Estonia: overheating and sectoral dynamics

Estonia's accession to the EU in 2005 led to a period of above-potential growth, fostered by expansionary monetary conditions. The predominance of foreign-owned banks accelerated the process of financial integration. Financial flows, while massive, were mostly directed at the non-tradable sectors of Estonia's economy, leading to an overexpansion of market services, while productivity growth in these sectors was declining, In contrast, manufacturing registered high total factor productivity (TFP) growth, while resources directed at this subsector were declining
in relative terms. This relative misallocation of resources progressively led to growing macroeconomic imbalances, triggering an abrupt end to the high phase of the economic cycle. However, in 2007, competitiveness in the higher skilled subsectors of manufacturing was still holding up fairly well despite rapid increases in unit labour costs. Exports by most subsectors were growing at a sustained pace and appeared to be laying the foundation for renewed growth.
been high and TFP growth.

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