Deloitte Monday Briefing: Krugman vs. Estonia

* Last month Estonia's Finance Minister, Jürgen Ligi, spoke at an London School of Economics seminar on the subject of 'Why Paul Krugman is wrong: lessons of Estonia for other European countries".

* The title may sound baffling but the subject is at the heart of the debate about how to revive growth in the Western world.

* Paul Krugman is a Nobel laureate in economics and writes a column for the New York Times. Professor Krugman is arguably America's most influential Keynesian economist, someone who sees spending cuts and tax rises as exactly the wrong prescription for Europe's or America's economic woes.

* In June Professor Krugman took issue with those who saw deep cuts in public spending in Estonia and the subsequent rebound in growth as a model of successful austerity. He tweeted, "So, a terrible — Depression-level — slump, followed by a significant but still incomplete recovery. Better than no recovery at all, obviously — but this is what passes for economic triumph?".

* This prompted a furious reaction from Estonia's President, who, in a series of tweets called Professor Krugman, "smug, overbearing and patronising".

* Professor Krugman's view is that, while the Estonian growth has rebounded in the last 3 years, the economy is still almost 10% smaller than at its peak in 2007. On this measure deep cuts in public spending and tax rises have failed. To Professor Krugman Estonia provides a cautionary tale for the US of the damaging effects of aggressive fiscal retrenchment.

* Estonia's Finance Minister, Jürgen Ligi, has a different view. In his remarks at LSE Mr Ligi argued that Estonia's deep recession was an inevitable response to the bursting of a credit and asset price bubble, not the result of government austerity. Pre-crisis GDP had been artificially inflated by the boom and it was unrealistic to expect the economy to return to such levels swiftly. Growth depended on make the private sector more flexible and competitive, not on government spending. For Mr Ligi, Estonia's experience shows why the euro area needs more austerity and reform, not less.

* The arguments are complex and the issues contested. But here are some of the facts behind the debate.

* The Estonian economy suffered a huge, near 20% contraction in 2008-09 and it will take years of growth to regain this peak. Estonia has fared better in recent years than other smaller economies which suffered boom bust cycles such as Greece or Portugal. The IMF forecasts that Estonia...