Shrinking without sinking: Lessons from Estonia

Estonia’s population is shrinking. By 2040, its population may shrink by 2%, with most regions losing over 20% of their residents. The Estonian population is also spread out thinly. With a population density of 30.3 people per square km, it’s among the lowest in the EU. Less than 70% of the population live in urban areas compared to the OECD average of 81%.

This is presenting major challenges for policy makers, especially as the decline is uneven. Among those who remain, many are leaving rural areas for bigger cities. While most counties (administrative subdivisions) experienced population declines of more than 25%, Estonia’s large urban areas like Tallinn and Tartu are still growing.

Not shrinking alone

Estonia is not shrinking alone. The average fertility rate in OECD countries was 1.6 children per woman in 2019 and it’s lower in EU countries. France and the U.S. make up the difference with new arrivals, but in low-immigration countries such as Korea and Japan, lower fertility means ageing and shrinking populations.

Estonia is not unique either regarding its internal migration dynamics. Many countries have seen major shifts in recent years, such as the west-ward migration from eastern Germany. In Italy, scenic hill towns are being left abandoned. Estonia, like many small countries, faces the “double-whammy” of low-birth rates and outward migration as people move abroad in search of opportunities. At the same time, we see internal migration towards the big cities.

A solution: Shrinking smartly

Declining populations can be a drag on labour markets, productivity and economic activity, resulting in less government revenue. At the same time, the loss of economies-of-scale increases the costs-per-person of maintaining key services, amenities and infrastructure. De-population also alters demand for local services. Those that remain are typically older, putting pressure on welfare, health and long-term care systems.

Too often, policy makers invest their energy in fighting rather than managing decline. This results in poorly managed contraction. In contrast, “smart shrinking” means accepting decline and developing a plan to manage it.

The very different trajectories of places within Estonia may first require a rethink in the organisation of public finances. Estonia is one of the most fiscally centralised countries in the OECD. Sub-national spending accounts for just 23% of public expenditure compared to an OECD average of 32%. The sub-national share of revenue is even lower – in fact the lowest among OECD and EU countries. Estonia’s sub-national governments receive just 1.5% of total tax revenue versus the OECD average of 20% and 0.3% of GDP versus 5%.

This makes it more challenging to tailor solutions to the very different needs of growing and shrinking places in Estonia. Greater decentralisation could also bring more transparency, accountability and public support for the re-organisation of public services. Furthermore, as the administrative reform (2017) reduced the number of municipalities considerably from 213 to 79, municipalities should be allowed to take more responsibility of their financing.

Municipalities should also be encouraged to co-operate to reduce costs where it is possible. National authorities should ensure that policies incentivise such co-operation. They should support municipalities through the transition, including with funds to manage unused or partially-used facilities and to upgrade public buildings.

In Sweden, local authorities respond to population decline by forming partnerships financed by members and transfers from central government that allow for the consolidation of services. In France, inter-municipal authorities can collect taxes or levy user fees to pay for services. Another, more radical way to solve the problem is municipal mergers.

Grants can also play a role, but in a way that leaves municipalities the authority to decide how services are organised. In Finland, rural municipalities have been shrinking for decades but equalisation grants protect them from financial collapse. Unlike per-capita general grants, equalisation considers shrinking tax bases and rising costs to help municipalities deliver a minimum standard of service at a standard tax rate. Japan’s grant formula includes a safety net to protect municipalities from sharp reductions in grants when population declines.

In Sweden, an indicator for population decline compensates municipalities for costs that cannot be reduced at the same rate as residents and revenues. In the United States, some states receive “small state minimum” federal grants, which effectively mean that per-capita grants in recipient states exceed the national average.

A window to the future?

Two-thirds of EU regions will be experiencing population decline by 2050. Estonia’s problems today are a window into the future of many other European and OECD regions. To meet these challenges, governments must think ahead and find ways to consolidate administrative structures and services to preserve economies-of-scale. While co-operative arrangements and municipal mergers will help, these must come with the financial support required to shrink smartly. They will also need to be accompanied by efforts to maximise the benefits of decentralisation, to improve engagement with – and policies for – the affected communities.

Read more on our last report: Shrinking Smartly in Estonia: Preparing Regions for Demographic Change.

Economist at | Website | + posts

Antti Moisio is Economist and Senior Policy Analyst in CFE/RDG. Before coming to the OECD, he worked in Finnish Prime Minister’s office as Senior Advisor. His duties in the ministry were primarily related to better regulation and legislative impact assessments. Prior to that, Antti Moisio worked for more than two years at CFE/ESG as a Policy Analyst, mainly in projects related to decentralisation and multi-level governance. Antti has also worked several years as Research Director and Principal Economist in VATT Institute for Economic Research in Helsinki. Antti has publications on local public finance, efficiency of public services, municipal mergers and political economy. Antti has taught courses on applied econometrics and local public finance in several universities, including University of Jyväskylä, Université de Rennes 1 and Université de Fribourg. Antti holds a PhD in Economics from University of Jyväskylä, Finland.