Estonia’s potential growth revisited

Abstract

There have been several data revisions to output statistics in Estonia during the past six years as methodologies have been harmonised. These changes are significant enough to require corrections to the earlier understanding of Estonia's potential economic growth rate. In this paper the latest data vintage from 2009 is used to estimate Estonia's potential output growth and output gap. The production function approach that has been used shows that the gap varies quite extensively, ranging from -8% in 1999 to +8% in 2007, while the average potential growth rate in 1997-2009 was around 6%. The macro model simulations expect the potential growth rate to fall in the future. The fall in the marginal productivity of production inputs makes growth slow to about 4-5% in the next five years, if there are no additional shocks to the economy.

Macroeconomic effects of zero corporate income tax on retained earnings

“…These benchmark parameter values provide a steady state that characterises the actual economy quite well. The share of consumption in the economy is 55%, which corresponds to the actual pre-reform share of 54%; the share of investments is 25%, which corresponds to the actual 25%; and the capital output ratio at around 2.1 corresponds to estimations by Kattai (2010) for 2008 and is higher compared to estimates of the pre-reform period 8 . The open economy case means lower consumption and current account deficit to the economy.…”

“…Calibration of models entails many difficulties as Statistics Estonia does not publish data on capital stock and there have been many revisions of the national accounts data, changing GDP and the growth pattern of its components considerably (see, for example, Kattai, 2010, for a more detailed discussion of these matters). Table 1 presents the parameter values for the benchmark estimations.…”

“…Given that in the long-term forecasts for Estonia wages are expected to grow faster than productivity (European Commission, 2009), the labour share is expected to increase and the capital share to decrease. We proceed from a capital share of 0.4, which has also been used earlier for Estonia (see, for example, potential growth rate estimates by Kattai, 2010). This share is higher than in high-income countries, but is a reasonable forecast for the long-term.…”

“…Due to the decreasing marginal product of capital, the increase in output was lower, 4% according to neoclassical models and 3.6% according to the model with endogenous corporate finance. This growth effect took place at the cost of allocating resources from consumption 8 Kattai (2010) estimates capital stock by the perpetual inventory method, which is usually more imprecise at the beginning of the estimation period and depends heavily on calibration of initial capital stock. He sets the initial capital output ratio to 1.05 in 1996.…”