Estonian wage pressures have not eased

  • An improved external environment and higher productivity are boosting economic growth
  • Rising food and energy prices will put an end in the second half of the year to the deflation that has been present for two years
  • Wage pressures have not eased, and growth in the average wage remaining close to 5% will force companies to make their production more efficient or exit the market

The Estonian economy will grow faster this year and in the next two as the external environment improves and productivity increases. Demand from trading partners has grown in the past six months at the rate that was forecast, and the data indicate that growth momentum will be maintained. In the short term growth will be boosted by increased productivity per employee, as the number of hours actually worked by the full-time employed has been temporarily reduced in expectation of improved demand to come. In the longer term it is only investment and employee development that can ensure higher productivity, and these should be supported by economic policies that favour growth and by increased competitiveness at both the state and company levels.

Increased investment alone is not enough to improve the growth capacity of the economy. The ratio of investment to GDP in Estonia is one of the highest in Europe, but the structure of investment should also be considered, and how efficiently the fixed assets acquired are used. The share of investment going into research and development in Estonia is one of the smallest in the European Union and so support for innovation is not strong. At the same time, the utilisation rate of production resources has been below the European Union average, which means that a relatively large part of the fixed assets acquired and the spending on them has been ineffective and has not supported growth.

The Estonian economy will become larger in the middle of this year than at its pre-crisis peak. The state of the economy is quite different from what it was during the boom some ten years ago, as corporate production capacity which is sustainable in the long-term is around 10% larger than the level of that time, and the economy is close to balance. Growth may still be forced slower by risks stemming from the external environment, the most important of which are the unsustainability of the growth in neighbouring countries that is founded on consumption; the migrant crisis, which is yet to be resolved; Brexit; volatility in commodities prices; complex geopolitical circumstances; and the bursting of a bubble in Swedish asset prices.

An accommodative monetary policy and access to funding aid growth in the economy, though the limited amount of labour available poses a problem. The central question for economic development is not how the supply of labour can be increased but how the actual available labour can be better used than before now. Sectors with low value added are particularly feeling the labour shortages, as their low average wages are hurting their competitiveness in the labour market.

Companies with low productivity and low wages exiting the market is a part of economic development. The movement of workers to jobs with higher productivity and higher wages will leave the structure of the economy more based on value added and will increase the incomes of residents. At the same time the changes in the structure of the economy should be in line with the redeployment of workers. Excessive pressure on companies with low productivity, one source of which could be steep rises in the minimum wage, could raise unemployment and harm the long-term outlook for growth.

Wage pressure has not eased and labour costs increased further at the start of this year at the expense of profits. Profits will stop declining when labour productivity increases. This will be aided by the flexible labour market, which has an institutional architecture that lets it adapt relatively easily compared to those in other countries. Collective agreements play only a small role beyond setting minimum wages and employers can decide directly about their wage costs. Even so it is possible that companies have been holding on to employees and raising wages because of overly optimistic expectations of growth in demand, and so wage growth could slow sharply.

Rising food and energy prices will put an end in the second half of the year to the deflation that has been present for two years, but for the year as a whole consumer prices will be at the same level as they were last year. Inflation will remain between 2% and 3% in the next two years and a large part of the rise in prices will come from tax rises, as excise increases on fuel, alcohol and tobacco. Higher inflation will restrain the rise in real household incomes, and that will then hold back growth in consumption over the next two years.

The financial situation of the Estonian general government is good and the budget has remained in surplus in recent years. However, the surplus has not been planned but has resulted from tax revenues being larger than expected or planned investment being postponed. Eesti Pank forecasts the budget position will be close to balance in the years ahead too, but there are major upside and downside risks. The structural balance rule in the State Budget Act ensures the long-term stability of state financing, but in order that companies and households not be faced with uncertainty about the future due to the government needing an unplanned additional source of funds, the government should set the target of keeping the budget in structural surplus or should allow more flexibility in its spending.

In the new budget strategy the government has put smoothing the economic cycle to the forefront and achieving nominal balance has been postponed. However, it will be harder in future to achieve balance. The budget was in surplus in recent years even though government wage costs increased rapidly and social benefit payouts increased strongly. This was possible because of a fall in capital expenditure and a tax-rich economic environment. Wage growth will slow in Estonia in the years to come and therefore the tax burden will decline, while the government is planning to increase investment, meaning pressure will increase to limit costs so the budget can stay in balance.

Source: Bank of Estonia

The number of job vacancies increased in 1Q

According to Statistics Estonia, there were about 8,300 job vacancies in the enterprises, institutions and organisations of Estonia in the 1st quarter of 2016. The number of job vacancies increased by 25% compared to the previous quarter and by 14% compared to the 1st quarter of 2015.

The rate of job vacancies, i.e. the share of job vacancies in the total number of jobs, was 1.5% in the 1st quarter of 2016; this is 0.3 percentage points higher than in the 4th quarter of 2015 and 0.2 percentage points higher than in the 1st quarter of 2015.

The rate of job vacancies was the highest in the economic activity of information and communication (3.6%) and the lowest in mining and quarrying (0.1%), which had the lowest rate of all economic activities in the 1st quarter of 2015 as well.

The largest share of vacant and occupied posts in the total number of jobs was recorded in manufacturing (19%), wholesale and retail trade (15.6%) and education (10%).

The increase in the number of job vacancies was the biggest in information and communication where there were two times more job vacancies than in the 1st quarter of 2015.

57% of the vacant and occupied posts were in Harju county (including Tallinn), followed by Tartu county (11%) and Ida-Viru county (7.5%). The rate of job vacancies was still the highest in Harju county (1.8%) and the lowest in Saare county (0.7%).

6,100 job vacancies (74%) were in the private sector and 2,200 (26%)  in the public sector. In the 1st quarter of 2016, the rate of job vacancies was 1.5% in both the public and the private sector. The public sector includes companies owned by the state or local governments.Diagram: Rate of job vacancies, 1st quarter 2007 – 1st quarter 2016

The movement of labour is characterised by labour turnover. In the 4th quarter of 2015, a total of 67,000 employees were hired or left their jobs, meaning there was a 2% decrease compared to the same quarter of 2014. Compared to the 4th quarter of 2014, the largest increase in labour turnover occurred in information and communication (25.5%) and in agriculture, forestry and fishing (24.0%).

The data are based on the job vacancies and labour turnover survey conducted by Statistics Estonia since 2005. In 2016, the sample includes 12,603 enterprises, institutions and organisations; the data of randomly selected units are imputed to the total population separately in each stratum.

The number of job vacancies is the total number of job vacancies on the 15th day of the second month of a quarter. A job vacancy is a paid post that is newly created, unoccupied or becomes vacant when an employee leaves, and for which the employer is actively trying to find a suitable candidate from outside the enterprise, institution or organisation concerned.

Source: Statistics Estonia

Estonian inflation in May 2016

According to Statistics Estonia, the change of the consumer price index in May 2016 was 0.1% compared to April 2016 and -0.9% compared to May of the previous year.

Compared to May 2015, goods were 0.9% and services 1.0% cheaper. Regulated prices of goods and services have fallen by 2.4% and non-regulated prices by 0.3% compared to May of the previous year.

Compared to May 2015, the consumer price index was influenced the most by transport, which became 5.9% cheaper, while petrol became 10% and diesel fuel 13.6% cheaper. The impact of electricity, heat energy and fuels, which became 7.9% cheaper, was nearly as big, with 11.5% cheaper heat energy contributing to almost two-thirds of the change. Out of the products which have become more expensive, alcoholic beverages had the biggest impact on the index, as their prices have increased 8.2% compared to May of the previous year. Compared to May 2015, of food products, the prices of processed fruit and sugar have increased the most (31% and 27%, respectively) and the prices of fresh vegetables have decreased the most (20% cheaper).

In May compared to April, the consumer price index was influenced the most by 11% cheaper fresh vegetables. 14% cheaper plane tickets which were bought for May and 11.6% more expensive accommodation services also had a bigger impact on the index.

Change of the consumer price index by commodity groups, May 2016
Commodity group May 2015 – May 2016, % April 2016 – May 2016, %
TOTAL -0.9 0.1
Food and non-alcoholic beverages -1.3 -0.3
Alcoholic beverages and tobacco 6.9 0.9
Clothing and footwear 3.8 0.9
Housing -3.8 -0.3
Household goods 0.3 0.1
Health 1.8 0.5
Transport -5.9 -0.3
Communications -1.8 -1.5
Recreation and culture 2.4 0.2
Education -13.5 0.0
Hotels, cafés and restaurants 2.4 2.3
Miscellaneous goods and services 1.4 0.5

Source: Statistics Estonia

The profit of the business sector decreased in 1Q

According to Statistics Estonia, in the 1st quarter of 2016, the total profit of the business sector was 521 million euros, which was 12% less than in the same period a year ago.

Compared to the 1st quarter of 2015, total profit decreased in almost all economic activities. The biggest contribution to the growth in total profit was made by information and communication enterprises. The growth in the profit of the business sector was negatively influenced mostly by manufacturing and transportation and storage enterprises.

In the 1st quarter of 2016, enterprises sold goods and services for 11.7 billion euros, which was 2% more than in the same period a year ago. The turnover of trade enterprises, which have the biggest share in the total turnover of the business sector, increased 7%, influenced mostly by an increase in the turnover of wholesale trade. The growth was supported also by retail and motor trade. The turnover of manufacturing enterprises stayed on the level of the previous year.

Compared to the same period a year ago, the total costs of enterprises increased 2%, which includes a 6% increase in personnel expenses. The number of persons employed as well as the number of hours worked increased 3%. The labour productivity of the business sector on the basis of value added amounted to an average of 4,900 euros per person employed per quarter, i.e. 2% more than in the 1st quarter of 2015.

The investment activity of enterprises continues to be at a low level. In the 1st quarter of 2016, enterprises invested 443 million euros, which was 5% less than in the same period the year before. The investments were made mostly in buildings, and machinery and equipment. The main investors were manufacturing, trade, energy and transportation enterprises, who made more than a half of the total investments of enterprises. Compared to the 1st quarter of 2015, investments in transport equipment and computer systems increased. Other investments fell, with the biggest decrease registered in investments in land.Diagram: Total profit of the business sector, 1st quarter 2010 – 1st quarter 2016

Source: Statistics Estonia

Electricity production decreased in 2015

According to Statistics Estonia, in 2015, the production of electricity totalled 10.4 terawatt-hours, which is approximately 17% less than in the previous year. Electricity production from renewable sources increased 3% compared to 2014.

Electricity generation decreased due to cheaper inflows of electricity from the Nordic countries. Imports from Finland grew 1.5 times in 2015 compared to the year before and constituted more than 96% of total electricity imports. At the same time, electricity consumption was at about the same level as the year before. Despite the decrease in production, annual electricity generation exceeded domestic consumption.

In the recent years, there has been a significant increase in the production of electricity from renewable sources. The introduction of renewable sources has somewhat reduced the importance of waste-intensive oil shale in electricity production. While in 2010 over 85% of electricity was generated from oil shale, the relevant share was 77% in 2015.

Since 2009, about half of the produced renewable electricity has been generated from biomass. There has been a considerable increase in the consumption of waste fuel and biogas for electricity generation. The production of wind power has also increased year by year. In 2015 it grew 18.4% compared to 2014. The volume of hydro energy has not changed significantly in the past three years, accounting for only 2% of total renewable electricity production.

In the past five years, the volume of oil shale production has increased every year but in 2015 production decreased approximately 7% compared to the previous year. The majority of oil shale is consumed in power plants and as raw material for shale oil. In 2015, compared to 2014, the consumption of power plants decreased by approximately 20%. Due to the continued demand in foreign markets, the shale oil production volume has increased year by year. In 2015, compared to 2014, the production of shale oil grew about 20%, and 90% of the production was exported. More than half (61%) of the exported shale oil was exported to the Netherlands, followed by Belgium and Sweden (10% each).

Over the past five years, wood pellets have been an important fuel on the energy market. In that period, the production of pellets has increased more than three times. Compared to 2014, the production of pellets grew 44% in 2015, with approximately 80% of the wood pellets produced being exported. More than half (57%) of the exported wood pellets were exported to Denmark, followed by the United Kingdom (27%), Sweden (10%) and the Netherlands (10%).

The production of peat fuels has been in decline for the past five years. In 2015, compared to 2014, the volume of production decreased more than two times.Diagram: Electricity production from renewable sources, 2005–2015

Source: Statistics Estonia

Swedbank and SEB will hold additional buffers from August

  • From August the commercial banks will have to hold systemic risk buffers of 1% rather than 2%
  • Eesti Pank will require Swedbank and SEB to hold a further buffer of 2% because they are systemically important banks

Changes to the capital buffer requirements for the commercial banks will start to apply from 1 August. Eesti Pank will replace the earlier 2% systemic risk buffer requirement with a 1% requirement for all banks operating in Estonia and will also require Swedbank and SEB, the two largest banks, to hold an additional buffer of 2%.

Eesti Pank introduced the 2% systemic risk buffer requirement for all commercial banks in 2014. The buffer was intended to make the banks hold more capital and so increase their resilience so that they could cope with a sharp drop in the economy, and to reduce the risks that come from the concentration of the structure of the banking sector.

“The systemic risk buffer has so far protected the banking sector against two risks, but from August we will cut this tool into two pieces in effect. We will start to require that all banks hold a buffer of 1% to reduce the risk of a sharp fall in the economy that arises because Estonia has a small and open economy. We will require the two largest banks to hold an additional 2% buffer though, as the banking sector in Estonia is one of the most concentrated in the European Union. Furthermore, the big banks here are vulnerable to the same risks as the structure of their assets and their funding is very similar”, said Ardo Hansson, Governor of Eesti Pank.

From August, the two biggest banks operating in Estonia will have a total capital requirement of 13.5% of total own funds, and all the other banks will have a requirement of 11.5%.

Eesti Pank informed the banks of its intention to change the capital buffer requirements at the end of April.

 

Currently

From 1 August 2016

Minimum own funds requirement

8%

8%

Capital conservation buffer

2.5%

2.5%

Countercyclical buffer

0%

0%

Systemic risk buffer

2%

1%

Systemically important institutions buffer

2%

Total requirement for Swedbank and SEB

12.5%

13.5%

Total requirement for other banks

12.5%

11.5%

The analysis by Eesti Pank of the introduction of the buffer requirements can be found on the website of the central bank.

Source: Bank of Estonia

Estonian labour market review

Key developments in second half of 2015

Growth has been slow in the Estonian economy for several years now and it slowed further in 2015. Despite this, the demand for labour remained strong as employment grew and growth accelerated in the payroll of the whole economy as a share of GDP.

Part of the reason for this contradiction may be that the slowdown in GDP growth was not broadly based, as certain sectors made a significant contribution to the slowdown, but do not account for a large share of employment. In the longer term the supply of labour in the economy depends on the number of residents of working age and how actively they participate in the labour force.

The number of people of working age has been declining in Estonia for a long time now, and this trend continued in 2015. This was more than offset however by increased participation in the labour force, and overall the amount of labour in the economy grew. People are encouraged to participate in the labour market by the increased chances of finding a job and by the steadily rising wage level. Annual growth in the second half of 2015 was as fast as in the first half, but this was because of extraordinarily high employment in the third quarter.

The estimate of employment may to some extent have been boosted by the delayed effect of the registration of employees. Estimates of employment based on data from companies put employment growth slower than in 2014, but most of them still show positive growth. For the year as a whole it was only full-time equivalent employment in the wage survey that fell. At the same time, demand for labour calculated from the number employed may be overestimated as there was an increase in the number of those in employment who were working part-time, and the number of hours worked in the whole economy grew more slowly than employment did. Increased employment led to a fall in unemployment for 2015 as a whole.

Unemployment in Estonia is markedly lower than in Latvia or Lithuania, and the reasons behind this are analysed in Box 3 of this report. The percentage of the long-term unemployed in total unemployment fell in the second half of the year. In the last quarter of the year both the labour force survey and the data on registered unemployment showed a rise in the number of short-term unemployed. Data on registered unemployment from Töötukassa, the unemployment insurance fund, gave a slightly less optimistic picture than the labour force survey.

The number registered as unemployed increased quarterly from the second quarter to the fourth and there was also a rise in the number of those whose working relationships were ended as they were made redundant. More people entered the register because of redundancy than did so in 2014, but still substantially fewer than in 2013. Unit labour costs continued to grow fast in yearly terms in the second half of the year. Wages grew fastest in the public sector, specifically in local government administration, but wage growth was lower in Estonian private companies.

Data on wages paid out show wage growth to have been fastest in the lower part of the wage distribution, probably because of the sharp rise in the minimum wage. The quarterly growth rate of the index of labour costs gives reason to think that growth in labour costs is slowing, as it fell notably at the end of 2015. Labour productivity fell in the second half of 2015, while yearly growth in unit labour costs was about as fast as in the first half of the year at 5.6%. This rise came from both the fall in productivity and the growth in labour costs per employee. In contrast to what was forecast, it may be noted that no adjustment in labour costs has yet taken place. Sentiment surveys show indeed that the expectations of companies for employment rose at the end of 2015 and the start of 2016 together with the share of companies complaining of labour shortages. In the longer term, rising unit labour costs mean shrinking profit margins for companies, and that in turn will make those companies more vulnerable in future to negative shocks.

Read more from the report made by the Bank of Estonia

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