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1. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department
by Maris Lauri, Elina Allikalt No. 1 • 19 May 2010
Economic Research Department. Swedbank AB. SE-105 34 Stockholm. Phone +46-8-5859 1000.
E-mail: ek.sekr@swedbank.com www.swedbank.com
Legally responsible publisher: Cecilia Hermansson, +46-8-5859 1588.
Maris Lauri, +372 6 131 202. Elina Allikalt, +372 6 131 989. Annika Paabut, +372 6 135 440.
Manufacturing output recovering strongly, supported
by improving export sales
 After a large-scale drop-off in manufacturing production during late 2008 and early
2009 due to falling domestic and external demand, output in Estonia started
recovering, confidence levels are rising, and manufacturing sales and exports are
growing. However, the recovery has been uneven within sectors, being more
notable in exporting sectors, while those targeting their production towards the
domestic market have been struggling more.
 In order to increase competitiveness, Estonian manufacturers have to continue to
restructure their production processes, diversify products, and search for new
export markets. Also, production should move from low-cost to higher-cost products
as the convergence process continues.
Weaknesses of manufacturing sector
exposed during downturn
The Estonian manufacturing sector, which suffered
a severe domestic and external demand drop-off at
the end of 2008 and the beginning of 2009, reached
its lowest production level about a year ago in April
2009. While signs of weaker domestic demand and
manufacturing sales were visible already in the
beginning of 2008, export demand declined sharply
at the end of 2008, coinciding with the global
recession. This decline lowered total production
volumes by about 40% from the highest levels
Manufacturing sector, Jan 2004 - Apr 2010
(Left scale: annual growth, working day adjusted; right
scale: points, s.a.)
-40%
-30%
-20%
-10%
0%
10%
20%
30%
2004 2005 2006 2007 2008 2009 2010
-50
-40
-30
-20
-10
0
10
20
30
40
Production, ls Conf idence, rsSources: SE, DG ECFIN
seen, in the beginning of 2008, to the levels of early
2003. In turn, confidence levels reached an all-time
low and export volumes plummeted.
Manufacturing production, Jan 2008 - Mar 2010
(Index Dec 2007=100, seasonally and working day
adjusted)
20
40
60
80
100
120
140
160
2008 2009 2010
electro-
nics
f ood
products
total
f urniture
wood, -
products
metal
products
building
materials
chemi-
calsSources: SE, Swedbank calculations
About a year ago, the biggest declines had been
left behind and stabilisation signs were visible. The
drop in domestic demand had slowed and external
demand even showed some recovery. As the
recovery in demand has since been uneven, the
growth in production has varied across sectors as
well. Branches, which are more dependent on
export sales, have recovered faster; this includes
among others the production of computer,

2. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
Nr 1 • 19 May 2010
2 (5)
electronics, and optical products, wood and timber
products, and food products. As domestic demand
has continued to be sluggish, industries such as the
manufacturing of building materials have been
taking more time to recover.
Manufacturing sales, Jan 2006 - Mar 2010
(Annual change compared to same period in previous
year)
-40%
-30%
-20%
-10%
0%
10%
20%
30%
2006 2007 2008 2009 2010
Total Export DomesticSource: SE
During the downturn, manufacturing export sales
suffered the most due to a sharp drop in Estonia’s
main export markets (Finland, Sweden, and
Germany). One can clearly see that the sharpest
decline in Estonian manufacturing occurred due to
a deterioration of production in those markets (see
chart). This was a result of the large share of
subcontracting in export production in Estonian
manufacturing, particularly in the production of
capital goods, which are more sensitive to the
fluctuations of an economic cycle. The
subcontracting and tight connections with high-
technology firms are good for acquiring knowledge,
developing business contacts, and production
transfers. However, subcontracting can be
problematic too, as Estonian companies saw during
the recent boom-and-crisis years: global cost
competition is harsh, and contracts tend to be short
term, which means that market share is easy to
lose. In addition, the convergence process, which
intensified as expected when Estonia became a
member of the EU, pushed up production costs,
particularly labour costs (also because of declining
labour supply), thus weakening the cost
competitiveness of Estonian producers even more.
Manufacturing production, Jan 2000 - Mar 2010
(Index 2005=100, 3-month averages, seasonally and
calendar adjusted)
40
60
80
100
120
140
160
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Capital goods Durable goods
Intermediate goods Nondurable consumer goods
Source: SE, Swedbank calculations
Manufacturing production, Jan 1997 - Mar 2010
(Index 2005=100, 3-month averages, seasonally
adjusted)
50
60
70
80
90
100
110
120
130
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Sweden Finland Germany Estonia
Source: Reuters EcoWin, Swedbank calculations
Of course, in addition to external demand factors,
there were local problems too regarding businesses
themselves as well as economic developments. For
instance, producers did not focus enough on
maintaining international competitiveness and
investing in more advanced technologies and
production. Instead, domestic demand in the
overheating economy was preferred and production
was expanded by using old technologies, while
efficiency issues were neglected as a rule. Many
companies started to invest in “popular” areas, like
real estate, which afterwards become a source of
difficulties or bankruptcy in the otherwise profitable
main business area.

3. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
Nr 1 • 19 May 2010
3 (5)
Manufacturing Survey: Competitive position, 1Q 2004
- 2Q 2010
(Balance of answers "better"/"worse", seasonally
adjusted)
-15
-10
-5
0
5
10
15
20
2004 2005 2006 2007 2008 2009 2010
Inside EU Outside EUSource: DG ECFIN
Manufacturing Survey: Current export demand,
1Q 2006 - 1Q 2010
(Balance of answers "above/below regular level", 6-
month average)
-100
-80
-60
-40
-20
0
20
40
2006 2007 2008 2009 2010
Wood and
-products
Tele-
communic.
apparatus
Food
products
Furniture
Chemicals
Textiles
Metal
products
Source: EKI
Demand in Estonia’s main export markets started
recovering rather slowly in 2009, thus motivating
Estonian companies to find new markets outside
their main markets, and especially outside the EU,
for which growth prospects are far weaker than for
other regions of world, and to diversify their
products accordingly. As the manufacturing survey
shows (see chart), the competitive position of
companies had always been higher inside the EU
than outside but the levels evened up during 2009,
and competitiveness outside the EU has overtaken
competitiveness inside in 2010. Although the EU
has remained the major export partner for Estonia
(covering about 65-70% of total), the shares of
Sweden and Finland have fallen in goods exports,
and other EU countries and non-EU countries have
strengthened their positions. This is a good
development, as it diminishes Estonia’s
dependence on only a few certain countries.
Overall manufacturing confidence hit its lowest
levels about a year ago in March 2009, when
production levels were the lowest as well. Within a
year, however, confidence has risen from -40 points
to almost equilibrium. Production trends and order-
book levels have been steadily improving, with
production targeted to the export markets assessed
as better than average. The stock of finished
products, however, has been thought to be too low
for the last half-year. Employment expectations
turned positive in April, for the first time since
February 2008.
Manufacturing Confidence, Jan 2006 - Apr 2010
(Seasonally adjusted)
-80
-60
-40
-20
0
20
40
2006 2007 2008 2009 2010
Total
Order-book lev els
Stocks of f inished products
Production expectations Source: DG ECFIN
All this gives reason to believe that the
improvement in manufacturing will continue in 2010
and 2011. Of course, the main basis for future
growth will come from recovering global demand,
which is still connected with many uncertainties and
poses several risks (especially inside the euro
zone). Nevertheless, the elimination of
extravagancies (e.g., overstaffing and a strong
reliance on the domestic market) has made
surviving companies stronger and benefited them in
international competition. The domestic demand-
oriented industries, however, are expected to
improve more slower. At the same time, it is
becoming more and more difficult to distinguish
between domestic and exporting producers. Even
the food industry, which traditionally is more
domestically oriented, is about to produce more for
export, as an increasing number of factories are
going into the hands of Nordic consortia (the latest

4. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
Nr 1 • 19 May 2010
4 (5)
being the candy-maker Kalev), and Nordic retailers
are looking for producers of label products in
Estonia.
Competitiveness needs to improve even
more
Although the Estonian manufacturers have
weathered the recent plunge quite well by
restructuring their production, more needs to be
done in order to increase competitiveness and to
profit more from their different strengths and
advantages - even more so because the Estonian
manufacturing sector is very dependent on exports.
Cost competitiveness in the Nordic region continues
to favour Estonia. Although one cannot expect that
costs will remain as low as they were or are now,
the convergence process will take several years.
Labour cost levels in Estonia are not the lowest in
the eastern coast of the Baltic Sea; however,
compared with its main economic partners
(Sweden, Finland, and Germany), Estonia’s are
substantially lower. Wages declined in 2009 and will
continue to do so in 2010, as the internal
devaluation process in the economy continues.
Looking ahead, wage developments will mostly be
dependent on labour supply, i.e. with
unemployment rate eventually starting to fall, the
wage growth will pick up too. In the long run, there
are also risks for a situation of too low labour supply
and unsustainable wage growth, as seen during
boom-years, to repeat.
Labour compensation per hour in selected countries,
Manufacturing sector, 2008
(PPP-adjusted, USD)
0 10 20 30 40
Germany
Netherlands
Norway
Austria
France
Finland
Sweden
Denmark
Italy
Spain
Greece
Slovak Rep
Czech Rep
Lithuania
Estonia
Source: OECD euro zone country
Other production costs are also lower than in richer
EU countries – this applies to transport costs
(particularly compared with transport, e.g., from
China, where production itself may be cheaper),
energy (however, it is on the increase due to global
processes, such as the opening of the electricity
market and the closure of the Ignalina nuclear
power station in Lithuania), land, water, services,
etc.
Consequently, the already low labour costs,
together with the high availability of labour
resources, should provide reasons for Nordic
investors and producers to replace and/or expand
their production in Estonia. Nevertheless, Estonia
will have to move towards higher-value production
in the long run, because the production cost during
the convergence process will increase.
It is also very important that the overall business
climate continue to be favourable in order to attract
more investments. The likelihood of euro adoption
will increase confidence in Estonia, thus making it
more attractive to possible investors, and will lower
the risks for business partners. In addition, last
year, during the low levels of production, the
government strengthened several export support
mechanisms and successfully increased the usage
of several EU fund instruments to support
companies. Other measures for boosting
employment (e.g., “wage support” by the
unemployment office, changes in social tax law to
increase part-time employment), education (e.g.,
supporting the finishing of higher education by
those who abandoned it during the boom years),
and training are being implemented as well.
R&D expenditure in selected countries, Business
enterprise sector, 2008
(% of GDP)
0 0.5 1 1.5 2 2.5 3
Sweden
Finland
Germany
EU27
Slov enia
Czech Rep
Estonia
Slov akia
Lithuania
Poland
Latvia
Bulgaria
Source: Eurostat
Several researches have shown that the
innovativeness of Estonian companies is very high
and above EU average; even more, recent
recession years have only strengthened that
attitude. Although the R&D expenditure in Estonia is

5. The Estonian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
Nr 1 • 19 May 2010
5 (5)
below the EU average, it is among the highest in
the CEE region (see chart). The government’s
attitude towards supporting R&D in the business
sector has been favourable so far and this needs to
strengthen even more, as the manufacturing
develops towards higher value-added production.
A stable economic and political environment is also
needed. Even though coalition governments have
changed relatively frequently in Estonia, the overall
economic policy has been the same starting from
early 1990s – i.e., equal treatment of all business
sectors and enterprises, diminishing differences in
tax treatment, and the increasing application of
simple procedures for businesses. We do not
expect this approach to change, although minor
shifts of course are possible depending on the
coalition partners.
Elina Allikalt
Maris Lauri
Swedbank
Economic Research Department
SE-105 34 Stockholm
Phone +46-8-5859 1028
ek.sekr@swedbank.com
www.swedbank.com
Legally responsible publisher
Cecilia Hermansson, +46-88-5859 1588
Maris Lauri +372 6 131 202
Elina Allikalt +372 6 131 989
Annika Paabut +372 6 135 440
Swedbank’s monthly newsletter The Estonian Economy is published as a service to our
customers. We believe that we have used reliable sources and methods in the preparation
of the analyses reported in this publication. However, we cannot guarantee the accuracy or
completeness of the report and cannot be held responsible for any error or omission in the
underlying material or its use. Readers are encouraged to base any (investment) decisions
on other material as well. Neither Swedbank nor its employees may be held responsible for
losses or damages, direct or indirect, owing to any errors or omissions in Swedbank’s
monthly newsletter The Estonian Economy.