100 Estonia’s Economy and Economic Diplomacy in the Wave of the Modern Mercantilism Viljar Veebel As a seventh Đhapter in ďook “Economic Diplomacy of the Baltic States“, pp. 100-114, Riga: Latvian Institute of International Affairs, 2014. Introduction Estonia has in last two decades often been characterized as proper example of the liberal economic policy, showing remarkable economic performance and high competitiveness since its re-independence in 1991 until the start of euro zone financial crisis). The Estonia’s progress has been related to the main characteristics of country’s economy: currency board type of the monetary system (until the accession to the euro zone), annual balanced state budget, liberal trade policy, flat income tax, and flexible labour market. After joining the European Union (EU) in 2004, Estonia started to follow more moderate EU strategies when formulating its economic policy, but has retained its reputation as an open liberal economy with modern and business friendly regulatory environment. Estonia’s openness to the world market has also increased country’s vulnerabilities to the external shocks, the impact of which was fully felt only during the global economic crisis since 2007. At the same time, differently to the Estonian liberal ideology, some of the EU countries have focused on promoting economic growth by neo-mercantilist way of expanding exports, supported by the economic structure of these countries exporting high technology and capital goods. As a result Estonia’s motives in following the ideology of free trade and liberal market economy have not fully been understood in several occasions (e.g. during the negotiations on a free trade agreement between the EU and Estonia from 1994 to 1995), Estonia is expecting that in a broader context the other EU member states share the same vision of liberal market economy. As stipulated by the former Undersecretary of the Ministry of Foreign Affairs (MFA), Mart Laanemäe, „Freer trade will make the whole EU richer and Estonia will benefit from a richer EU. Many other EU countries share this vision. We would like to see more countries understand us better and understand how we have looked for solutions to our problems“ (Laanemäe 2005, 45). Economic diplomacy offers a good tool for explaining country’s positions and motivation behind the selected ideological approaches, as well as overcoming the divergence of views among the economic partners. Thus, the importance of economic diplomacy for a small country highly depending on external trade and foreign investments should not be underestimated. Therefore, based on theoretical framework, the current chapter discusses Estonia’s economic position in the European Union, which is the main market for Estonian products, in the wave of modern neo-mercantilist views widespread in some EU member states. More precisely, the chapter analyses the economic challenges and achievements of the Estonian economy as well as of Estonian economic diplomacy during the period 1991–2013. The rationality of a small state mercantilism: Theoretical aspects General discussion whether countries ― and specially small open economies ― should rely on the free trade principle to improve world welfare or use interventionist trade policy regimes to protect domestic producers, deal with market imperfections and improve the domestic welfare, is one of the fundamental questions of the international trade theory already for centuries. According to the classical theories dating back to the early 19 th century (particularly referring to