1

Blog Post
Macroeconomic Theory II
ECO-2202-1
Professor Anuradha Saha

by
Aviraj Chopra

"Estonia's Digital Transformation: A Blueprint for Post-Soviet Economic Revival."

Estonia’s emergence as a pioneer in digital society from the ruins of the Soviet collapse prompts
us to challenge our conventional understanding of economic transformation in the 21st century.
Therefore, it is imperative to explore how a country has rebuilt its economy on bytes, broadband
and blockchain, a very unusual phenomena unlike the one where tangible assets like natural
resources like oil and gold are used for revival. Hence, the primary question poses itself, "Can
technology alone lift a nation from the shadows of economic hardship to the forefront of the
global digital economy? Estonia's story suggests a resounding yes."

Estonia lost its independence when it was forced to be a part of the German Non-Aggression
Pact of 1939, leading to its incorporation in the USSR as one of the Soviet Republics in 1940.1
Being a part of the USSR came with several costs to Estonia, especially with respect to its
economy and sovereignty. Soviet occupation of Estonia meant a dismantling of its market
economy and replacing it with a planned economy. Nationalization of industries, collectivization
of agriculture and repression of the entrepreneurial class through arrests, executions and
deportations eroded innovation and hampered economic growth and social development.2

Due to the fact that Estonia would now respond to Soviet needs, traditional trade patterns were
disrupted along with the loss of property rights, which led to rampant inefficiency, as is
associated with planned economies. The prioritization of agriculture and industry outputs based
on the needs of the wider Soviet Union strained the emergence of private enterprise, which
further stifled technological innovation that could have come about as a result of competition.
Schrumpeter’s theory of creative destruction can be extended to this example of Estonia where
the path to “long-term economic advancement” was sidelined purely due to the fact that
entrepreneurial innovation, a primary characteristic of a free market economy, was subdued.3

1
The Editors of Encyclopaedia Britannica, “German-Soviet Nonaggression Pact,” Encyclopædia Britannica, March 5, 2024.

2
The Editors of Encyclopaedia Britannica, “Independence Lost,” Encyclopædia Britannica, accessed March 7, 2024.
3
Richard Alm and Cox W. Michael , “Creative Destruction,” Econlib, May 12, 2023.
 2

The Soviet capture of Estonia, coupled with the resultant second world war, subjected Estonia to
subpar economic policies, political changes and destruction of physical infrastructure, that only
restricted utilization of resources and prevented the workforce from unlocking its potential.

Post Estonia’s independence in 1991, the first order of business was transitioning from a
centrally planned economy to a free market economy, which was characterized by privatization
of state-owned enterprises, aggressive economic reforms and heavy investment in digital
infrastructure. Estonia’s strategic integration with Europe by joining NATO and the EU in 2004
is noteworthy. Figure 1 shows how expenditure on Research and Development as a share of GDP
rose sharply post 1991. Intuitively, the decline post 2010 can be justified as this graph represents
the share of GDP spent on R&D, and during this journey, the GDP of Estonia also rose
manyfolds. Hence, in nominal terms, R&D expenditure increased.

Figure 1 4

Delving deep into Estonia’s digital transformation opens the doors to the view of nothing short of
a miracle. The Tiger Leap Program introduced in 1997, which aimed to expand computer and
internet access in schools, laid the foundation of Estonia’s digital society. The 2000s saw a surge
in digital governance initiatives like digital ID cards in 2002, and i-Voting in 2005, which
demonstrated Estonia’s commitment to digital public services.5 Post the e-Residency program in
2014, which allowed global citizens to start and manage businesses in Estonia remotely, is when
Estonia became part of global discourse in the sphere of technological advancements. Imagine a
country where you can start a business, vote in elections, and access healthcare from anywhere in

4
“Research & Development Spending as a Share of GDP,” Our World in Data, accessed March 7, 2024.

5
“Estonia - We Have Built a Digital Society & We Can Show You How,” E-Estonia, February 21, 2024, https://e-estonia.com/.
 3

the world, digitally. This isn't a hopeful future but Estonia's present reality. It has come to be
known as the Baltic region’s rising economic star.6 Today, Estonia is known for its e-government
services and is considered a hub for tech startups. 99% of these government services in Estonia
are online.7 It has received global recognition in the realm of cybersecurity, digital education and
digital services.

What is essential is assessing the impact that this turnaround in digital infrastructure has had on
Estonia’s economy. This has led to a monumental impact on different facets of the economy,
which are eventually the causes of Estonia’s miraculous economic growth. Ease of doing
business in Estonia is a result of 100% data privacy, speed with which one can open a startup and
hassle free e-taxation. This encouraged innovation and technological advancements at a rate that
is unimaginable. The 2007 cyber attacks only translated into Estonia emerging stronger in terms
of cybersecurity. Digital health and education systems have produced competent children and a
solid healthcare system in Estonia. Estonia’s digital infrastructure was its saving grace during the
Covid-19 pandemic.8 Digital education, through its accessibility, flexibility and
cost-effectiveness have made education affordable for wider populations, raising the overall skill
level and productivity of the workforce. These are all the channels through which we observe
positive economic growth in Estonia post the 1991 digital revolution. Figure 2 and 3 show the
rise in Estonia’s GDP and GDP per Capita post 1991 respectively.

Figure 2 9
6
Gerard O’Dwyer, “Estonia: Digital Economy Drives Growth,” Global Finance Magazine, August 29, 2023.

7
“Estonia - We Have Built a Digital Society & We Can Show You How,” E-Estonia, February 21, 2024.

8
Jana Silaškova and Masao Takahashi, “How Estonia’s Digital Society Became a Lifeline during COVID-19,” World Economic
Forum, July 1, 2020.
9
“GDP (Current US$) - Estonia,” World Bank Open Data, Accessed March 7, 2024.
 4

Figure 3 10

Hence, it is evident that public policy via investment in technology and education have been the
key contributors to Estonia’s growth experience. Our World in Data shows some interesting
statistics on the proportion of medium and high-tech manufacturing value added in total value
added (%), as can be seen in Figure 4. Between 2000 to 2020, this proportion increased from
almost 17% to 30%. This is a remarkable increase, and concrete proof of technological progress
as on the the drivers of Estonia’s economic growth.

Figure 4 11
10
“GDP per Capita,” Our World in Data, Accessed March 7, 2024.

11
“Share of Medium and High-Tech in Gross Domestic Product (GDP),” Our World in Data, Accessed March 7, 2024.
 5

As for education as a contributor to economic growth in Estonia, we observe two channels. One
is through technology, which is essentially investment in and advancement of digital education.
The other is through an increase in public spending on education, regardless of its digitalization.
While digital education penetrates the masses, increase in government spending on education is
essential for building infrastructure and raising the overall skill level of the population. Figure 5
is a testament to Estonia’s commitment to not just primary, but higher education. As can be
interpreted from the graph, the share of the population with post secondary education increased
from about 14% in 1989 to just over 40% in 2018.

Figure 5 12

Estonia’s growth trajectory is closely aligned with the theories and predictions of the Romer
model. The Solow model does not seem a good fit as it treats technology as an exogenous factor,
whereas the Romer model assumes technology to be endogenous, much like in the case of
Estonia, where digital innovation takes place as a result of internal policies and investment.
Additionally, contrary to the Solow model, people are a key input in research and development in
the Romer model.

It is important to note that the romer model does not rely on technology alone. It says that
constant research effort cannot sustain long term economic growth unless “productivity of
research” grows over time. “...the long-run growth rate of this economy is determined by the
parameters of the production function for ideas and the rate of growth of researchers, which is
ultimately given by the population growth rate.” What we derive from this is that not just
research, but a growing number of researchers is needed to sustain growth. For the assumption to
hold that more people generate more ideas, these people also need skills. This emphasizes the
importance of human capital in the romer model, depicted by investment in education in Estonia.

12
“Share of the Population with Post secondary Education,” Our World in Data, Accessed March 7, 2024.
 6

Looking at Estonia’s digital transformation, and the constant investment in digital infrastructure,
one could expect the growth rate of technology and level of technology to move as depicted by
Figure 6 and 7. Therefore, it becomes important to explore how the growth experience of Estonia
serves as a fitting example of the Romer model.

The journey of Estonia from a post-Soviet economy to a digital leader is an illustration of how
technology and education can stimulate economic growth. As of the 2023 Global Innovation
Index, Estonia is one of the 14 countries in the high income bracket that have performed above
expectations for level of development when it comes to innovation.13 It ranks 16th in the world
for innovation, with its regional rank being 9th.14 Unlike the Solow Model, which posits
technological progress as an exogenous factor, the Romer Model helps to explain Estonia’s
development in terms of deliberate policy choices aimed at fostering a culture of innovation and
digital literacy.

The story of Estonia informs us that visionary leadership and strategic investments can enable
small nations to compete internationally while setting benchmarks for economic development
and public service delivery. For example, its successful implementation of e-government
services, ability to attract tech start-ups as well as building one of the most digitally literate
societies globally shows how technology can reshape economies for higher standards of living.
Estonia's ongoing transformation holds important lessons for other countries seeking to exploit
digital technology and education for sustained long term economic development.

13
WIPO, “Global Innovation Index 2023,” World Intellectual Property Organization (WIPO), Accessed March 7, 2024.

14
WIPO, “Global Innovation Index 2023,” World Intellectual Property Organization (WIPO), Accessed March 7, 2024.
 7

References

Alm , Richard, and Cox W. Michael . “Creative Destruction.” Econlib, May 12, 2023.
https://www.econlib.org/library/Enc/CreativeDestruction.html.

“Estonia - We Have Built a Digital Society & We Can Show You How.” E-Estonia, February 21,
2024. https://e-estonia.com/.

“GDP (Current US$) - Estonia.” World Bank Open Data. Accessed March 7, 2024.
https://data.worldbank.org/indicator/NY.GDP.MKTP.CD?contextual=max&locations=EE.

“GDP per Capita.” Our World in Data. Accessed March 7, 2024.

https://ourworldindata.org/grapher/gdp-per-capita-world-bank-constant-usd?tab=chart&country=
~EST.

O’Dwyer, Gerard. “Estonia: Digital Economy Drives Growth.” Global Finance Magazine,
August 29, 2023. https://gfmag.com/data/estonia-digital-economy-drives-growth/.

Research & Development Spending as a Share of GDP.” Our World in Data. Accessed March 7,
2024. https://ourworldindata.org/grapher/research-spending-gdp?tab=chart&country=~EST.

“Share of Medium and High-Tech in Gross Domestic Product (GDP).” Our World in Data.
Accessed March 7, 2024.
https://ourworldindata.org/grapher/total-manufacturing-value-added-from-high-tech?tab=chart&
country=EST.

“Share of the Population with Post Secondary Education.” Our World in Data. Accessed March
7, 2024.
https://ourworldindata.org/grapher/share-of-the-population-with-a-completed-post-secondary-ed
ucation?tab=chart&country=EST.

Silaškova, Jana, and Masao Takahashi. “How Estonia’s Digital Society Became a Lifeline during
COVID-19.” World Economic Forum, July 1, 2020.
https://www.weforum.org/agenda/2020/07/estonia-advanced-digital-society-here-s-how-that-help
 8

ed-it-during-covid-19/#:~:text=URL%3A%20 https%3A%2F%2Fwww.weforum.org%2f
Agenda%2F2020%2F07%2Festonia.

The Editors of Encyclopaedia Britannica. “German-Soviet Nonaggression Pact.” Encyclopædia

Britannica, March 5, 2024.
https://www.britannica.com/event/German-Soviet-Nonaggression-Pact.

The Editors of Encyclopaedia Britannica. “Independence Lost.” Encyclopædia Britannica.

Accessed March 7, 2024. https://www.britannica.com/place/Estonia/Independence-lost.

WIPO. “Global Innovation Index 2023.” World Intellectual Property Organization (WIPO).
Accessed March 7, 2024.
https://www.wipo.int/edocs/pubdocs/en/wipo-pub-2000-2023-en-main-report-global-innovation-i
ndex-2023-16th-edition.pdf.