After regaining independence Estonia adopted the principles of a market economy. Policy makers eliminated most controls over prices and production levels, liberalized international trade, and privatized industries, financial and service institutions, and dwellings. Labor, capital and goods are now Tree to move within the country and across its borders. As a consequence, the nation's productive structure has experienced drastic change. Some sectors are prospering and expanding while others are collapsing; new professions are being created and others are struggling to adapt themselves to the new realities. In good measure, this kind of process is necessary so that the country will reallocate its human and financial resources to the areas in which they can be most productive. Nevertheless, it has been a harsh process for many.
Social roles and responsibilities have been altered. The system of economic and social status has been profoundly changed. Previously, rewards and status were conferred mostly conspicuously on those with skills in the areas such as public administration, science and technology. Now those fields arc rewarded relatively less, and entrepreneurial skills and other business-related abilities reap the greatest returns, particularly in the service-related sectors. Now hard work can bring greater benefits to individuals and families, but that is not yet true in all sectors. Persons in some occupations face heightened economic uncertainty. Undoubtedly most of the basis for the nation's future prosperity has been laid, and Estonians generally understand that the transition requires time, but still for many persons the nature and extent of the changes are greater than anticipated. This has been especially the case in agriculture.
This profound transformation has been underpinned by an extensive overhaul of the nation's legal system, a process which still is underway. Estonia's deep commitment to restructuring its economy and institutions has been recognised internationally, and it was rewarded recently by preliminary acceptance of its candidacy for membership in the European Union, a milestone which augurs well for the nation's future prosperity and stability.
While many positive and dynamic forces have been unleashed in our society by these changes, agriculture's role still has not been defined in the new economic order. The economic strategy followed to date has been basically a macroeconomic strategy. The country does not have a comprehensive agricultural strategy or policy for agricultural growth and development in the new economic context. As a consequence, many important questions about agricultural choices and . policies remain without a satisfactory answer.
This document, the product of a long and extensive consultative effort in Estonian rural circles, attempts to fill this void, to assist in defining the role of agriculture in the new economic system and to specify possible policies which can help it fulfill that role successfully. Agricultural policy-making is a dynamic process, especially in a transition situation such as the present one. Therefore the main purpose of this Strategy is to stimulate discussion of objectives and policy options in that process. No document can provide definitive solutions to all issues in a sector, but it is hoped that the information and analysis contained in this Strategy, as much as the proposed solutions to problems, will stimulate further reflection and will contribute to a better-informed national dialogue on agricultural policy issues.
A National Agricultural Strategy necessarily arises out of the economic, social and political context of the country. This organic relationship has been recognised in the formulation of the objectives of the Strategy. By the same token, if it is adopted and implemented by decision-makers, a Strategy for a major sector such as agriculture can contribute to the continuing evolution of that context.
From the viewpoint of designing sectoral policy, the most relevant aspects of the economic policy framework in Estonia today are: a) the commitment to a generally liberal economic policy, which in fact is considerably more liberal than the OECD norm in the area of trade policy; and b) the rapid and continuing realignment of relative prices and incentives within the economy, in favor of the service-related sectors and against manufacturing, mining and agriculture. Together, these two factors are driving a sharp restructuring of the economy and a reallocation of productive resources among sectors and lines of production. As a result, notable increases in economic productivity and output have occurred in some sectors and enterprises while others find themselves making losses and struggling to survive.
As commented above, agriculture is one of the sectors most adversely affected by the changes to date. This is demonstrated by the lack of profitability of many agricultural activities, the drastic decline in its output, the sharp deterioration of the agricultural trade balance, and the lack of interest in cultivating large expanses of agricultural land in some regions of the country.
Agriculture also is a sector in which the process of liberalisation itself remains incomplete in significant respects, particularly in the area of land markets and the structure of enterprises. Also, as noted in Chapters 6 and 8 of this Strategy, the transition process itself has been incomplete in regard to restructuring farm support services and rural social services. Nevertheless, agriculture has undergone a sweeping transformation and that process is continuing.
The social context of the Strategy is dominated by a realization that Estonian society is now undergoing a rapid evolution, alongside that of the economy, with both positive and negative trends. Recent experience has included:
Increased scope for expression of the national culture and character,.
Increased individual freedoms and the potential for personal fulfillment which that trend represents.
Greater potential for individual economic advancement.
Greater opportunities to have contacts with societies in the West.
Losses economic welfare of those families which are affected by the economic restructuring, especially in rural areas, at a time when programmes to support the poor generally have been reduced.
Concern over social problems in both rural and urban areas that have arisen in part from the combination of increased individual freedom and economic dislocation, problems such as crime, alcoholism and family violence.
The emergence of problems concerning nationality and language in some regions of the country.
A low national fertility rate and a high rate of emigration.
The special problem of loss of access to some high-quality institutions of higher education in the former Soviet system without, as yet, provision of fully satisfactory alternatives.
The most relevant aspects of the political context, for the National Agricultural Strategy, may be the strong and palpable national desire to consolidate the country's independence, and the associated aim of diversifying and strengthening economic, political and social links with many countries, especially but not exclusively those in Western Europe. A second relevant political factor is the fact that Estonia is still in the process of defining what is the most appropriate role of the Government in the society and in the economy. The Strategy and its implementation can make a contribution to this process of definition of the role of Government.
This Strategy marks an effort to bring both technical expertise and the opinions of the rural population to bear on questions of agricultural policy. The work has been coordinated by the Ministry of Agriculture, and technicaJ experts from the Estonian agricultural University, the Institute for Agrarian Economics, the Estonian Fisheries Bureau, the Marine Research Institute, the Land Board, and the Ministry of Agriculture itself, provided the technical expertise to develop much of the framework for the Strategy. These experts were organised into ten national task forces comprising about fifty persons in total.
A Project Steering Committee, under the chairmanship of the Ministry of Agriculture, guided the work, to ensure consistency among the task forces and to be sure all. relevant issues were addressed. Advisory assistance for the work was provided throughout the project by the FAO.
Four of the ten task forces based their work in part on extensive consultations with farmers, fishermen, entrepreneurs and the rural population in general, and two of them carried out detailed surveys. In the case of one task force, hundreds of rural citizens were interviewed in focus groups.
Another kind of consultation was carried out in the form of two workshops held during the period of development of the Strategy, and a few representatives of farmers' associations and of Parliament attended those workshops. It is anticipated that farmers' associations and the public in general will have a wider opportunity to comment on the Strategy as it is circulated in draft form.
Thus, the participants in the development of this document have striven to make it a truly Estonian effort, to reflect nation-wide concerns, priorities and preferences for avenues of solution to problems. At the same time, care has been taken to make it a technically sound document, for policies must be soundly based if they are to really solve problems without creating other problems in their wake, and in order for the solutions to be lasting in time.
In a context of such rapid and not always predictable change, strategic objectives cannot be stated as quantitative goals but rather must express the principal directions in which policy should encourage the rural sector to move. They may be accompanied by a list of principles which also will guide the formulation of policy and will govern the way policy instruments are utilised.
In the final instance, economic policy responds to a social and political vision and helps promote the achievement of societal aims that are not exclusively economic in nature. Therefore the Strategy must begin with an enunciation of overriding social, or societal, goals for the agricultural and rural sectors, and then posit the economic objectives required to support those goals.
Another basic consideration is that objectives must be carefully separated from means, for the sake of clarity in specifying both. For example, the Development Strategy for the Rural Economy. elaborated in 1995, adopts as one of its objectives “promoting the development of competitive enterprises, efficient market structures and international trade relations.” While these developments undoubtedly would be desirable, they are most logically viewed as means of achieving broader goals such as improving the rural standard of living. The overarching goals of a strategy, or its basic objectives, should be expressions of the general desire to promote human development.
Fostering more efficient market structures and other steps mentioned in the above-mentioned document are recommendable because they improve the productivity of the labour force and therefore its earning power. Consequently they improve the population's material standard of living, which is an important factor in human development, but they are not final goals in themselves. Enshrining such steps as goals would be logically equivalent, for example, to stating that a basic goal for programs in the transportation sector is to build technologically sound and cost-efficient bridges, when in reality the goal is to reduce time spent in transit on highways, and the bridges are means toward that end.
If certain means are felt to warrant special emphasis, :hen they can be identified as subsidiary objectives, but in that case the hierarchy of objectives always must be borne in mind in order to elucidate their relationship to the operational means, which are policies and programmes for implementing policies.
In this regard, it also is essential to distinguish between means that are in the hands of decentralised decision makers (e.g., producers, marketing agents) and means which are available to the Government. The former are not in the Government's control and therefore must be influenced indirectly by instruments of policy. A classic example involves the role of agricultural production. Increasing production obviously is an important means (although not the only one) for increasing rural incomes, but it is not an instrument of policy. On the other hand, policies and programmes to support production are numerous, including investment in infrastructure, policies and programmes to enhance rural financing, farm support services, and policies that influence farmgate prices.
Prices are another major means for influencing levels of producer income, but again they are not subject to direct control in a market economy. To do so prevents prices from adjusting in response to variations in supply and demand and introduces distortions whose economic harm usually is greater than any direct benefits from the controls. Nevertheless, as will be discussed further in this document, major policy instruments arc available that strongly influence prices and their relative levels among sectors. Therefore production and prices can be said to be major concerns of policy, and development of a successful strategy requires identification of viable policies (means) that can influence those elements to move in the desired directions.
The attached Figure I provides a schematic illustration of the relationship between overall objectives, subsidiary objectives, decentralized means (decentralized decision variables), and Governmental means (policy instruments).
In the first seminar of the project for a National Agricultural Strategy,1 the opening speakers underscored the consensus that the Strategy should not be narrowly agricultural in scope but rather should deal with the concerns of the ruraJ population as a whole.2 This orientation implies developing policies for productive sectors other than crops and livestock. Such sectors would include forestry, coastal fisheries and agricultural service suppliers, among others. It also implies dealing explicitly with social issues faced by the rural population in this time of transition. Agricultural production clearly is the economic foundation of the rural population's well-being, but the Strategy must deal with 2 broader set of issues. It also must link rural policies with the macroeconomic framework.
1 September 3 and 4. at the Estonian Agricultural University in Tartu.
Figure 1. Goals and Policy Instruments in an Agricultural Strategy
Reviewing past policy documents, it appears that three principal objectives represent the principal concerns for policy makers for agriculture:
Improving the rural standard of living and quality of life, including providing an adequate social environment, striving to achieve approximate equality with urban areas in these respects.
Reducing the trend toward depopulation of some rural areas, especially the border regions.
Ensuring a degree of food security for Estonia.
The second objective derives in part from the political context, and also from a deep-seated conviction that Estonia should utilise all of its productive resources, of which land represents the most abundant endowment. It can be argued that fulfilling the first objective adequately also would lead to fulfilling the second one. Accordingly, they could be combined into a joint objective, which might be expressed as follows:
Broad Objective No. 1:
Improving the rural standard of living and quality of life in all regions, including providing an adequate social environment, striving to achieve approximate equality with urban areas in these respects.
For this objective, or both of the first two objectives in the preceding list, increases in real rural incomes and their purchasing power and important means. They are necessary but not sufficient conditions for satisfying the objective(s).
Care must be taken in interpreting the objective of food security, for it has the potential to be contradictory to the first broad objective stated above. In all regions of the world, it is increasingly recognized that national food self-sufficiency in the physical sense has little relation to national economic development or to access to food by a nation's citizens. There are rich countries that import much of their food (Switzerland, Japan, Norway), owing to the nature of their resource endowments. In fact, most countries both export and import food products. Although agricultural prices fluctuate on world markets, it always is possible to import the necessary amounts to make up a shortfall in domestic supply.
Pursuing to an extreme the objective of national food self-sufficiency could actually lead to reductions in rural incomes. For example, it could be taken to mean that Estonia should lower its output of dairy products, reducing correspondingly the export of those items, and devote more land and labor to producing wheat, in order to replace the imports of that cereal. This would result in a net loss of foreign exchange to the country: per hectare of land used, exports of dairy products Generate more foreign exchange than would be saved by an additional hectare of wheat. It would also reduce rural incomes, since on average dairying is more profitable (or less unprofitable) than wheat. This is an example of the operation of the law of comparative advantage
As household incomes rise the progressive diversification of consumer tastes also can make it more difficult to attain national food self-sufficiency, since demand for products like sugar, coffee, rice and bananas may grow.
In reality, from a viewpoint of national interest the main role of food production is providing a source of incomes for rural people. This is an important role in itself, as raising rural incomes already has been stated as a principal means, or subsidiary objective, for attaining the first broad objective of the Strategy.3 Nevertheless, it should be recognized that there are uncertainties in the long-run projections of world food supplies, and therefore to be on the safe side Estonia may wish to pursue a moderate degree of national food self-sufficiency. The figure of 70 percent sufficiency has been adopted elsewhere, and the caveat may be added that comparative advantage be respected.
Another expression of the food security objective derives from acknowledging the role of agricultural products in supporting Estonia's balance of payments. In concrete terms, the goal can be established that the net trade balance in agriculture not be negative. Historically it has been strongly positive, but it has declined precipitously in recent years and now is negative.
Hence the second broad objective of the Strategy may be stated in the following way:
Broad Objective No. 2:
Achieve at least 70 percent national food self-sufficiency, and maintain a positive net balance of external trade in agriculture, provided that achieving these benchmarks docs not lead to farmers abandoning more profitable lines of production for less profitable ones.
These are the dominant goals of this National Agricultural Strategy; Earlier agricultural policy documents also contained references to supplying the population with foodstuffs at “affordable prices.” Although statements of this nature are sometimes used in agricultural policy documents, careful reflection shows that they can undermine the pursuit of the other objectives stated above. First of all, food prices in Estonia already have declined considerably in relation to non-food prices in the last four years, to the detriment of the economic well-being of rural families. In order to try to reduce the gap in incomes that has emerged between urban and rural areas, it would be important to pursue policies that raise agricultural prices relative to other prices in the economy. Raising relative agricultural prices also is one of the requirements for reversing the decline of agricultural output that has occurred in recent years.
For this reason, it is not appropriate for an agricultural strategy document to adopt as a major objective the maintenance of low levels of food prices for urban populations. Of course, poverty exists in urban areas as well, but it can be most effectively addressed through targeted programs of food assistance, rather than through the generalized subsidy to urban households of all income levels that is implied by holding down agricultural prices. In light of the fact that rural poverty appears to be more extensive and severe than urban poverty at present, holding down agricultural prices constitutes a regressive subsidy, in the sense that it benefits the population which on averge is better off (the urban population) and penalizes the one that is worse off (the rural one). Also, it is an inefficient subsidy, for it benefits all income strata rather than only the poor households. Therefore it is more costly (to the welfare of farm families) than a targeted food subsidy is (to the Government budget). Thus, it can be seen that it is way of shifting a cost out of the Budget to that population which can least afford to pay it.
An objective is not enough to guide the development of a Strategy, even if it is accompanied by a clear statement of subsidiary objectives. It also is necessary to develop a set of principles which will guide the development of policies. In other words, the overall objective will not be pursued at any cost, or at the cost of policies which have significant adverse effects in other areas.
In the present context, the main examples of such principles would be the following:
The policies and programmes that provide assistance to the rural poor will do so in a framework which encourages them to help themselves; i.e., in a way that puts them on a self-sustaining growth path of their own, so that eventually they will not be dependent on assistance from others.
That agricultural policies will not aim to promote agriculture only, ignoring the possibilities for development offered in other sectors of the economy, but rather policies shall be oriented toward ensuring that agriculture is not an economic parasite on the rest of the economy, and neither is it exploited by the other sectors in the economy. This is a concrete expression of what is meant by adopting a balanced view of the role of agriculture in the economy.
That the institutional arrangements made for the agricultural sector shall be sustainable in the long run.
That environmental sustainability shall be pursued as an integral part of the Strategy.
That fiscal sustainability shall govern the policy recommendations. That is, expenditure policies shall be conditioned by the budgetary realities and where new levels of outlay are required, the corresponding sources of funding shall be developed in the Strategy.
These principles for the Strategy also may be called its policy conditions, for in effect they represent conditions on the kind of policies that may be adopted under the Strategy. Together with the overall objective, they provide the necessary normative framework for development of appropriate policies for the sector.
The bulk of the technical work on this Strategy is devoted to the identification of issues and supporting objectives at a more microeconomic level, and then the formulation of policies to achieve those objectives. In order to do so, one more piece of broad guidance is needed: a specification of the principal optional policy orientations, or alternative scenarios, that are to be considered and evaluated at a sector-wide or macroeconomic level. This topic is taken up in Chapter 2.
The remainder of this chapter provides a brief summary of each Chapter's principal findings, analysis and recommendations. The summaries are necessarily concise, and so the reader interested in particular topics is urged to consult the corresponding material in the other Chapters, where a wide range of information and analyses is provided.
The 1990s have been a period of decline in production, real incomes, and real prices4 for the agricultural sector. In 1995, total output in the sector stood at 53% of its 1986 level, and 63% of its 1991 level. Producers' income fell along with output. Official statistics show that real agricultural GDP declined by 24% between 1992 and 1995, and other evidence points to a sharp fall in this concept between 1991 and 1993. The real agricultural price index, which measures the purchasing power of farmers' output, with respect to all goods and services in the economy, declined by 40% between 1992 and 1995. Related to these trends, the agricultural trade balance, which historically was always strongly positive, has turned negative in recent years.
Review of past and current policies for agriculture shows that while the sector was, in effect, highly subsidised by policy in the previous economic regime, it now receives less economic support than the agriculture of any OECD country. In fact, the net subsidy it receives now is slightly negative, whereas in the OECD as a whole, the average subsidy for agriculture is 41% of the price level.
It is recognised that not all farmers and types of production will be able to make a successful transition to the market economy. As a rule, those who succeed in dealing with the profound changes in the policy environment, and those products which continue to be produced, will be the more efficient ones. For the long run, surely this will be a healthy outcome. The sector's representatives understand that it is imperative to become more efficient in order to be able to survive economically. Indeed, in a very fundamental sense this Strategy can be regarded as a programme for overcoming the structural problems in all areas of the sector and making it more efficient. The efficiency goal is not doubted.
However, policy has wide latitude in determining the threshold between “efficient” and “inefficient” enterprises and activities. It is analogous to setting the height of the bar for high jumpers, in order to determine which athletes qualify for further rounds of competition. Setting the bar high means most of the producers will fail, and setting it lower allows more of them to continue.
In general, EU countries have set the bar rather low for agricultural producers, compared to other countries in the world. Initially through tariffs and controls on prices and trade, and increasingly through direct support measures, the European countries have decided to adopt a rather generous interpretation of what is an efficient operation in agriculture.
Estonia probably has set the bar higher than any other country, for its farmers. To date, it has no direct support measures, no controls on prices and trade, no tariffs to speak of, and a real exchange rate which penalises exporters and favors imported products. It is hard to identify another country which has created an environment of macroeconomic and trade policy in which it is so challenging for farmers to survive economically. In addition, this policy has been carried out at a time when the sector's institutions still are struggling to complete its transformation from a planned economic regime to a market economy, particularly in the areas of land tenure policies and farm support services.
Therefore a major policy issue with respect to the agricultural sector is: Where is the threshold of efficiency to be set? In practical terms, this means: What are the most appropriate policies for tariffs, direct support and the exchange rate? This Strategy is a forward-looking document, and its goals are to create an Estonian agricultural sector which is robust and capable of surviving under varying international circumstances in the future. Therefore, it does not advocate a protectionist policy that will create inefficiencies and a lack of competitiveness. However, given that Estonia plans to join the EU, a logical question is whether modest tariffs and a programme of direct support (known as the McSharry Plan in the EU) are not appropriate. Equally, if the balance of payments trends are suggesting that the exchange rate policy is not sustainable in the long run, is it wise to maintain it in the short and medium run, given that it makes it very difficult for the agricultural and manufacturing sectors to compete on world markets, and to compete with imported products?
The principal policy objective of price and trade policy is to improve the economic incentives for agricultural production, including fisheries and forestry, within the framework of balanced growth for all sectors on the economy. It is not expected that all of the decline in incentives since 1992 can be recovered, but some of it should be. The economic trends of recent years, which have been wholly in favor of the service sectors and of urban consumers, must be changed. Neither are special privileges sought for agriculture. A more appropriate balance in our economic growth pattern should be the national goal for economic management.
The broad objective for this Strategy is to improve the quality of life in rural areas. This goal has acquired greater national urgency, since poverty and its associated problems have worsened particularly in rural areas. Within this context, the role of macroeconomic policies is to establish a framework in which farming can become more prosperous, without going to the extreme of some countries in terms of measures which are very costly to the government budget or which produce very high food prices for consumers. With a modest improvement in incentives and with better supporting programmes, Estonian agriculture can realise its very considerable potential.
The most basic question to be answered about agriculture is whether it has the potential to be competitive vis-a-vis world markets in the future. The currently high agricultural prices within the EU are likely to be reduced, and the abnormally low international prices for many commodities are likely to rise as a result of further rounds of international trade negotiations. Therefore long-term trends in international prices will become increasingly the benchmark against which the costs of production in Estonia should be measured.
If analysis of cost structures were to reveal that Estonia does not have the potential to be competitive (a comparative advantage), then it could be concluded that the present governmental policies of promoting almost exclusively the service sectors are correct. But if it is determined that indeed agriculture does have the potential to survive and compete in an international framework, then corrective policies should be put in place.
Recently an analysis of the comparative advantage of Estonian agriculture was carried out for 15 products on the basis of price and cost data for the years 1994 and 1995.5 A cautionary word should be mentioned in the sense that results of this kind for only 2 years can sometimes be misleading, and also there always is a margin of error in the calculations. Nevertheless, for most products, the results are sufficiently clear that they probably can serve as guides to policy.
Of the 15 products analyzed, 11 have a clear comparative advantage. It is strongest in pulpwood, sawlogs, sawnwood, potatoes, barley, oats and sprat and herring, but it also is very significant in wheat6 and plywood. These calculations confirm what many agricultural experts have said, that Estonia has definite long-run potential in these products, some as export lines and the grains as substitutes for imports.
The results for milk show a decided comparative advantage as a substitute for imports. In the case of exports, the results were mixed due to fluctuations in world market prices, but the average result for 1994 and 1995 also indicated a comparative advantage. If world market prices were to rise as a result of a negotiated reduction in subsidies to dairy farming in other countries (Table 2–4), then Estonia's comparative advantage in milk would be even clearer. More generally, taking into account the presence of heavy international subsidies in dairying, vs. none in Estonia, it can be said that Estonia has a strong comparative advantage in dairying in the truest sense.
To held realise the potential inherent in Estonian agriculture's comparative advantage, the three most favourable policy options analysed in Chapter 2 are the following:
Macroeconomic policy that promotes, via better incentives, agriculture and manufacturing in all branches; this will be called macroeconomic policy to promote the productive sectors.
Policy that shields the industries and products that face competition from imports, but not the exporting industries and products. This will be called policy favoring import substitutes.
Policy that directly compensates all agricultural activities for part of the cost of the present policy; this option may be termed a compensator)' policy for agriculture.
A summary of each of these options is as follows;
Option 1: Macroeconomic policy to promote the productive sectors
This policy basically would consist of devaluations of the nominal exchange rate in order to correct part of the excessive appreciation of its real level. Most countries in the world allow exchange rate corrections to take place when their inflation persistently exceeds that of their trading partners. This policy does not assume that the goal of fixing the exchange rate with respect to European parities is invalid in the longer run; on the contrary, that goal would be consistent with the stated intention to join the European Union. The question is whether, in retrospect and in view of the unexpectedly high cumulative inflation that has occurred since June of 1992,7 the fixing of the nominal exchange rate has not proven to be premature. Finland, which has a considerably higher income level, fixed its rate only after letting it float for four years, and even so there is a strong national debate on the issue, in light of Finland's 17% unemployment rate. It should also be recalled that some experts consider that Estonia delayed its devaluation in the early 1930s too long, to the great detriment of employment and income levels in the productive sectors and the economy as a whole.
Therefore this policy scenario would involve progressive devaluations of the exchange rate8 for a period of a few years, and then fixing it anew when both domestic prices and the exchange rate have more or less stabilised. The cost would be a slower rate of decline of inflation, i.e., more time required to achieve full price stability. But with a low Government budget deficit (currently around 2% but scheduled to fall to zero), which is very much in Estonia's favor, the inflationary consequences of devaluations are transitory and proportionately less than the devaluations themselves. Ultimately, both price levels and the exchange rate would stabilise at a new, higher level.
The advantages of such an approach to policy would include: higher real prices for agriculture and manufacturing (and therefore for agroindustry also), higher output and income growth in those sectors, higher employment growth in those sectors, and less rural poverty. Service sector growth undoubtedly would slow somewhat, but international experience has shown that the net effect on the economy's growth would be positive.
This policy option could also be called the one of maintaining Estonia's international competitiveness, because it would give additional price incentives to Estonian exporters and to those sectors and subsectors that compete against imports. It would strengthen Estonia's comparative advantage. Viewed in this light, in effect the present national policy has conferred an economic advantage on producers in other countries., although that was certainly not its intention. This is a serious problem, because given the small size of Estonia's domestic economy, it must expand its exports rapidly in order to grow and prosper.
It should be underscored that this policy option would maintain fully Estonia's commitment to a liberal economy. It would preserve the free trade policies and confirm the lack of protectionism, and it would serve to dampen the calls for fiscal subsidies to agriculture, by virtue of increasing agriculture's profitability. While it would represent a departure from the fixed nominal rate of exchange, it would move to stabilise the real rate of exchange and in all other respects would maintain the guidelines of present macroeconomic policy.
Option 2: Policy favoring import substitutes
This policy option would utilise the instrument of import tariffs, imposing tariffs as a means of inducing a rise in the prices of domestic products which compete with imports. It already has been proposed as a way to implement the Agricultural Market Regulation Law, and a relatively high tariff ceiling has been negotiated with WTO.
The situation of the exchange rate makes the calls for tariff protection almost irresistible, and certainly tariffs would improve the profits of import-competing activities (e.g., cereals). However, the imposition of tariffs would mark a significant retreat from the liberal (open) policy orientation, much more so than a movement in the exchange rate would. And it would bring with it important disadvantages, most notably an increase in the costs of production for industries that use as inputs the products of the protected sectors.. Note that these objections do not apply to the products that would be protected by countervailing duties, for the purpose of offsetting subsidies in exporting countries.
Therefore a tariff policy tends to work against export sectors (such as dairy products, wood products and fish), because by raising the costs of some of their inputs it makes them less able to compete on world markets, and they receive no compensation in the form of higher output prices in kroons, as they would under a devaluation. If import tariffs were applied very selectively to only a few agricultural products, then this kind of consequence could be minimised, but once a tariff policy is instituted, it is hard to avoid its extension to many products. Another disadvantage of tariffs, in the form in which they are usually established, is that they favor some products more than others, and those favored products may not the ones that have the brightest future prospects.
These disadvantages can be ameliorated somewhat by making the tariffs relatively modest and as uniform as possible over the commodities that are protected. In that way, Government would not be attempting to “pick the winners” among the subsectors, but rather it would let market forces determine which lines of production prosper and expand, and which ones contract. This is the best way to respect comparative advantage and enhance the economy's growth prospects.
It should be emphasised that, strictly in terms of economic efficiency, the tariff option is inferior to an explicit devaluation. However, if the rigidity of the nominal exchange rate is maintained, then this option could be important for some parts of agriculture, mostly the grain producers, who suffer the consequences of international agricultural subsidies.
Option 3: Compensatory Policy for Agriculture
In the EU there has been a shift in policy thinking, away from measures that attempt to influence prices that producers receive, and toward direct economic compensation of the producers. This is part of a general concern to move away from policies that distort prices from their market-determined levels. The WTO also endorses instruments of direct compensation, as opposed to price-distorting measures.
In the Estonian context, such a policy could take the form of direct payments to producers, per hectare of land in cultivation (or in a fallow cycle). Again to give the hypothetical policy a concrete illustration, payments could be made of about kr 1000 per hectare for a fifteen-year period, as a compensation for the decline in real producer prices that has occurred. Comparable sums could be provided per cow to beef and milk producers, and per boat to fishermen. It may be desirable to try to give small (lower-income) producers a proportionately greater compensation by, for example, putting a cap on a farm's total land area eligible for the programme, say of 100 or 200 hectares.
Alternatively, the payment per hectare could be reduced for land in excess of 100 hectares in any one farm.
How would such a programme be financed, respecting the requirement that the Government budget not enter into a deficit? Since exchange rate policy has caused an intersectoral transfer of resources, away from agriculture and into services, the logical approach would be to tax the private service sector (banking, wholesale and retail trade, construction, business services, hotels and restaurants, transportation, etc.), at a rate designed to raise the revenues for the compensation programme. Thus, this option would rely on the mechanism of fiscal transfers to be put into effect. As envisaged, these direct payments would be in addition to expenditures on rural infrastructure and farm support services, which should occur in any event.
This policy option has the significant advantage of being neutral with respect to prices, thereby avoiding distortions in relative prices and not putting some sectors, such as exporting activities, at an economic disadvantage. At the same time, it would go a long way toward restoring profitability to agriculture.9
There is an important variant of this option, which consists of capitalisation of the direct payments so that a farmer, forester or fisherman may utilise the corresponding lump-sum payment for purposes of purchasing equipment or making other investments, without needing recourse to bank financing, which is difficult to obtain in these sectors. Under this variant, the producer could elect to receive a high-interest Government bond, which would be quite distinct from the vouchers used to compensate landowners in the land reform programme. The bond would pay attractive rates of interest so that it could be sold by the producer for its face value to a bank or private individual (including foreigners), thus raising a capital sum for the producer. The face value of the bond would be calculated as the present value of the 15-year time stream of payments. The mechanism of the bond is recommended in order to avoid placing too much pressure on the Government budget in a single year. In effect, the capitalised sums would be provided by private financial markets, and the Government would make its contributions over the 15-year time horizon.
In sample numbers, the mechanism would work something like the following. Suppose an enterprise held 100 hectares and the direct payment plan envisaged payments of kr 1000 per hectare. Then under Option 3, the enterprise could elect to receive kr 100,000 per year. Alternatively, under Option 3a, it could receive a bond whose face value were 700,000, if a discount rate of slightly over 14% were used. The Government would pay the bondholder 14% per year on the face value, or 98,000.10 The producer could then sell the bond for approximately 700,000 and use the resulting funds to capitalise the farm or forestry operation, or purchase fishing gear.
It may be said that three advances of fundamental importance have been registered recently in the area of agrarian reform (including land reform and agricultural reform), as follows:
The process of receiving claims for restitution of land to previous owners, that is, families that owned land before the expropriations of the 1940s, has been brought to a conclusion (as of January 15, 1997). Not all of the claims have been processed yet, and some claims are in conflict with each other, but the majority of them have been settled and no more will be forthcoming. Therefore it is now fairly clear how much agricultural land will remain to be adjudicated in other ways.
The process of privatising the structures and equipment of the former collective farms and state farms is virtually complete. It has been administered at the county level. These assets have been transferred to new enterprises (cooperatives or shareholding companies) that have replaced the former collective farms and state farms, and to individuals who worked on those farms. The mechanisms have been based on the assignment of “labour shares” to former workers of the farms, in amounts corresponding to their years of employment, and on group decision-making regarding the formation of new enterprises.
The coverage of the cadastre has expanded rapidly in the last 18 months. The area registered • in the Title Book is much less, but it too expanded considerably in 1996 and the first part of 1997. Now over 20% of the arable land is titled, mostly restituted land, as compared with 10% at the beginning of 1996.
The following table summarises the current status of landholdings in agriculture. Tthe dominant role of household plots stands out clearly. In fact, often the difference between a household plot and a family farm (private farm) simply is a legal question: the latter have full (fee simple) title to their land, whereas the former do not. This situation underscores the importance of giving both these classes of landholdings more equal treatment in future land policy.
The Status of Agricultural Landholdings (January, 1996)
| Type of farm | No. of farms | Arable land in production (has) | % of total arable land in production | Gross agric. output, 1995 (000 EEK) | % of total gross agric. output, 1995 |
| Household plots | 45,000* | 193,782 | 22,2 | 1,951,950 | 34,0 |
| Family farms** | 19,767 | 261,022 | 29,9 | 1,007,658 | 17,6 |
| Farm enterprises | 925 | 419,168 | 48,0 | 2,778,828 | 48,4 |
| Totals | 65,692 | 871, 972 | 100,0 | 5,738,436 | 100,0 |
Notes to the table:
In addition to the area recorded in the table above, at the end of 1995 the State held 226,371 of unused farmland, as a result of the increasing trend toward abandonment of land in the 1990s. This phenomenon has a regional dimension, being much more pronounced in the southeastern part of the country than elsewhere. Hence the search for appropriate ways to privatise this land is an important policy issue.
The limits to the approach of restitution can be seen by reviewing the cases of two countries which are far advanced in that process. In Põlvamaa and Tartumaa the applications for restituting the farms have practically all been satisfied. Only the most complicated cases remain to be resolved. The data of these two counties has been used for making prognosis for the other counties. In the county of Tartu 44,862 hectares of land, or 23% of the total, has been restituted. This figure includes the land in towns but these areas are not considered in the prognosis due to their smallness. In Põlva county 38,441 hectares of land, or 26%, have been restituted. From these data it can be seen that on an average about 25% of the agricultural land may be restituted when the process is complete for the entire nation. This basis for prognosis is not very reliable but we don't have anything better now.
It may be assumed that 10% of the land that remains after the restitution process is complete will not be usable —that it will be covered with swamp or dense shrub or otherwise be unsuitable for agriculture. Nevertheless, even under this conservative assumption, approximately two-thirds of the agricultural land will remain in State hands after the restitution process is complete. (Without the above assumption, the remaining proportion would be three-fourths.) This finding underscores the fact that restitution alone is not a complete solution to the land reform problem, and it shows the magnitude of the remaining challenge.
More than half of the agricultural land that eventually will be restituted already have achieved that status. Now no more restitution claims may be filed, so what remains is the work of processing the claims already made. Unfortunately, many potential owners deliberately delay in registering their restituted land, in order to avoid paying land taxes. Such lands become overgrown with weeds and shrubs, and their drainage systems further deteriorate, so neighboring farms are affected by this inaction. Parliament may eventually have to pass a law that requires payment of taxes on such lands, even if they are not fully registered but a defined period of time for registration has elapsed. Alternatively, a new law could require transfer of use rights (usufruct) of such lands to persons who are willing to use them. The Estonian Parliament passed a legal disposition of this nature in 1926.
Expressed in a concise manner, it can be said that there are four principal issues still to be resolved with respect to the process of agrarian reform:
The farm enterprises (successors to the State farms and collective farms) do not have security of tenure of their land. In most cases, they own buildings and machinery, but they do not own the land the buildings sit on, nor the land they work. Rather, this land is still in the hands of the State, awaiting final disposition, and it is rented to the enterprises on short-term contracts. Therefore they cannot use the land as guarantees for bank loans, nor sell part of it in order to invest in improved operations on the rest of it. According to the Land Reform Law of October, 1991, this land is to be sold at public or limited auction. Given the limited-economic success that most of the enterprises have had in the short period since their creation, it is likely that auctions would result in transfer of the land to other owners, thus generating a counterproductive situation in which the owners of the improvements on the land are different from the owners of the land itself.
A faster method of privatising the unused State land is required. In the present circumstances of declining real agricultural prices and low or negative profitability for many farming operations, there has been little interest in this land, so an effective privatisation procedure may have to be accompanied by special incentives.
The household plots also do not have title to their land. As explained in section II above, these plots are a legacy of the way in which State farms and collective farms were managed, and for many families they now are the sole source of subsistence. While their average size is a little over 4 hectares, many of them are less than two hectares in size and the families that operate them live below the poverty line. On the other hand, these plots are highly productive, yielding almost twice as much output per hectare as the average of family farms and enterprises. Giving them title would contribute to increasing their productivity further, and it would contribute to placing low-income families on a self-sustaining path of economic improvement by endowing them with an asset of economic value. Even those families who chose to leave agriculture subsequently would be beneficiaries of titling, because they could then sell their plots in order to raise funds to start a new occupation. This option now does not exist for them.
Over time, undoubtedly many titled household plots would be sold and consolidated into larger holdings, which would be a normal and healthy dynamic path for the sector. However, in order for this to happen, titling the plots again is a prerequisite. Thus titling these plots turns out to be important for the three goals of poverty alleviation, short-term efficiency in production, and long-term efficiency in production.
Although the work on the cadastre and the titling process both have a advanced more rapidly in recent months, it is necessary to accelerate those processes to the maximum. Inclusion in the cadastre is a prerequisite for titling, and the goal should be to have all farms registered in both the cadastre and the title book in a period of five years.
On the basis of the information and analysis presented in Chapter 3, it can be concluded that while the Land Reform Law of 1991 has laid the basis for the progress to date in regard to restitution of land to former owners and their descendants, it has proven to be in inadequate instrument for the privatisation of the remaining unclaimed but cultivable lands, which are at least two-thirds of all agricultural lands. It is clear that the fundamental orientation of a new land reform policy should be to redefine the process so that it adequately covers the cases of the agricultural enterprises, the household plots, and the unused and unclaimed agricultural lands. The present situation in which the State is the owner of those two-thirds of the country's agricultural land is not viable in the long run. It does not establish a basis for improving the economic efficiency and competitiveness of the sector, which are essential for its survival.
In designing new solutions, attention needs to be paid to the weakened economic state of the sector, and consequently new forms of land tenure need to be explored, such as long-term tradeable leases. The legislative framework for such leases does not now exist, but it can be created. For the same reason, it is necessary to be realistic about the prices at which land will be sold to those who are already working it.
Also, clearer guidance for local governments, especially parishes, is necessary in regard to land reform. While the process should be implemented primarily at the local level, the present framework is too flexible and therefore is open to abuses at the local level.
More consideration is required of how to handle the flows of governmental revenues that will emerge from an accelerated land reform. Adequate formulas need to be devised for the sharing of such revenues between national and local governments, and institutional arrangements need to be made that will ensure that most of these revenues are returned to rural areas in the form of improved infrastructure and services.
The following suggestions for revisions to the land reform process are written in fairly precise language, to better indicate how a revised agrarian reform could be structured, but it should be borne in mind that they are preliminary ideas and should be carefully reviewed before a programme for their implementation is developed. They are put forward here for the purpose of stimulating further thinking on how to accelerate the process of land reform. The suggestions consist of five interrelated proposals that are designed to deal with the issues outlined above and to take into account of the considerations mentioned.
Proposals for unused State lands. Following the provisions of the Land Reform Law (October, 1991), all of the more than 200,000 hectares of unused and unclaimed State land should be privatised at limited or public auction. In preparing the land for selling, it is important that scattered plots be brought together in compact farms. Sizes of parcels need to be defined for purposes of the privatisation, and they should vary but upper and lower limits need to be established by policy. For example, it could be decided that they should not be less than 10 hectares nor greater than 250 hectares. In view of the crisis of profitability in agriculture, financial conditions similar to the following should be established for the sale of these parcels:
Minimum auction prices should be low, following the above discussion of land prices. It is suggested that one-half of the tax assessment value be used. It is far more important to put these lands into private hands that will make them produce than to wait for an undefined period of time for a possibly better price.
The required down payment should be 10%.
A special State fund should be established to issue mortgages for 15 years at a special interest rate of 5%, and to collect the mortgage payments for the Treasury. The mortgage payments shall be apportioned between national and local governments according to a prescribed formula. (See the section on land capital below.)
In the event of serious arrears in the mortgage payments, the purchaser of the land could be given 120 days to arrange a private sale of the land to another person or enterprise who can take over the mortgage payments. Failing such a sale, and if the arrears still exist at the end of the specified period, the land will be repossessed by the State agency and auctioned again. However, by extending this transition period, the possibilities are minimised of the State's having to incur the administrative costs of repossession and auction again. In addition, a measure of economic fairness is extended to the farmer who originally purchased the land and made the attempt to become viable in agriculture.
If no buyers place bids at the original auction for sale of a piece of land, then within 90 days the parcel should be offered again at auction for long-term leasing (under a 25-year transferable lease). The minimum lease rate in the auction should be 10% of the minimum sale price specified in step a) above.
If there are no bids in the leasing auction either, then the parcel should be retired from the market, and the process should be started again one year later, with a new auction for sale.
Creation of the legal framework for leases. The legal figure of a 25-year transferable agricultural lease needs to be created. Under such a figure, the leasehold should have full rights to produce, invest in the land, sell part or all of the lease, or sub-lease all or part of the lease, subject to being current on the lease payments. The State agency created to handle the mortgages under section 1) above should manage the leases on State land and collect the lease payments for the Treasury and local governments, to be apportioned between them according to a prescribed formula. The legislation creating the framework for long-term leases should make it clear that such leases may be used for loan guarantees and that financial institutions may take possession of the leases in the event of defaults. (This kind of clause is subordinates legally the interest of the State to that of a private lending institution.) At the expiration of a 25-year lease, the parcel should be auctioned for sale again, but the last leaseholder should be given the right to equal the highest bid for the land, thereby becoming its owner.
Privatising lands of agricultural enterprises. Notwithstanding the auction procedure followed for unused State land which is not claiméd by previous owners, a different procedure is recommended for the land of agricultural enterprises which has not been claimed by previous owners. The principles governing the “privatisation” of enterprise lands could be developed along the following lines:
The current members of the enterprise, as defined by holdings of labour shares, or stock shares if a shareholding company has been created, should be empowered to decide the form in which the land shall be privatised (by type of parcel), according to the options described in paragraph d) below.
The current members of the enterprise would have the first right to possession of the land. Only in the event of their unwillingness to enter into the corresponding financial obligations, and keep current on them, should the land be auctioned.
The initial form of possession of the land could be 25-year transferable leases. At any time after the fifth year, the leaseholder would have the right to convert the lease to a mortgage, and he or she (or the enterprise) would be credited with the sum of lease payments made as a down payment on the purchase. If such right is not exercised during the lifetime of the lease, then at the end of the 25 years the land would be sold at auction. Again, the last leaseholder would have the right to equal the winning bid at the auction.
Regarding the form in which the land of the enterprise shall be “privatised” by the above procedures, the holders of labor shares in the enterprise, or stock shares if a shareholding company has been created, should decide on its form by vote (1 share = 1 vote), choosing among the following three options:
Privatising all the land of the enterprise as a single entity.
Dividing the lands into a minimum of two and a maximum of five parcels, each of which would be privatised.
Dividing the land completely into parcels, one per member of the enterprise according to the number of shares that he or she holds.
The new State agency in charge of leases and. mortgages should bear the cost of surveying and registering the parcels, under all options.
Titling household plots. In light of the relative poverty of holders of household plots, and their high productivity per hectare, they should be given full freehold title to their plots, and all the costs of surveying and titling should be assumed by the above-mentioned State agency. No price should be charged for the plot as long as it does not exceed 3 hectares, and the holder of the plot is a current or former member of a State farm or collective farm. The legislation of regulations in this area could allow that additional area from 3 to a maximum of 5 hectares be leased or purchased by the household, under the price conditions described in sub-sections 1) and 2) above (1/2 the tax assessment value, 10% down payment in the case of purchase, etc.). Area beyond 5 hectares would not be considered part of the household plot for purposes of the land reform.
Titling procedures. Titling procedures and procedures for registration of land in the cadastre should be modernised and accelerated so that all agricultural properties, leasehold and freehold, enterprises and family farms and household plots, are surveyed and recorded in the Title Book within 5 years.
Municipal lands. In the case of State agricultural land which is both unused and unclaimed, it could be desirable to allow transfer of portions of it to parishes and counties for educational, scientific and recreational uses. Perhaps up to 100 ha. per parish and 1000 ha. per county could be transferred, at no cost, for such purposes, provided that the land is determined to be both unused and unclaimed as of a given date. A policy of this nature should be coordinated with the proposal to create local forests for public uses, as proposed in Chapters 6 and 10 of this Strategy.
Clearly, variants of these approaches could be considered, but the essential conclusion is that it is necessary to revise the existing land reform legislation so that it deals more adequately with the cases of agricultural enterprises, household plots and unclaimed lands. Approaches along the lines indicated above would finally integrate the agricultural reform and the land reform, as well as laying a basis for agricultural growth and improvements in efficiency. They would also make a strong contribution to alleviating rural poverty and the associated rural social problems.
Auctions of land, for sale and for lease, and the other administrative measures proposed above would be carried out mostly by local governments, by parishes with the cooperation of counties. However, the national Government would have a supervisory role. By its nature, land policy must be carried out mostly at the local level, but for an issue of overriding national importance like the land reform, it is essential that local governments be given more guidance by national legislation and national authorities than they have been given so far in this process.
Estonia is traditionally a foodstuff-producing country which has always been able to feed its own people. Between the two world wars, the Republic of Estonia exported foodstuffs through Eesti Võieksport (Estonian Butter Export), Lihaeksport (Meat Export) and other export organisations to Europe and beyond. The agricultural industry in Estonia was superior to that of its competitors in Finland and the other Baltic countries. The forest industry, the products of which were similarly sold in many places in Europe,was also up to standard.
Estonian agro-industry today is not as competitive as it was in that period. It is undergoing a period of critical change, involving ownership of the industry, technologies of production, and restructuring markets. The context is one of sharply reduced profitability in the sector in recent years, loss of market share, and increased unemployment, both in the agro-industrial sector and in.the. primary agricultural sector.
According to expert assessments and official statistics, current employment in Estonian rural areas is as follows:
| Total jobs | 131,938 | |
| With main job in agriculture | approx. 51,000 | |
| Gentleman's farms, “hobby” farms and households (bearing in mind that they provide some 35% of the produce) | 39,600 | |
| Forestry | 4,000 | |
| Coastal fishing, breeding and small-scale production | 700 | |
| Meat plants in rural areas | 1,200 | |
| (79 sites averaging 15 workers) | ||
| Dairy plants in rural areas | 360 | |
| (36 sites averaging 10 workers) | ||
| Mills in rural areas | 100 | |
| (37 sites averaging 2.5 workers) | ||
| Local authorities | 4.600 | |
| School teachers | 3,000 | |
| Nursery school teachers | 1,000 | |
| Medical workers | 1,500 | |
| Police | 250 | |
| Other occupations (services, commerce etc.) | 24,628 | |
The estimated total figures for jobs in agro-processing industries (rural and urban plants combined) are:
| Dairy industry | 2,150 |
| Meat industry | 2,300 |
| Bread and concentrated animal feed industries, mills | 1,390 |
| Total | 5,840 |
At the same time, the total of people left unemployed in agriculture and agro-processing by the restructuring process, or in other words the shortfall of jobs, is 39,707, a very high proportion of the rural total. Characteristic features of the Estonian meat, dairy and grain industries include high fixed_costs, obsolete technology and inaccurately calculated storage and distribution costs caused on the one hand by inadequate accounting for general inflation in the economy and on the other by low profit margins.
It is understood that closing excess and inefficient production capacity in agro-industry has been a necessary part of the economic restructuring process, and that economic growth eventually will create new jobs to replace those which have been lost. Nevertheless, while some industries have succeeded in improving their efficiency, most of the surviving segments of the agro-industrial sector are in deep crisis, unable to generate profits or find the investments necessary to become more competitive.
Compared to 1992, the production of full-cream milk products, fish products, soft drinks, crude spirits, beer, sawn timber, timber-based boards and fertilisers in Estonia had increased by 1995. In the same period, the production of meat products, butter, bakery products and pastries, flour, animal feed, cellulose and paper decreased, often drastically. Compared to 1990 levels, the production volume of foodstuffs in Estonia had decreased by 1995 as follows (in %):
| margarine | 98.0 |
| pasta | 89.3 |
| yeast | 81.7 |
| meat and meat products | 79.7 |
| fish and fish products | 77.3 |
| flour | 76.4 |
| mayonnaise | 74.6 |
| milk products | 73.1 |
| butter | 51.6 |
| cheese | 49.7 |
| sausage products | 38.9 |
| bread | 37.0 |
| beer | 25.8 |
Foodstuffs make up one-third of all Estonian industrial output. According to figures from the Association of Estonian Foodstuff Producers, there are 440 firms operating in Estonia producing foodstuffs and drinks. The foodstuff industry provides employment for approximately 25,000 people. The Association of Estonian Forest Industry Enterprises represents enterprises with an approximate total turnover of two billion EEK. Some 13,000 people work in these enterprises alone.
The forest industry is of particular importance to the Estonian economy, for example in 1994 providing 7.3% of total industrial output. The export of timber and timber products accounted for 12.2% of the total value of exports in 1995 (in 1994 the figure was 10.2%). As a comparison, the corresponding figure from pre-war Estonia could also be quoted; in 1935–1936 it was 36%. In the section of this report dealing with the current situation of and the development prospects for the Estonian timber industry, forest industry enterprises are surveyed, including those involved in logging and/or producing cellulose, paper, timber-based boards, plywood, processed sawn timber, furniture, carpentry and buildings for assembly.
The lack of sufficient investment, which often brings with it new technologies of production, is the principal problem facing Estonia's agro-industry. In the long run, the problem of renewing the capital stock of agriculture and agro-industry must be solved by private capital. To expect the Stale to take on that burden would place an unsupportable strain on public finances. However, the State can play an.important transitional role in promoting the required investments, as part of its responsibility for directing the change of economic regime from one of central planning to one which is based on market principles. A transitional programme for agro-industry, designed to promote investment in renewal and upgrading of the industry, would contain the following basic elements:
The tariff programme discussed in Chapter 2.
Legislative reforms to eliminate the remaining restrictions on privatised agro-industry, in terms of maintaining certain levels of employment, staying with the existing locations of plants, making investments of certain sizes and types, etc.
Technical advisory assistance to processing cooperatives on how to strengthen their business management practices.
Technical advisory and legal assistance to processing cooperatives on how to convert their structure into shareholding enterprises, and how to attract outside investors.
A widening of the programme of the Agriculture and Rural Life Credit Fund (PMKF) so that it can provide more loans through banks at reduced interest rates for soundly designed plans for capital investment in and rehabilitation of agro-industrial plants, for a five-year transitional period only. Such a programme would also take into account sector-wide projections and parameters, e.g., the existing overcapacity in the grain milling industry and therefore the inevitable requirement that many mills close down. In other words, not all plants in the agro-industrial sector can be made viable, but those which have decent prospects deserve support during a transitional period so that they are able to stand on their own feet afterwards.
The reasoning for this last recommendation is similar to that proposed in Chapter 5 for credit programmes in agriculture. Both farmers and processors need to invest in order to be able to improve their efficiency and become more competitive, and yet this is precisely the time when they are least able to invest their own funds or to qualify for bank loans or pay the interest on them. The State must take the lead in showing the way out of this trap in the short run and medium run, so that State support will not be necessary in the longer run.
It should be remembered as well that failure to provide this kind of support will mean higher unemployment, lower incomes, and more social problems, and therefore the necessity of greater State expenditures for social support purposes.
Chapter 4 reviews many food processing industries, and space requirements prevent summarising those reviews in this introductory chapter. However, given the special importance of the dairy industry, it should be pointed out that to assist in the recovery of the dairy industry State resources would be needed:
for research into milk quality with the objective of bringing the quality of dairy products into line with EU directives and the Estonian Food Law;
for the preparation of a certification bureau for international accreditation;
for improving the conditions for determining the quality of dairy products to be exported;
for earning out applied research so that the quality of dairy production could be improved by bringing the managing of dairy cattle up to date, as well as the organising of symposiums, conferences and exhibitions and developing advisory activities;
according to expert assessments, it is necessary to make investments of 1.5 billion EEK in the renewal of dairy production technology, 1.0 billion EEK in the renewal of feed production technology and 0.36 billion EEK in the reconstruction and re-equipping of the dairy industry. In the case of these investment requirements, it is expected that private resources should constitute the necessary financing.
There is a lack of adequate information about the lending in rural areas by credit institutions, and therefore the total volume of loans granted to agriculture and rural management is not known. The classification of bank loans according to type of economic activity has hitherto been lacking in the bank statistics of the Bank of Estonia. As a result of the cooperation between the Ministry of Agriculture and the Bank of Estonia, it is probable that from 1997 onwards information about agricultural loans will be available from commercial banks
According to the Bank of Estonia, the situation as of 01/01/1996 was that loans granted directly to agriculture by banks amounted to 218.9 million EEK. This figure includes loans granted from the resources of the Agriculture and Rural Life Credit Fund. The highest loan interest rate was 36.75% and the lowest 12.97%
As of 28 February 1997, the loan resources of Estonian commercial banks totalled 15,890.8 million EEK. The largest share of this (15,015.8 million EEK or 94.5%) comprised demand deposits and fixed-term deposits (of which short-term deposits made up 10,733.4 million EEK or 71.5% of total deposits). Besides these, debts to non-resident credit institutions, promissory notes issued and governmental loan and foreign aid funds arc also considered to be loan resources. Commercial banks issued loans to the extent of 12,749.7 million EEK, of which 25.3% were short-term loans and 74.7% were long-term loans. The average interest rates on demand deposits (EEK) and fixed-term deposits in February 1997 were 2.52% and 4.95% respectively. The average interest rates on short-term loans (EEK) and long-term loans in February 1997 were 11.76% and 11.68% respectively.11 Obviously, financial intermediation costs arc high in Estonian banking sector.
There are mainly two Estonian commercial banks involved in lending to agriculture and rural life, the Union Bank of Estonia and the Estonian Land Bank. Loans given to agricultural producers make up a relatively large proportion of the loan portfolio of this latter bank. According to employees in the loans department, approximately 50% of loans from private individuals may be added to this category. The majority of loans granted to agriculture are typically long-term and arc financed by various funds. The balance of loans granted from fund resources as of 31/03/1997 was 209,700,000 EEK.
State-supported financing for agriculture is a deeply ingrained tradition in Estonia. From a long-term, market-oriented viewpoint, it may be agreed that eventually private financial institutions should be responsible for meeting all the credit needs of agriculture. On the other hand, in the short and medium term, agriculture is in an economic and financial trap. Since the change of economic system, agriculture has found itself requiring large amounts of investment to modernise its production technologies, along with extensive investment in human capital, especially in the areas of business management and marketing. Yet the cost-price squeeze induced by falling real agricultural prices, in part attributable to the orientations of the present macroeconomic policy (Chapter 2), has depressed both the value of agriculture's principal asset, land, and the profit expectations in the sector. Therefore agriculture is in a weak position to qualify for loans precisely at the time when it most needs to borrow in order to invest in new equipment and technologies.
In addition, most commercial banks in Estonia have little experience in evaluating agricultural projects and little interest in lending their own funds to the sector, especially in light of the less risky financial opportunities offered in urban estate and the urban services sector. Hence most agricultural producers find themselves dependent on Government-supported sources of finance in order to become more efficient and emerge from the economic and financial trap.
11 Souce of information; Bank of Estonia, Review of Banking as of 28 February 1997).
The problem is exacerbated by the fact that completion of the land reform will require a very large amount of mortgage financing for purchases of land, and such financing is simply not available at present in the required volumes.
How to resolve this contradictory situation is the main challenge in developing strategic orientations and policies for the rural financial sector. First of all, it is clear that this dilemma cannot be resolved quickly, and that present approaches for financing the sector will have to be continued for at least several more years, although they should undergo an evolution during that time. Second, an eventual solution will have to contain most or all of the following main elements:
Modifications in macroeconomic policy so that real agricultural prices begin to recover some of the ground lost since 1992 and hence the profitability of the sector increases.
An acceleration of land reform so that producers, both enterprises and individual farmers, enjoy greater security of land tenure and therefore have a larger base of assets that may serve as collateral as well as greater incentives to invest in their operations.
Encouragement of reforms in the banking sector itself that will lead.to more competition both for deposits (financial resource mobilisation) and loans. Those reforms could include improvements in the process of approval of applications of foreign banks to operate in Estonia and legislative changes that would support creation of a strong network of rural savings and loan cooperatives (SLCs).
Development of indirect means of State support to agricultural lending, in particular an agricultural loan guarantee fund.
Gradually increasing the required share of banks' own resources in loans supported through the rediscount lines.
In the programmes of State-supported lending rediscount lines), a reduction of the emphasis on short-term loans for current input costs (working capital), accompanied by a stronger emphasis on long-term loans for fixed capital investments. The reasons for this are three-fold:
Fixed investments are the key to greater production efficiency in the future.
The rate of return to short-term agricultural loans usually is much higher than the rate of return to long-term loans. Hence the former generally can pay unsubsidised (commercial) interest rates and still yield a profit to the borrower. This effect occurs because, once the farm is in place, additional working capital allows its capacity to be used more fully, and so relatively large increases in output can be brought about by relatively small amounts of financing. In contrast, investments in land and buildings, essential as they are, usually have low real rates of return.
Long-term fixed investments represent the need that is least adequately satisfied by private capital markets at present.
It is recognised that subisidised interest rates are not economically healthy measures in the longer run. Their negative effects include a tendency to divert capital resources away from the most productive uses and toward less productive ones, temptations to disguise the real purpose of the loan in order to qualify for the subsidy, a weakening of the banks' commitment to adequate portfolio management since the loans are taken out of their own resources, and a tendency to discourage private capital from filling the sector's investment needs. In addition, subsidies for lending must be phased out prior to accession to the EU, because they are viewed as creating unfair competition among member States.
Nevertheless, for the reasons cited above, the present lending policy cannot be changed abruptly. But a six-point programme along the lines mentioned above could place the rural financial sector on healthier foundations in several years' time and could allow the phasing out of the credit subsidies.
The activity of SLCs (in Estonian LHÜ) is directed at rural areas and the following factors restricting their development have become apparent, some of which have been mentioned already:
A network of commercial banks is already in existence in rural areas, so enabling inhabitants to carry out their most vital transactions. The proportion of transactions not involving cash is small in rural areas because cash is a widespread method of payment. Branches of banks often offer almost all retail banking services including foreign currency transactions.
SLCs cannot accept savings from the general public. If they were to be allowed to do so in the future, then application of more stringent reliability standards would be required and justified.
The size of a member's loan is restricted by the amount of the member's shareholding in the cooperative, independently of other guarantees that could be offered.
The minimum required shareholding is 200,000 EEK is a rather large sum for most rural dwellers.
There is a need for more training of individuals in key positions in the SLCs, for example the managing directors and chief accountants.
In order to increase the interest of country people in the founding and operating of SLCs, the concepts behind SLCs should be made better known using the example of those already in operation. Either the classical founding method or the so-called American way may be used for founding. Classically, SLCs are established along the lines of the Cooperative Law. Regarding the so-called American way, in 1917 the United States of America established the system of Farm Credit Services, within the framework of a programme for the development of the national economy. In addition to that, all opening capital was lent for thirty years. Because of the current situation of national agricultural policy, the possibility of the American way is not being actively considered. However, the founding of SLCs may be given an impetus in rural areas where smaller branches of banks are closed because they are not considered to be profitable. If heed is paid to current farmers' initiatives, then it will be possible to develop plans of activity for the support and development of the SLC system. According to Ksenia Lukkanen, director of Leie LHÜ, the lack of an umbrella organisation for the SLCs can already be felt. Such an organisation would help to organise training, to elaborate example regulations and bills, computer programmes and other such things which are costly and time-consuming for one cooperative to undertake alone. The formation of a reserve fund could also be planned through the umbrella organisation.
As a first step in creating a system of SLCs, it would be necessary to review the procedures as established by the Bank of Estonia for the founding, operating and liquidating of SLCs, and to add to them the suggestions made by the SLC initiatory committee (U. Silberg, L. Raag, T. Blank) in summer-autumn 1997. The second step would be for Parliament to draft a Law on Cooperative Credit Institutions which itself must be in accordance with the Law on Credit Institutions. It is important to ensure that the legislation contains the following components before it is finalised:
1) Creation of a network of SLCs
A system of SLCs should be created that has central institutions, among which the following would be integral parts:
A central reserve fund for excess liquidity.
An advisory and promotion group to educate the rural public on the role of SLCs and to train their officers.
A separate supervision mechanism, under the aegis of the Central Bank, with procedures that are appropriate for small SLCs and therefore different from those of commercial banks.
Individual SLCs that are members of the system should be required to maintain specified reserves, as a risk cover, in the central reserve fund. They also could deposit seasonal excess liquidity there, and earn interest on both the liquid funds and the required reserves. This fund would help to minimise the risk of failure of SLCs by being able to make short-term loans to its member institutions, under strict rules for upgrading their portfolios when necessary. In extreme cases of SLCs in serious financial difficulties, the reserve fund would be empowered to force a merger with a stronger SLC, or to close down an SLC, in the interest of safeguarding the financial health of the entire system. The State should provide an initial reserve for the central fund, to help the system start operations. Foreign donors would possibly be interested in making financial contributions for that purpose.
At the same time, the training and promotion group would be attached to the reserve fund and from the beginning would work to ensure that SLCs use appropriate loan evaluation procedures and appropriate guidelines for portfolio management, in order to reduce the chances of financial failure among the member institutions. The training should emphasise techniques of evaluating farms' business plans, as such plans should be one of the bases for loan approval.
It is important that the supervising entity be completely separate from the promotion entity. The supervision should be carried out under the aegis of the Central Bank, although not necessarily by a Department of the Central Bank, and its rules and procedures should differ from those applied to commercial banks. The supervising, entity, logically, also would be empowered to close down SLCs if they failed to follow the guidelines for reliability applicable to them. Ensuring the viability of such institutions is of the highest priority. Agriculture and rural households will not gain if the financial institutions which serve them turn out to be fragile.
2) Participation in the PMKF Programme
The legislation adopted should allow the PMKF and any other governmental financial institution to channel its rediscount funds to agriculture through SLCs as well as through commercial banks.
3) Restrictions on Deposits and Lending
The restriction that SLCs cannot take deposits from non-members, nor lend to non-members, should be removed. In its place there should be a carefully specified set of rules for lending decisions and portfolio management.
4) Collateral Requirements
SLCs should be permitted to use non-fixed assets (newly-sown crops, young livestock) as collateral for loans.
5) Risk Minimisation through Portfolio Diversification and Interest Rates
Although a principal aim of rural SLCs is to mobilise financial resources in rural areas and channel such resources into agricultural development, it must be recognised clearly that agriculture is inherently more risky than some other kinds of economic activity. Therefore, it is important that the asset portfolios of SLCs not be completely specialised in agricultural loans. A maximum share of each SLCs portfolio for agriculture should be specified, probably in the range of 60%. Even with such a limit, the SLCs would be lending proportionately much more to agriculture than banks do. The remaining loans could go to forestry, fisheries, rural commerce, processing industries, consumer loans, house improvement loans and other purposes. Another principal instrument for reducing risk is a variable policy on interest rates. For new borrowers, rates should be higher, until they acquire an established record of repaying loans on time. Similarly, the possibility should be allowed that both deposit and lending rates (for working capital loans) could be higher than in commercial banks, in order to attract financial resources and to cover the risk of agricultural loans.
Chapter 5 also contains other analyses and recommendations on many financial issues of concern to the sector.
