Labour market

At the end of the growth period, the economy reached the stage of full employment and thus slower growth was inevitable. Since a large part of the resources were employed, the labour market started to hinder growth and strong wage pressures emerged. The opportunities of working abroad caused additional pressures. In the years of rapid growth in labour demand, the employment rate grew mainly on account of those residents who would have had more difficulties in getting a job if the demand for labour were lower (e.g. the retired). In 2008, the share of the retired among the economically inactive started to grow again.

Robust wage growth, which exceeded considerably productivity growth in the last two years, raises serious concerns about the flexibility of the cost of labour. However, as the economic cycle reversed, wage growth started to decelerate slightly. Owing to the high inertia of wage growth, it should take 6–8 quarters to get it in line with productivity growth. In Estonia, the balance between those indicators was hindered by public sector wage growth at the beginning of 2008, which, given the current phase of the economic cycle, was not the most appropriate time, but would not affect the overall situation in the longer term. In the second quarter of 2008, average wage growth decelerated, falling to 12.2% in June. in the first half of 2008, real wage growth decelerated from 15.0% in the previous year to 3.4%. As wage growth exceeded that of economic growth, it also brought along a relatively faster rise in labour costs and a decline in the share of profits in the value added.

From the perspective of further economic developments, labour resources should be reallocated to sectors with stronger productivity growth. In order to support the new growth cycle a part of the workforce serving domestic demand should probably move to export-oriented sectors. Furthermore, domestic demand oriented sectors might have to reorient themselves to earning export revenue.

The most crucial aspect is the flexibility of the labour market so that labour resources would be employed more effectively. In the long run, this should stimulate economic activity and income growth. On July 2009 the new and long waited Employment Contracts Act will come into force removing unnecessary administrative burden and providing more flexible labour market.

Inflation

In the first nine months of 2008, consumer prices increased by an average of 11.1%, year-on-year. The double-digit inflation rate largely arises from an increase in global energy and food prices. By now, commodity prices have dropped from the high levels, but external markets are still sending hectic signals.

As demand has eased and wage growth has slowed, Estonia’s inflation has been decelerating also in the second half-year 2008. Administrative factors have been one of the main driving forces of inflation.

In the autumn forecast (2008) of Eesti Pank has been revised this year’s inflation forecast up by less than a percentage point to 10.7%, since the earlier high price levels of energy and food are still affecting the comparison basis. At the beginning of 2009, inflation will decelerate at a faster rate. By that time, both the domestic and external price pressures will ease. It’s expected consumer price inflation to be 4.8% in 2009. As various surveys indicate, households and companies expect inflation to decelerate over the next twelve months. According to the base scenario of the autumn forecast, consumer price inflation will slow to 2.8% in 2010, and thus the likelihood of Estonia meeting the Maastricht inflation criterion will increase.

As the tensions in the labour market have not eased yet, price pressures remain strong. With regard to consumer price inflation, it is important to distinguish "imported" inflation from the domestic one as well as the impact exerted by tax policy measures. Inflation has picked up also in the euro area. In the coming years, Estonia's inflation rate will decend at its current level as a result of food decrease growth. Along with a slowdown in wage growth, domestic price pressures are expected to ease in 2009.

Key Macroeconomic Indicators and Economic Development Perspectives

* Forecast

Source: Bank of Estonia