## cr18126

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---

### Wages and Wage Drivers — Key findings
- Estonia’s income per capita ≈ 51 percent of EU15 (2017), third-highest of the New Member States (NMS).
- Recent wage growth has outpaced labor productivity and risen faster than elsewhere in Europe; divergence from fundamentals could undermine growth, income convergence, and competitiveness.
- Paper objectives:
  - Identify drivers of wage growth and inflation and test for a wage-price spiral.
  - Assess whether direction and magnitude of drivers differ in Estonia and relative to Europe.

### Drivers overview
- Post-GFC three key drivers of wage growth in advanced economies: productivity gains, inflation expectations, and labor market slack.
- In Estonia and other Baltic economies:
  - Unemployment has fallen and labor market tightened appreciably.
  - Productivity growth has slowed.
  - Inflation is more volatile than in larger EU economies, likely reducing the anchoring role of expectations.
- Implication: low inflation may have had less downward drag on wage settlements in Estonia than elsewhere.

### Productivity, inflation, and wages
- Productivity:
  - Productivity growth slowed from previously high levels tied to investment and income convergence.
  - From 2013 until recently, wage growth outpaced nominal GDP growth → rising labor share and rising real unit labor costs.
  - Compared to pre-GFC levels, both GDP and wages growing at a slower pace.
- Inflation:
  - Estonia’s inflation broadly in line with European trends but at higher levels and with higher volatility.
  - Three phases in past decade: pre-crisis (high inflation/high wage growth); crisis (negative inflation/declining nominal wages/internal devaluation); post-2014 (broadly stable wage growth despite declining inflation until recent acceleration).
  - Core inflation accelerated to 4.1 percent y/y in Q42017; part (0.9 percent) attributed to tax increases generating a one-off effect.
  - Since 2016 wage growth and measures of core and harmonized CPI have broadly accelerated simultaneously (partly due to tax increases); caution to avoid another wage-price spiral.

### Labor market characteristics and dynamics
- Outcomes and indicators:
  - Unemployment has declined strongly since 2008/09 peak and remains below Baltic peers and EU/EA levels.
  - Youth unemployment lower than most peers.
  - Integration of low-skilled workers into employment broadly in line with EU28 and better than Baltic peers.
  - Output ≈ 1 percent above potential.
  - Involuntary part-time work is the second-lowest in the EU.
  - Temporary contracts are the fourth-lowest in the EU.
  - Indicators of labor shortages are edging up.
- Flexibility and exposure:
  - Wages are flexible; Estonia had negative nominal wage growth in 2009/10.
  - Limited employment protection legislation provides flexibility.
  - Exports and imports > 150 percent of GDP limit domestic firms’ pricing power; mark-ups adjust where wages rose faster than productivity.
- Labor force and migration:
  - Working-age population declined; labor force participation steadily rose to about 77 percent, keeping labor force broadly stable but ageing.
  - Emigration is relatively high, increasing worker bargaining power via opportunities in Nordic countries and Western Europe (including weekly commuting to Finland via the 2–2½ hour ferry from Tallinn to Helsinki).
  - Net migration turned positive since 2015; foreign nationals and residents born abroad ≈ close to 15 percent of the working-age population and labor force.
  - Recent immigrants (e.g., Ukrainians) may be less employable and have lower productivity, limiting offset to emigration effects.

### Structural and idiosyncratic factors
- Structural shifts explain a small part of wage increases:
  - Estonia average hourly pay rose 63 percent over 2006–14; structural shifts explain just under 2 percent of this increase.
  - Structural components in hourly wages (2014/06, % change): Pay gap 1.9; Female LFP -1.1; Increasing part time -0.7; Occupation 1.8; Residual 60.9; Total 62.9.
- Public sector and minimum wage:
  - Public-sector-dominated sectors ≈ almost a quarter of employment; public wages influence average wages and private settlements.
  - Public sector wages decelerated early 2017, rose again in Q3 2017 to 7 percent (4Q/4Q); part due to Estonian presidency of the EU in H2 2017.
  - Minimum wage rose ~10 percent each year during 2013–17; rise for 2018 was being contained (text cut off), later sections note: From 2019, social partners agreed on a formula including productivity growth; agreement to cap minimum wage at 40 percent of the average wage.
  - Data reflect employees in industry, construction and services (excluding public administration, defense, compulsory social security), ≈ 60 percent of employed persons.

### Econometric testing — cross-country panel regression (1995–2016)
- Dependent variable: nominal hourly compensation.
- Explanatory variables: one-year-ahead inflation (proxy for inflation expectations); change in real labor productivity; share of involuntary part-time employment; share of temporary contracts.
- Main findings:
  - Inflation has limited impact in the NMS; inflation expectations significant for All Countries and EU15 but not in NMS and Baltics.
  - Productivity significant in all groupings except NMS; coefficient in the Baltics much higher than EU15.
  - Labor market slack indicators play larger role in NMS (including Baltics) than in EU15.
  - Positive and significant coefficient on temporary contracts in NMS and Baltics suggests temporary contracts may signal labor market tightness.
  - Insignificance of constant in Baltics suggests wages more flexible than in EU15.
- Selected regression coefficients (Dependent variable: Compensation per hour worked; % change):
  - Inflation (HCPI one year ahead, % change): All Country 0.0207* (0.0106); EU-15 0.0127** (0.00521); NMS 0.0201 (0.0243); Baltics -0.00693 (0.0319).
  - Real labor productivity per hour worked (% change): All Country 0.0364*** (0.0111); EU-15 0.0191*** (0.00459); NMS 0.0421 (0.0268); Baltics 0.126*** (0.0294).
  - Involuntary part-time employment (% of total employment): All Country -0.578*** (0.218); EU-15 -0.586*** (0.0727); NMS -2.492** (1.243); Baltics -4.876*** (1.144).
  - Temporary contracts (% of total employment): All Country 0.0289*** (0.00659); EU-15 -0.00392 (0.00282); NMS 0.0797*** (0.0168); Baltics 0.0621** (0.0265).
  - Constant: All Country -2.383 (2.323); EU-15 4.749*** (0.874); NMS 30.58*** (7.020); Baltics 5.682 (4.296).
  - Fixed effect: Country for all groups.
  - Observations / Number of Countries: All Country Observations 579; Number of Countries 30. EU-15 Observations 307; Number of Countries 15. NMS Observations 20053; Number of Countries 113.
  - Adjusted R-squared: All Country 0.3959; EU-15 0.3639; NMS 0.3689; Baltics 0.4441.
  - Significance: *** p<0.01, ** p<0.05, * p<0.1.
  - Sources: Eurostat, IMF staff calculations.

### Conclusions on wages
- Inflation and inflation expectations play a smaller role in wage formation in Estonia and the NMS than in the EU15.
- Limited downward pressure on wages during very low inflation in 2014–16 contributed to a significant increase in labor’s share of national income.
- Current simultaneous acceleration in prices and wages is not evidence of a wage-price spiral; a significant share of inflation increase is due to exogenous factors.
- Low unemployment and low measures of labor market slack have reduced a factor that elsewhere contributed to low wage growth.
- Productivity slowdown post-GFC led only to a modest wage adjustment; wage-productivity link weaker in Estonia and other NMS.
- Structural shifts account for a relatively small share of recent wage increases; public sector pay correlated with overall pay; association of minimum wage increases with overall pay appears to have weakened.

### Policy options to align wage growth with productivity
- General: pursue a package addressing both wages and productivity; no single measure likely decisive.
- Labor supply:
  - Strengthen labor supply to alleviate wage pressures; options limited given high labor force participation (~77 percent).
  - Possible measures: further streamline public sector employment to encourage private sector employment; further raise labor force participation.
  - Relax immigration policies could help but political constraints likely.
- Wages:
  - Wages negotiated by social partners limit authorities’ options; government can influence through its own remuneration and minimum wage negotiations.
- Productivity:
  - Raising labor productivity growth is key to continued convergence.
  - Encourage private sector capital investment and raise public-sector investment; ensure public infrastructure enhances private investment productivity.
  - Adequate wage growth could trigger more investment if it forces firms to enhance productivity or shift to higher value-added activities, but wage growth must not be too high to deter investment.
  - With economy above capacity, expansion of public investment needs offsets; fiscal demand management should focus on revenue and current spending measures while raising investment.
- Tax policy:
  - Use tax system to dampen labor cost growth by reducing social security contributions and/or income taxes, and to support investment.
  - Recent income tax reform significantly reduced tax burden on lower incomes; increasing basic allowance to EUR 500 estimated to increase net wages of low-wage workers up to 15 percent and generate revenue loss ≈ 0.8 percent of GDP in 2018.
  - Enhance effective progressivity of income taxation; avoid pro-cyclicality by timing tax relief with slowdowns where possible.

### Public expenditure efficiency — selected issues highlights
- SIP assesses efficiency and effectiveness of public expenditure and benchmarks spending vs peers.
- Estonia achieves generally efficient use of public funds, but structural reforms could yield efficiency gains in social, health care, and education spending.
- Fiscal context:
  - Public reserves exceed gross debt.
  - Structural balance positive since 2009 and turned into a slight deficit in 2017.
  - Low overall capital stock and demographic shifts will impose spending pressures.
- General government spending estimated ≈ 40 percent of GDP; increased by 3 percentage points over 2011–16, mostly due to public wage bill and social benefits.
- Spending is mostly current spending; compensation of employees and social benefits elevated.
- Selected figures (percent of GDP):
  - Estonia Total expenditure: 2011 37.4; 2012 39.3; 2013 38.5; 2014 38.5; 2015 40.4; 2016 40.4; Difference (2011-2016) 3.0 (ppts of GDP).
  - Estonia Current spending: 2011 33.0; 2016 35.2; Difference 2.2.
  - Estonia Compensation of employees: 2011 10.7; 2016 11.8; Difference 1.1.
  - Estonia Social benefits: 2011 12.9; 2016 14.0; Difference 1.1.
  - Estonia Capital spending: 2011 5.8; 2016 5.3; Difference -0.5.
  - EU Total expenditure: 2011 46.4; 2016 43.9; Difference -2.6.
  - CESEE Total expenditure: 2011 41.8; 2016 40.0; Difference -1.8.
- Wage bill and employment:
  - Wage bill at 10.8 percent of GDP in 2015, slightly higher than European average.
  - General government employment levels at 16.4 percent of the working age population (European average 11.9; CESEE average 11.4).

### Public sector employment, pensions, and social protection
- Average public-sector wages relatively low; negative public-private wage premium gap noted.
- Low public-sector wages could limit ability to attract staff and, if gap narrows, could substantially increase wage bill.
- Recommendation: reduce general government employment to boost labor supply; authorities pledged to keep government employment in full-time equivalent terms pegged at 12 percent of population aged 15–74 years.
- Social protection:
  - At-risk-of-poverty rate after social transfers highest in Europe for the elderly and above EU average for the non-elderly in 2015.
  - Contributions to decrease in Gini (Estonia, in percent): Pensions 69.4; Non-means-tested social spending 10.5; Means-tested social spending 4.0; Direct taxes 14.4; Social contributions 1.6.
  - Only ≈ 1 percent of social protection spending is means-tested (EU average 9.4; CESEE average 3.5).
  - Pensions contribute ≈ 70 percent of inequality reduction; benefit ratio for pensions ≈ 30 percent and expected to decline.
- Policy measures underway:
  - Income tax reform (2018 budget) increases basic allowance to EUR 500.
  - Planned pension reforms: shift calculation basis for first pillar to years worked by 2037; tie national retirement age to average life expectancy in 2027; abolish special pensions of certain groups by 2020.
  - Increased monthly benefits for large families in July 2017: additional EUR 300 for families with three children, and EUR 400 for families with seven or more children.
- Recommendations: better target the poor, expand in-work benefits, expand active labor market programs and link them to social assistance; be cautious on means-testing given limited scope and administrative costs.

### Health sector — spending, outcomes, and efficiency
- Health spending ≈ 5.5 percent of GDP in 2015 (≈ ½ percentage point higher than in 1990; ≈ ¾ percentage point lower than EU average).
- PPP-adjusted per capita health spending ≈ USD 1,670 in Estonia vs ≈ USD 3,100 for the EU in 2014.
- Demographics: old-age dependency ratio projected 28 percent in 2013 → 54 percent by 2060 (EC, 2015).
- Service structure: share of doctors in hospitals 65 percent (≈ 10 percentage points higher than EU average); share of nurses in hospitals ≈ 8 percentage points higher than EU average.
- Outcomes and risk factors: HALE at birth ≈ 69 years vs over 70 years EU average; crude deaths ≈ 20 percent higher than EU; circulatory and ischemic heart diseases ≈ 37 percent higher than EU; external injuries/poisoning ≈ 59 percent higher; alcohol-related diseases ≈ 45 percent higher; smoking-related diseases ≈ 10 percent higher.
- Efficiency: distance to efficiency frontier ≈ 4 years of HALE; potential gains via rebalancing to primary/preventive care and shifting inpatient care to lower-cost settings.
- Ongoing reforms: networks between regional and general hospitals; excise tax hikes on tobacco and alcohol; investments in e-health; increase role of nurses and midwives.

### Education — spending, outcomes, and efficiency
- Education spending in 2015 ≈ 0.9 percentage points of GDP higher than EU average and 1.2 percentage points higher than CESEE average.
- Higher spending components: Goods & Services 1.3 ppts higher than EU; capital spending 0.8 ppts higher than EU.
- Teacher-student ratios exceed EU average by 1.1 (primary) and 2.4 (secondary).
- Net school enrollment ratios slightly above EU average and ≈ 3 percentage points above CESEE average for both primary and secondary.
- Distance to frontier (net enrollment): ≈ 3 years for primary; ≈ 7 years for secondary.
- PISA performance: scores consistently higher than the 75th percentile of EU and CESEE averages for math, reading and science.
- Reform priorities: improve supply efficiency while maintaining outcomes; develop technology-intensive skills; make teaching more attractive via targeted wage increases; adapt to declining student numbers; change teacher remuneration from contact hours to general working time; more autonomy for principals on salaries; higher education free for full-time Estonian students since 2013/2014.

### Public Investment Management (PIM) — findings and recommendations
- Context:
  - Public investment > 4.5 percent of GDP for more than a decade; new government announced additional investments of 0.5 percent of GDP annually for next three years from 2018.
  - Structural fiscal surplus since 2009 until 2016; nominal deficit ≈ 0.3 percent of GDP in 2017 (preliminary); gross public debt peaked at 10.7 percent in 2014 and was 9 percent in 2017.
  - Major projects include Rail Baltic: capital cost projected at €5.8 billion (25.2 percent of Estonia’s 2017 GDP); Estonia’s share expected €1.35 billion (5.9 percent of GDP).
- PIM assessment (selected institutions):
  - Planning — Institutional strength: Medium; Effectiveness: Low (plans often not linked to fiscal framework; lack consolidated presentation of investment plans and costings).
  - Coordination — Institutional strength: Good; Effectiveness: Good.
  - Allocation (Multi-Year Budgeting) — Institutional strength: Medium; Effectiveness: Medium (ceiling application limited; total costs of multi-year projects not published).
  - Project Appraisal — Institutional strength: Medium; Effectiveness: Low (no standard methodology; limited central capability; risks not systematically managed).
  - Project Selection — Institutional strength: Medium; Effectiveness: Low (absence of binding selection criteria; projects can be added outside process).
  - Implementation — Transparency of Execution: Institutional strength Good; Effectiveness Good (e-procurement, audits).
  - Implementation — Project Implementation: Institutional strength Medium; Effectiveness Medium (limited central monitoring of cost/time overruns).
- Identified strengths: high transparency in planning and procurement; robust execution oversight; strong coordination supported by fiscal rules; sustained fiscal discipline enabling high public investment.
- Main weaknesses/risks:
  - Planning outputs not linked to fiscal framework; lack of consolidated public sector investment plan with costings.
  - No central, standardized appraisal methodology or central appraisal capability.
  - Budget documents omit total costs of multi-year projects; grant-financed projects exempt from ceilings.
  - Limited central monitoring of project implementation prevents systematic measurement of cost/time overruns.
- Recommendations:
  - Streamline and simplify strategic planning; align national plan with fiscal framework; identify fiscal implications and costings in plans.
  - Prepare a consolidated public sector investment plan with financial projections and project costings.
  - Establish a standard appraisal methodology and central appraisal capability; systematically identify and manage project risks.
  - Include total costs of multi-year projects in budget documentation and apply ceilings more consistently.
  - Enhance central monitoring of implementation and collect comprehensive data on overruns to inform corrective action.
  - Consider establishing a modest centralized public investment management capability within the MoF to lead appraisal, monitor implementation, institutionalize audits for overruns, and provide overall leadership.

### Project cost and time overrun examples and oversight
- Eastern Border project:
  - Initial estimate Feb 2015 €79 million; Feb 2018 estimate €197 million (2.5 times initial).
  - Internal audit: weak planning/monitoring and limited information at planning stage contributed to overrun.
- Auvere Power Plant:
  - Construction began 2011; plant producing electricity in 2015 but particle emissions exceeded limits at higher capacities.
  - Remedial actions: General Electric built additional fabric filters; final delivery expected Q2 2018.
  - In 2016 General Electric and Eesti Energia agreement: General Electric to pay liquidated damages for delay; for 2017 General Electric had to pay €30.9 million of which €21.9 million was settled by year end.
  - Project budget €638 million; €568 million invested up to end-2017.
- Oversight and audits:
  - National Audit Office of Estonia (NAOE) conducts ex post audits on selective basis; audit of major investments priority under 2014–20 strategy.
  - NAOE audit on Rail Baltic raised concerns about lack of clarity on Estonia’s obligations, burden-sharing, and risks if external financing reduced or parties withdraw.
  - Data gaps: little consolidated data on project adherence to original cost/time budgets; anecdotal evidence suggests overruns are non-trivial.
- Suggested institutional improvements: systematic monitoring/reporting; institutionalized investigations of overruns beyond thresholds.

### Box — National Development Planning in Ireland (illustrative)
- Ireland’s NDP evolution: first NDP 1993–2000; recent NDP 2018–27 and Ireland 2040 integrate planning with medium-term fiscal framework.
- Features: strategic priorities, indicative budgetary allocations, annual projections of capital expenditure by funding source, annual departmental capital allocations.

Italic line: *Source: cr18126 — Selected Issues Paper excerpts from the IMF Republic of Estonia country report (as provided).*

### 1. Wages and Wage Drivers  ____________________________________________________________ 4

### 1. Wages and Wage Drivers

### A. Introduction
- Estonia’s income per capita has risen to about 51 percent of the level of EU15 (2017), the third-highest of the New Member States (NMS).
- Wages have risen commensurately, but in recent years have increased more rapidly than labor productivity and faster than elsewhere in Europe.
- Continued divergence of wage dynamics from economic fundamentals could undermine growth and income convergence in the longer run and impact competitiveness.
- Paper objectives:
  - Identify drivers of wage growth and inflation and test whether a wage-price spiral is emerging.
  - Assess whether direction and magnitude of drivers differ in Estonia and whether effects differ from elsewhere in Europe.

### B. Key Drivers of Wage Growth — Overview
- After the Global Financial Crisis (GFC) three key factors drove wage growth in advanced economies: productivity gains, inflation expectations, and labor market slack.
- In many European countries these factors tended to push wage inflation lower; in Estonia and other Baltic economies:
  - Unemployment has fallen and the labor market has tightened appreciably.
  - Productivity growth has slowed.
  - Inflation is more volatile than in larger EU economies, likely reducing the anchoring role of expectations.
- Implication: low inflation rates may have had less downward drag on wage settlements in Estonia than elsewhere.

### C. Productivity
- Productivity growth in Estonia has slowed from previously high levels tied to investment and income convergence with Western Europe.
- From 2013 until recently, wage growth outpaced nominal GDP growth, implying a rising labor share of national income and rising real unit labor costs.
- Compared to pre-GFC levels, both GDP and wages are growing at a slower pace.

### D. Inflation
- Inflation in Estonia is generally in line with European trends but at higher levels and with higher volatility.
- Three distinct phases in the past decade:
  1. Pre-crisis: high inflation and high wage growth.
  2. Crisis: rapid adjustment with negative inflation and declining nominal wages (internal devaluation policies).
  3. Post-2014: broadly stable wage growth irrespective of declining inflation rates until recent acceleration.
- Specific figures:
  - Core inflation in Estonia accelerated markedly to 4.1 percent y/y in Q42017; part (0.9 percent) attributed to tax increases generating a one-off effect.
- Prior to the GFC wages appear to have led inflation, suggesting a past wage-price spiral; since 2016 wage growth and measures of core and harmonized CPI have broadly accelerated simultaneously (partly due to tax increases).
- Caution needed to avoid emergence of another wage-price spiral.

### E. Labor Markets
- Labor market outcomes:
  - Unemployment has declined strongly since its peak in 2008/09 and remains below Baltic peers and EU/EA levels.
  - Youth unemployment is lower than in most peers.
  - Integration of low-skilled workers into employment is broadly in line with the EU28 and better than Baltic peers.
- Labor market characteristics:
  - Wages are flexible; Estonia experienced negative nominal wage growth during 2009/10 (internal devaluation), an outcome rare outside crisis countries.
  - Employment protection legislation is limited, providing labor market flexibility.
  - Exposure to international markets (exports and imports of goods and services amount to more than 150 percent of GDP) limits domestic firms’ pricing power; mark-ups have adjusted where wages rose faster than productivity.
- Indicators of tightness and slack:
  - Output is about 1 percent above potential.
  - Involuntary part-time work is the second-lowest in the EU.
  - Temporary contracts are the fourth-lowest in the EU.
  - Indicators of labor shortages are edging up.
- Labor force dynamics:
  - Working-age population has declined, labor force participation has steadily risen, keeping the overall labor force broadly stable but ageing.
- Migration and bargaining power:
  - Emigration is relatively high, enhancing workers’ bargaining power via opportunities in Nordic countries and Western Europe (including weekly commuting to Finland via the 2–2½ hour ferry from Tallinn to Helsinki).
  - Net migration has turned positive since 2015; foreign nationals and residents born abroad account for close to 15 percent of the working-age population and labor force.
  - Recent immigration (e.g., Ukrainians) may be less employable and have lower productivity, limiting offset to emigration effects.

### F. Other Drivers and Structural Factors
- Structural shifts account for a small part of wage increases:
  - Estonia’s average hourly pay grew by 63 percent over 2006–14; structural shifts explain only just under 2 percent of this increase.
- Specific small effects:
  - Narrowing gender pay gap would raise average wages if higher-paid, female-dominated public sector wages rise.
  - Increasing share of women in the labor force would, ceteris paribus, push average wages down given existing gender pay gap.
  - Increasing part-time work (associated with higher female labor force participation) tends to lower average hourly wages.
  - Occupational shifts toward better-remunerated jobs can raise average wages.

### G. Idiosyncratic Drivers: Public Sector and Minimum Wage
- Public sector wage dynamics:
  - Public-sector-dominated sectors account for almost a quarter of employment, so public sector wages influence average economy-wide wages directly and serve as a reference for private sector settlements.
  - Public sector wages decelerated in the first half of 2017 but rose again in Q3 2017 to 7 percent (4Q/4Q); at least part of this is due to the Estonian presidency of the EU driving up public sector pay during the second half of 2017.
  - Causality runs both ways: private sector wages also influence public sector remuneration to maintain competitiveness for staffing.
- Minimum wage:
  - Minimum wages are largely determined in negotiations between social partners with government representation and legal backing.
  - After rising by 10 percent each year during 2013–17, the rise for 2018 is being contained at

### H. Synthesis — Forces Pulling in Different Directions
- Factors pushing wages up in Estonia relative to other advanced economies:
  - Tight labor market, declining unemployment, increasing worker bargaining power due to emigration options.
  - Public sector and minimum wage policies that influence economy-wide wage benchmarks.
  - High inflation volatility reducing the anchoring role of expectations.
- Factors pulling toward wage moderation:
  - Pronounced slowdown in productivity growth relative to peers limits firms’ capacity to sustain rapid wage growth.
  - High labor income share as a proportion of national income and relatively high inequality notwithstanding rising labor share.
- Policy implication highlighted: care needed to avoid a wage-price spiral as wage and price dynamics accelerate.

*Prepared by Alexander Pitt with research assistance provided by Nhu Nguyen.*

### 6.4 percent. However, the link between minimum wages and overall wages appears to have

### cr18126 - 6.4 percent. However, the link between minimum wages and overall wages appears to have

### Overview
- Minimum wage increases continued to be high, but overall wage growth declined and only recently caught up again.
- From 2019, social partners agreed on a formula which includes productivity growth to guide minimum wage negotiations.
- Agreement reached to cap the minimum wage at 40 percent of the average wage.
- Data referenced reflects employees in industry, construction and services (excluding public administration, defense, compulsory social security), which account for about 60 percent of employed persons.

### Wage dynamics and structural components
- Structural Components in Hourly Wages (% change, 2014/06):
  - Pay gap: 1.9
  - Female LFP: -1.1
  - Increasing part time: -0.7
  - Occupation: 1.8
  - Residual: 60.9
  - Total: 62.9
- Quarterly wage dynamics (quarter-on-quarter percent change) shown for:
  - Gross hourly wages (total economy)
  - Public sector wages
  - Minimum wage
- Sources cited for wage series: Eurostat, IMF staff calculations, Statistics Estonia, and https://countryeconomy.com

### Testing the Main Drivers (cross-country panel regression, 1995–2016)
- Dependent variable: nominal hourly compensation.
- Explanatory variables included:
  - One-year-ahead inflation (proxy for inflation expectations)
  - Change in real labor productivity
  - Share of involuntary part-time employment in total employment
  - Share of employees with temporary contracts in total employment
- Main regression findings:
  - Inflation appears to have a limited impact in the NMS; inflation expectations significant for All Countries and EU15 but not in the NMS and the Baltics.
  - Productivity significant in all country groupings except NMS as a whole; coefficient in the Baltics much higher than in EU15.
  - Labor market slack indicators play a larger role in the NMS (including the Baltics) than in the EU15 or across all countries.
  - Positive and significant coefficient on temporary contracts in the NMS and Baltics suggests temporary contracts may signal labor market tightness.
  - Insignificance of the constant in the Baltics regression suggests wages there are likely more flexible than in the EU15.

- Selected regression coefficients (Dependent variable: Compensation per hour worked; % change)
  - Inflation (HCPI one year ahead, % change):
    - All Country: 0.0207*
    - EU-15: 0.0127**
    - NMS: 0.0201
    - Baltics: -0.00693
    - Standard errors: (0.0106), (0.00521), (0.0243), (0.0319)
  - Real labor productivity per hour worked (% change):
    - All Country: 0.0364***
    - EU-15: 0.0191***
    - NMS: 0.0421
    - Baltics: 0.126***
    - Standard errors: (0.0111), (0.00459), (0.0268), (0.0294)
  - Involuntary part-time employment (age 15-74, % of total employment):
    - All Country: -0.578***
    - EU-15: -0.586***
    - NMS: -2.492**
    - Baltics: -4.876***
    - Standard errors: (0.218), (0.0727), (1.243), (1.144)
  - Temporary contracts (age 15-74, % of total employment):
    - All Country: 0.0289***
    - EU-15: -0.00392
    - NMS: 0.0797***
    - Baltics: 0.0621**
    - Standard errors: (0.00659), (0.00282), (0.0168), (0.0265)
  - Constant:
    - All Country: -2.383 (2.323)
    - EU-15: 4.749*** (0.874)
    - NMS: 30.58*** (7.020)
    - Baltics: 5.682 (4.296)
  - Fixed effect: Country for all groups.
  - Observations / Number of Countries:
    - All Country: Observations 579; Number of Countries 30
    - EU-15: Observations 307; Number of Countries 15
    - NMS: Observations 20053; Number of Countries 113
  - Adjusted R-squared:
    - All Country: 0.3959
    - EU-15: 0.3639
    - NMS: 0.3689
    - Baltics: 0.4441
  - Significance legend: *** p<0.01, ** p<0.05, * p<0.1
  - Sources: Eurostat, IMF staff calculations

### Conclusions on wages
- The role of inflation and inflation expectations in Estonia and the NMS differs from the EU15; impact of inflation on wage formation is smaller.
- Limited downward pressure on wages during very low inflation in 2014–16 contributed to a significant increase in labor’s share of national income.
- Current simultaneous acceleration in prices and wages is not evidence of a wage-price spiral; a significant share of inflation increase is due to exogenous factors.
- Low unemployment and other low measures of labor market slack reduce a factor that elsewhere contributed to low wage growth.
- Labor market frictions do not appear to have increased; labor force participation at 77 percent is already among the highest in the EU.
- Productivity slowdown after the GFC led only to a modest adjustment in wage growth; the wage-productivity link is weaker in Estonia and other NMS.
- Idiosyncratic factors matter, but structural shifts account for a relatively small share of recent wage increases:
  - Public sector pay correlated with overall pay.
  - Association of minimum wage increases with overall pay appears to have weakened.
  - Structural shifts raising wage growth: declining gender pay gap, shift in occupational structure.
  - Structural shifts lowering wage growth: increasing female labor force participation, increasing part-time work.
  - Total structural effect appears small.

### Policy Options to bring wage growth more in line with productivity
- General approach: pursue a package of measures addressing both wages and productivity; none alone likely decisive.
- Labor supply:
  - Strengthen labor supply to alleviate wage pressures; options limited.
  - Possible measures:
    - Further streamlining public sector employment to encourage private sector employment.
    - Further raising labor force participation (current level at 77 percent).
  - Immigration policies could be relaxed further, but political constraints likely limit this.
- Wages:
  - Authorities’ options limited because wages are negotiated by social partners.
  - Government can influence wage settlements through its own remuneration policies and presence in minimum wage negotiations.
- Productivity:
  - Raising labor productivity growth is key for continued convergence with Western Europe.
  - Encourage private sector capital investment and raise public-sector investment.
  - Public infrastructure should enhance productivity of private investment.
  - Adequate wage growth could trigger more investment if it forces employers to enhance productivity or shift to higher value-added activities.
  - Caveat: wage growth cannot be too high so as to deter investment.
  - With the economy operating above capacity, expansion of public investment would need to be offset by other measures.
  - Fiscal demand management should focus on revenue and current spending measures while raising investment.
- Tax policies:
  - Use tax system to dampen labor cost growth by reducing social security contributions and/or income taxes, and to support investment.
  - Recent income tax reform has significantly reduced the tax burden on lower incomes.
  - Going forward, effective progressivity of income taxation could be enhanced further.
  - Avoid pro-cyclicality: time tax relief to coincide with a slowdown where possible.

### Public expenditure efficiency (Selected Issues Paper highlights)
- SIP assesses efficiency and effectiveness of public expenditure in Estonia; benchmarks spending levels and composition against peers and takes stock of spending outcomes.
- Estonia achieves generally efficient use of public funds, but structural reforms could provide efficiency gains in social, health care, and education spending.
- Background fiscal context:
  - Public reserves exceed gross debt.
  - Structural balance positive since 2009 and turned into a slight deficit in 2017.
  - Low overall capital stock and imminent demographic shifts will impose spending pressures.
- General government spending:
  - Estimated at 40 percent of GDP; increased by 3 percentage points over 2011–16, mostly driven by public wage bill and social benefits.
  - EU and CESEE averages decreased by 2.6 and 1.8 percentage points respectively over the same period.
  - Spending is mostly current spending, particularly compensation of employees and social benefits.
  - Estonia’s low public debt translates into low interest payments, providing fiscal space.
  - Spending on compensation of employees, goods and services and public investment is above the EU average, while social benefit spending is below the EU average.

- Selected figures (percent of GDP):
  - Estonia Total expenditure:
    - 2011: 37.4
    - 2012: 39.3
    - 2013: 38.5
    - 2014: 38.5
    - 2015: 40.4
    - 2016: 40.4
    - Difference (2011-2016): 3.0 (ppts of GDP)
  - Estonia Current spending:
    - 2011: 33.0
    - 2016: 35.2
    - Difference (2011-2016): 2.2
  - Estonia Compensation of employees:
    - 2011: 10.7
    - 2016: 11.8
    - Difference (2011-2016): 1.1
  - Estonia Social benefits:
    - 2011: 12.9
    - 2016: 14.0
    - Difference (2011-2016): 1.1
  - Estonia Capital spending:
    - 2011: 5.8
    - 2016: 5.3
    - Difference (2011-2016): -0.5
  - EU Total expenditure:
    - 2011: 46.4
    - 2016: 43.9
    - Difference (2011-2016): -2.6
  - CESEE Total expenditure:
    - 2011: 41.8
    - 2016: 40.0
    - Difference (2011-2016): -1.8

- Wage bill and employment:
  - Wage bill at 10.8 percent of GDP in 2015, slightly higher than the European average.
  - General government employment levels at 16.4 percent of the working age population, higher than European average of 11.9 and CESEE average of 11.4.

*International Monetary Fund — Republic of Estonia Selected Issues excerpts (as provided).*

### 2015. At the same time, average wages in the public sector are relatively low as evidenced by a

### 2015. At the same time, average wages in the public sector are relatively low as evidenced by a

### Findings
- Average wages in the public sector are relatively low as evidenced by a negative public-private wage premium gap (IMF, 2016a, 2016b).
- Low public-sector wages could limit the public sector’s ability to attract and retain qualified staff, while severely increasing the overall wage bill should the gap narrow going forward.
- Reducing general government employment could boost labor supply, alleviating pressures stemming from demographic headwinds and an already tight labor market.
- Labor force participation is currently at about 77 percent, one of the highest in the EU.
- Unemployment has decreased to very low levels by historical standards: 5.8 percent in 2017.
- Wage growth has consistently been high, outpacing labor productivity growth in the past years, leading to rising unit labor cost, which could affect Estonia’s competitiveness.
- Estonia, like many other CESEE countries, is facing severe demographic headwinds, making policies aimed at alleviating labor market tightness even more important.

### Policy recommendations and ongoing measures
- Ongoing public-sector reforms should be complemented with further structural measures.
- A policy to shrink the size of the government sector, targeting a yearly staff reduction of

### Key statistics and risks
- Labor force participation: about 77 percent.
- Unemployment: 5.8 percent in 2017.
- Trend: Wage growth > labor productivity growth → rising unit labor cost (potential competitiveness risk).

*Source: cr18126 - 2015. At the same time, average wages in the public sector are relatively low as evidenced by a*

### 0.7 percent is in place, and has been overachieved in 2016.

### 0.7 percent is in place, and has been overachieved in 2016.

### Public sector employment and wages
- The government has pledged to keep government employment in full-time equivalent terms pegged at 12 percent of the population aged 15–74 years.
- There appears to be room for a faster reduction in general government employment to free up labor resources for the private sector.
- Cross-country evidence suggests effective policies include rationalizing size and structure of government, outsourcing non-core functions, improving service efficiency and hiring processes.
- Downsizing that is part of a reorganization and targets specific positions/functions is likelier to achieve permanent reductions than untargeted, across-the-board cuts.
- Voluntary departure schemes have not been very effective due to adverse selection problems (Haltiwanger and Singh, 1999; OECD, 2011; Holzman and others, 2011).
- Public–private wage differential: measured as a percent of private wage based on regression studies controlling for skill differentials (within-country average over time).

### Public investment, capital stock, and infrastructure quality
- Public investment has been higher than most European countries and sustained for a decade, reaching over 5 percent of GDP in 2017.
- Estonia is a major recipient of ESI Funds and is allocated EUR 4.5 billion during the 2014–20 budget period.
- The public capital stock still needs some 3 percentage points to catch up with the European average, estimated at about 63 percent of GDP in 2015.
- Quality of overall capital stock and infrastructure perceived about the same as OECD average; air transport, roads and railroads perceived to be lower; ports score higher than OECD or advanced-economy averages.
- Policy focus: preserve efficiency in public investment through tight project management, stronger prioritization, and guarantee sufficient maintenance spending in the medium term.

### Public spending by functional classification (key figures and comparisons)
- Estonia total expenditure (percent of GDP): 2011 37.4; 2012 39.3; 2013 38.5; 2014 38.5; 2015 40.3; Difference (2011–2015) 2.9 (ppts of GDP).
- Estonia spent more than the EU average in 2015 in:
  - Defense: 0.7 percentage points of GDP higher (Estonia 1.9 vs EU 1.2 approximately).
  - Recreation, culture and religion: 0.8 percentage points of GDP higher.
  - Education: 0.9 percentage points of GDP higher.
- Estonia spent less than the EU average in 2015 in:
  - General public services: 2.1 percentage points of GDP lower.
  - Health: 0.8 percentage points of GDP lower.
  - Social protection: 3.9 percentage points of GDP lower.
- Estonia’s spending is mostly driven by current spending, particularly compensation of employees and social benefits.

### Social protection and redistribution
- The at-risk-of-poverty rate after social transfers was the highest in Europe for the elderly and above the EU average for the non-elderly in 2015.
- Contributions to decrease in Gini (Estonia, in percent):
  - Pensions 69.4
  - Non-means-tested social spending 10.5
  - Means-tested social spending 4.0
  - Direct taxes 14.4
  - Social contributions 1.6
- Only about 1 percent of social protection spending is means-tested (EU average 9.4 percent; CESEE average 3.5 percent).
- The amount of income-inequality reduction achieved by 1 percent of GDP of social spending is above the EU average but slightly below the CESEE average.
- Pensions contribute about 70 percent of the reduction in inequality, about 15 percentage points higher than in the EU.
- The benefit ratio for pensions is comparatively low (around 30 percent) and is expected to further decline in the medium to long run.
- Policy measures underway:
  - Income tax reform (2018 budget) increases basic allowance to EUR 500—about 55 percent of the average wage.
    - Authorities estimate the new basic allowance will increase net wages of low-wage workers up to 15 percent.
    - Change estimated to generate a revenue loss of around 0.8 percent of GDP in 2018.
  - Planned pension reform elements:
    - Shift calculation basis for first pension pillar to years worked by 2037.
    - Tie national retirement age to average life expectancy in 2027.
    - Abolish special pensions of certain groups by 2020.
  - Increased monthly benefits for large families in July 2017: additional EUR 300 for families with three children, and EUR 400 for families with seven or more children.
- Recommendations for social protection:
  - Better targeting the poor.
  - Greater use of in-work benefits.
  - Expand active labor market programs and strengthen their link to social assistance benefits.
  - Caution on means-testing due to limited scope (share of transfers after pensions and family benefits about 20%) and administrative costs; design means-tested benefits to avoid work disincentives.

### Health sector: spending, outcomes, and efficiency
- Health spending: about 5.5 percent of GDP in 2015 (about ½ percentage point higher than in 1990); about ¾ of a percentage point lower than the EU average.
- PPP-adjusted per capita health spending: about USD 1,670 in Estonia vs about USD 3,100 for the EU in 2014.
- Demographic pressure: old-age dependency ratio projected from 28 percent in 2013 to 54 percent by 2060 (EC, 2015).
- Service structure:
  - Share of doctors working in hospitals: 65 percent (about 10 percentage points higher than EU average; 7 percentage points higher than CESEE).
  - Share of nurses working in hospitals: about 8 percentage points higher than EU average (10 percentage points higher than CESEE).
- Health outcomes and risk factors:
  - HALE at birth about 69 years vs over 70 years for EU average.
  - Crude deaths exceed EU average by about 20 percent.
  - Diseases of circulatory system and ischemic heart diseases both about 37 percent higher than EU.
  - External injuries/poisoning about 59 percent higher than EU.
  - Alcohol-related diseases about 45 percent higher than EU.
  - Smoking-related diseases about 10 percent higher than EU.
  - Self-perceived “Good or very good” health lower than EU average across income levels except higher quintiles approach EU average.
- Efficiency assessment:
  - Data Envelopment Analysis suggests distance to efficiency frontier about 4 years of HALE.
  - Potential efficiency gains by rebalancing toward primary/preventive care and shifting acute inpatient care to lower-cost settings.
  - Medical training reforms: move from narrow specialization toward general skills; intensify continuous education and re-skilling.
- Ongoing reforms/actions:
  - Create networks between regional and general hospitals to share specialist expertise; a limited number of networks operating in 2017.
  - Recent excise tax hikes on tobacco and alcohol aimed at changing risk behaviors.
  - Investments in e-health systems to create efficiency gains.
  - Increase role of nurses and midwives to address human resource constraints.

### Education spending, outcomes, and efficiency
- Education spending in 2015 was about 0.9 percentage points of GDP higher than the EU average and 1.2 percentage points higher than the CESEE average.
- Higher spending components: Goods & Services (1.3 percentage points higher than EU) and capital spending (0.8 percentage points higher than EU).
- Teacher-student ratios:
  - Exceeds EU average by 1.1 for primary education.
  - Exceeds EU average by 2.4 for secondary education.
  - Exceeds CESEE average by 1.5 for primary and 2.1 for secondary.
- Net school enrollment ratios slightly above EU average and about 3 percentage points above CESEE average for both primary and secondary education.
- Distance to frontier (net enrollment):
  - About 3 years for primary education.
  - About 7 years for secondary education.
- PISA performance: scores consistently higher than the 75th percentile of EU and CESEE averages for math, reading and science.
- Reform priorities:
  - Focus on achieving efficiency gains in supply of education services while maintaining high outcomes.
  - Develop skills required for a technology-intensive economy.
  - Make teaching more attractive (addressed via targeted wage increases for teachers).
  - Adapt to declining numbers of students—redefine and coordinate allocation of education resources; consolidation potential limited by need for reasonable commuting distances.
  - Ongoing reforms: change teacher remuneration from contact hours to general working time; more autonomy for principals on salaries; higher education free for full-time Estonian students since 2013/2014; reforms to improve school transport and administrative reform to help municipalities organize school systems more efficiently.

### Policy implications and recommended reform areas
- Better outcomes should be achieved in a budget-neutral way where possible; given low spending levels, improving social outcomes (notably old-age poverty) may require broadening the tax base.
- Estonia’s overall spending: 40.4 percent of GDP in 2016 vs EU average 43.9 percent of GDP.
- Key recommended reforms:
  - Reduce general government employment faster to free up labor resources for the private sector, complemented by structural measures.
  - Preserve efficiency in public investment through tight project management and stronger prioritization to avoid leakages and inefficiencies.
  - Improve social spending efficiency via better targeting, greater use of in-work benefits, and expanding and linking active labor market programs to social assistance.
  - Achieve efficiency gains in health by rebalancing toward primary and preventive care and shifting acute inpatient care to lower-cost settings while ensuring sustainability given demographic challenges.
  - Reform the education sector to achieve efficiency gains in supply while maintaining outcomes and adapting to declining student numbers.

*IMF staff summary based on the Republic of Estonia country report content.*

### References

### cr18126 - References

### Overview and context
- This Selected Issues Paper (SIP) assesses key institutions involved in the public investment management (PIM) function in Estonia, guided broadly by the IMF PIMA framework.  
- Public investment has exceeded 4.5 percent of GDP for more than a decade and is expected to remain high. The new government announced additional investments of 0.5 percent of GDP annually for the next three years from 2018.  
- Estonia maintained a structural fiscal surplus since 2009 until 2016; the nominal deficit was contained to 0.3 percent of GDP in 2017 (preliminary results). Gross public debt peaked at 10.7 percent in 2014 and reverted to 9 percent in 2017.  
- Major projects include Rail Baltic with a capital cost projected at €5.8 billion (25.2 percent of Estonia’s 2017 GDP), of which Estonia’s share is expected to be €1.35 billion (5.9 percent of GDP), partly to be met by EU grants.

### PIM significance and assessment framework
- PIM institutions influence public investment efficiency, infrastructure quality, and productivity. McKinsey (2013) estimates scaling up PIM best practices could save an average of $1 trillion a year globally in infrastructure costs by: (i) making better decisions about project selection; (ii) streamlining project delivery; and (iii) making the most of existing infrastructure.  
- The IMF (2015) identifies 15 institutions across three PIM phases — Planning, Allocating, Implementing — and developed the PIM Assessment (PIMA) instrument to evaluate them. Over 30 PIMAs have been conducted to date, of which eight have been or are in the process of being published.  
- The SIP provides a preliminary assessment of selected PIM institutions in Estonia (national and sectoral planning; coordination; multi-year budgeting; project appraisal and selection; transparency of budget execution; management of project implementation). It is not a substitute for a full PIMA.

### Key findings (summarized from Table 1)
- Planning — National and Sectoral Planning  
  - Institutional strength: Medium — national and sectoral plans are published, most include measurable targets, and some include costings although public investment and overall fiscal implications are not always obvious.  
  - Effectiveness: Low — absence of a link between national/sectoral plans and the fiscal framework, and lack of a single consolidated presentation of public sector investment plans with sectoral allocations and costings of large projects undermine planning effectiveness.
- Coordination within the Public Sector  
  - Institutional strength: Good — local governments subject to fiscal rules, formula-based fiscal transfers, state budget covers general government; SOE sector enjoys autonomy but is actively monitored.  
  - Effectiveness: Good — low indebtedness, compliance with fiscal rules, clear functional responsibilities, substantial EU-funding supports coordination; large SOE investments are discussed with central government.
- Allocation — Multi-Year Budgeting  
  - Institutional strength: Medium — medium-term budget strategy and annual budget plan include capital spending projections over a four year horizon; ceilings binding for budget year and indicative for outer years; total costs of multi-year projects not published.  
  - Effectiveness: Medium — budget ceilings are not applied to grant-financed projects; non-inclusion of total project costs in budget documents means allocations can be approved without a view of total costs.
- Project Appraisal  
  - Institutional strength: Medium — cost-benefit analyses are conducted for major and externally-financed projects; other projects receive qualitative appraisals within sector ministries and the MoF.  
  - Effectiveness: Low — lack of a standard methodology and central capability undermines appraisal rigor; project-related risks are not systematically identified and actively managed.
- Project Selection  
  - Institutional strength: Medium — all projects are scrutinized by the MoF before budget inclusion; a project pipeline is maintained.  
  - Effectiveness: Low — absence of formal appraisal and binding selection criteria and latitude to add projects from outside the process weaken selection effectiveness.
- Implementation — Transparency of Execution  
  - Institutional strength: Good — public procurement is open and competitive; project costs and physical progress are monitored; financial oversight and ex post audits conducted.  
  - Effectiveness: Good — e-procurement platform allows open access to procurement information; internal and external audit reports produced; procedural violations highlighted.
- Implementation — Project Implementation  
  - Institutional strength: Medium — individual ministries and agencies oversee implementation; project budgets typically include provisional sums for modest adjustments; ex post reviews done especially for externally financed projects.  
  - Effectiveness: Medium — absence of central monitoring of project implementation means comprehensive data on cost and time overruns are not readily available, though anecdotal evidence suggests overruns do occur.

### Identified strengths
- High levels of transparency in planning documents and procurement processes.  
- Robust arrangements for project execution oversight, including e-procurement and audit mechanisms.  
- Strong coordination across levels of government supported by fiscal rules and formula-based transfers.  
- Continued sustained fiscal discipline that has kept deficits and public debt low, enabling high public investment within a prudent fiscal framework.

### Main weaknesses and risks
- Planning outputs are not formally linked to the fiscal framework and often do not indicate financing constraints, producing largely unconstrained sectoral aspirations.  
- No consolidated public sector investment plan with comprehensive details and costings of major projects is readily available.  
- Lack of a central, standardized project appraisal methodology and central capability to appraise projects and manage project risks.  
- Budget documentation does not publish total costs of multi-year projects; grant-financed projects are exempt from budget ceilings.  
- Limited central monitoring of project implementation prevents systematic measurement of cost and time overruns.

### Policy recommendations and reform priorities
- Streamline and simplify the strategic planning framework to reduce the number of plans and optimize performance indicators and targets to improve monitoring effectiveness.  
- Align the national plan with the fiscal framework and make sectoral plans indicative of available resources.  
- Identify clearly within each plan the implications for the public finances, including the public investment requirements and indicative costings of major investment projects.  
- Prepare a consolidated public sector investment plan with details of major public sector projects and accompanying financial projections and project costings.  
- Strengthen project appraisal by establishing a standard methodology and a central appraisal capability; systematically identify and manage project-related risks.  
- Consider including total costs of multi-year projects in budget documentation and applying budget ceilings more consistently, including to grant-financed projects where appropriate.  
- Enhance central monitoring of project implementation to permit comprehensive data collection on cost and time overruns and inform corrective action.

*Source: cr18126 - References — https://www.imf.org/-/media/files/publications/cr/2018/cr18126.pdf*

### Box 1. National Development Planning in Ireland

### Box 1. National Development Planning in Ireland

### Background and origins
- Ireland’s national development planning function has its origins in the planning cycle for EU structural funds.
- Ireland’s first national development plan (NDP) covered 1993–2000, coinciding with the EU cycle.
- Since then, the planning function has evolved considerably and successive NDPs have served as strategic investment plans.

### Evolution and integration with budgetary processes
- Successive NDPs were costed and integrated with the budget process.
- Following a PIMA conducted by the IMF in 2017, Ireland concluded a new National Planning Framework, Ireland 2040, along with the new NDP 2018–27.
- The Irish NDP maintains a close integration with the medium-term fiscal framework and long term fiscal projections, and connects these with the national vision and sectoral aspirations.

### Features of NDP 2018–27 and Ireland 2040
- The NDP 2018–27 identified the strategic priorities for public investment for all sectors.
- It reaffirmed the commitment to stronger coordination of sectoral strategies and more rigorous selection and appraisal of projects.
- It included indicative budgetary allocations to support the delivery of each national strategic outcome, and for identified strategic investment priorities under each outcome.
- It included annual projections of capital expenditure by funding source, as well as annual departmental capital allocations over the life of the plan.

_Source: Government of Ireland (2018a) and (2018b)._

### Box 3. Project Cost and Time Overruns

### Box 3. Project Cost and Time Overruns

### Eastern Border
- Initial presentation to Cabinet in February 2015 at an estimate of €79 million.
- In February 2018, the Police and Border Guard Board (PPA) presented estimates to the Ministry of the Interior that the project would now cost 2.5 times more at €197 million.
- Internal audit findings:
  - Lack of information on factors that could affect construction price, like construction volumes and geology, at the time of planning the project.
  - PPA had only one and a half months to present their initial assessment.
  - Weak planning and monitoring identified as contributory factors for the cost overrun.

### Auvere Power Plant
- Construction began in 2011 by Eesti Energia AS.
- Plant began producing electricity in 2015, but commissioning revealed particle emissions exceeded regulatory limits at higher production capacities.
- Remedial actions:
  - In 2017, General Electric undertook to build additional fabric filters and ancillary equipment.
  - Since August 2017, the builder has been adjusting the plant and the fabric filters and conducting tests; results confirm that after installation of additional equipment the emissions remain within regulatory limits.
- Delivery, costs, and penalties:
  - Due to deferral of commissioning, final delivery expected to take place in the second quarter of 2018.
  - In 2016, General Electric and Eesti Energia signed an agreement under which General Electric undertook to pay Eesti Energia liquidated damages for the delay until full delivery.
  - For 2017, General Electric had to pay €30.9 million of which €21.9 million was settled by the year end.
  - Project budget is €638 million, of which €568 million was invested up to the end of 2017.

### Central oversight, audits, and data gaps
- Ex post audits:
  - The National Audit Office of Estonia (NAOE) conducts ex post audits of projects on a selective sample basis.
  - Under the NAO’s audit strategy for 2014–20, audit of major investments is identified as a priority area for attention.
  - Audit reports are examined by the State Budget Control Committee, which monitors implementation of the state budget and use of budget funds and state assets; the Committee reports once a year to the parliament.
  - Recent NAOE audit on Rail Baltic raised concerns about:
    - Lack of clarity on Estonia’s financial obligations under the project agreement.
    - Burden-sharing amongst national parties to the agreement.
    - Risks to Estonia in event of reduced availability of external financing for the project or withdrawal by any of the other parties.
- Data and institutional gaps:
  - Individual ministries manage and control projects during execution, but central capabilities for managing the overall portfolio could be strengthened.
  - There is little consolidated data on the extent to which projects are implemented within their original cost and time budgets; reliance has to be placed on anecdotal accounts which suggest that this risk is non-trivial.
  - Suggested institutional improvements include more systematic monitoring and reporting, and institutionalized arrangements for investigating any cost and time overruns beyond specified thresholds.

### Possible areas for strengthening public investment management (as described)
- Establishing a modest centralized public investment management capability within the MoF (possibly by expanding the mandate of one of the existing departments), tasked with:
  - Leading the project appraisal and selection function including setting standards for project appraisals and monitoring compliance with same.
  - Monitoring project implementation in collaboration with responsible ministries and agencies.
  - Institutionalizing audits of cost and time overruns above specified thresholds.
  - Providing overall leadership on public investment management issues.

*Source: Eesti Energia SA 2017 Annual Report, mission discussions.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18126.pdf_