“Latin Americanization” of the Estonian economy: institutional analysis of financial fragility and the financialization process

Abstract

By drawing on the tradition of institutionalism and the Minsky–Kregel framework on sovereign financial systems, the paper discusses the nature of and the institutional factors behind financial fragility in Estonia within a wider financialization phenomenon. The study reveals the emergence of two interrelated manifestations of the financialization process in Estonia in the form of increased international inequality in favor of foreign actors, accruing from cross-border investment activity, and higher debt burden of the household sector against the accumulation of savings in the economy as a whole. Institutionally, these developments have been supported by the embeddedness of the Washington Consensus policies. Given the lack of intervention in the economy by means of either prudential capital account controls or specific foreign direct investment policies, the result has been a heavy reliance on foreign capital in both the financial and nonfinancial sectors. Furthermore, the privatization process and recurring banking failures associated with the transition process have created a particular historical context in terms of institutional arrangements and idiosyncratic elements that laid the groundwork for deteriorating internal and external imbalances in the economy.

Key words:

• financial fragility
• financialization
• foreign direct investments
• institutions
• transition economies

Notes

¹Theoretically, external financing can contribute to sustainable development by financing investments in competitive manufacturing export industries through balanced growth with the establishment of backward and forward demand linkages that would improve the balance of payments position and ensure a long-term debt sustainable development pattern (Kregel, 2004, pp. 11–13).

²The high degree of financial liberalization in terms of capital account and financial sector liberalization was an essential part of the process of accession to the EU. In particular, the signing of the Europe Agreement in 1995 and the Free Trade Agreement with the EU in 1994 required external liberalization in terms of opening its financial markets to foreign banks and financial institutions after 1999 for further integration. The Europe Agreement stipulated that Estonian and the EU’s credit institutions had the right to commence their activities in each other’s territory on equal terms with domestic credit institutions. One of the core provisions was the free movement of payments, investments, and other capital and also the obligation that Estonia will not impose restrictions on the movement of capital (Eesti Pank, 1996).

³The privatization process in the early 1990s was deliberately targeting foreign investors by implementing the Treuhand model, that is, selling state-owned assets to strategic investors, which explains the key role of foreign investors in the privatization process and high FDI inflows (OECD, 2000; Purju, 1996).

Additional information

Notes on contributors

Egert Juuse

Egert Juuse is junior research fellow at the Ragnar Nurkse School of Innovation and Governance, Tallinn University of Technology. The research leading to these results was supported by funding from the European Union Seventh Framework Programme (FP7/2007-2013) under grant agreement no. 266800.