecasts consider the same ideology, the economic forecast for year 2000 is different. The latter can be explained with different model structure and expert opinions.
[2] Source: The EU Economy: 1999 Overview.
[3] 80-90% of the export of services are transport and travel services which according to the classification of economic activities are under transport, storage and communication and hotels and restaurants. Other services cover construction, government, business and all other services.