Andrus Alber
Vice-Chair of the Fiscal Council

Unusually low interest rates in international financial markets and modest economic growth have raised the question of whether it would be sensible for the Estonian government to borrow for new investment and to reignite the economy.

When the interest rates on the bonds of many advanced countries are negative, meaning that lenders are actually paying borrowers, the idea may initially seem appealing. But despite the excitement, the fact remains that it is not money that is needed for new investment, but ideas.

Estonia is not even able to use up in full the money that the European Union provides for investment, and those funds are much cheaper than even the most favourable loan that could be taken. It is as if we are standing before an apple tree that has plenty of ripe apples hanging from its lower branches, but our attention is taken only by those on the uppermost branches.

In the first half of this year, the government’s investment was reduced by almost one fifth. Although investment fell mainly at the local government level, it also declined at central government level. The lack of government investment comes mainly from the passivity in the use of money from the European Union and is evidenced by the reduction of construction work on facilities such as roads.

Passivity is bad

The current passivity in the use of European Union money is harmful for several reasons. Firstly, the forecast by the Ministry of Finance shows that general government investment will be quite volatile in the near term, as it will drop sharply this year and then spring back up next year. The effect of this is that sectors that depend on European money, especially construction, will have to cope with dramatic fluctuations in orders. Secondly, the postponement of the use of European money makes it more likely that investment will have to be ramped up needlessly in the final years of the current European Union budget period, which runs from 2014 to 2020, and that in the worst case a large part of the funds will go unused.

Focusing primarily on discussing the need to borrow means neglecting the efficient use of support funds from the European Union. If we are not able to use the European Union money that is sitting in one part of the government’s wallet, why should we think that we will be so much more effective if we open up a borrowed wallet? Seven years ago, when the previous European Union budget period was at the same stage we are at now, the deep economic crash gave a strong boost to the active use of European funds. No similar such pressure is currently visible.

Any discussion about government borrowing cannot be restricted to the question of how the money can best be used, but must consider also how far the borrowing affects government investment and how appropriate it is for the current economic circumstances.

We generally prefer that government borrowing be used to fund investment, not to cover current expenses. It would be logical to expect that those countries where the government has borrowed more would have more government investment.

Unfortunately though, data from the European Commission show that over the past fifteen years there has not been a positive correlation between borrowing by European Union countries and the size of government investment. This means that borrowed money has indeed been used by most of the countries to cover their current expenses.

There are many amongst us who think that the small Estonian debt is inappropriate when wages need to be raised for teachers, doctors, emergency responders and others. But how could we then later escape from a credit spiral if current expenditures are largely covered with borrowed money? We see it as irresponsible if someone starts to buy their weekly food and washing powder with instant loans, so why do we recommend that the state should act in exactly this way?

Unusual circumstances

In simple terms, the right time for borrowing and for budget deficits is when unemployment is high, but when unemployment is low it makes more sense for the budget to be in surplus. This is the logic behind the fiscal rules of the European Union.

The current circumstances of the Estonian economy are unusual, as growth has been weak in recent years, but the labour market has reflected the opposite image, with strong wage growth, rising employment and falling unemployment. This makes it hard, looking at the labour market, to see any need to borrow to reignite the economy. Part of the cause of the contradiction between weak growth in the economy and good figures for the labour market is that capital intensive industries in particular have been doing less well in the past couple of years.

Clear cases of this are the transit business, the electricity industry, and shale oil production. It is hard to see how government borrowing and spending could substantially improve matters in any of those industries. This makes it more reasonable right now to pick the apples from the lower branches by focusing on using the money from the European Union in the right place at the right time. Once those funds have been used up, then it may be time to consider whether it is necessary to start borrowing.

Published: 28.10.2016
Published in: Äripäev