IV. Policy Analysis and Recommendations

A. Overview

On the basis of the factual information used in the preparation of this development strategy, we can say that Estonian agriculture and its industry has gone through a substantial decline during the past five years of the reindependence period. As can be seen from the figures, total output of agricultural products fell by almost 50% between 1989 and 1995 while the production of dairy products fell by even more. Significant changes have also occurred in consumption. In the years 1990–1995, meat consumption fell from 78 kilos to 51 kilos, the consumption of milk products expressed in milk equivalent from 502 kilos to 295 kilos and egg consumption from 290 to 224 eggs per person (16).

The situation in forestry and the forest industry is somewhat better, as can be concluded from the information already presented. However, even that sector has problems which require solution.

On the other hand agriculture, which has for centuries (we could even say millennia) been the main source of income for Estonians, is being suffering gravely. One single remedy is not enough for "rescuing" agriculture. A whole set of remedies need to be implemented now, the combined effect of which would prevent any further decline.

- The recommendations below call for changes in some governmental policies, in order to assist in the recovery of agro-industry. Nevertheless, it should be remembered that only those few enterprises who seriously strive for product quality, refine their recipes and technology, replace obsolete equipment with contemporary equipment, intensify quality control and, probably the most important single aspect of all, are able to sell their products more cheaply than others can, will survive in free market competition (6).

B. Macroeconomic and Tariff Policy

Customs tariffs are one part of the economic policy of a country. The Estonian farmer finds himself in a totally unequal position compared to other producers. The OECD countries (including the USA) pay farmers an average of 40% of world market prices while the European Union pays an average of 49%. The export prices of products originating in these countries are therefore at least 40% cheaper than the actual cost of the farmer's products (16). The import of such agricultural products at dumping prices causes severe economic hardship for Estonian farmers.

At the same time, it must be remembered that before 1940 approximately one third of Estonian budgetary revenue came from customs tariffs. It has been estimated that were customs tariffs to be imposed in the current situation, 25% of the income from them could be used for supporting agricultural production and its profitability; the other 75% would go straight to the Treasury. From there it would be possible to share the money out to low-income groups of the population as social help in order to offset increased food prices (17) that would result from the tariffs.

Here it is useful to provide a discussion which supplements that of Chapter 2. In that chapter it was pointed out that the maintenance of a fixed nominal exchange rate in spite of rapid increases in price levels since June of 1992 has caused production costs to rise more rapidly than output prices, for both agriculture and industry. In addition, it has made imported products markedly cheaper relative to Estonian products, and it has made our exports expensive in international markets. Obviously this conclusion applies to agro-industry as well, as seen in the extensive information presented in this Chapter concerning its economic decline. In effect, this policy is subsidising consumers at the expense of farmers and agro-industry.

In Chapter 2 the analysis indicates that there are only three feasible policy paths which would lead out of this situation and restore profitability and growth to agriculture and industry:

1. A devaluation of the kroon.

2. A programme of direct support payments to farmers.

3. A system of import tariffs, although this solution would not help exports.

To add to the material presented in Chapter 2, it is important to point out that the scheme of support payments to farmers, even though it is similar to EU programmes in agriculture, would not improve the profitability of agro-industry at all.

Therefore, logic inexorably leads us to the conclusion that if the Government wishes to maintain the present exchange rate policy, which is prejudicial for the development prospects of agriculture and industry, it must consider implementing a system of tariffs on imports. While this would help Estonian producers recover some of the lost share of the domestic market, it would not assist our exporters, so it is an imperfect solution. Nevertheless, in the present crisis an imperfect solution is better than none at all.

In addition to the concerns about the lack of profitability for domestic producers, there are two powerful external reasons for considering a system of tariffs:

1. Subsidies to agriculture in major exporting nations create artificially low prices for the import of food products in Estonia and elsewhere. As noted earlier, milk is the most highly subsidised import in this sense, followed by wheat

2. The European Union maintains import tariffs and controls which offer effective economic protection to its farmers. Although there has been a downward trend in this protection, it still is fairly strong. Since Estonia aspires to join the EU, it must eventually harmonise its policy on import tariffs with that of the EU.

Regarding this last point, in article 95 of the European accession agreement it is stated that the parties are obliged to develop customs cooperation so as to guarantee compliance with the conditions on all exchanges of goods and to bring the Estonian custom's system closer to that of the Union. An international agreement has already been signed on this question and is being implemented in practice (18).

Other considerations relevant to the development of a tariff system are the following:

1. The average level of tariffs should be relatively modest, or otherwise they will encourage the development of inefficient industries in the long run. Although agricultural protection still is the norm in OECD, its trend is definitely downward.

2. Tariffs should be as uniform as possible over types of goods. International experience has shown that whenever the State tries to favour certain industries with higher tariffs, they tun out to be the least efficient industries. Therefore this kind of “preferential tariff policy” ends up encouraging capital and labour resources to go to the industries which have the least development prospects in the long run. (Exceptions to this policy of uniform tariffs may be made for wheat and dairy products, because of their high degree of international subsidies.)

C. Requirements for Capital Investments

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 State 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:

1. The tariff programme proposed in the foregoing sub-section.

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.

3. Technical advisory assistance to processing cooperatives on how to strengthen their business management practices.

4. Technical advisory and legal assistance to processing cooperatives on how to convert their structure into shareholding enterprises, and how to attract outside investors.

5. 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.

D. Export Promotion

Foreign trade is essential for the economic development of our country. We lost our trading partners in Western Europe while under Soviet occupation. Now it is necessary once again to find countries where it is possible to market and sell goods produced here. The Russian market would, of course, be ideal for both agriculture and industry. Russia is, after all, our nearest neighbour and its market is huge. Yet it is not currently practical to have particularly extensive contacts with Russia; so our trading partners must be found elsewhere. The decision of the leading Estonian meat combines to form a common export organisation should be welcomed. It will begin to search for markets for its products in Poland, the Baltic countries and partially in the St Petersburg region (21).

To supplement private initiative in export promotion, the Government should undertake the following programme, some elements of which have been suggested by the Estonian Foodstuff Industry, as mentioned above:

1. Develop laws on food hygiene, alcohol production and distribution, etc., to fill present gaps in the legislative framework, and development regulations and standards covering:

   • Standards and control methods for, and supervision of, food additives.

   • Standards and control methods for, and supervision of, contaminating substances.

   • Identification of micro-organisms relevant to food processing and establishment of their limits per unit of product, and the corresponding supervision procedures.

   • Identification of materials permitted to come into contact with foods (types of packaging materials, equipment, etc.), along with monitoring and supervision procedures for the industry in this area.

   • Identification of prohibited production method and dissemination of information regarding them.

2. Develop a quality certificate programme for export products.

3. Provide integrated technical and financial assistance to farmers and processing industries in meeting quality standards. A starting point here would be financing the State programme “Milk.”

4. Develop and implement a publicity campaign in foreign markets for Estonian food, forestry and fisheries products that meet international standards.

5. Reinforce the priority in PMKF loans for export-oriented producers and processors.

6. Create centres which meet EU requirements for the analysis and laboratory control of milk, meat, grains and other agricultural products. Financial aid is required to equip these centres with the needed apparatus.

E. Promoting Recovery of the Dairy Industry

To assist in the recovery of the dairy industry State resources would be needed:

1. 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;

2. for the preparation of a certification bureau for international accreditation;

3. for improving the conditions for determining the quality of dairy products to be exported;

4. for carrying 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;

5. 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.

F. The Development Potential of the Forest Industry

There is development potential in the Estonian forest industry. There are sufficient timber reserves and the workforce is also plentiful.

The problems of the forest industry are the poor organisation of the felling and sawing of timber, the low standard of the processing equipment, sizeable financial requirement for improvement of technology, and the lack of direct contacts between the producers and final consumers in the sales process. The competition for round timber is intense and new local enterprises claim that they find themselves in an unfairly worse position because foreign firms have built up their business so well and are in better financial condition.

One weak point of the Estonian forest industry is the limited possibility to invest in equipment. However, there are many areas in which enterprises can increase their production or considerably strengthen their position with very small investments or even without investments at all. In some of these areas policy reforms are required and in others industries must take the initiative, acting either individually or together. They are as follows:

1. Improving the quality of the felling and sale of timber and of transport should be considered to be essential, as should increasing the value of logs. One possibility for improving quality would be developinng long-term agreements between larger buyers and forest industry enterprises.

2. The current system of selling State forest timber - primarily the auction of standing forest on a short-term basis - makes it more difficult for enterprises to direct their timber supplies according to the selection they actually need. It is essential that the State begin to auction standing timber on the basis of very long-term concessions for felling, of at least 80 years. As pointed out in Chapter 10, this policy also would encourage management practices in concessions on State forests that favour regeneration of the trees, and afforestation by concessionaires as well. Suggestions for changing the system have also been made in the Estonian Forestry Development Programme.

3. The introduction in practice of directions for minimum quality requirements and product range designation for sawn timber. Inconsistencies in the rules for selection designation are one reason why Estonian sawn timber prices are low. The product range rules have been published in the document Põhjamaade puidusortimendi määramise eeskirjad mǎnni- ja kuusesaepuidu osas (Directions for the designation of timber product ranges in the Scandinavian countries in terms of sawn pine and spruce timber, or the so-called “Sinine raamat/Blue Book”). It is recommended that this be used as the basis for common rules for the designation of the timber product ranges exported by Estonian suppliers.

4. Shortening the sales channels and getting closer to the final consumer would have obvious advantages. The Estonian forest industry, with its small volumes and irregular supplies from individual producers, is finding it difficult to stand out from amongst the ranks of the large-scale producers.

5. There is a considerable volume of market information and the regular collection and processing of it requires resources. The founding of a marketing organisation would create enough funds for that.

6. From an investment point of view, local raw material resources are sufficient even for the creation of large-capacity enterprises for the mechanical processing of timber. As the cost of labour in Estonia is low, plans to make capital intensive investments should be considered carefully. Viewing matters from a slightly longer perspective, the potentially most profitable branch of the timber industry is probably labour intensive wood processing, for instance the furniture industry.

7. In addition to the obvious advantages such as cheap labour and energy, other possible reasons for the growth of investments in the Estonian timber industry are the rapid transition of the country to a market economy and the rapid development of a structure of entrepreneurial institutions. According to the 1995 assessments of the European Bank for Reconstruction and Development, Estonia has wide-ranging and highly effective legislation encouraging investments. Priorities for such investments could be the following:

   1. An increase in the capacity for drying sawn timber would guarantee that the majority of sawn timber produced in Estonia would be sold dried. The sales value of timber rises dramatically if it has been dried.

   2. The import and placing into operation of barking machines.

   3. The reorientation of the sawmill industry, especiaally to improve the precision of sawing. Shortcomings in the production technology used are directly reflected in the quality of the product and this is an area which even the low labour costs cannot compensate for.

   4. The construction of a factory producing wood chips. Virtually all pulpwood is currently sold as round timber. The local production of wood chips would raise the production value and would also create the possibility for smaller-scale raw materials to be used. It would also open new markets for selling pulpwood, such as in Japan.

   5. Investments in the further processing of wood. Relatively low labour costs have been the advantage of the Estonian timber processing industry over its competitors. The preference of labour-intensive activities would enable this situation to be exploited and maximised to the full.

   6. Because of the irregularity and small size of supplies from individual producers, it would be important to support the development of competitive large-scale production in the forest industry on the basis of forest owners' cooperatives.

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APPENDICES

Appendix 1. Milk production and purchases

Appendix 2. Milk production and sales

* Statistical data for 28 dairies

Appendix 3. Production and export of dairy products

Appendix 4. Meat production and sales

* Statistical data for 54 meat processing plants.

Appendix 5. Production volumes of processed grain (x1000 t.)

Appendix 6. Production volumes of potato starch and starch syrup (x1000 t.)

* Figure is actual output although output of AS Nurga is not presented in official state statistics

Appendix 7. Domestic market wholesale price of potato starch and syrup (without sales tax)

Appendix 8. Analysis of the chemical composition of concentrated feed in 1996

Appendix 9. Flour and bread production 1980–1995 (x1000 tons)

Appendix 10. Export-import of foodstuffs by product group (million EEK)

Appendix 11. Permitted annual felling volumes in Estonia by tree type and usage

Source: Metsakorralduskeskus (Centre for Forest Management), January 1996

Appendix 12. Maximum possible felling volume

Source: Metsakorralduskeskus (Centre for Forest Management), January 1996

Appendix 13. Production of timber-based boards in Estonia 1989–1995

Source: Statistika aastaraamat 1995 (Statistical yearbook 1995).

* million m².

Appendix 14. State programme and development plan budgets for 1995–1996 and applications for budgetary resources 1997–2000 (x1000 EEK)