"Estonia's economy is not used to a relatively mild but prolonged downturn or zero growth," says Peeter Luikmel, an economist at the Bank of Estonia. Since regaining independence until the global financial crisis, downturns meant a rapid and sharp decline for Estonians, followed by recovery within a couple of years. "External demand vanished and then returned. Everything happened so quickly in the past that there was no time to reflect or look for culprits," he recalls.

Where Estonia once relied on low labor costs to weather crises, wages have since risen and that advantage has disappeared. Nor can further momentum come from access to the European Union's single market, since Estonia already has it. "We've stalled at about 70–80 percent of the EU average in terms of income levels. Countries like Portugal have remained in this range for decades," Luikmel explains.

At the Delta Economic Conference in Tartu, Estonia's current economic situation was compared to a "poorhouse" where constant quarrels occur. In his presentation, Luikmel analyzed the roots of Estonia's lost growth and proposed solutions in light of rising public debt.

Ruth Oltjer, founder of Chemi-Pharm, discussed who might push Estonia toward knowledge‑intensive business. "It all depends on the individual official  —  whether they want to lend a hand or not. I would like the president and the government to think about this," she says.

The influence of wealthy neighbors

How did Estonia end up in this "poorhouse"? According to Luikmel, the economy turned downward about five years ago and has since hovered around zero growth with small fluctuations. Rapid government intervention and debt expansion, he argues, can actually hinder growth. "It's like a patient lying on the ground and, without checking if they're alive, someone immediately starts resuscitation and costly procedures," he illustrates.

Another complicating factor is Estonia's proximity to wealthy neighbors like Finland and the Scandinavian countries. "Income levels and price levels in Estonia used to move together," Luikmel notes. By the time of the COVID-19 pandemic, both had reached about 80 percent of the EU average. Now, due to stagnation, output per worker has nearly flatlined while prices continue to rise under the influence of neighboring economies.

Price and wage levels in Finland and Scandinavia are about 125 percent of the EU average, and this convergence effect on Estonia is unavoidable. "It is practically impossible to retain workers in Estonia if wages are higher in Scandinavia or Finland. The same unfortunately applies to prices," he says. Estonia is moving irreversibly toward higher price levels, but matching neighbors' prosperity will not happen automatically.

One solution, according to Luikmel, is to invest more in research and development. Estonia spends roughly 2 percent of GDP on R&D, compared with over 3 percent in Finland and Sweden, with Estonian companies contributing relatively little.

"That additional percentage point could likely move us into the ranks of wealthier countries. If we consistently prioritize and promote innovation, we could get there in 15–20 years," he says. Otherwise, Estonia risks remaining among countries stuck at around 80 percent of the EU income level while facing price levels closer to 125 percent. "We'll reach our neighbors' price levels but remain far behind in prosperity," Luikmel adds.

The "elephant in the room": public debt

At the same time, Estonia must confront the shadow of rising government debt. Luikmel notes that countries with lower debt burdens tend to grow about one percentage point faster on average, with a turning point around 30 percent of GDP.

"Estonia still has an advantage here, but it will be lost if debt keeps growing. We urgently need to increase innovation spending without increasing public debt," he says. This is possible if businesses view R&D as a path to higher productivity, although election cycles may encourage different kinds of spending.

He also warns that geopolitical events could sharply increase interest rates on existing debt. "Estonia's central bank has shown that at the current trajectory, we could be spending around €600 million annually on interest payments in four to five years," he notes — roughly the same amount currently allocated to the country's three largest universities.

If the state borrows to cover the gap, interest accumulates like a snowball. So far, Estonia has financed spending through higher deficits or VAT increases. "If we tried to eliminate the projected 4 percent deficit the same way, we'd have to raise VAT from 24 percent to 34 percent — assuming revenues hold up, which is very naive," Luikmel says.

Because traditional measures are no longer sufficient, conference participants also discussed alternative revenue sources, including higher taxes on the wealthy. "A third of our budget deficit comes from the elimination of the so‑called tax hump," Luikmel remarks. Options include progressive income taxation or other ways of taxing higher earners.

"The deficit has become so large that it cannot be fixed by cuts alone," he adds. Reducing taxes on the wealthy during a large deficit is particularly harmful, as they are more likely to save the extra income rather than boost demand.

Another idea raised was introducing corporate income tax in a form that exempts R&D spending. "That could nudge companies toward innovation," Luikmel says. While it may not generate large revenues, it would signal that the tax system rewards growth‑enhancing activities.

Officials as a barrier

Ruth Oltjer also offered solutions based on personal experience. Her key message was that public officials should not become obstacles to innovation: new products cannot be expected to fit existing frameworks. "It's actually very easy for officials to say no," she notes.

She encountered bureaucratic rigidity during the pandemic, when — before vaccines were available — her company developed a colostrum‑based protective spray in cooperation with the University of Tartu and Icosagen. She still does not fully understand why authorities refused to grant it international registration. "It didn't fit the framework of the Health Board, the Medicines Agency, or the Food Board — even at a time when approvals were being simplified for anything that might help against COVID," she recalls.

Oltjer believes officials may fear making mistakes, but she questions why they would resist the international success of an Estonian company. She hopes emerging sectors like drone technology will not face similar barriers.

She emphasized that success comes when businesses, researchers, and the state collaborate. Although the cooperation during the development of the spray was strong, she sees a persistent gap between academia and industry: "Entrepreneurs have a short time horizon — they need quick solutions and marketable products. Researchers have a long horizon, focused on publications and development."

To bridge that gap, she suggests more open laboratories where entrepreneurs can work alongside scientists. "When you work side by side, you better understand what they do and how," she says. She also encourages companies to approach researchers proactively, noting that studies show better outcomes when they do.

According to Oltjer, a friendly environment that fosters connections between entrepreneurs and researchers is essential. From the university perspective, basic and applied research must be balanced — and she believes the University of Tartu has already achieved that.

Ruth Oltjer and Peeter Luikmel presented these ideas on June 5 at the Delta Economic Conference in Tartu.