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The following OECD assessment and recommendations summarise chapter 4 of the Economic Survey of Estonia published on 20 April 2009.
Enhanced flexibility of labour markets is the key to timely recovery and long-term growth
In the past several years, overall labour market outcomes were favourable unemployment declined and employment rates increased, including among women and older workers. At the same time, large regional differences have persisted and outcomes for low-skilled and young workers have improved only marginally. Moreover, skill and labour shortages have led to wage increases above productivity growth. More flexible labour markets, including wage growth reflecting labour market conditions and productivity gains, will be needed for re-employing laid-off workers in more knowledge-based export sectors. The importance of labour market flexibility is further underscored by the goal of adopting the euro in an environment of low, albeit increasing, synchronisation of Estonia’s business cycles with those of the euro area. Barriers to internal mobility such as relatively underdeveloped job search programs or high tax wedge on labour that would prevent labour reallocation into more productive activities across occupations, sectors, and regions thus need to be removed.
The recently adopted Employment Act combines lower employment protection with higher income replacement in case of unemployment…
The new Employment Act combines deregulation of the employment protection legislation (EPL) against higher unemployment benefits. The very comprehensive Act reduces both the notice period and the amount of severance payments for regular contracts, thereby making Estonia’s EPL restrictiveness comparable to Central European OECD members. Furthermore, the severance payment obligation will be shifted from employers to the Unemployment Insurance Fund thereby lifting liquidity constraints on SMEs. However, the changes to the unemployment benefit scheme increase the initial benefit/wage replacement rate and de facto prolong the period during which the benefit can be collected, therefore discouraging job search. To shorten the search period, it would be preferable if benefit recipients start receiving the unemployment benefit immediately after being laid off. Furthermore, active labour market measures should give more priority to supporting job search. Conditions for active job search should be adjusted such that swift re-employment is facilitated in order to avoid putting the sustainability of the unemployment insurance system in danger. To encourage labour mobility further, Estonia could also consider replacing the severance payment system with a compulsory, transferable saving scheme, such as the one recently introduced in Austria.
In addition reductions of labour costs are needed
To prevent the emergence of a high unemployment trap, active job search requirements should be stepped up, with effective sanctions imposed for non-compliance. In other countries, well-designed and targeted measures geared towards engaging workers in job search and reducing search cost have mitigated the disincentives stemming from changes in the unemployment benefit system and have improved unemployment outcomes. Strategies combining job search with selective training programmes seemed to have the greatest impact. Over the medium term, the incentives for firms to create jobs could be further enhanced by reducing the relatively high social security tax and replacing it by less distortionary sources of revenue, including on consumption and real estate.
Finally, to enhance flexibility of labour markets and maintain the competitiveness of the economy, increases of both minimum and public sector wages should reflect productivity gains. More specifically, outside economic expertise could be used in the negotiations between the trade unions and the employers’ confederation as a means to de-politicise the process.
Ethnic non-Estonians and migrant workers should be better integrated
Labour market performance of non-Estonian ethnic minorities, who represent a significant portion of the total population, depends to a large extent on language capacity and has been lagging behind for a large part of this group. Progress in this area is uneven. Important differences remain between the two main ethnic groups. Ethnic non-Estonians have also exhibited markedly worse social indicators than ethnic Estonians, a difference that has widened since independence. Better integration of ethnic non-Estonians into the economy is thus an important challenge.
The income and employment opportunities of ethnic non-Estonians seem to be strongly determined by their command of the Estonian language and language competence is also crucial for obtaining Estonian citizenship. The policies aiming at better integration of this group should therefore expand Estonian language and professional training (including the use of the Internet) for the considerable non-Estonian segment of the population. The work permit process for non-EU foreign workers could be simplified further.
How to obtain this publication
The complete edition of the Economic survey of Estonia is available from:
The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations.
For further information please contact the Estonia Desk at the OECD Economics Department at email@example.com.
The OECD Secretariat's report was prepared by Zuzana Brixiova and Laura Vartia under the supervision of Andreas Wörgötter. Research assistance was provided by Margaret Morgan.