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Democratic Transitions 

Estonia — The Small Country that Could
By Mart Laar

Return to Independence 

 Estonia is a small country located on the shores of the Baltic Sea. Through many centuries, we have been a crossroad between East and West, and South and North. As Samuel Huntington states, Estonia marks the border of Western civilization, a border where civilizations clash. 
Estonia’s history has not been easy. Estonians have had to fight for freedom many times. In 1918, Estonia declared independence and successfully built a modern Western state over a period of 20 years. When World War II began, Estonia was again occupied, first by the communists, and then by Nazis, and then by communists again. We fought, but were defeated. During the war, Estonia lost 30 percent of its population, both through repression and the resistance movement. The number of Estonians living in Estonia has not yet reached its pre-war level. The Estonian economy was destroyed, private property was nationalized, and independent farms collectivized. The Estonian economy was made totally dependent on the Soviet economy and ties with the rest of the world were cut off. Some economic development was achieved, but often at enormous environmental costs. In 1939, Estonia enjoyed a living standard more or less equal to Finland, but after years of Soviet occupation and a controlled economy, Estonia’s living standards are four to ten times lower. 

Nevertheless, we never gave up, and when history in the 1980s offered us a new chance, we used it. By the 1980s, the failed Soviet economy and relative backwardness of Soviet society was evident to everybody, even to the Soviet leaders. The introduction of reforms revived a sense of Estonian national identity and ushered in Westernization and the destruction of the Soviet empire. Technological revolution and the development of communications eroded Moscow's position in the world, and the West's technological superiority defeated the Soviet Union in the Cold War. As a consequence, the USSR was forced into a corner and its only option was reforms.

But pressures on the Soviet Union came from within the system as well as from outside it. In order to cope with these pressures, the new leader of the Soviet Union, Mikhail Gorbachev, decided to transform the Soviet Union, modernize it and, thereby, save socialism and the Soviet empire. He failed to understand the nature of democracy — once it is adopted, central authority diminishes. 

In the first years, the effects of Mikhail Gorbachev's "perestroika" (restructuring) were more visible in Moscow than in Estonia. More rapidly, however, the media stimulated the radicalization of public opinion and advised people to make use of the broadened opportunities for public participation.  Two issues — environment and history — served as symbols of change in the Baltic States. Similar to the Estonian national awakening of the 19th century, a lot of work was done in 1980s to restore the historical memory of the nation. In 1986, the Estonian Heritage Society, the first independent non-governmental organization, or NGO, in the history of the Estonian SSR, was founded. The Society rapidly attracted a significant number of national activists from both the younger generation, most of whom were intellectuals, and the older.  In less than a year, it built up a network of grassroots organisations all over Estonia. The Society also started collecting "living histories" and organized lectures on Estonian history. 

At its meeting in December 1986, the Estonian Writers Union raised the issue of the environmental damage caused by phosphorous mining in Estonia. In February 1987, Estonian television broadcast Moscow's plans for extensive phosphorous mining in Estonia and a massive protest movement broke out.  Tens of thousands of signatures against the plan were collected in less than a few months as media became more receptive to public debate. On May 1, 1987, Tartu University students went to the official May Day celebration with anti-phosphorous mining slogans.  Protests against environmental pollution are benign and very difficult to attack by the authorities.  By the Fall of 1987, the protest movement had become so widespread that the authorities were forced to rescind their mining plans. This concession by the authorities was a sign of their weakening control and encouraged people to further action.

The protest movement rapidly became politicized. Latvians held a public meeting on June 14, 1987, to commemorate the 1941 mass deportation of Latvians by the occupation Red Army.  The capitals of the three Baltic States held public gatherings on August 23, 1987, to draw attention to the signing of the Molotov-Ribbentrop Pact (MRP) on that day in 1939. In Estonia, the site was Hirve Park (Deer Park) and the organisers were long-time dissidents. Thousands of people assembled to hear speakers demand the publication of the Pact’s secret protocols [detailing the division of territory between Nazi Germany and the Soviet Union from the Baltic to Black Seas] and also the more radical demand of independence for the Baltic nations. The KGB and Communist officials did not intervene. The demonstration in Hirve Park was a major breakthrough and it radically changed the minds of people. As a consequence, the numbers turning out for public demonstrations increased.  People were no longer afraid.

Between August 1987 and February 1988, the atmosphere in Estonia changed more than it had during all of the preceding 40 years. People awoke to the possibilities of public protests.  The "old guard" party leaders tried to prevent protest, but only suffered a loss of face.  A large political demonstration on February 2, 1988, commemorating the signing of the Tartu Peace Treaty with Russia, was met by armed riot police with dogs. On February 24, Estonia's Independence Day, and on March 25, the anniversary of the 1949 round of Soviet mass deportations, the demonstrations were unprecedented in size. The Communist Party organized counter-demonstrations by "Soviet people," condemning foreign intervention "in internal affairs of the Soviet Union," but these efforts failed.

Hirve Park and the other demonstrations placed the reform-minded political establishment of Soviet Estonia into a quandary.  These establishment Estonians had hoped to direct the play, but instead, the main actors, the former dissidents, were chosen by the people. The younger members of the establishment wished to achieve some kind of autonomy for Estonia within the Soviet Union.  For the "Hirve Park people," full restoration of Estonia's independence was the goal from the beginning.  For the local communist establishment, all of this was madness. 
After the meeting at Hirve Park, reform-minded communists tried to seize the initiative from the more radical forces by publishing a plan for Estonia's economic autonomy in September 1987. The proposal, which became known as IME (for Self-Managing Estonia) gave basic recommendations that the principles of factory level autonomy be applied to Estonia as a whole, including areas of administration, finance, and supply.

The Estonian national movement found itself divided: the forces from Hirve Park demanded full independence while IME supporters demanded autonomy. The radicals wanted to abolish the Soviet regime and to restore the pre-war Republic of Estonia.  The so-called centrists thought it better to move forward as an autonomous country within the Soviet framework. 

A plenary meeting of the Union of Estonian Arts and Letters was held in Tallinn at the Hall of Parliament on April 1-2, 1988, marking the beginning of the national movement. The meeting, organized by the Cultural Council of Creative Societies, focused on fundamental questions of national identity.  With unprecedented courage, critical issues of Estonia's national survival were raised. The communist leaders, and even the KGB, were severely criticized. Many speakers condemned the policy of forcible Russification and colonization of Estonia by the Soviets.  The message of the plenary meeting was clear: restrictions are off! 

The leaders of the Estonian Communist Party (ECP) had lost control and the Party's authority decreased rapidly thereafter.  This strengthened the position of its reform-minded wing, worried about the growing popularity of the non-communist forces.  Negotiations began with Moscow to replace the unpopular head of the Estonian Communist Party, Karl Vaino, with someone who could restore the authority of the Party.  Another means the Party used to try to exploit the protest movements in the interests of Soviet power was the creation of Popular Fronts. Originally proposed in 1987 by the leadership of the Communist Party of the Soviet Union (CPSU), the popular fronts were intended to support party-inspired reforms and to ensure the continuation of Soviet power. But much to their chagrin, the Party bosses watched control of their empowered creations pass swiftly to more radical national leaders. 

But when, on April 13, 1988, a communist official, Edgar Savisaar, stated on television that a Popular Front (PF) should be created in Estonia to support perestroika policies, the situation in Estonia already had changed fundamentally. A crucial event was the general meeting of the Heritage Societies on April 14-17, in Tartu, where organizers decided to use the strictly forbidden Estonian tricolor flag to give the national movement further impetus. On April 15, a large demonstration of about 10,000 people took place in front of the former Estonian University Students Union. Three bolts of blue, black and white fabric covered the facade of the building in the manner of the flag. In the crowd, an abundance of blue, black and while streamers, small flags and even standard sized ones could be seen. The power structure had lost control over these new developments. Even emissaries from Moscow, who had been called to threaten punishment for the organizers, were powerless. The blue, black and white had come to stay.  Those who had come to the gathering returned to their homes all over Estonia with the spirit and colors obtained at the meeting.  By the end of May and early June, the tricolor was on display at many public meetings all over Estonia.

At the same time, the Popular Front gained strength.  By the end of July, over 1,100 Popular Front departments had been established all over Estonia. A temporary state agency, the Popular Front Founding Center, was established on May 14, as a coordinating body. But the emphasis on cooperation with the Communist Party and “complete compliance with USSR Communist Party's course" caused suspicion among non-communist activists and overall criticism of the front. As a result, it had a considerable change of direction distanced itself from the USSR Communist Party.

The political movement attracted more and more young people after May 1988. The main reason behind that was the delivery of the political message in understandable language and style.  Leading Estonian rock musicians embraced the project, “Five Patriotic Songs,” and they were presented to the public for the first time on May 14, at a popular music festival in Tartu, and their popularity spread fast from there to all corners of the country, reaching even the more passive youth.     Significant growth in the movement took place during the so called "night song festivals" held in Tallinn during June 1988.  On the evening of June 4, a large number of youth, carrying blue, black and white flags, appeared at the Old Town Square.  They started singing familiar patriotic songs and soon commenced to move in a column toward the Song Festival Grounds.  Others joined them along the way and, eventually, an estimated 100,000 people had gathered.  Out came the national flags, and those assembled sang and celebrated throughout the night.  The same thing happened on the next day and continued for weeks. During this period, people even brought out national flags that they had kept hidden for decades.  The spirit that prevailed was tremendous.  Nobody participating had ever experienced such a feeling of unity.  Being together, people felt strong and courageous, and they realized that it would be very difficult for the authorities to oppose such a large group. One of the leaders of the Popular Front, Heinz Valk, christened it “The Singing Revolution.”

The night song festivals caused panic among ECP leaders.  Karl Vaino turned to Moscow for permission for a show of strength against the young people at the Song Festival Grounds.  But the events in Estonia had already reached the media in the West, and Moscow was fearful of using force in public.  It would be harmful to the image of perestroika in the West if tanks were sent to silence thousands of singing people.  Moscow had to look for an alternative. 

The 10th plenary meeting of the ECP Central Committee took place in Tallinn on June 16.  Karl Vaino was replaced as the First Secretary and Vaino Valjas was elected at the recommendation of the Central Committee of the USSR Communist Party. The ECP began to work openly with the Popular Front, no longer disassociating itself from it, so as to reduce the influence of non-communists in it. The first expression of joint action was the announcement by the Popular Front that national flags should not be displayed at demonstrations, because their presence could endanger public order.

One hundred thousand people came to a demonstration called for June 17 at the Song Festival Grounds. Despite the Popular Front’s announcement, hundreds, if not thousands, of national flags waved in the crowd.

An inseparable part of the "Hot Summer" of 1988 was the physical restoration of history. The War of Independence monuments, which had been destroyed by the Soviets, were restored, and a collection of living history was organized in a manner emulating a 19th century campaign to collect 19th century folklore. 

The Estonian National Independence Party (ENIP) was founded pn August 20-21, 1988 in Pilistvere in southern Estonia.  ENIP's platform opposed the Communist Party and demanded restoration of democracy and full independence for Estonia. On September 11, the Popular Front organized a massive "Song of Estonia 1988" at the Festival Grounds in Tallinn, with up to 300,000 people attending.  Although most of the speakers had nothing new to say to the listeners, Trivimi Velliste, the chairman of the Estonian Heritage Society, created greater reverberation by  demanding the release of all political prisoners and the restoration of Estonia's independence.  The audience responded with an ovation, while the leaders of the Popular Front condemned it for its bluntness.  The national movement had split in half.

The split in the national movement in the fall of 1988 clearly strengthened the position of the ECP, and  Vaino Valjas, the Party's First Secretary became the country's most popular politician.  A strong media campaign was launched against the “extremists”who demanded independence. Indeed, it is difficult to imagine progress in the national movement if the Soviet leadership had not made a decision that gave impetus to fresh activity. Specifically, the CPSU decided to initiate political reforms by calling for new elections to a Congress of People’s Deputies, and proposing to limit the rights of member republics, for example, by taking away their rights on paper to secede from the Union, a right that existed in the constitution.
The plan created a storm of protests in the member republics. Various organizations in Estonia collected thousands of signatures against the proposal.  Increasingly, people began to support the view that Estonia must secede from the Soviet Union before any constitutional reforms are adopted.   This position found support even in the central officies of the Popular Front while its leaders were in Moscow for negotiations.

This sudden surge of desire for independence forced the leaders of the ECP and Popular Front to face complicated choices.  They would have to radicalize their own position in order to put brakes on the surge. When Popular Front leaders returned to Tallinn, while first destroying offending publications printed in their absence, they then sat down with those of the ECP and worked out a milder proposal to declare “sovereignty” of the Estonian Soviet Socialist Republic (ESSR). The All-Union laws were to be effective in Estonia only after approval by the Estonian Supreme Council. Relations between Estonia and the Soviet Union were to be conducted on the basis of agreements. On November 16, 1988, the ECP forced through its proposals at a meeting of the Estonian state Supreme Council. The people cheered the Council actions and the ECP leaders became national heroes.

Fuel was added to the fire by foreign press and public opinion, which announced Estonia's declaration of independence without understanding the distinction between the Soviet meaning of “sovereignty” and actual independence. Moscow reacted swiftly. Other republics were categorically forbidden to follow the Estonian model and Estonia's political leaders were called to Moscow and asked to rescind their decision.  Estonia's example proved to be contagious, nevertheless, and in the following two years most of the Soviet republics adopted similar declarations. 

The declaration of sovereignty did not bring about major changes in Estonia. Things seemed to be at a standstill and under pressure from Moscow; ECP leaders began to back from earlier decisions. People were also getting tired of the increased haggling among political organizations.  The overall impression was one of treading the water, if not an actual crisis. Many of the plans that started with enthusiasm in 1988 could not survive in the new situation.  It seemed that it was easier to start organizations than to sustain them. It appeared that the disappointments could not be eliminated by events that usually found wide public support, such as the proposal by ECP to raise the blue-black-white flag at the Tall Hermann tower on February 24, 198[9].  Many national organizations criticized the ECP proposal, arguing that such an act would only legitimize the ESSR.  Initially, the Popular Front also opposed the idea but later supported it.

On March 26, 1989, elections to the All-Union Soviet Peoples Deputies Congress were held, the first time a choice of candidates was presented to voters.  Since democratic freedoms had not yet been secured in Estonia, some national forces boycotted the elections, putting themselves into political isolation. The Popular Front candidates got the most votes, followed by the ECP and the newly created pro-Soviet Interfront organization.

At the All-Union Congress of Peoples Deputies, the Estonian delegates formed a faction with the Latvian and Lithuanian delegates that set the goal of democratization of the Soviet Union on one hand and, on the other, the adoption of an economic autonomy program and the Congress’s formal denunciation of the Molotov-Ribbentrop Pact. Despite numerous promises, officials took no action on these points, dashing hopes that Moscow might make concessions and engage in a constructive political development.  Moscow clearly was afraid to yield to the Baltic States out of fear of strengthening the other independence movements in Soviet republics. As a result, it became increasingly clear to everyone that their objectives could not be reached through Moscow but only directly, fueling a resurgence of political activity.

A new era in the national movement was signalled by the creation of the Estonian Republic's Citizens Committees, which were founded on February 24, 1989 by the Estonian Christian Union, the Heritage Society, and the Estonian National Independence Party (ENIP). The idea of the Citizens’ Committees was to register the legitimate citizens of the Republic of Estonia (those who were citizens on the day Soviet occupation ended the independent state of Estonia in June, 1940, and their descendents), to organize a truly representative Congress of Estonia, and to restore the Republic of Estonia as the legal continuation of the prewar state.  The Citizens' Committees distanced themselves from both the ECP and the Estonian SSR and wanted to free themselves fully from the Soviet legacy.  The Congress of Estonia was intended as the continuation of the national movement begun at the demonstration in Hirve Park in 1987.
Organizing the Citizens' Committees was not easy. The ECP and Popular Front immediately adopted a negative attitude toward them and tried to intimidate people. They labeled the Citizens' Committees as extremist and radical nationalists.  Yet, it was this movement that took the first real steps to integrate non-Estonian residents, mainly ethnic Russians, and to include them in the freedom movement. Non-Estonians were offered the opportunity to register as applicants for Estonian citizenship and given the promise to be granted full citizenship later without further conditions. 

As it became clear that the Soviet Union would make no concessions, the Citizens’ Committees gained more and more influence. By the Fall of 1988, Citizens’ Committees were formed all over the country.  By the end of the year, the number of registered citizens passed the half million mark, meaning more than half of all eligible citizens had actively signed up. Different political organizations began to support the Citizens Committees, and eventually the Popular Front, afraid of losing its influence, joined them.  Hence, all political organizations with the exception of the Interfront and the ECP had arrived at the same position of support for full independence, one a position that was now being bolstered by the radicalization of Latvia and Lithuania. 

On the 50th anniversary of the signing of the Molotov-Ribbentrop Pact, August 23, 1989, several million Balts formed a human chain that ran across all three countries, dramatizing to the world how the desire for freedom had not been snuffed out by the Pact.  The event made front page news around the world, bringing the Baltic question more clearly than ever to the attention of the world.  Moscow reacted furiously to the Baltic chain. A statement by the Central Committee of the CPSU sharply attacked the “separatist manifestations” in the Baltic States and threatened the Baltic peoples should independence demands continue. Moscow's threats achieved unintended results. They crushed the last grain of hope that reconciliation with Moscow could be possible.  The radicalization of the people's mood brought with it increased authority for the Citizens Committees and support for demands of complete independence. 

Elections to the Congress of Estonia took place on February 24, 1990.  It was the first democratically conducted election in decades.  Although the elections were organized by popular initiative, the people’s participation exceeded expectations.  Tens of thousands registered themselves either as citizens or applicants for citizenship on Election Day. The candidates representing ENIP and the national heritage movement received the most votes. 

The Congress of Estonia met for the first time on March 13 and 14, and it adopted decisions that would set Estonia on the road to independence, ones, however, that required a close working co-operation with the ESSR Supreme Council. While the leaders of the Congress did not run a slate of candidates for the Supreme Council, the winning candidates were nevertheless mainly supporters of independence; a majority were members of the Popular Front.

In the beginning, cooperation between the Congress of Estonia and the new Supreme Council (the Estonian equivalent to the All-Soviet Congress of Deputies) was good.  Both approved the government,  whose leader, the head of the Popular Front, was  Edgar Savisaar.  But Savisaar began to move away from the agreed-upon terms of cooperation and started to advance the idea of a “third” ESSR.  The result was a long-lasting political conflict and Estonia became divided into two camps. The competitition between two representative bodies for public support, however, turned out to be advantageous as “political schooling” and helped the development of a multi-party political system.

Estonia's democratic strength became evident when, at a decisive moment, the two representative bodies found a way to engage in constructive cooperation. When the coup attempt against Mikhail Gorbachev took place in Moscow in August 1991, the free Congress of Estonia and the more official Supreme Council jointly declared on August 20, 1991, the full restoration of Estonia’s independence. Diplomatic relations with foreign countries were restored and on September 17, 1991, Estonia and the other Baltic States which had also announced their fullly restored independence were accepted as members of the United Nations. Estonia had returned to the family of free nations.

The Estonian Miracle

 In 1991 Estonia was a free country again, but what freedom was this? Estonia was ruined, the economy in shambles, and the spirit of the people spoiled by a socialist heritage. Shops were entirely empty and the currency did not have any value. The four-year struggle for independence had not left enough time for an effective economic reform. Even during the times of the Great Depression of the 1930s, industrial production had never declined so much as 30 percent during a two-year period. But after independence, real wages fell by some 45 percent, fuel prices had risen by more than 10,000 percent, and inflation ran more than 1,000 percent per annum. Forecasts for unemployment rate ran at 30 percent. People stood hours and hours in lines to buy food, while bread and milk products were rationed. 

 There were not many who believed in a better future during this period. Yet today, after less than ten years of independence, Estonia has changed beyond recognition. Already after five years there was very little to remind us of the situation in 1991. The popular American magazine Newsweek called Estonia the “little country that could.” Figures of Estonian economic development are astonishing. Inflation is down to 2-3 percent per annum, unemployment is somewhere between 3 and 4 percent, the state budget is balanced, and GDP is growing on average 5-6 percent each year. Estonia has one of the highest amounts of direct foreign investments among the countries in Central and Eastern Europe. In 1990, 22 percent of the population worked in agriculture, but by 1996 this figure was down to 8 percent. In a few short years, Estonia went from total dependence on the East (the Russian portion of Estonian trade even as late as 1995 was 92 percent), to an economy oriented to the West. Today, Estonia conducts 66 percent of its trade with the European Union countries. Even more important, according to a Gallup Poll organized by the U.S. Agency for International Development (USAID) in 1995, Estonia is the only nation in Central and Eastern Europe where a majority of the people believe that they are living better now than during socialism. In July 1997, the European Commission decided to begin membership negotiations with five Central and Eastern Europeans countries: the Czech Republic, Hungary, Poland, Slovenia, and Estonia as only country from the territory of the former Soviet Union. Estonia has declared as its goal to be a full member of the European Union by January 1, 2003.

 Lots of experts and politicians have asked how we did it. This question is not an easy one to answer. I could tell a lot about the Estonian experience, but I am not fully convinced that adopting the same steps as we in countries with different cultural and historical background will give the same results as in Estonia. Still, there are some main lessons that seem to work everywhere, where transition from a totalitarian society and controlled economy to democracy and market economy is on the way.

 Planning our “jump to nowhere” we tried to learn from the experiences of other countries which had recently undertaken a similar transition. Some main lessons emerge. One is to take care of politics first and then to proceed with economic reform. Don’t underestimate the importance of a new modern constitution and democratic legislation on elections. Parliamentary systems with a strong Prime Minister and weaker President looks to be much more effective as a model to fight against strong industrial and agricultural lobbies that at one point or anther will necessarily turn against the reform process. Lots of studies have shown that parliamentary democracy proves to be a more successful tool in transition than a presidential one. One should not fear democracy. Rather the opposite: support the development of political parties and democratic institutions. 
 The next lesson is summed up by the well-known advertising slogan of Nike: “Just do it.” In other words, be decisive about adopting reforms and stick with them despite the short-term pain they bring. Politics has to be dealt with first, to initiate and sustain radical reforms; there must be a legitimately formed consensus for change. This is possible only though democracy, using regular, accountable institutional structures and free and fair elections.

  Leszek Balcerowicz has said that the opportunity for such “extraordinary politics” lasts usually two years. The brevity of this exceptional period means that a radical economic program launched as quickly as possible after the breakthrough has a much greater chance of being accepted than either a delayed radical program or a non-radical alternative that introduces difficult measures (e.g. price increases) in a step-by-step fashion. To put it simply again in advertising jargon: no pain, no gain.

 Of course, that is easy to say and hard to do. Estonia has gone through pain and achieved fast development. Our first goal was to:

 LIBERALIZE the economy. Price control was lifted in the first part of 1991, along with most other economic restrictions. But this is only the first step. More important is next the step that is to lift of price controls, and this must follow as fast as possible. 

 STABILIZE economy. Radical transition is not possible without monetary reform, which makes the national currency convertible. Estonia launched monetary reform in June 1992 —the first country in the former Soviet Union to introduce its own currency. Based on a currency board system the Estonian kroon was made fully convertible from the very first days, its exchange rate pegged to the German mark at a fixed rate. 
 Currency board arrangements (CBAs) are one form of a fixed exchange rate system. The main goal of having a currency board arrangement is to restrict usage of some policy tools. In conventional fixed peg regimes, central banks have relatively free hands. Under currency board arrangements,  the risk of making shortsighted decisions in monetary system is minimized by CBA, and all or a majority of the money in circulation must be backed with international reserves. The central bank is not allowed to increase the money supply by printing more money or buying and selling government securities. 

 Seventy countries have at some stage introduced the currency board system. Among the best known examples of countries that still have a currency board of some kind are Hong Kong and Singapore. In both of these cases, however, the currency board has developed a long way towards being an ordinary central bank over the years. Argentina adopted the currency board principle in spring 1991, and it has succeeded in curbing its high inflation rate and bringing down interest rates. 

One reason why currency board was selected for the currency reform was its simplicity. A leading Estonian economist, Ardo Hansson, has stated that the currency reform was planned very simply because of Estonian poverty, the backwardness of the monetary system, and the insufficient training and reliability of employees. The reform was an attempt to incite people's confidence in the national currency, regardless of unfavorable tendencies in the national economy. In Estonia, this was done by requiring a 100 percent backing of the kroon, meaning that the Bank of Estonia could not under law devaluate the kroon (this right is enjoyed only by Parliament). 

 The first head of the Bank of Estonia, Mr. Siim Kallas, said, “We decided to carry out the reform as soon as possible. We’ve been accused of being overly ambitious, but the project was always realistic given our skills, education, and experience. We conducted  a very simple version of  monetary reform that could be handled by our own people in order to assure the Estonian people that paper issued by the Government, or by Eesti Pank (Bank of Estonia), is solidly backed and that these authorities are to be trusted.

 After having lived under Soviet rule, this was no easy goal. We needed something else, and we opted for a currency board. In practice, the idea was to return to a modified version of the gold standard. This has worked out quite well. 

 At the time of monetary reform there was almost nothing on the shelves. Rationing applied to several things — I’ve held on to the coupons, and to the newspaper list which tells me what and how much I was permitted to buy, and when I was allowed to redeem coupons. A number of shops, restaurants and bars accepted only foreign (hard) currency. This divided people into “blacks” and  “whites” —  the whites were the ones with the hard currency. It was a cause of social tension because the shops were closed for ordinary people. Most people had great stockpiles to draw on; indeed, newspaper articles suggested that some people had hoarded so much detergent in their flats that they had put their health at risk. 

 In Estonia, the currency board system has proved to be highly successful. Undervalued currency boosted exports and brought down interest rates. Fixed exchange rates created trust in the national currency among Estonians and foreigners, and also boosted foreign investments. Shops were filled with goods and the “black market” disappeared nearly overnight. 

 At the same time, it is clear that a currency board could not have had a positive effect without an extremely conservative and strict monetary policy. The state budget must be balanced. In Estonia, we enacted a balanced budget law. This helps the parliament to ratify a balanced budget even as radical reformers are ousted from power. A balanced budget is important not only for monetary politic, but it prevents the country from spending more than it earns, and now the economy is becoming healthier.

 Effective monetary reform demanded introduction of an independent Central Bank, which would not finance the state budget or help commercial banks. In 1992, some commercial banks were in crisis and asked government credits. The government decided to let them go bankrupt, thus making it clear for everyone that the government would not spend taxpayers’ money to help failed private businesses. This signal was understood, and today, Estonian banks are among the strongest in the region.

  This kind of restrictive monetary policy will lead to lower inflation, but production will fall at the same time. The fall in Gross Domestic Product (GDP) has been severe in all countries of Central and Eastern Europe. To overcome this and to make economies grow, each country must:

 ENERGIZE its economy and people. This may be the most decisive and hard task during a transition period. The most basic and vital change of all, however, must take place in the minds of the people. Without a major readjustment of attitudes, the post-Communist predicament would become a trap, and the nation would never move forward to become a “normal” country with a free government and free markets. In the era of Soviet imposed socialism, people were not used to thinking for themselves, taking the initiative, or assuming risks. Many had to shake free of the illusion — common in post-Communist countries — that somehow, somebody else was going to come along and solve their problems for them. It was necessary to energize people, to get them moving, to force them to make decisions and take responsibility for themselves. 

 To achieve this change, the political leaders had to "wake up the people." Primarily, competition has to be supported. From 1992 Estonia has abolished all import tariffs and has become one big “free trade zone.” Foreign competition pressed local enterprises to change and rearrange their production. At the same time Estonia lifted all subsidies, supports, and cheap loans to enterprises. Only two options were left - to die or start to work. Surprisingly lots of the entrepreneurs chose the second option, but around 30 percent ended in bankruptcy.

 To avoid huge unemployment, we decided first not to pay people huge unemployment support. We considered it better to support retraining and loans to start-up business. Government had to make it clear that if somebody works more and earns more, he will not be punished for this. A radical tax reform was introduced, sharply decreasing the taxation level and introducing a flat rate proportional income tax. Flat rate proportional income tax has worked very well in Estonia. The results of introduction of the flat tax are: 

 1) the tax-system is simpler and easier to understand both for taxpayers and tax-collectors. Taxpayers can easily fill their tax forms and avoid overly complex calculations and bureaucracy. Tax collectors can avoid a lot of unnecessary work and concentrate their efforts on those who are not paying taxes at all; 

 2) state budget revenues will increase.

  After the introduction of the flat tax, revenues of the state budget in Estonia started to increase very quickly. The Estonian state-budget moved rapidly to a surplus of more than 10 percent and it became necessary to pass two supplementary budgets during one year. One reason for this is that people started to report their income and pay taxes more honestly. In the mean time, tax collectors will collect them more effectively and as a result, the revenues will naturally increase. It is even more important that as people are having more possibilities to earn more money and decide for themselves what they want to do with it, family income and spending will increase and bring  more revenues from the VAT (value-added tax) to the budget. In the case of Estonia, VAT revenues have become the most important part of state budget revenues:

 3) Rapid increase in economic activity. The Estonian people saw that if they work more efficiently, they can earn more and as the government was not punishing the more successful, people's attitude changed surprisingly fast. Thousands and thousands of new small and medium-size enterprises, restaurants, hotels, and shops were established. In 1992, Estonia had in total about 2,000 enterprises. In 1994 the figure was 70,000. Estonia had turned a country of the working class into a country of entrepreneurs; 

 4) Unemployment decrease.  In 1992, one of the most serious problems facing Estonia was unemployment. As large, out-dated Soviet military factories went bankrupt, about 25-30 percent of Estonians lost their jobs between 1992 and 1994. Nevertheless, the official unemployment rate in 1994 was only 2 percent. Looking for possibilities to earn money, people decided not to wait for help from the government through unemployment support programs and established their own small businesses. The government supported this by providing long-term financing through a special fund. The rapidly developing private sector created many jobs and Estonia was able to avoid mass- unemployment.

 The main goal for a government in rapid transition is to create a simple, low-intervention business environment. First and foremost, this means the rule of law, and development of a justice system and courts. A large number of laws and modern legal codes have to be adopted to integrate transition countries into the modern world. The importance of rule of law is often underestimated, but the failure of reforms in Russia demonstrates very clearly where such mistakes can lead. 

 In order to speed up the change of people’s mentality, Western models of management and competitive relations were introduced in all spheres of life. Training and advice was welcomed and provided by experts from the IMF, the World Bank, and the European Council Phare program. Recommendations by these organizations in post-Communist countries have often been criticized, but Estonia has had mostly positive experiences from cooperation with these institutions. The mechanical adoption of their recommendations has been avoided, but certain principles have been strictly followed in economic policy and financing. 

 Additionally, domestic private initiatives were encouraged in all sectors. People who had received privatization vouchers for their years of work or as compensation for their nationalized properties were given the opportunity of using these vouchers for buying not only apartments, but also land and shares of privatized state companies. More than 200,000 claims for restitution of pre-1940 property were submitted by the April 1993 deadline. Previously underdeveloped sectors such as finance, tourism and all kinds of services grew rapidly. 

 The project of scaling back the overgrown state and getting people to step up to greater responsibility entailed the shifting of various public functions from the centralized state apparatus to local governments. It also entailed the fostering of non-governmental organizations, independent print and electronic media, local cultural activities, and national-minority institutions such as schools, churches and cultural groups. Ready to help those who showed a genuine readiness to help themselves, the government in many cases assisted in financing such efforts.
 As rapid reforms proceeded in 1993-1994, carried out by young politicians and supported by new businessmen (mostly young), a growing generational cleavage emerged. In general, younger people were successful and full of optimism, whereas older people felt unhappy and disappointed by the changes. As to be expected in a successfully reforming country, divisions between losers and winners in Estonia were creating the image that some social groups, such as middle-aged and older women and the inhabitants of certain regions or ethnic minorities, were destined to become losers. 

 In this situation, it was vital to begin with the creation of effective social, regional, and minority policies in order to avoid political backlashes and to soften emerging social barriers. In planning social reforms, the government preferred measures to increase knowledge in order to make better use of personal resources, rather than the more passive policy of money transfers. With help from Western countries, the government opened training centers in certain regions, mostly in those that were suffering from structural unemployment. By making business training available for the unemployed and expanding opportunities for young and educated people, the government hoped to stimulate self-employment and avoid the dangers of high unemployment predicted by many Western experts. Special efforts were made for the language and business training of the unemployed Russian-speaking youth in order to avoid their social exclusion. Changes were made in the scale of salaries in order to foster higher qualification and create incentives for higher education.

  Radical economic reforms created an urgent need for an improved social safety net. The most vulnerable groups, hit by the rapidly increasing prices of food and housing, were families with children, disabled people and pensioners. In the beginning of 1993, a new pension law was adopted, which abolished flat-rate benefits and linked pensions to one's length of service. In 1993, a poverty line was established, based on the calculated price of the minimal ‘food basket.' A system of means-tested social assistance, based on the poverty line, was implemented. Flat-rate benefits for families with children were changed into a differentiated system. Social and health insurance funds were separated from the state budget and their administration was improved in order to guarantee that the level of old-age pensions would increase with the rise of average wages and the funding of health care would be improved.

  However, many social problems remained unsolved or even worsened because of a scarcity of public resources, lack of political support, poor administrative skills, and underdeveloped infrastructure. The absence of a contribution-based social insurance system had created the illusion that it was the state's responsibility to find money for paying adequate earnings-related pensions. In 1993-1994, desperate pensioners organized several demonstrations and meetings, demanding that the suspended Soviet-era, earnings-based pension scheme be immediately re-implemented. However, it was unacceptable to raise the social tax in order to raise pensions, because this would have destroyed possibilities for an economic recovery. Pension reform can be introduced as one of the last big reforms, not as a first one. In Estonia a new modern insurance-based pension-system will be introduced in 2001. 

 To support economic development, it is important to PRIVATIZE the economy. Estonia has one of the best over all privatization records in transition economies. With three years, an estimated 50 percent of state-owned enterprises and business units were transferred to private ownership or control by the end of May 1994. True, Russia and the Czech Republic have moved even faster on privatization; their divestiture over the same time is almost 70 percent of the industrial sector, which would seem nearly miraculous. However, this privatization was mainly a transfer of controlling stakes of shares to insiders/workers and managers or privatization through vouchers distributed to the whole population. The question remains as to whether these new owners can or will undertake restructuring to the extent and at the pace required. Developments in the Czech Republic and in Russia have showed the seriousness of this problem. Companies with a large number of owners or owned by investment banks do not have effective management, new technologies or investments for reconstruction. In many cases they have failed or have become serious problems. 

 In contrast, Estonian ownership transfer does not emphasize payoffs to insiders (except for allowing a discount to insiders at small-scale auctions). Instead, Estonia has adopted a range of divestiture methods aimed at putting assets into the hands of those with the incentives and skills to use them wisely. The methods include: 

  • Restitution of homes, farms, and businesses expropriated during the communist periods. 
  • Auctions of small-scale business units. 
  • A tender process for medium-size and large firms thought to be of interest to foreign or domestic investors. 
  • Lease arrangements for parts or all of certain enterprises. 
  • Joint ventures, combining foreign private management and capital with government owned assets.
  • An active bankruptcy process, which liquidates insolvent, non-performing state firms, and turns the assets over to private entrepreneurs. 

A voucher program has also been introduced; voucher holders will be able to exchange these for shares in privatized firms, in investment companies that are being created, in housing, and in land. 

Over just two years, these efforts resulted in: 

  • 125 contracts signed through the tender process. 
  • Over 1,000 small business units auctioned off, representing about 85 percent of the small businesses originally designated for sale.
  • 340 leases for all or parts (sometimes quite small parts) of enterprises. 
  • 200 joint ventures. 
  • An estimated 300 bankruptcy proceedings (most of which are thought to deal with state-owned entities). 

Four tenders conducted by mid-May 1994 generated $63.4 million in sales proceeds (with more to come from signed contracts). Buyers contracted to invest more than $30 million in the privatized firms and to guarantee more than 14,000 jobs. Between 30 and 50 percent of sales through tenders went to foreign investors or to domestic purchasers with foreign partners or foreign financial backing. Very few of the privatized companies maintained more than 500 employees, and only two contracted to maintain 1,000 or more workers. Nonetheless, the tender program is quite important in a country of 1.5 million people. All in all 1997 saw the completion of the tender process. 

A program of trade sales of up to 20 large companies, supported by the European Bank for Reconstruction and Development (EBRD) was prepared at the same time. The idea was that the tender process had worked well for medium-size and smaller firms, but some larger companies require detailed financial engineering or the hiring-off of ancillary or social assets. The EBRD became the sell-side privatization agent for a group of firms, of which eight or nine was selected. The plan was to undertake a minimal amount of cleanup, and sell these companies within twelve to eighteen months. 

Yet another 20 large companies were privatized through a public offering, supported by the PHARE program of the European Union. The intention was not simply to privatize but also to promote the Estonian equities market, provide the first opportunity for citizens to trade privatization securities (vouchers) for shares of firms, and divest the state's portion of a group of existing joint ventures. The Estonian Privatization Agency (EPA) attempted to find a core investor to take a majority stake in several high-potential firms. The rest of the shares will be offered to the public, for vouchers, cash, or both. This method was later used to privatize large infrastructure enterprises, such as the main port, the state airline, and utilities such as telecommunications. 

Estonia combined the German Treuhand model with the Czech vouchers used in privatization. 
It must be highlighted that goal of the privatization is not to collect money for the state budget, but to move ownership of ill-managed state enterprises to private hands. We sold a number of  enterprises at a very low price, which guaranteed both investments and employment. Enterprises were sold by the Estonian Privatization Agency in open international auctions to one core-owner, privatizing minority-shares to people for vouchers. Privatization of industry has finished in Estonia with nearly 80 percent of GDP derived from the private sector. Today Estonia is moving toward privatization of infrastructure, hoping to finish this in 2000-2001. 

 As a result of these radical steps, the Estonian economy, in just one year after the start of the radical reforms, began to grow, and has one of the highest growth rates now one of highest in Central and Eastern Europe. But to achieve stable development we had to: 

MODERNIZE the country. To decrease the role of government of a country in transition one must have a strong and effective government. Effective government means small government. One of the first reforms of a new government must be to reform the government itself. In Estonia we decreased the number of ministries by a third. The Soviet administration was changed by representatives of the younger generation, those unspoiled by the Soviet past. Our slogan “clean house" meant the end of a system of decision-making based on personal relationships and political manipulations characteristic of Soviet times, but also continuing during the period of transition. Young politicians — the average age of my government was 33 years — and businessmen created a new vision of Estonia and Estonians. The Estonian people were presented with new perspectives, changing their national image: no longer members of a suffering, miserable and helpless nation, but of a nation capable of successful integration with the West. 

This new vision helped us to attract foreign investors to our country. Foreign investment will not only bring money to the country, but modern attitudes and technology, too. Technological change and an increase of productivity are crucial aspects to achieving stable growth. Foreign investments are not coming to a country that is politically unstable or non-democratic. They are not coming to a country looking miserable. In 1993 we launched a well-paid advertisement campaign to shape Estonian image as country needing “trade, not aid”. At the same time we guaranteed foreign investors the same rights - not more and not less - as local investors, including right to buy land. As a result Estonia has became one of the most successful countries by amount of foreign investment per capita in CEE. 

Foreign investment requires a stable environment that can be guaranteed only by the rule of law and a working court system. Producing the necessary laws is a crucial task for every transition government. It is very important to adopt laws that are not too complicated, otherwise they will not be implemented. Countries in transition don’t need highly paid Western advisers to work out the “most modern and progressive law in the world,” they need laws that work. 
Of course, these are only some aspects of the Estonian experience. But even with this, I believe I can predict what will happen to a government which implements such policies. You will become unpopular and will be ousted from power. But this is not important. More important is that your country will be changed beyond recognition. Looking back you can say: This was a dirty job, but someone had to do it. The train that you put in motion will not stop, and this is the only thing that is important. Only by doing this can you be sure that one day you can say: We are back.

Prime Minister of Estonia 1992-1994 and 1999-2002

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