Arrested Development

Global Finance, Sep 2004 by Hawser, Anita

With their educated workforce and low costs, the Baltic states present some of the most interesting FDI opportunities in Europe. So why are they still struggling to attract investment?

Two years ago, a British laboratory equipment manufacturer, Grant Instruments, stumbled across a little-known Latvian company at a trade fair in Germany. Grant had never encountered a company quite like Biosan, the brainchild of Dr.Vasily Bankovsky, a specialist in genome libraries. "We had never heard of them," Paul Pergande, director of laboratory equipment at Grant, recalls, "but we were rather surprised at the innovation and quality of products coming out of Latvia." While the company had been established only in 1992, Biosan s instruments for biomedical research Were a legacy of the well-funded scientific and research institutes during Soviet times. Following perestroika, these institutes were dismantled. While most of the 500 scientists Bankovsky worked with at the former Institute of Microbiology left Latvia to pursue careers in the West, he and his wife, Svetlana, stayed in Riga, building their own company with a euro15,800 grant from the Ministry of Education and proceeds from selling office furniture. Today Biosan distributes to Japan, Germany and South America and has a turnover of more than euro1 million a year.

From the remnants of the former Soviet scientific and research institutes scattered across the Baltics, a new generation of companies in the fields of IT, biotech and agro food processing arc. emerging, providing their countries with new opportunities for economic growth. In neighboring Lithuania, (or example, Alna-one of the Erst privately owned companies to be formed under perestroika-is now one of the region's most profitable IT companies, with revenues in excess of euro1.5 million. Having spent more than 40 years in the economic wilderness, there is considerable pressure on the countries of Central and Eastern Europe to achieve levels of economic growth and productivity comparable with their Western European counterparts, particularly if they want to encourage significant growth in inward investment. As these countries begin to join the European Union, both the pressure and the opportunities grow.

"Further continuous and high growth is essential if Central and Eastern European countries (CEECs) are to increase standards of living and to improve social and economic cohesion within the enlarged EU," observes Dr. Slavo Radosevic from the School of Slavonic and East European Studies' Center for the Study of Economic and Social Change in Europe.

Playing Catch-up

Combined, the 10 countries that recently joined the EU will contribute no more than 5% of the Union's total GDP. Compared to their much larger CEE counterparts-Poland being the largest country, followed by the Czech Republic and Hungary-the Baltic countries are relatively small, with a combined population of 7.2 million, compared with a total of 60 million in the three most populous CEECs. According to UNCTAD's latest projections for foreign direct investment (FDl) flows, Poland was the most attractive location for foreign investment, ahead of Russia. Hungary and the Czech Republic also received high rankings. In Latvia, FDI in the first quarter of this year increased by 11.4% on the previous year; however, 54.7% of all investment comprised re-invested earnings. And unlike Poland, Hungary and the Czech Republic, the Baltic countries are still trying to shake off the Soviet legacy. "It is difScult to market to Western European companies," says Teet Jagomagi, chairman of Estonian company Reach-U, the first to develop a public mobile positioning system, which pinpoints the location of mobile phones. "Within Europe, anything north of Poland is unknown territory," notes Jagomagi.

The EU accession countries are predicted to enjoy growth of 4.5% this year, well ahead of the 1.7% predicted for the remainder of the euro zone. In the largest Baltic economy, Lithuania, GDP is expected to slow to an average of 6% in 2004, as is the case in Latvia. The IMF predicts that Estonia will sec real GDP grow by 5.5% this year, driven by domestic demand and an increase in exports. But as imports rise in the accession countries, concerns remain around current account deficits, with Estonia boasting the highest of the Baltic countries, at 11% of GDP.

Money from the EU might foster higher levels of economic growth in the Baltics, but, according to Radosevic, the potential of these economies is still not being fully exploited. "You would expect five times the productivity," he says, adding that the influx of IT has not filtered down to traditional industries such as timber, agriculture and manufacturing. Although the services sector comprises more than 60% of GDP in the three Baltic countries, industry and agriculture still employ more than 50% of the population (see table, page 27)."The Baltic countries have competent IT firms" Radosevic explains, "but how do you spread that to other enterprises. They need to focus more on improving production capabilities and quality-control procedures, which arc still far behind."