In recent years, the Estonian labour market was characterized by rising employment, declining unemployment, and skill and labour shortages that contributed to large wage increases. Labour productivity grew rapidly, but the level remains low. While the aggregate labour market outcomes improved, differences persisted among ethnic groups, regions, and workers with different skill levels. As Estonia entered recession in 2008, unemployment increased from 4% in the 2nd quarter to 7.6% in the 4th quarter, and is expected to rise further in 2009 and 2010. More flexible labour markets will be a key adjustment mechanism in the current recession as well as in the medium term if Estonia is to become a knowledge-based economy. This chapter focuses on: i) removal of barriers that hamper worker reallocation into more productive jobs; and ii) a better integration of ethnic non- Estonians and foreign workers into the labour market.