It is not possible to simply dissuade ourselves from the security risk looming over Estonia, and to convince investors to put money here, we need to invest in our defense capability, writes Markus Villig.
When I talk to investors or job candidates about Bolt, I often hear the question “How are you doing with this Russian threat in Estonia?”
This week, Eesti Pank presented a worse-than-expected economic forecast. It is not in our power to influence the European economic environment, but we can determine how attractive Estonia is as a destination to the outside world. In order for investors to have the courage to invest their money here and for foreign talent to come to work, it is important that they perceive Estonia as a safe country.
For investors, a deterioration in the security environment is a risk, and that risk comes with a price. This price weighs on every company, family and even our state budget. In essence it is a “Putin tax”, which does not create added value in the economy, but hangs around our necks like a loan shark bandit. This is the price we will pay if Estonia’s defense capabilities are not sufficiently developed.
How big is the “Putin tax”?
The simplest way to calculate this risk premium is to compare the change in bond interest rates of Estonia and countries similar to ours at the outbreak of the war in Ukraine.
Let’s take Slovenia for example, a country similar to us in terms of size and economic development. In the fall of 2022, Estonia issued a bond hoping to earn a 3% yield, which would be the same as the yield on Slovenia’s 10-year bond issued in September. Instead of the yield on the ten-year debt, Estonia got 4%, i.e. 1% more.
Estonia’s national debt totals around five billion euros, while private sector debt amounts to around 40 billion euros. If the “Putin tax” were 1% of this figure, it would mean 450 million euros per year. This makes 350 euros for each of our residents. For comparison: Estonia’s national defense budget in 2024 is 1.3 billion euros.
There are numerous examples in the world of how it is possible to develop an attractive environment for investments and interests alongside aggressive neighbors: South Korea, Singapore, Israel, Taiwan or Finland. All these countries are characterized by higher than average defense costs.
In the case of Finland, for example, the threat from Russia is similar to that of Estonia, but interest rates are on average 1% lower. Therefore, it can be tentatively stated that the “Putin tax” can be significantly reduced by developing the Estonian defense forces to be similar to the Finnish ones.
Increasing defense spending would help
According to the Ministry of Defense, the critical deficit in Estonia currently amounts to 1.6 billion euros. Instead of carrying an invisible burden, the first step could be to add an amount equal to the “Putin tax” to the defense budget for the next three years. This would help reduce security risk, which would increase the interest of foreign investors and talent in Estonia, which in turn would promote the development of the economy.
“A further deterioration of the security environment would mean a significantly higher risk premium for us than the current 1%.”
By postponing investments, we put at risk not only Estonia’s security, but also higher capital costs in the future. This is because a further deterioration of the security environment would mean a more significant risk premium for us than the current 1%.
Of course, this must be done with sensible management and taking into account the deficit rules agreed in Europe. A few weeks ago, the President of the European Commission, Ursula von der Leyen, proposed the application of an exception to the 3% deficit rule for defense investments. It would be difficult to justify not using this option.
Potential for the local defense industry
Of course, in addition to defensive investments, investors’ risk perception depends on many other factors. In the example of Israel and South Korea, the innovation of the defense industry and the technological level of the countries are also important. Investor interest in defense startups has grown rapidly in recent years. According to the Financial Times, venture capital investments in this field amounted to $16 billion in 2019 and will double to $33 billion by 2022.
Estonia is known for its digital country and successful technology companies, and we also have similar potential in building a new generation of defense companies. The country could seriously consider supporting defense technology companies and making efforts to attract players from other parts of the world, certainly including Ukraine.
It is not possible to simply dissuade ourselves from the security risk facing Estonia. To convince investors to put money here and talent to come to work, it is necessary to invest in Estonia’s defense capacity both in substance and in perception.
2023-12-21 08:23:00
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