Rushing to Capitalism, Estonia Trounces Its Ex-Soviet Mates

The career of Oleg Klyushin - a compact fellow with a crinkly eyed but reserved smile - is a case study in how, out of the 15 countries of the former Soviet Union, this tiny nation has forged the most successful path so far through the treacherous transition to market capitalism.

As director of Kreenholm Textile Factory, a monolithic Soviet state enterprise and one of Europe's largest textile plants, Mr. Klyushin for 15 years ran nearly every aspect of the lives of his 11,000 employees - apartments, schools, vacations, and their productivity at work. He answered only to Moscow.

But after the Soviet Union collapsed in 1991, 95 percent of Kreenholm's customers disappeared. Unsold cloth began to pile up in a local soccer stadium.

Similar massive enterprises are still staggering along all over the former Soviet Union from Moldova to Kazakstan. A Russian official acknowledges that fully half the Russian textile industry, for example, still needs to be "restructured" into a different business.

But Kreenholm has rebounded as a private company that, among other things, now supplies more than half of all the cotton diapers Gerber sells in the US.

With a strong arm, you could literally throw a yarn bobbin from the wall of the Kreenholm compound across the Narva River into Russia. But economically, Kreenholm operates in a different world.

Moscow no longer dictates to Klyushin, an ethnic Russian, whom he will buy from and sell to - or anything else. But he is no longer the local czar either. Now he is the director of one of six internally competitive divisions of Kreenholm, and he answers to ethnically Estonian corporate managers and the company's new private owners, based in Sweden. Kreenholm's revenue so far this year is up 52 percent over the same period last year - or 25 percent after accounting for inflation.

A European Hong Kong?

With privatization of the Estonian economy nearly complete, the country is emerging as what some call the potential Hong Kong of Eastern Europe. Since the 1991 breakup of the Soviet bloc, Estonia has ranked behind only the Czech Republic and Hungary in the level of foreign investment per capita.

Of Estonia's former compatriots inside the Soviet Union, all of whom embarked on their own different economic courses, only Latvia is even competing in the same league as Estonia.

Estonia's economy has grown at rates of 4 to 6 percent a year. By comparison, the Russian economy shrank by 14 percent in 1995. Ukraine, not long ago the breadbasket of the Soviet Union, has been in a much steeper downward spiral. Other relatively well-off regions from Georgia to Belarus have nosedived to a fraction of their Soviet living standards.

There are many reasons for the different outcomes in formerly Communist-run economies, but international experts and observers in Estonia say the reasons come down to the ideological choices each country made.

"There was a moment in time when the past was no longer relevant and the future wasn't defined," says US Ambassador to Estonia Lawrence Taylor. Estonia, he says, "seized the moment."

A tiny Baltic country with a population of 1.5 million - a third of them Russians who moved in during the Soviet years - Estonia had only 20 years as an independent nation before the Soviets annexed it in a pact with the Nazis just before World War II.

From the moment of independence, Estonia adopted a radical free-market approach. The model was the low-tax, low-regulation, low-safety net approach of Britain's Margaret Thatcher. Some of Mrs. Thatcher's top economic advisers, in fact, were Estonians.

Estonia now has no import quotas, no tariffs, a flat 26 percent tax rate on all corporate and personal income, a fully convertible currency, and a government budget that is balanced by law.

"[Estonia's] policies are so unambiguously market-oriented that [it] could soon have the most open economy and smallest government sector of any country on the European continent," according to economist David Hale of Chicago-based Zurich Kemper Investments.

He notes that foreign direct investment is already more than 10 percent of the country's gross national product, close to the record set by Singapore.

In 1992, Estonia became the first formerly Soviet country to create its own currency, the kroon, whose value it pegged to the German mark. This created a financial stability at a time when the value of the Russian ruble, for example, was plummeting thousands-fold.

The other critical choice that Estonia made was to adopt a different model of privatization.

In Russia, privatization has combined simple auctions of state firms to the highest bidder and a preference for the employees of the enterprise as buyers.

The result is that in Russia, as in many former Soviet countries, the privatized enterprises are owned and run by many of the same directors that managed them as state enterprises.

Privatization to insiders is "frequently just a delay of privatization," says Basil Zavoico, representative of the International Monetary Fund in Estonia. By contrast, the Estonian Privatization Agency sought outside investors.

But the enterprises were not simply sold to the highest bidder. Estonia adopted the German "Treuhand model" of privatization. The privatization agency negotiated with buyers for the best long-term benefit to the enterprise, its workers, and the Estonian economy.

In the case of Kreenholm, the Swedish textile company Boras Wafveri AB took control in January 1995 when it agreed to pay $25 million over 10 years for Kreenholm's assets. It also committed to investing a further $1.6 million in the enterprise within three years and to maintain the jobs of at least 2,000 workers for at least three years.

As it happens, the Swedish company has already put the required investment into Kreenholm, and the company's managers do not expect employment to ever drop below 4,000. Kreenholm has also managed to stay in the black.

Location, location, location

Policy choices are not the only reasons that Estonia is prospering relative to its formerly Soviet fellows. Its Baltic location and close ties cultural ties with Finland put it in the heart of prosperous northern Europe. Labor costs in Estonia can be a 10th of those in Germany or Sweden - one reason that cellular telephones that carry the trademarks of Finland's Nokia or Sweden's Ericsson are often assembled in Estonia.

Estonia was more prosperous than other Soviet republics even before independence. Russian analysts, and politicians in particular, explain Estonia's success in terms of its geography, its tiny size, and heavy Soviet-era investments in Estonia's infrastructure.

And while Estonia does derive benefits from Soviet-built port facilities and oil shale production facilities along the north coast, Western experts point out that the vast majority of Soviet investment was in what one calls "white elephants" - economically outdated factories, many of them defense-related. Further, the environmental costs of cleaning up the pollution from these factories, including radioactive wastes merely dumped behind earth mounds, is enormous.

A Russian institute, the Institute of Economic Analysis, divided the former Soviet countries into four groups earlier this year according to how radically or slowly they had approached economic reform. In the radical group were the three Baltic nations of Estonia, Latvia, and Lithuania. All three outperformed the other groups in measures such as economic growth and average wages. In general, the slower reforms were adopted, the worse the economic performance.

Most countries are privatizing in the Russian pattern and frequently have industries run by their communist-era managers.

The pace of reform in many countries is even slower and involves more state intervention than in Russia. Belarus still seems to be rolling back the steps it took toward market competitiveness. Its economy shrank by 22 percent last year, and average wages are half those of Russia and far below Estonia's.

But Estonia has also paid a price for its Thatcherism. Social supports are very low for the unemployed and pensioners, although unemployment is also relatively low at between 4 and 7 percent. Imports have clobbered Estonian agriculture, which is heavily taxed in most Western countries and faces double tariffs going into Russia, a primary market.

Farmers have formed political groups to represent their interests, as have pensioners and other interest groups. But the initial independence government here "blew away" such interest groups with free-market ideology, says Mr. Zavoico, and that pattern has held.

Kreenholm lost almost half its 11,000 employees in 1992, when it lost most of its Soviet-based customers. Since privatization, the payroll has dropped only slightly from 5,600 to 5,300. The company plans to bring it down to 4,000 in the next year. But some attitudes have yet to change, even at Kreenholm. The workers still don't understand why the company sold the vacation cottages instead of giving them to the workers, says financial director Mai Palginnom. And when their banks change their policies, they still complain to the company.

Ms. Palginnom says the prevailing attitude of workers shows they still see their world as it once was - run by the Soviet economic dictum "Our customers must buy from us. They must!"