Ülo Ennuste Economics

papers and articles in wordpress

14.IX 09

 Estonian hyper-crisis lessons confirm importance of more effective high quality coordination/regulation and harmonisation: Mechanism design theoretic approach            

Talk to the debate in Tallinn 16 Sept 09 “European Union:  Costs, Benefits and Strategies for Estonia”

           Ülo Ennuste

Preface: Meta-remark

From the viewpoint of Modern Political Economics the most powerful economic policy statement by the European Union was made in Lisbon Agenda 2000: the economy should be knowledge based. That means in modern understandings that socio-economic institutions/mechanisms/coordination/regulation/rules etc of the EU and member countries should be knowledge based. Meaning that these should be based on modern high level mechanisms design theory, decision theory, evolutionary economics, and information theory, information technology etc.

In other words, regulations should not be based on ruling incumbent political camps beliefs, pre-election myths and utopias. And mechanisms should not be adapted and changed with the change of ruling political camps, but these should be adapted, enhanced, complemented and their quality enhanced according to the real socio-economic and technological and ecological developments. Political changes may only take place in the sphere the socio-economic desiderata, especially the income redistribution and inequality structure.   And most importantly, we have by that to keep in mind Rothstein (2009) anti- devolutionary third argument:

The third argument is that it is unlikely that such mechanisms will be efficiently designed/evolved/adapted endogenously by communicating actors. “Moreover, if such institutions have been created, we should expect market agents to try to destroy them. Based on insights from various approaches.”

Coordination theme is the basic socio-economic problem, as Friedman (1962,12) has postulated:

“basic problem of social organization is how to co-ordinate the economic activities of large numbers of people.” 

(By the way in macro-economics the dominant general term is “coordination” – “regulation” means a kind of coordination.)

Coordination theme belongs in the Modern Macro-Economy  generally to the domains of  Evolutionary Economics and Mechanism Design Theories – the first is happily enough more or less a narrative one. But the last one is nowadays rigorously formalized, based on heavyweight mathematics: see e.g. Note (N1) on 2007 Nobel Prize in economics:

Mechanism design theory is a branch of game theory (NB: generally dynamic Bayesian mathematical game theory. ÜE) … and extends (sic! e.g. on the field of social behavior, animal spirit etc. ÜE) the application of game theory to ask about the consequence of applying different types of rules to a given problem.”

and see also e.g. (N2) on an example of theoretic optimization model of building of national socio-economic institutional structure.

As the politicians and lawmakers, the implementers of institutions, as a rule don’t  know  mathematics and hate it and high level tedious scholarship in general, the try, especially in this very crisis period to claim that mathematical macro-economics is to blame as the significant destabilizing factor (lately especially Lord Roland Skidelsky:

They were preoccupied with sophisticated mathematical models – a serious weakness, … .”(Lunch with FT August 28 2009 and (N3)),

and mathematical dismal science is also not able to forecast important socio-economic events and is no good altogether and whatsoever.

But, this is absolutely not true ((N12) Bezemer 2009a), actually slander: first of all, the high level, e.g. Nobel domain, mathematical macroeconomic theories, are in the mainstream credible, these contain all the uncertainties and moral hazards of animal spirit in all varieties (limited rationality, strategic manipulative distortion of communication, incompetence, greed etc), and these theories should be implemented especially in the times of crisis (Bezemer 2009b).

For example the extant definition of Maastricht inflation (complex) criterion is methodologically defective: semi-formalized mathematically and therefore non-transparent (restrictive information level is mathematically defined by +1.5%, but prices stability/sustainability restriction is only vaguely verbally defined and so open for all kinds of interpretations).

And, just last year the Estonian Parliament enacted abortive “pre-payment income tax law”. The law was dynamical (several years interactively involved) and so to be transparent should have been mathematically formalized, it was not, and so in the end on the basis of public protests the law was abolished before enforcement – tens of millions kroons wasted.

But interpretations of excellent mathematical macro-theories by dominating politicians, policymakers, jurists, journalists, spin doctors etc, are generally incorrect caricatures, e.g. (N4). And secondly, there are certainly some distorting biases and divisions in dismal science community globally and locally, on the basis of regrettable biases of independence and divisions towards to different political power-camps:

“Consensus economics does exist. The Obama administration and the Federal Reserve are trying to apply it. The economics professoriate has an obligation to criticize and improve those policies. But if politics is allowed to split the discipline, and communication across that divide continues to break down, the science of economics will forfeit what little respect it still commands.” – C. Crook “Politics is damaging the credibility of economics” FT February 8 09.

1. Introductory remarks: The central dilemma

Wilde  discussions have already started about instant necessity of time consistent adaptations of European economic mechanisms and member counties ones versus mechanisms and multilateral harmonisation on the fresh knowledge base of the crisis lessons: as for greater coordination/regulation and harmonisation, and as for relaxation and liberalization.


Remarkable among first ones in the Estonian context has been the paper in FT June 17 2009 by PM of Finland Matti Vanhanen „Europe will need to raise taxes in harmony” (N5):

 “EU policy with respect to tax competition is currently based on member states refraining from implementing new tax competition measures and on dismantling old measures perceived to be harmful. These codes of conduct are not legally binding. I do not think this could or should be changed. But member countries could agree, for example, to change the levels of certain taxes in parallel.

Parallel measures would help all of Europe: tax competition risk would be reduced and the public finances of individual countries would improve. Such co-ordinated tax changes could set also an important global example.”

From the mechanism’s theories point this is an extremely important paper for Estonia, but alas, has already here got publicly only sarcastic side-remarks.

And in the same vein the Letter to the FT from the President of the Party of European Socialists Poul Nyrup Rasmussen “Sustainable growth requires greater regulation”:

Our future must be based on real jobs in a green economy. We need transparent, highly competitive and low-cost financial markets to serve that purpose. No amount of short-sighted industry lobbying will stop policymakers from pursuing this goal.”(etc (N3)). 

In the vein of deregulations the most outstanding publication in the Estonian context seems as far to be “OECD urges rich countries to strive for flexibility” By Chris Giles, Economics Editor, The Economist March 3 2009. There we may read:

 “The countries should redouble efforts to increase flexibility in labour markets and boost competition even though they are suffering the worst recession since the second world war,… .

Arguing that liberalisation was the surest route to a speedy recovery, the Paris-based international organisation locked horns with a vocal group of European economists, who have been extolling the virtues of labour market rigidities as a way of preventing deflation and depression.

Thus, our main dilemma will be: to regulate more, or to deregulate, and where so. To figure out some Estonian solutions, first of all let us look for the Estonian crisis idiosyncrasies. 

2. Main Estonian hyper-crisis idiosyncrasies

 Estonia started to solve the crisis in the own way

First of all we have to notice that all the Eastern-European countries have their differences and had already applied different varieties of crisis management strategies:

That highlights an important problem. Outsiders tend to lump “the ex-communist world” or “eastern Europe” together, as though a shared history of totalitarian captivity was the main determinant of economic fortune, two decades after the evil empire collapsed. Though many problems are shared, the differences between the ex-communist countries are often greater than those that distinguish them from the countries of “old Europe” (The Economist   “The whiff of contagion”. Feb 26th 2009 http://www.economist.com/world/europe/displaystory.cfm?story_id=13184594):





Source: The Economist (Note: Estonian GDP per person 2009 in current prices is                   about kilo-USD 15-16, ÜE)  

Estonia, pegged to euro, mainly “squeezes spending to stay afloat” (N8).


Estonian crisis started relatively earlier 

In the second half of 2007 the export actually began to decline in real terms (according to the Eurostat). In particular, the decrease of competitiveness began because of relatively much higher inflation than in partner countries (without, increase the quality the products of services).

The export crises worsened due to the start of global financial crisis in 2008, and the unemployment started rapidly to increase.  As the Government started to alleviate crisis by severe cuts of the budget, the local demand also started to decline and GDP started to fall rapidly and so in repeating cycles.

The Economist Table “Output, prices and jobs” Sep 3rd 2009 (see the Table below or:  http://www.economist.com/markets/indicators/displaystory.cfm?story_id=14365843),           implicitly classifies Estonia at the moment in the group of most high magnitude crisis countries, as in the EU and more broadly as well. Although the indexes may be approximate, we may still with great certainty claim that the combined magnitude of Estonian complex crisis is at the moment 2-3 times higher than in the EU member countries in general. Easy to see even at first glance, as Finland indexes are given in the Table nearby. Notice that most important crisis indicators as prices instability of the two countries are about 12 and 5 percentages points and unemployment accordingly 17 and 9 percentage points(for Estonian QII 09 statistics in more details see (N9)).

Note: It is important to add to The Economist table that according to the Bank of Estonia Statistics, Estonian national Gross eternal debt has been in the last years and is presently excessively high – about 120-140% of GDP, and Current account deficiency has been chronically relatively high, International investment position retreating etc;    according to Eurostat economic Inequality index by quintiles barbarically high etc.




Truth value of Estonian public socio-economic knowledge structure is at the moment relatively low: full of low quality, non-transparent, and distorted statements and of boasting and distorting bluff bubbles


Random extract from one of the recent State Budget Laws




























































Materiaalsete ja immateriaalsete varade soetamine ja renoveerimine (ü)









74000101. Riigikogu Kantselei






















Sihtotstarbelised eraldised











Sihtotstarbelised eraldised jooksvateks kuludeks











Valitsussektorisisesed eraldised











– Eesti Keele Instituut






















– tegevuskulud









70008256. Vabariigi Valimiskomisjon






















Sihtotstarbelised eraldised











Sihtotstarbelised eraldised jooksvateks kuludeks











Valitsussektorisisesed eraldised











– valimiskomisjonid









Notice that e.g. the first number in the table is prognostic, thus in this number at least 80% of numerals are totally incredible, and according decision theories senseless to fix these, as these are contaminating transparency, that at least is especially disturbing conceptually the parliamentary discussions.

Random Estonian research paper on euro-area accession from TUTWPE 2005 (133): M. Sõrg 2005. Estonia’s Accession to the EMU


EE countries have passed the process of transition to market economy and eight of them, including Estonia, joined the European Union in 2004. Estonia has been very successful in the transition process, mainly owing to the currency board-based monetary system, which serves as a signal of commitment to prudent monetary policy and as a guarantee of sound money during the transition period. The current paper discusses the thirteen years of experience in operating the currency board-based monetary system in Estonia. Estonia’s accession to the European Union will soon be accompanied by membership of the Economic and Monetary Union (EMU). Here it is also explained why Estonia wants to join the EMU as fast as possible and what the prospects are to do it on time, at the beginning of 2007.

Notice that in this very late 2005 paper the Abstract contains no word that Estonia started to spoil Maastricht inflation criterion already in 2004 and continued so in 2005, and high inflation risk is not discussed in the text and the plan to join euro at the beginning of 2007 was roughly abortive because of this criterion, although immense resources were spent for preparations. Notice also that Prof Sõrg was in the time of writing the paper the Head of the Board of the Bank of Estonia.

Random GDP administrative forecasting example: Extract of Bank of Estonia 26 Aug 09 forecast:

Table 1. Economic forecast by key indicators 

                                           2008   2009   2010  


Real GDP growth (%)          -3,6    -12,3      0,2   

HCPI (%)                              10,6        -0,5     -2,9


Easy to see that published for public forecast is low probability “V “forecast, as among specialists “W” shape is much more credible, thus just for political manipulations.

Note: It is important to add that according to the Bank of Estonia Statistics, Estonian national Gross eternal debt has been in the last years and is presently excessively high – about 120-140% of GDP, and Current account deficiency has been chronically relatively high, International investment position retreating etc;    according to Eurostat economic Inequality index by quintiles barbarically high etc. Alas these indicators are in the Estonian public knowledge space and administrative rhetoric, especially in the present crises, in overshadowed position, thus helping to play down real severity of the situation, and not enabling to make high quality forecasts (N12).   


Much boast about “Baltic Shining Star” and slander on the addresses of other member states

E.g.: “Openeurope” 2006 (p7) “Beyond the European Social Model” :

“Meelis Kitsing notes that success in the information economy has made the Nordic

       model “as hot as stones in a sauna” among EU policymakers. But studies which try

to show a link between Nordic welfare systems and the information economy

suggest that this is less of a “model” and more of a coincidence. He argues that

success stories like Nokia can be explained by getting a few big things like telecoms

regulation right, and also by the “gales of creative destruction” unleashed on

Scandinavia in the early 1990s by the collapse of the Soviet Union. He argues that if

poorer member states want to break into the new economy they should learn from

low-tax Estonia instead. He notes the story of the revolutionary telecoms company

Skype: technology developed entirely in Estonia – by entrepreneurs who had left

Denmark and Sweden.”

By the way, low are only Estonian profit taxes, and just this “low-tax” thing forced the Estonian Government to implement high inflationary and money illusionary policies, and may be blamed for relatively excessive crisis phenomenon at the moment, and more importantly – the probabilities of successes certainly depend on development of information technology.

And there is no credible proof whatsoever known till now that low-tax system helped Estonia “to break into the new economy” in other ways. 

In the Estonian mass-media the strange caricatures of socio-economic realities are customarily circulating:

E.g.:  (the EU)=(the SU)

 – perhaps one explanation for that kind of slander can be found in:

“Stalin still looms large over eastern Europe” By Stefan Wagstyl FT August 30 2009:

Lies are allowed to multiply with, for example, an official historian recently denying the 1940 occupation of the Baltic states took place and saying they joined the Soviet Union voluntarily.”

The problem is that Estonian Press has considerable commercial interest connected with the large Russian speaking Diaspora, many with very strange irredentist beliefs of anxieties about market economy and the EU expansion to Estonia (Ott and Ennuste 1996).

No research centers for macroeconomic studies in Estonia, R&D expenses pc are magnitude lower than in Nordic countries             

Unfortunately, the current system of financing universities is such that universities are not at all interested in (independent) macro-economic research activities. There is extreme shortage of second-degree macro-economists in Estonia.

The official macro-economic statistical communication is very slow and selective


On the basis of these idiosyncrasies in mind, I am trying schematically to tackle enhancements and complementation strategy problems in the three the most urgent regulation and harmonization are: Maastricht criteria, tax system, and communication mechanisms; mainly on the basis of the concepts of mechanism design theory in narrative form.

(Main concepts:

*combined vertical (included hierarchical e.g.: Brussels>Baltic Rim>Estonia) and horizontal ( e.g.: Estonia-Finland-Sweden-Russia) coordination;

*Complex and parallel coordination networks (e.g. governmental and nongovernmental, optimally detailed, updated);


*Complex coordinating instruments (e.g. material and moral);


*Complex coordinating principles (e.g. incentives and constraints, bargaining, consultations, updated);


*Complex incentive and restriction mechanisms and consultations;




3. Most urgent Estonian regulation and harmonization strategies and conceptions

A. The Maastricht inflation criterion amendments

Criterion * consists of economic quantitative component: anchoring of the three best national averages of annual inflation + 1.5 percentage points. Secondly, it includes a qualitative not numerically calibrated component: requirement for the sustainability of prices where the “sustainability” is not rigorously defined and so gives ways for diverse political interpretations and manipulations. This methodological error has to be by Commission immediately corrected.

In addition to that the Commission has rigorously to formalize the definition of the price stability for the case of deflation (crisis period).

But one thing is certain: theoretically in 2009-2010 price instability is high in Estonia and according to extant criterion it is not transparent is it unfulfilled or fulfilled, or what will be the respective probability.

 ************************************************** *********

* The inflation criterion is formally set out in Article 1 of the Protocol is

Convergence Criteria of the Maastricht Treaty (European Union, 1992b: 29 —


[A] Member State has a price performance that is sustainable and an

average rate of inflation, observed over a period of one year before the

examination, that does not exceed by more than 1 1 / 2 percentage points

that of, at most, the three best performing Member States in terms of

price stability.


B. New member countries tax-systems harmonization should be more rigorous

Matti Vanhanen is absolutely right (FT June 17 “Europe will need to raise taxes in harmony”) claiming:  

We should avoid tax competition and the damage this would cause to Europe’s economic growth.” Understandably this kind of damage comes first of all from incompetent competition instead of rationally coordinated cooperation between the partner countries, as e.g. Prof Krugman has proved.” 

It is easy to see that in given case the incompetence that he had in mind comes from Baltic-States, first of all from Estonia (0-profittax). And it seems evident that these countries are not jet mature to design civilized tax systems, at least in the Baltic-Rim advanced Nordic-Counties sense (rational cooperation between countries in the region and avoiding political instability in the country via excessive income inequality etc). Thus it is first of all in the interest New-Member sustainability to introduce, without any delay, a more rigorous taxing harmonization, to save some countries from deepening their socio-economic degeneration.   


C. Conceptual suggestions for designing optimal public socio-economic communication mechanism                          

“This note is discussing implementing mechanism design Conceptions compiled for Optimizing public socio-economic information structures. Proposed for discussion meta-synthesis concept emphasizes compiling methods with the imitation variety of implementations of theoretical models and empirical evolutionary principals of real world mechanisms.  

The main idea of the proposed design is to sequentially and adaptively coordinate reasonable learning and private information disclosure of the actors with the help of stimulating their reporting credibility (non-Distorting with sufficient disclosure and transparency) and respectfulness for incoming reports (reasonable learning from credible actors). Incentives and constraint may be heterogeneous: relevant material and moral side-payments etc and consultations and informational constraints.  

The main Suggestion is to complement extant respective public reporting coordination mechanisms with more complex instruments, especially moral ones with voluntary and non-governmental monitoring Webs”. (Ennuste 2009). 


4. Summary: under-coordination, low quality harmonization and public socio-economic knowledge structure stunt Estonian socio-economic sustainability probabilities from the viewpoint of mechanism design theory    

First, Estonia shouldn’t at all in the present hyper-crisis rush to exit from significant fiscal stimulus policies categorically (see also Note (N13)). It is not yet late to ensure a proper sequencing of fiscal expansionary relief  instruments, with the goal of preventing further increase of   high-unemployment (already about 17%) and soften the likely double-dip recession.

Second, but Estonia should rush to “harmonize” and seek better time-consistency (crisis-contingency) with the EU Commission at least to the extant Maastricht inflation criterion: in present form it is also non-transparent and technically defective, and with that may cause for Estonia irretrievable socio-economic and credibility losses; and perhaps in the hyper-crisis situation, it may be rational for Brussels to move beyond a rigorous adherence to the hole stability and growth pact altogether and be more state-contingent and charitable to micro-member states with a past in half of century in the occupational centralised planning limbo with huge economic and human capital losses (see N17).

Third, instant reform of the Estonian tax system is probably necessary: in the sense of harmonization of moral competition with member countries, for enhancement of Estonian socio-economic sustainability, lowering the risks of domestic capital flight without domestic taxing and avoiding worsening of the Estonian international investment position. And most importantly, presently there is a lack of balance between tax laws and national pension law, the income tax law is biased towards incompetently low capital income taxation etc (see also (N14)). 

Fourth, the crisis has shown that macroeconomic policy in the Baltic- Rim area needs to be better coordinated regionally, especially when it comes to post-crisis management, e.g. “free” movement of “all kind” of labour, credit, investments, financial obligations, and most importantly to the Baltic-See protection against third-parties contaminating activities etc.

Fifth, the coordination mechanism of the Estonian public knowledge space building should be basically adapted to the IT and liberal non-censorship conditions. Unfortunately at present such significant indicators as Estonian high national gross eternal debt, current account chronically relatively high deficiency, international investment position retreating, Estonian economic inequality index by quintiles barbarically high compared to nearby Nordic countries etc – are, alas, from the Estonian public knowledge space by self-important administrative and incumbent political camp rhetoric, in overshadowed position in mass media and administrative statistics, thus helping to play down cognition of real severity of the present national economy situation, and not enabling to make high quality forecasts – so probably significantly magnifying national socio-economic sustainability risks. 

Unfortunately, most of suggested points stand no chance of easy implementation. Adopting these policies would require high competence and quality of political leadership, Estonian leaders according by existing policies lack, and Brussels seemingly prefers by existing policies not to enough notice these local objective shortcomings in the economic mechanisms harmonization and consultation processes.



Notes and Extracts


(1)  Nobel Museum 2007: Press Release

The Royal Swedish Academy of Sciences has decided to award The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2007 jointly to

Leonid Hurwicz
University of Minnesota, MN, USA,

Eric S. Maskin
Institute for Advanced Study, Princeton, NJ, USA


Roger B. Myerson
University of Chicago, IL, USA

“for having laid the foundations of mechanism design theory.”

The design of economic institutions

Adam Smith’s classical Metaphor of the invisible hand refers to how the market, under ideal conditions, ensures an efficient allocation of scarce resources. But in practice conditions are usually not ideal, for example, competition is not completely free, consumers are not perfectly informed and privately desirable production and consumption may generate social costs and benefits. Furthermore, many transactions do not take place in open markets but within firms, in bargaining between individuals or interest groups and under a host of other institutional arrangements. How well do different such institutions, or allocation mechanisms, perform? What is the optimal mechanism to reach a certain goal, such as social welfare or private profit? Is government regulation called for, and if so, how is it best designed?

These questions are difficult, particularly since information about individual preferences and available production technologies is usually dispersed among many actors who may use their private information to further their own interests. Mechanism design theory, initiated by Leonid Hurwicz and further developed by Eric Maskin and Roger Myerson, Has greatly enhanced our understanding of the properties of optimal allocation mechanisms in such situations, accounting for individuals’ incentives and private information. The theory allows us to distinguish situations in which markets work well from those in which they do not. It has helped Economists identify efficient trading mechanisms, regulation schemes and voting procedures. Today, mechanism design theory plays a central role in many areas of economics and parts of political science.”


 (N2) Ennuste 2003: A Linear Planning Analysis of Institutional

Structure in the Economy



The paper uses the paradigms of the New Institutional Economics to

quantify a linear optimal choice model to design perspective

institutional clusters for a national economy. This model uses binary

integer institutional choice variables and structural parameter values

based on subjective probabilities collected from experts by calibration


The optimisation goal may be e.g. a high expected probability of

stable national economic performance under socio-economic

development-credibility constraints, dependent on the realization of

prospective significant events. The model may be useful as a

complementary tool for the social design of the effective institutional

structure, and especially for evaluation of the socially optimal values

of co-ordinating shadow prices and implementing side-payments in

the political institutional design game.

We use the Estonian case as an example. The model variables

and data calibration table illustrations are provided mainly to

demonstrate the broad spectre of issues that may be involved in this


Journal of Economic Literature Classification numbers: B4, D71, E5,

K0, P3, F15.

Keywords: The New Institutional Economics, market design,

comparative institutional analysis, economic sector institutional

design, institutional structures, credibility effects, linear programming,

implementing side-payments, co-ordinating shadow prices,

computational economics, data calibration.


(N3) Skidelsky 2009: “For 30 years or so Keynesianism ruled the roost of economics – and economic policy. Harvard was queen, Chicago was nowhere. But Chicago was merely licking its wounds. In the 1960s it counter-attacked. The new assault was led by Milton Friedman and followed up by a galaxy of clever young disciples. What they did was to reinstate classical theory. Their “proofs” that markets are instantaneously, or nearly instantaneously, self-adjusting to full employment were all the more impressive because now expressed in mathematics. Adaptive Expectations, Rational Expectations, Real Business Cycle Theory, Efficient Financial Market Theory – they all poured off the Chicago assembly line, their inventors awarded Nobel Prizes.

No policymaker understood the maths, but they got the message: markets were good, governments bad. The Keynesians were in retreat. Following Ronald Reagan and Margaret Thatcher, Keynesian full employment policies were abandoned and markets deregulated. Then along came the almost Great Depression of today and the battle is once more joined.”

(N4) Wickens 2009: “The problem is not with the theory but with its interpretation. Nobody believes that people are rational or that they are identical. These are just simplifying assumptions to make the analysis of complicated economies more tractable.

From time to time economies are hit by large shocks. What we have learnt from the current crisis is that it is crucial to have financial systems that correctly price the risks that these shocks generate, to have appropriate regulatory structures to avoid bank failures and to use the theory to stabilise the macro-economy in the short term.”

(N5) Vanhanen 2009: Europe will need to raise taxes in harmony:

“The global recession is forcing Europe to re-evaluate the co-ordination of economic policy. Surviving the present crisis, ensuring the sustainability of European countries’ public finances and maintaining the continent’s competitiveness will compel us to co-operate more deeply than ever before.

We have to initiate discussions at the European Union level about how to prepare for the post-crisis period. Getting public finances in order is a must if we are to grow, create employment and provide the welfare services that we in Europe value so much.


After the recession, we will have to reduce elevated public debt-to-GDP ratios if we are to cope with the expenditure pressures that will come with the ageing of the EU’s population. This will require tight control and, in many countries, painful cuts. However, it would be unrealistic to assume that all the balancing could be done on the spending side alone.

The overall tax rate will have to rise as well over the longer term. In some areas that can be done without much consultation between the countries. ………………………………………………………………………………..

I am not advocating overall tax harmonisation. But I believe that we should follow in taxation the examples of what we did in banking policy and fiscal stimulus last autumn. In both areas, EU member states decided to co-ordinate their policies in important ways. Decisions to provide banks with guarantees and capital injections, and to create national stimulus packages of a certain minimum scale, have proved important in stabilising Europe’s financial system and arresting a free-fall in economic activity.

These measures were not based on the authority of the Union but on the fact that member states considered parallel measures and recommendations to be sensible policy. The same co-ordination will be needed to balance public finances after the recession. It is important that different countries do not find themselves with very different tax solutions. We should avoid tax competition and the damage this would cause to Europe’s economic growth.


EU policy with respect to tax competition is currently based on member states refraining from implementing new tax competition measures and on dismantling old measures perceived to be harmful. These codes of conduct are not legally binding. I do not think this could or should be changed. But member countries could agree, for example, to change the levels of certain taxes in parallel. …”

(N6) Rasmussen 2009: “Sir, Jonathan Russell, chairman of the European Private Equity and Venture Capital Association, misunderstands the European Union treaties when he attacks proposed EU regulation of private equity funds for allegedly undermining their free movement of capital principle (“Private equity attacks EU plan”, June 27).

The EU’s free movement principles are meant to apply to the European single market, not the world. The forthcoming European directive will indeed introduce a uniform regime to enable the marketing of alternative funds to professionals across the entire European single market.


Business as usual is not an option. We cannot afford financial crises of this kind in future, causing the worst recession since the 1930s. I believe moves towards regulation in the EU and US will lead to a welcome regulatory convergence at global level, which will benefit us all. Private equity executives – who by their own admission pay less tax than their cleaners – have generated moral outrage at their use of offshore tax havens to avoid paying their fair share. If the UK’s Financial Services Authority has not been able to review the exposure of funds until now, it is because they are located offshore. …”

(N7) Giles 2000: OECD urges rich countries to strive for flexibility 

Rich countries should redouble efforts to increase flexibility in labour markets and boost competition even though they are suffering the worst recession since the second world war, the Organisation for Economic Co-operation and Development said on Tuesday.

Arguing that liberalisation was the surest route to a speedy recovery, the Paris-based international organisation locked horns with a vocal group of European economists, who have been extolling the virtues of labour market rigidities as a way of preventing deflation and depression.

Klaus Schmidt-Hebbel, OECD chief economist argued: “More flexible product and labour markets are likely to strengthen country resilience to weather future downturns with less disruption to output and employment.”

But the OECD did not limit itself to its perennial calls for greater economic flexibility in its latest “going for growth” report.

It also identified higher spending on infrastructure, increased spending on training and reduction of personal income taxes for low earners as policies that gave a “double-dividend” of limiting the depth of the recession and boosting longer-term growth prospects.

The list will please the new US administration of Barack Obama since it reflects much of the thinking behind Washington’s stimulus plan.

The OECD also says that recessions have previously proved a good time to introduce reforms because the complacency and inertia of good times is swept away, “even if it is easier to cope with adjustment costs of reform when the economy is strong”.

The main message of the report is that the drive for economic flexibility must continue. Flexible markets for goods and services “will induce producers to cut profit margins”, lower prices will help to support demand”, the OECD argues, and flexible labour markets allow workers to agree to lower wages, which will protect jobs.

The US, the report concludes, has tended to rebound form recessions faster because it has been more flexible even if its original downturn was deeper.

Mr Schmidt-Hebbel insists that “the debacle in financial markets does not call into question the beneficial effects of recommended reforms of product and labour markets in this report”. It urges countries to avoid policies that allow people to lose contact with the world of work.

In the early 1970s, many European countries responded to the recession with early retirement programmes, something the OECD said, “proved to be a failure”.

“Attempts to cut unemployment by reducing labour supply would prove as damaging as in the past and leave our societies poorer; keeping markets open and avoiding new protectionism is key to strengthen prosperity throughout the world,” Mr Schmidt-Hebbel insisted.

The difference between the OECD’s view and those who have praised rigidities – such as professor Paul De Grauwe of the University of Leuven – is that the latter worry that debt remains fixed in a downturn and so flexibility in other prices and wages potentially increases its burden.

The OECD argues that rigidities take their toll on company profits and will end up raising unemployment even higher, in any case exacerbating the problem of debt.

Its solution is to urge compulsory training for those out of work, big spending on infrastructure if it can be introduced quickly and improves the efficiency of the economy, and tax cuts to boost the spending power of low earners when borrowing is constrained.

Separately, the OECD says the gap between underlying US and European economic performance, which opened up in 1995, might have closed, ending an unusual decade where the US appeared streets ahead of Europe in boosting productivity and household incomes.


(N8)The whiff of contagion” 2009:

“… At one extreme is Russia, which enjoyed huge external surpluses thanks to its wealth of raw materials. But its big companies borrowed lavishly on the strength of that, creating a potential short-term debt problem. Russian corporate borrowers have to pay back around $100 billion this year. At the other extreme lie countries such as Slovakia. They attracted billions from foreign car manufacturers, drawn by a skilled workforce, low taxes and decent roads in the heart of high-cost Europe.

 (N9) A.    Bank of Estonia:







2. Quarterly economic indicators for Estonia








 % change comparing to


 Period /as of



 same period of
previous year


    1.      GDP 1






    1.1.      current prices (EEK mln)






    1.2.      constant prices (EEK mln)






    2.      Industry






    2.1.      Volume index of industrial production (at constant prices (2005=100); %)






    3.      Investments in fixed assets (at current prices; EEK mln)






    4.      Construction






    4.1.      Construction activities of construction enterprises (at current prices; EEK mln)






    4.2.      Usable floor area of completed dwellings (thousand m2)






    4.3.      Usable floor area of non-residential buildings (thousand m2)






    5.      Consumption






    5.1.      Retail sales volume index (at constant prices, 2005=100; %)






    5.2.      New registration of passenger cars (pieces)






    6.      Prices






    6.1.      Consumer price index (%)






    6.2.      Producer price index (%)






    6.3.      Export price index (%)






    6.4.      Import price index (%)






    6.5.      Construction price index (%)






    6.6.      Estonian kroon real effective exchange rate index (REER; %)






    7.      Labour market and wages






    7.1.      Employment rate (employed persons/working-age population, %; based on the Labour Force Survey) 2






    7.2.      Unemployment rate (unemployed/labour force, %; based on the Labour Force Survey) 2






    7.3.      Registered unemployed






    7.4.      % of workforce 2






    7.5.      Average monthly gross wages and salaries (EEK)






    8.      General government budget 3






    8.1.      revenue (EEK mln)






    8.2.      expenditure (EEK mln)






    8.3.      balance (+/-; EEK mln) 2






    8.4.      Period’s revenue to the planned annual revenue (%) 2






    9.      Transport






    9.1.      Carriage of passengers (thousands)






    9.2.      Carriage of goods (thousand tons)






    10.      Tourism, accommodation






    10.1.      Visitors from foreign countries received by Estonian travel agencies (thousands)






    10.2.      Visitors sent to foreign tours by Estonian travel agencies (thousands)






    10.3.      Accommodated visitors (thousands)






    10.4.         o/w foreign visitors (thousands)






    11.      Foreign trade (special trade system)






    11.1.      exports (EEK mln)






    11.2.      imports (EEK mln)






    11.3.         balance (EEK mln) 2






    11.4.      Foreign trade balance/exports (%) 2






    12.      Balance of payments 2






    12.1.      Current account balance (EEK mln)






    12.2.      Current account balance to GDP (%)






    12.3.      Foreign direct investment inflow (EEK mln)






    12.4.      Foreign direct investment outflow (EEK mln)






    13.      International investment position (at end-period)






    13.1.      Net international investment position (EEK mln)






    13.2.      Direct investment in Estonia (EEK mln)






    13.3.      Net external debt (EEK mln)






    13.4.      o/w government (EEK mln)






    14.      EEK/USD average quarterly exchange rate







1 Preliminary estimation of the GDP growth has been calculated according to the new methodology. Whereas, Statistics Estonia previously calculated the GDP growth at the constant prices of fixed year 2000, since 2008 the growth is calculated by chain-linking method in which the year preceding the accounting period is applied as a base year.
2 Instead of changes comparing to previous periods, absolute figures for the periods are shown by this indicator.
3 Net borrowing is not included here.

SA – Statistical Office of Estonia
ARK – Motor Vehicle Registration Centre
EP – Eesti Pank /Bank of Estonia
TK – Estonian Unemployment Insurance Fund
RM – Ministry of Finance
EKI – Estonian Institute of Economic Research

Financial assets and liabilities*

   EEK mln
     S.1  S.11  S.12  S.13  S.14  S.15  S.2
     Total  Nonfinancial
 NPISHs  Rest of
the world
 AF.A  Financial assets  1,134,488.5  411,641.7  506,565.1  86,018.6  127,700.7  2,562.4  449,828.3
 AF.1  Monetary gold and SDRs  90.4    90.4        
 AF.2  Currency and deposits  200,735.7  54,566.0  71,080.2  10,230.5  62,409.3  2,449.7  144,950.8
 AF.3  Securities other than shares  75,468.3  5,007.2  54,854.4  14,991.7  610.1  4.9  24,802.4
 AF.4  Loans  424,462.7  100,187.8  321,389.1  2,756.1  129.7  −  92,047.3
 AF.5  Shares and other equity  248,470.8  111,404.6  51,019.5  45,584.5  40,403.2  59.0  159,231.8
 AF.6  Insurance technical reserves  19,795.4  1,987.6  −  −  17,807.8  −  170.3
 AF.7  Other accounts receivable/payable  165,465.2  138,488.5  8,131.5  12,455.8  6,340.6  48.8  28,625.7
 AF.L  Financial liabilities  1,326,709.2  659,096.2  506,849.5  26,925.1  128,915.9  4,922.5  257,517.2
 AF.2  Currency and deposits  306,422.5    306,422.5        39,264.0
 AF.3  Securities other than shares  33,179.5  13,287.7  15,715.7  3,935.4  238.7  2.0  67,091.2
 AF.4  Loans  464,356.1  255,816.1  68,992.0  9,651.6  125,445.7  4,450.7  52,153.9
 AF.5  Shares and other equity  343,577.8  256,133.8  87,079.1  −  −  364.9  64,124.8
 AF.6  Insurance technical reserves  19,965.7    19,965.7        −
 AF.7  Other accounts receivable/payable  159,207.6  133,858.6  8,674.5  13,338.1  3,231.5  104.9  34,883.3
 BF.90  Net financial assets  -192,220.7  -247,454.5  -284.4  59,093.5  -1,215.2  -2,360.1  192,311.1

* After additional information is received, data of the earlier periods have been updated accordingly.

 The Economist poll of forecasters, September averages

Sep 10th 2009
From The Economist print edition







(N10) Pope Benedict XVI’s “Caritas in Veritate”: It is Man’s Selfish Use of Markets, Globalization That Is The Problem

The Pope on “Love in Truth” by Father Robert Sirico from the Wall Street Journal is a penetrating analysis of Pope Benedict XVI’s latest encyclical on the economic crisis, “Caritas in Veritate”.

Sirico points out that Pope Benedict doesn’t condemn markets, globalization – but rather man’s selfish uses of these instruments.

Caritas in Veritate by Pope Benedict XVI

Democrats Link Pope’s ‘Economic Justice’ Plea With Obama Agenda

Caritas in Veritate is an eloquent restatement of old truths casually dismissed in modern times. The pope is pointing to a path neglected in all the talk of economic stimulus, namely a global embrace of truth-filled charity.

Benedict rightly attributes the crisis itself to “badly managed and largely speculative financial dealing.” But he resists the current fashion of blaming all existing world problems on the market economy. “The Church,” he writes, “has always held that economic action is not to be regarded as something opposed to society.” Further: “Society does not have to protect itself from the market, as if the development of the latter were ipso facto to entail the death of authentically human relations.”

The market is rather shaped by culture. “Economy and finance . . . can be used badly when those at the helm are motivated by purely selfish ends.

(N11) Samuel Bowles and Sung-Ha Hwang 2008:


„Social preferences such as altruism, reciprocity, intrinsic motivation and a desire to uphold ethical norms are essential to good government, often facilitating socially desirable allocations that would be unattainable by incentives that appeal solely to self-interest. But experimental and other evidence indicates that conventional economic incentives and social preferences may be either complements or substitutes, explicit incentives crowding in or crowding out social preferences. We investigate the design of optimal incentives to contribute to a public good under these effects would make either more or less use of explicit incentives, by comparison to a naive planner who assumes they are absent.“


(N12) Bezemer 2009: Understanding Financial Crisis Through

Accounting Models 



Table 1: Anticipations of the Housing Crisis and Recession

Analyst Capacity Forecast


Dean Baker, US co-director, Center for

Economic and Policy


“ …plunging housing investment will likely push the economy into

recession.” (2006)


Wynne Godley, US Distinguished Scholar,

Levy Economics

Institute of Bard


“The small slowdown in the rate at which US household debt levels are

rising resulting form the house price decline, will immediately lead to

a …sustained growth recession … before 2010”. (2006). “Unemployment

[will] start to rise significantly and does not come down again.” (2007)


Fred Harrison, UK Economic


“The next property market tipping point is due at end of 2007 or early

2008 …The only way prices can be brought back to affordable levels is a

slump or recession” (2005).


Michael Hudson, US professor, University

of Missouri

“Debt deflation will shrink the “real” economy, drive down real wages, and

push our debt-ridden economy into Japan-style stagnation or worse.”



Eric Janszen, US investor and iTulip


“The US will enter a recession within years” (2006). “US stock markets are

likely to begin in 2008 to experience a “Debt Deflation Bear Market”



Stephen Keen, Australia associate professor,

University of Western


“Long before we manage to reverse the current rise in debt, the economy

will be in a recession. On current data, we may already be in one.” (2006)


Jakob Brøchner Madsen


Jens Kjaer Sorensen,




graduate student,



“We are seeing large bubbles and if they bust, there is no backup. The

outlook is very bad” (2005)” The bursting of this housing bubble will have

a severe impact on the world economy and may even result in a recession”



Kurt Richebächer, US private consultant and

investment newsletter


“The new housing bubble – together with the bond and stock bubbles – will

invariably implode in the foreseeable future, plunging the U.S. economy

into a protracted, deep recession” (2001). “A recession and bear market in

asset prices are inevitable for the U.S. economy… All remaining questions

pertain solely to speed, depth and duration of the economy’s downturn.”



Nouriel Roubini, US professor, New York


“Real home prices are likely to fall at least 30% over the next 3

years“(2005). “By itself this house price slump is enough to trigger a US

recession.” (2006)

Peter Schiff , US stock broker,

investment adviser

and commentator

“[t]he United States economy is like the Titanic …I see a real financial

crisis coming for the United States.” (2006). “There will be an economic

collapse” (2007).


Robert Shiller , US professor, Yale


“There is significant risk of a very bad period, with rising default and

foreclosures, serious trouble in financial markets, and a possible recession

sooner than most of us expected.” (2006)


Note: for sources and more detail, please refer to the Appendix.


(N13) Balanced budget vs. Tax smoothing in a small open economy: A welfare comparison


Constantine Angyridis


A b s t r a c t


The objective of this paper is to investigate the effect of lending and borrowing constraints on the dynamics of public debt and optimal taxation policy in the context of a general equilibrium model with tax smoothing. The results from the numerical simulation of the model show significant welfare gains, provided that the policymaker is allowed to borrow and lend in order to smooth taxes across time instead of maintaining a balanced budget at all times. Moreover, for a specific process for asset prices, it is also shown that if the government can issue state-contingent debt then overall welfare can be further improved substantially.

(2008 Elsevier Inc. All rights reserve). 


(N14) Flat tax reform: The Baltics 2000–2007


Helmuts Azacis and Max Gillman


A b s t r a c t


The paper presents an endogenous growth economy with a representation of the tax rate system in the Baltic countries. Assuming that government spending is a given fraction of output, the paper shows how a flat tax system balanced between labor and corporate tax rates can be second best optimal. It then computes how actual Baltic tax reforms from 2000 to 2007 affect the growth rate and welfare, including transition dynamics. Comparing the actual reform effects to hypothetical tax experiments, it results that equal flat tax rates on personal and corporate income would have increased welfare in all three Baltic countries by more than the actual reforms. Experiments show that movement towards a more equal balance between labor and capital tax rates, through changing just one tax rate, achieve almost as high or higher utility gains as in actual law for all three countries.

( 2009 Elsevier Inc. All rights reserved)

(N17) Sapir, A. (Ed). 2009 Sept. Europe’s economic

priorities 2010-2015. Memos to the new Commission. Bruegle.


e) A blueprint for recovery in the new member

states and euro-area enlargement

Several of the new member states have been hit

very hard by the crisis and you should be prepared

for the unexpected. It is to be hoped – but it is by no

means certain – that the intensity of the crisis will

have abated somewhat and instead of managing

further crises you will be able to concentrate on

supporting the recovery. But even on this

optimistic assumption your task will not be an easy

one. There is a clear risk that the successful growth

model that allowed rapid catching-up in the region

will not survive the crisis and that some of the new

member states will experience relative stagnation.

You should therefore assess the obstacles to

growth and propose a blueprint for recovery in the

new member states.

An issue of major importance in this respect is euro

membership. The euro area members, the ECB and

the Commission have argued so far that euro entry

should be decided country-by-country on the basis

of the criteria set out in the early 1990s for the

formation of monetary union in 1999. But this

makes less and less sense. First, the country-bycountry

approach ignores regional spillovers. As

Slovakia has experienced, a country’s fate in the

euro area depends to a great extent on the

bruegel memos to the new commission 2009 25

monetary strategy of its competitors. Second, the

criteria made little sense in normal times but they

have now become wholly inappropriate. When two

criteria designed to be mutually consistent –

inflation and deficits – convey opposing messages,

it is likely to be because there is a problem with the


So your economic brief is clear: you should break

with the formalistic approach and make an

economic assessment of the costs and benefits of

euro membership on the basis of both the

immediate benefits of joining and the longer-term

sustainability issues, and taking into account the

regional dimension. You should assess at what

exchange-rate level potential members should join

and what should be the preconditions, including in

some cases as regards the restructuring of private

hard-currency debts. This assessment should be

discussed with candidates and euro-area members

and serve as a basis for a renewed euro-area

enlargement strategy. To countries wishing to join

the euro, a path to membership should be offered,

with clear, economically meaningful benchmarks

instead of a-temporal, nowadays largely irrelevant

criteria. Countries preferring to postpone euro entry

should be free to do so. Looking beyond the EU

borders, monetary cooperation should be offered to

neighbouring countries.

To restore some economic logic to a process where

a legalistic approach has been allowed to dominate

(in large part because it offered a convenient

excuse for procrastination) will not be easy. But

you should remind everyone that the criteria for

joining the euro were introduced in order to ensure

that economic logic prevails over political logic, not

that legal logic prevails over economic logic.







Azacis, H. and Gillman, M. 2009. Flat tax reform: The Baltics 2000–2007.- Journal of Macroeconomics (in press).


Bezemer, D. 2009a. „No One Saw This Coming”: Understanding Financial Crisis Through Accounting Models. Groningen University.


Bezemer,  D. 2009 b. Why some economists could see the crisis coming. FT September 7 2009.

Bowles, S. and Sung-Ha Hwang, S.H. 2008. Social preferences and public economics: Mechanism design when social preferences depend on incentives.- Journal of Public Economics, 1811-20.

Ennuste, Ü., Kein, A. and Rajasalu, T. 2002. Institutional Determinants of Convergence: Conceptual Framework AND Empirical Studies of Australian Socioeconomic INSTITUTIONAL HARMONIZATION AND CONVERGENCE WITH THE EU. CERGE-EI GDN No program project. 34. (http://www.cerge-ei.cz/pdf/gdn/RRCII_34_paper_01.pdf).

Ennuste, Ü.  and  Rajasalu, T. 2002. Critical Probability of the EU Eastern Enlargement Project’s Institutional Failure: Aspects of Calibrated Economic Impacts of the Failure. In: Monitoring Preparations of Transition Countries for EU-Accession. 4th International Conference October 4-6, 2002 in Pärnu, Estonia, The Institute for European Studies, Tallinn, 212-227.

Ennuste, Ü. 2003. A Linear Planning Analysis of Institutional

Structure in the Economy.

Ennuste, Ü. 2007th Dual-Market Transition in Estonia 1987-2006: Institutional Mechanism Analysis Approach. In: “HISTORICAL EUROPE AFTER ENLARGEMENT. The Proceedings of 5th Audentes Spring Conference, May. 28 2007, Tallinn, 60-126. (http://www.ies.ee/iesp/No3/).

Ennuste, Ü. 2008th https://uloennuste.wordpress.com/2008/10/31/synthetic-conceptions-of-implementing-mechanisms-design-for-public-socio-economic-information-structure-illustrative-estonian-examples/).

Ennuste, Ü. 2009. Towards Synthetic Design of Communication Mechanisms Implementing Socio-Economic Structures and Public Information. – In spe: Amsterdam, 2009 Conference EAEPE Nov 7, 10:00:


Research area C Room: E0.07
Chair: Paolo Ramazzotti
Stam: Designing institutions for dynamic efficiency
Jacquinet: The problem of order and economic regulation
Happy: The role of technology in institutional reproduction of capitalism
Ennuste: Towards synthetic design of implementing socio-economic communication mechanisms.______________________________________________

Friedman, M. 1962. Capitalism and Freedom. University of Chicago Press.

Giles, C. 2009. OECD urges rich countries to strive for flexibility. The Economist, March 3 2009.

Kukk, K. 2005. Economic Losses. In:”The White Book” (Ed. Vello Salo), Tallinn, 125-5, http://www.riigikogu.ee/public/Riigikogu/TheWhiteBook.pdf

North, D. 1990. Institutions, Institutional Change and Economic Performance. Cambridge University Press.

Ott, A. F. and Ennuste, U. 1996. Anxiety as a Consequence of liberalization: an Analysis of Opinion Surveys in Estonia. – Social Science Journal, 33, 2, 149-164.

Pryor, F. 2005: Market Economic Systems. – Journal of Comparative

Economics, 33, 1, 25-46.


Phelps, E. 2006. Macroeconomics for a Modern Economy. Prize Lecture.

Nobel Museum.


Ramazzotti, P. 2005. Knowledge and Macro-Coordination. Google.


Rosser, J. 2007. The Rise and Fall of Catastrophe Theory Applications in

Economics: Was the Baby Thrown out with the Bathwater? –Journal

of Economic Dynamics & Control, 31, 3255-80.


Rothstein, B. 2009.  Preventing Markets from Self-Destruction: The Quality of Government Factor.  Department of  Political Science, University of Gothenburg, Working Paper Series 2009:2, ISSN 1653-8919, http://www.economist.com/world/europe/displaystory.cfm?story_id=13184594


Royal Swedish Academy of Sciences. 2007. Mechanism Design Theory.


Sapir, A. (Ed). 2009 Sept. Europe’s economic

priorities 2010-2015. Memos to the new Commission. Bruegle.

Schweitzer, U. 2005. Law and Economics of Obligations. – International

Review of Law and Economics, 25, 2, 209-228.


Serrano, R. and R. Vohra. 2001. Some Limitations of Virtual Bayesian

Implementation. – Econometrica, 69, 785-792.


Vanberg, V. 2005. Markets and States: The Perspective of Constitutional

Political Economy. – Journal of Institutional Economy, 1, 23-49


Walker, David. Guidelines for Disclosure and Transparency in Private

Equity (20 Nov 2007), http://walkerworkinggroup.com/?section=10366 .


Wallis, J. 2006. Evaluating Economic Theories of NPOs: a Case Study New

Directions for Socio-Economics – The Journal of Socio-Economics,

35, 959-979.


Rasmussen, P. 2009. “Sustainable growth requires greater regulation” Letter to the Editor of the FT July 2 2009.


Skidelsky, R. 2009.  Economists clash on shifting sands. FT June 9 2009.


Vanhanen, M. 2009. Europe will need to raise taxes in harmony. FT June 17 2009.


“The whiff of contagion”. 2009. The Economist. Feb 26th 2009.

 Wickens, M. 2009. Interpretation is wrong, not theory. FT July 23 2009.

September 14, 2009 - Posted by | Uncategorized

1 Comment »

  1. […] conclusion of my talk https://uloennuste.wordpress.com/2009/09/14/154/  at “Open European Forum”  in Tallinn 16.IX 09 has […]

    Pingback by Ülo Ennuste Economics | September 21, 2009 | Reply

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