We are living in a new era for Estonia, one in which the government's debt burden is rising rapidly. While in the coming years we can sharply increase defense spending without major difficulty thanks to the conservative fiscal policy of previous decades, over the long term a permanently higher level of expenditure will not be affordable for the state without significant changes in fiscal policy.

In numerical terms, this means that while Estonia's government debt amounted to just 9 percent of gross domestic product (GDP) in 2019, it is set to reach 26 percent this year and, without additional measures, 35 percent by 2029.

Over this period, interest costs on government debt will rise to nearly half a billion euros annually. It was precisely this concerning development that prompted the Fiscal Council to organize a public seminar on public finances, where, in addition to analyzing the domestic situation, we also looked to lessons from our northern neighbors Finland and Sweden in restoring fiscal order.

Efforts by successive Finnish governments to repair the state of public finances have been widely covered in the media and we have a valuable opportunity to learn from a neighboring country within the eurozone.

In Finland's case, the roots of the current difficulties lie in the past. When Apple launched the iPhone in 2007, dethroning Nokia, another major shock arrived in Europe a year later from across the Atlantic in the form of the global financial crisis triggered by the collapse of Lehman Brothers.

Finland has yet to fully recover from the impact of these shocks — particularly on public finances. Since the global financial crisis, the Finnish economy has grown by an average of just 0.5 percent per year. In addition, a rapidly aging population has significantly increased social spending.

Finland's last four parliamentary terms have all, in words, affirmed a commitment to restoring public finances, yet debt has continued to grow. Even European Union fiscal rules, which limit budget deficits to 3 percent of GDP, have not been sufficient to curb the increase.

Last year, as Finland's government debt approached 90 percent of GDP, the government decided to act, taking several painful but necessary steps. A cross-party working group was established to restore public finances, bringing together both coalition and opposition parties. The solution took the form of new domestic fiscal rules, signed by all parties except one.

Sweden's government debt ballooned in the 1990s following a banking crisis and years of overspending. In a vivid example, investment bankers in New York told Sweden's finance minister at the time that they were not prepared to finance Sweden's secure welfare state indefinitely. For a time, trading in Swedish government bonds was even halted on financial markets due to a lack of buyers. At the same time, a thorough reassessment of the foundations of public finances began and the memory of the crisis became embedded in Sweden's fiscal thinking for decades.

Whereas Sweden's fiscal policy had previously been based on annual state budgets without a strong long-term perspective, reforms succeeded in largely balancing revenues and expenditures and stabilizing government debt at a level that now stands at around 35 percent of GDP. Notably, maintaining this level of debt was also set as Sweden's long-term target in 2019. More importantly, the core principles of fiscal policy have remained insulated from day-to-day political pressures.

The examples of Finland and Sweden underscore one key point: we must put our public finances in order ourselves before financial markets demand it and before painful solutions become even more painful. We have done so before and, with political will, could do so again.

During the global financial crisis, Estonia managed to cut costs across the public sector — from operating expenses and wages to investments, pensions and unemployment benefits, road maintenance and health insurance. In other words, everyone contributed and the state budget was decisively consolidated on both the expenditure and revenue sides.

Whereas at the time the need for fiscal adjustment was justified by the goal of adopting the euro, today our motivation could be the will to defend ourselves. In any case, the time has come to look ahead and decide how to sustainably finance higher defense spending from the state budget.

How can this be achieved? Avoiding a large debt burden cannot rely solely on compliance with European Union fiscal rules. To keep government debt under control, we must therefore be more demanding than the Maastricht criteria. The repeated loosening of rules or their temporary suspension — something that has been frequent in Estonia in recent times — has certainly not benefited public finances.

Domestic fiscal rules must not be like children without political parents, simply ignored. No matter how good a fiscal rule may be, without political will and broad agreement, nothing will be achieved. And for politicians to value sound public finances, their voters must value them as well.

Drawing on the experiences and lessons of other countries, we could already be asking what political parties seeking a seat in parliament see as a sustainable level of government debt for Estonia and what they plan to do about it after the 2027 elections.

Based on the experience of our northern neighbors, we will likely need to look once again at expenditures, revenues and structural reforms (such as healthcare reform) to improve the fiscal position. We hope that these elections — at a time when one global crisis follows another — will not turn into a festival of increased spending and tax cuts without identifying sources of funding.

--

Follow ERR News on Facebook and X and never miss an update!