Let’s hear It for Estonia and Iceland

Two small European countries which have battled their way out of economic holes are setting an example for the US and the rest of Europe. 

While Washington continues to increase spending and accumulate government debt as if it had a vocation to become Athens on the Potomac, some smaller European countries have turned away from profligacy and pursued strategies which have culminated in notable achievements. American policymakers should take note.   

Despite obituaries written by various American pundits, Europe is still very much alive! Notwithstanding negativism over downgraded sovereign debt, a plunging euro and the frenzy to establish regional financial aid for the weakest within the European Union, other factors have been at work. Without much fanfare, two major decisions were taken in July: Estonia will become the 17th country to adopt the euro, replacing the kroon, and accession negotiations were opened with Iceland. Both countries bring very positive attributes to the EU.

Estonia joined the EU along with the other Baltic States and seven others in May 2004. Since it broke away from the Soviet bloc, Estonia has pursued free market policies more vigorously than other new EU members. It achieved substantial economic growth, only to witness a sharp contraction after a real estate bubble burst and domestic inflation spiked. But the Estonians were willing to stay the course and applied harsh policies which led to a 17 percent decline in GDP over the past two years. (If only Greece had the same determination!) Encouragingly, there was some economic growth in the final quarter of 2009. So even severe economic problems are surmountable if there is a will not to resort to self-indulgence through borrowing but to endure temporary sacrifices. 

How did Estonia have the political will to absorb the pain, unlike Greece? It never borrowed excessively and for the most part, it lived within its means. As with other euro area adherents, Estonia had to meet the Maastricht criteria in order to adopt the euro. The 2010 Convergence Report gave Estonia a green light on price stability, exchange rate convergence, independent monetary policy, and most importantly the government budget and debt criteria. Indeed, Estonia has an enviable track record on the last two indicators that have caused much consternation among some euro countries.

According to 2009 data, the government budget deficit was only 1.7 percent of GDP, the third lowest in the EU, and the general government debt ratio to GDP was a mere 7.2 percent – the lowest among the 27 member states. Estonia had a government budget surplus in the five years ended 2007. With such rectitude on fiscal matters, Estonia should be welcomed with open arms into the euro area.

In recent times, Iceland is best remembered for two catastrophes: an ash-spewing and unpronounceable volcano that fouled European skies and the reckless financial dealings of its very few banks. The volcano has quieted down and the government will make restitution to the daring overseas depositors who feasted on improbable Icelandic investments. At the same time, the government decided it was time to apply for EU membership.

This is not as improbable as it sounds. Iceland was a founding member of the European Free Trade Association (EFTA) and has always had a fairly open economy. Unlike the last 12 countries to join the EU, it has a high standard of living. Its per capita income is estimated at over US$39,600, higher than the EU average of $32,600 and higher even than Germany’s $34,000. Bouts of high inflation are now history and the jobless rate of 8 percent is lower than the current EU average of 10 percent. Public finances, too, are in relatively good shape. Despite the estimated 14 percent government deficit relative to GDP in 2009, there were surpluses in excess of 5 percent of GDP in 2005-2007 and near balance in 2008.

The banking crisis taught the Icelandic private sector some lessons. Banking supervisors need to be more vigilant and you don't have to be American to be greedy (the British and Dutch were the primary depositors in a scheme called Icesave). Now the chickens have come home to roost. Iceland must make good on these external financial obligations and find a solution as part of the EU accession negotiations.  

Iceland has only 320,000 people but when it joins the EU it will have the highest fertility rate. It is the only European country with fertility at the replacement level of 2.1, while the EU average is 1.5. Compared with the rest of the EU, Iceland has a relatively young population: the 0-14 year old age group comprises 21 percent of the population versus 15 percent in the EU.

The population is highly educated and industrious. About 37 percent of women have had tertiary education versus 27 percent for men. Women have exceeded men enrolled in higher education since 1985. Iceland has one of the highest women’s employment rates at nearly 78 percent. Although there are several political parties and governments are unstable, it is worth recalling that Iceland’s parliament, the Althing, is the world’s oldest, dating back to the year 930.

Both Estonia and Iceland demonstrate that the European experiment is not moribund, but overshadowed by acute financial throes experienced by a few countries and the general economic malaise that confronts and confounds major world leaders. These two small European countries have dealt convincingly with their economic and financial difficulties and have something to contribute to the rest of Europe – if only their example.

What can the United States learn from developments in these two small countries? First, that spending and borrowing need to be reined in and, secondly, that the euro, despite alarms of a premature demise, is a viable currency that will continue to secure its place in the international marketplace in direct competition to the US dollar.

Estonia and Iceland deserve a round of applause.

Vincenzina Santoro is an international economist in New York. She represents the American Family Association of New York at the UN.

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