The Baltic Course
SUMMARY
ECONOMY
POLITICS


In Search of the Baltic Tiger

Olga Pavuk

This article was triggered by the unsatisfactory rate of Latvian GDP per capita, the poorest one among the countries of Central and Eastern Europe moving onto the market line ten years ago. To our mind, the sharp fall has been caused by a complete collapse of large-scale industry in Latvia. Our analysis aims to figure out the current role of industry in the context of economic development of the Baltic States.

Analyst of Nomura Int Karine Saroukainen emphasises that all of the three Baltic States hold low inflation and the pegged recovering domestic economies facilitate growth of domestic demand. The three Baltic States have achieved real growth of macroeconomic indicators in the beginning of 2000. At the same time, the Deutsche Bank report states that recovery is happening at a pace far too slow to be speaking of "Baltic tigers".

Peteris Gulans, Deputy Director of the Institute of Economics predicts that it will take 30 years for the Latvian population to catch up with European income levels.

Estimations from the Ministry of Economy in Latvia show that we should reach European living standards in twenty years. It should be noted that a similar view is shared by Lithuania, Estonia and the European Union. Calculations are based on the assumption that annual GDP growth rates should reach 5 to 6%. However, comparisons are made with respect to Europe of today, and not to the Europe as it will be in 20 or 30 years from now with its 2 to 4% rate of annual economic growth.

In search for a Magic Wand

In order to fundamentally improve the situation, extraordinary economic solutions must be found. In other words, it is necessary to find something that could serve as a strong trigger for development in all three countries. Nevertheless, multiple discussions with people of economic circles in various countries have proved that the magic wand for the "Baltic miracle" has not been discovered yet.

All of the three Baltic States have put their stakes on transit, especially the transit of oil. Such a choice can be understood, taking into consideration the geographic and human factors. However, the bipolar policy providing work for the sector has so far only been developing one-way. We have focused on Europe, while relations with the other party involved in transit services - Russia - are hindered by various obstacles. Russian plans of constructing new Baltic ports on their own land should not be neglected either.

Latvia and Estonia are actively exploiting the timber industry, fully orientated towards Europe. Still, the resources are not everlasting, and although timber export will bring profit for quite a long time, we cannot count on an endlessly growing income.

Lithuania lies in a slightly more specific situation as regards to the potential growth of its national product. The nuclear power plant in Ignalina and the oil refinery concern in Mazeikiai are nowadays of utmost significance to the entire economy of the country. But even here, no cheers are being heard - the European Union requests that Ignalina should be closed down. Full operation of the oil concern, in turn, depends largely on political relations with Russia.

All other arguments in favour of expected developments in the energy sector and high technologies in the future are still too amorphous and vague. Not so long ago, we spoke of food processing and light industry. Of course, these industries are working today, but the food industry, being orientated towards Russia and the CIS has been showing a sharp decline in volume over the last two years; while light industries have not been able to establish any significant share of the GDP despite its rapid development. Besides this, development of light industries targeted at western markets is tied to the cheap labour force and highly dependent on orders. When the wages of tailors and textile-workers are raised, European orders will move to regions with lower labour costs.

The traditional chemical industry, which exported mot of its output to the East, got the hardest blow from the Russian crisis. For instance, in 1999, only 15% of Latvian chemical product exports went to EU member countries.

Old Things Well Forgotten

Future promises in the Baltic States are linked to the development of small and medium sized businesses. This is quite understandable from the point of view of small countries like ours. The issue lies in something else - the degree of impact small and medium sized enterprises could actually have on economic growth.

For some reason, our state economists try to avoid the issue of establishing rather than developing large-scale industries, well known to significantly increase the national product. For example, until recently, in the reports of the Latvian Ministry of Economy the term "industries" was only used in the context of "processing industries".

Latvia is the only one of the Baltic States to have completely lost some of its "expensive" industries after the collapse of the USSR, which brought significant shares to the GDP. These industries include electronics, radio engineering, automation, mechanical engineering and the well-known companies standing behind them - VEF, Alfa, Radiotehnika, RAF, the Riga Carriage-Building Plant and others. Even the nearly only large heavy industry company left in Latvia- Liepajas Metalurgs, according to President of the company Kirov Lipman, has been forced to cut production by 50% after anti-dumping duties were introduced for steel exports to the USA.

Latvian Minister of Finance Aigars Kalvitis (the twelfth minister in ten years, by the way) was probably the first out of the state's leading officials to admit that: "We should have by all means preserved large companies, either by selling them or privatising at a low price, giving them away to Western companies for as cheap as one lat. They would have achieved recovery of the plants by now, creating work places, production and increasing their share in the GDP well above the current 14%. RAF, Alfa.... - we made mistakes, and we have to admit it. If we had let foreigners buy the companies, workplaces would not have been destroyed. Latvia should develop industries producing higher added value."

Latvia's neighbours stand in a slightly better position as regards to large-scale industries. At least several enterprises - like Ekranas, Snaige, Lifosa, Azovlitas, Achema in Lithuania and Norma, Nitrofert, Sadolin in Estonia - have found their place among the top 100 largest companies in the Baltic States.

Pure Statistics

Industrial indicators of all of the three countries compared to the early 1990s, give clear evidence of the decline of Baltic industries (see Tables 1-3). Consequences of the Russian crisis can be seen when comparing indicators of 1999 and preceding 1998: a repeated fall after several years of growth, which was more obvious in Estonia and Latvia and not so significant in Lithuania.

The results of the first half of 2000 against the same period of the previous year showed an increase in industrial production: 14.3% in Estonia, 8.4% in Latvia (when this article was being prepared no data was available on Lithuania). As for Latvia, significant growth has been recorded in the production of cellulose and paper, clothing, furniture and timber. Estonian statistics supplement the list with chemical production and production of radio and TV equipment, as well as producing means of communication and equipment for other branches of industry. All of the Baltic States experience a continuing general decline in food production volumes (at the same time, production of alcohol and beer is maintained at the same level or even promoted).

The Latvian Parliament's decision to raise the quotas for duty-free imports of a series of agricultural products from the EU as from July 1st will ruin farming in Latvia. Moreover, the quotas are not equal for both parties: for instance, Latvia can export 625 tons of poultry to Europe duty-free, while imports can reach up to 5300 tons. Deputy of the Saeima, Janis Jurkans estimates that upon accession to the EU, only 2-3, or 5% at the largest, of the population of Latvia will remain engaged in agricultural activities.

Why must we discuss these issues? People moving from rural areas to cities need workplaces. Under certain conditions, industry is the right solution for reducing unemployment, ensuring employment for the capable population and increasing the added value in GDP significantly.

Euro Hinders Export

The introduction of the euro met variable responses from Baltic exporters. Estonia found itself in the best position, as the kroon is attached to the German mark, and a devaluation of the euro has even cut down expenses for exporters. The Latvian lat is attached to the SDR basket, therefore exporters - mainly those in timber processing and textile industries - suffer losses caused by a reduction in prime costs of their products, 17 to 20% last year (according to expert estimations). Lithuanian exporters are facing hard times - The lit is directly bonded to the dollar, so they lose out on more than the others do. As all of the three Baltic States are oriented towards accession to the EU, entrepreneurs working for Europe increasingly voice their anticipation for introducing the euro.

Tax Cuts For Investors

Of course, Baltic manufacturers are looking for and finding investments from outside. In Estonia, the Ecoteq company established by Finns and America's Coca Cola are both operating with success. The global giant Kraft Jacobs Suchard entered the Lithuanian confectionery market in 1993 by purchasing the control package of shares at the Kaunas Confectionery Factory.

However, we do have our own sources for developing industry too. First of all, trade and transit sectors, having managed to pull themselves together before others, are making long-term investments in the industry today. For example, the largest trade company in Lithuania - Vilniaus prekybos - is investing in food processing. According to Viesturs Grinbergs, Head of the Investment Department of one of the most successful Latvian companies, Venstpils Nafta, the company is involved in several investment projects. One of these - footwear enterprise Venttopaz, which is a joint venture with Canadian Topaz Shoe MFG Ltd - has already commenced production in the city of Ventspils.

Still, the attraction of a more significant investment flow requires support on behalf of the state. Investors are waiting for the tax burden to slacken. One of the most recent developments in this respect is the statement made in August by the Latvian Minister of Economy, Aigars Kalvitis, on the proposed alleviation for large-scale investment projects (exceeding LVL 10 million) in the IT field. Perhaps this industry could become the economic miracle so very necessary for the Baltic States.

Riga

Comment

Aigars Kalvitis, Latvian Minister of Economy

The role of industry is crucial not only in the context of gross domestic product, but for the overall development of the national economy. The State, just like the enterprises, has to diversify its risks. We cannot keep up a country, when services (including transit) form 60% of the GDP. One or another kind of service can lose demand, or the transit channels may move to other places, and we may find ourselves in a difficult position.

According to the information at our disposal, the share of industries in the GDP is only 14%. For six months the Ministry of Economy has been working on drafting a strategy for the development of industry in Latvia. We will try to find out, what instruments could help raise this percentage. I do not think we can count on 50%, but at least 20-25% should be achieved within 5 to 10 years.

We should look at things as they are. Industry has been going through tremendous change for the last 10 years. Privatisation has been launched, and after this many enterprises start a new life, get new orders. Let's say the emphasis is on change. The transition period has resulted in a deep decline of industries. After privatisation is completed, we can find a lot of positive examples for work in the field of high technologies.

The Market has experienced some change as well - 60% of trade goes to the European Union. The Russian crisis was the cause for re-orientation to the West, expected to secure growth in the future. I am absolutely sure about it. Of course, opportunities to deliver orders and engage in trade with the CIS countries should not be neglected, but before the crisis we were too focused on the East. Industry was the one to suffer most of all from the crisis.

As regards to development of particular fields, we have to be very careful. The basic task of the Ministry of Economy is to create an appropriate environment. Development will refer to the traditional industries - automation, electronics, radio engineering, having made Latvia famous in the past. It would be quite utopian to invent something new. Certainly, metallurgy based on Liepajas Metalurgs will keep its place. However, the thing that we can really count on is high technologies requiring a highly qualified workforce and traditions we have.

The only way for attracting Western investors is creating such an investment environment in Latvia that would outrun its neighbouring countries.

Large companies will remain absent in Latvia for the next 10 to 15 years. The market is limited. Workplaces cannot serve as a catalyst. We should look at it the other way round. Our country is suitable for small and medium-sized enterprises. We are not able to establish companies employing between 5 and 10 thousand people.

Riga

Kestutis Glaveckiais, professor, Member of Parliament, Lithuania

Agriculture is still playing a major role in the production sector of Lithuania. This is one of the most serious problems of our structure. Agricultural production is extremely inefficient, but raising efficiency requires significant resources for the maintenance of new workplaces, change of profiles, etc.

On the whole, speaking about industrial production in Lithuania, it is stronger than in Latvia and Estonia, because we have a nuclear power plant and an oil refinery. Thus, industry has a significant impact on the economy of Lithuania.

We can expect better operation of the Mazeikiai concern in the future, so there is hope that it might hold on to the oil product market in the Baltic States or even expand it. The market of the Ignalina nuclear power plant faces problems due to our commitment to close down the first reactor of the NPP according to the requirements of the European Union.

These two main macroeconomic objects will have utmost influence on the share of industry in the economy of Lithuania as a whole. Even now, it is apparent - as soon as the oil refinery is operating inefficiently (for instance, when it doesn't receive oil), a sharp fall can be marked in the GDP of the country.

If we take a closer look at food processing, for instance, its share has to remain at the current level or even increase slightly. The service sector, like information services, mobile communications and transit are going to achieve particular growth.

Growth of GDP can be essentially triggered by the oil refining industry, transit and shipping in the first place. Transit and oil make up nearly 20% of the whole GDP. This part is also the most sensitive one. It depends on relations with Russia and on the political situation in both the East and in the West.

Although all other branches contributing to the GDP (such as the processing of agricultural products, services, communications, etc.) do not necessarily decline if this share shrinks, it is as if they cannot complete a full cycle.

As regards to the inflow of investments, many fields have already been filled up. For example, the market of telecommunications, mobile and fixed communications, is fully distributed among the players involved. For now, the Internet market remains relatively open. The energy sector, gas-works and ports are still open for restructuring and investment. Klaipeda port will require a lot of investment as it needs to be deepened. The above-mentioned are the basic macroeconomic blocks that will attract investment. Besides that, there area large number of microeconomic ones as well.

Vilnius

Olev Raju, doctor of economic sciences, member of the Finance Commission of the Parliament of Estonia

Evaluating the industrial potential of Estonia, the following directions should be mentioned. First of all - utilising the resources found within the country, e.g. shale and timber. Secondly, traditional fields of development like furniture and light industries (dressmaking, in particular), as well as shipbuilding and docking. The latter two have established themselves in Estonia since World War I. The third direction could be development of construction materials for at least the local market.

In the future perspective I would also note such fields as biotechnology and pharmacology. The situation is a little more complicated as regards to information technologies. Estonia is not big enough to compete with the IT giants. The branch is dominated by USA, while in pharmacology millions instead of thousands of various products can be offered, thus enabling Estonia to find its own niche.

I believe that Estonia will never become a super industrial country. Currently, we can notice success in the development of tourism, trade and transit in North-South, East-West, and West-East directions. Fortunately, our geographical location is favourable for such activities. Production of electric energy can also be mentioned as one of the future opportunities.

As regards to foreign investment, Estonia has already undergone the period when capital was as badly needed as the air to breathe. Capital always costs money. We are rather in the stage when the selling of certain resources to foreigners should be limited - this refers to agricultural and coastal lands, for instance. Instead, capital should be attracted to the fields requiring huge amounts of investment, like railways, which need billions, production of chemical fertilisers, shale chemistry where the existing technologies are outdated and new, environment-friendly solutions have to be found.

Tallinn

Adalbert Knobl, Senior Resident Representative in Estonia and Latvia

Yes, one of the largest industries is food processing, the export market being hit very hard after the Russian crisis, having been basically orientated to the East, but it has started to recover. They [the Baltic markets] have tried to move to the EU, but there are two problems in this. One is that the EU market is not fully open, the other is that the product structure does not exactly fit the EU.

As for timber, as far as Latvia is concerned, I was surprised as to the extent of raw timber exports compared to total export. That of course is not the future, the future there has to be processing. Although there are some large projects on the way, like the pulp factories, I think that furniture producers are the way to go, because you have the raw materials. The Baltic States don't have too many raw materials, but timber is certainly one that the Baltic States have and as much value as possible should be attracted to the sector domestically before exporting.

Textiles is certainly one of those areas which has great potential and some niches could be filled by the Baltic States, but the higher value areas of textiles would have to be taken. Particularly in Estonia, companies have also turned to high-tech areas. They of course have great future potential. There are other companies in Estonia dealing with the assembly of, for instance, cellular telephones. Here the Baltic States really have an advantage with a skilled labour force - that is the most important part, as well as costs against quality still being well below, say, western Europe. In a market economy, this should carry over time.

The Baltic States also function as a bridge to the East, which Latvia, I think, fills more than its neighbours do. But what one does need to attract foreign investors is political and economic stability. As for cheap labour, what you actually have is high quality labour or skilled labour as the education system is still quite strong.

I should say that a major part of foreign investments has gone to transportation and communications, and also finance. The majority of the banking sector is foreign owned, which of course has brought about stability, but the future still lies in manufacturing and of course tourism. This area has also been underestimated. Riga-Tallinn-Vilnius has something to offer.

Riga-Tallinn

Industry in Latvia

Year

Million LVL,
in comparative prices

Industry index in permanent
prices, 1990=100

Industry index, % compared
to the previous year

1990

3179.5

100

100.8

1991

3160.4

99.4

99.4

1992

2066.6

65.1

65.5

1993

1399.0

44.2

67.9

1994

1494.3

40.0

90.1

1995

1208.2

38.0

96.0

1996

1271.8

40.0

101.4

1997

1462.6

46.0

106.1

1998

1637.4

51.4

102.0

1999

1493.3

47.0

91.2

Source: Latvian Central Statistics Bureau

Industry in Lithuania

Year

Million LTL, in current prices

Industry index in
permanent prices, 1990=100

Industry index, % compared
to the previous year

1990

32 128

100

 

1991

30586

95.2

95.2

1992

21847

68.0

71.4

1993

13913

44.6

65.6

1994

9767

30.4

70.2*

1995

12763

39.7

100.9*

1996

15529

48.3

103.5*

1997

18386

57.2

108.0*

1998

19532

60.7

109.3*

1999

18127

56.4

92.1*

* in prices of 1995,
Source: Central Statistics Bureau of Lithuania

Industry in Estonia

Year

Million EEK,
in current prices

Industry index in
permanent prices, 1990=100

Industry index, % compared
to the previous year

1991

18195

100

92,8

1992

11784

64,4

64,4

1993

14535

52,4

81,3

1994

19832

50,8

97,0

1995

26118

51,8

101,9

1996

31412

53,8

102,9

1997

40385

61,0

114,6

1998

43827

63,5

104,1

1999

42117

 

96,1

Source: Central Statistics Bureau of Estonia


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