Plowing Ahead in the Shadows of a Fractured Global Economy

The Top of Europe – Plowing Ahead in the Shadows of a Fractured Global Economy

th State of the Region Report 2013

Authors Lead author: Christian Ketels Authors of Selected Topics-chapters: Torbjörn Becker, Matias Kalm, Mika Pajarinen, Petri Rouvinen, Timo Seppälä and Alf Vanags

Published by Baltic Development Forum Nytorv 3, 1st ﬂ o o r DK-1450 Copenhagen K Denmark Telephone +45 70 20 93 94 Fax +45 70 20 93 95 [email protected] www.bdforum.org www.newswave.eu

Layout: Bitdesign, Leena Närhi, Finland Print: InPrint / Laura Breimane Cover: Bitdesign, Leena Närhi, Finland Photo credits: Nordic Council of Ministers free photo data base http://www.norden.org/da/aktuelt/billeder ISBN 978-87-996254-0-6

2 STATE OF THE REGION REPORT 20132012 10 years of the State of the Region reports

As in previous years, the 2013 Does that mean that regional cooperation is State of the Region Report will only about pragmatism, doing business and self- be presented at the Baltic Devel- interest? No, it does not tell the whole story. Ever opment Forum Summit, taking since the fall of the Iron Curtain, support to the place in Riga, and give us essential regional cooperation has been motivated by the insights into the Region’s overall wish to return to normality and to correct the in- economy, competitiveness and dynamics. Th e key justices made during the 20th Century. Solidarity message in 2013 is that the Region’s post-crisis with your neighbours is part of the story but to recovery has slowed down signifi cantly. In other a pragmatic region the everyday motivation is to words, we need to do better. prosper and “do business”. Th is year is however special – we have now To our mind, it has to be a guiding star for published the report for 10 years, given us food the EU Strategy for the Baltic Sea Region and for for thought and facts about the Baltic Sea Region, other regional settings to raise prosperity through for better or worse. Over the years, the reports doing business and upgrading of the competitive- have tracked the developments of the Region’s ness. Th e present economic situation in the Re- competitiveness and each year included new as- gion and the wider European context demands us pects and dimensions of this concept. to have a clear focus. It requires facts and data For Baltic Development Forum, upgrading that the State of the Region Report is giving us. of the Region’s competitiveness is at the heart of Celebrating 10 years of the report, we are ex- our mission and the State of the Region Report tending a special gratitude to our sponsors who has played a very important role in this regard. this year again are the European Investment Bank Essentially, competitiveness describes the overall and the Nordic Investment Bank, and to thank quality of the region as a place to do business. Christian Ketels and his colleagues for the many In our understanding, it is extremely im- high-quality reports. Th ey have given us a lot of portant that the region’s aim is “to do business” inspiration. Th is being said, the conclusions are because it is a key feature of the Baltic Sea Re- those of the author only and do not necessarily gion that we proceed in a very pragmatic manner. refl ect the views of Baltic Development Forum We have not defi ned a clear end-target but most and the sponsors. countries, organisations and decision-makers are concerned about making a diff erence and cooper- We wish everybody a good read! ating where it makes sense. We want and need to see results, outputs and progress, which includes a better way of living – in short, prosperity. As Christian Ketels puts it: the State of the Region Report aims to provide policy makers with data Hans Brask and analysis that support fact-driven policies de- Director signed to raise the level of prosperity. Baltic Development Forum

STATE OF THE REGION REPORT 2013 3 10 years of the State of the Region reports . . . 3 Cluster presence ...... 58 Table of contents ...... 4 The Baltic Sea Cluster Development Introduction ...... 7 Center ...... 60 Company Sophistication ...... 61 Business Culture and Values in Section A: the Baltic States ...... 62 Competitiveness in times of Assessment ...... 63 macroeconomic uncertainty ...... 10 3. Summary ...... 64 1. Current economic climate in the Region . . . . 13 Think small - insights from the small Short-term Growth Dynamics ...... 13 advanced economy experience ...... 65 Back into the fold? Renewed Baltic- Russian Economic Relations ...... 16 Impact on labor markets and Section B: public fi nances ...... 18 Collaboration in the Baltic Sea Region ...... 68 Economic sentiment ...... 20 1 Regional networks and initiatives ...... 70 Assessment ...... 21 1.1 Governmental organizations ...... 70 2. Foundations of sustainable prosperity: Balticlab Network – Young Entrepreneurs Competitiveness of the Baltic Sea Region . . . 23 around the Baltic Sea ...... 72 2.1 Prosperity outcomes ...... 24 The BSR StarDust project ...... 81 Prosperity ...... 24 1.2 Non-governmental and public-private Accounting for oil and gas in Norwegian organizations ...... 82 and Russian GDP measures ...... 25 2 The EU Baltic Sea Region Strategy ...... 89 Prosperity accounting ...... 28 2.1 EUSBSR – EU Commission Update ...... 89 Assessment ...... 32 2.2 Impressions from the EU Interreg 2.2 Intermediate indicators of economic activity program ...... 91 33 3 International Financial Institutions in Trade ...... 33 the Baltic Sea Region ...... 96 Foreign Direct Investment ...... 35 3.1 Nordic Investment Bank ...... 96 Domestic Investment ...... 37 3.2 European Investment Bank ...... 97 Innovation ...... 37 Examples of project loans recently Entrepreneurship in the Nordic countries . 38 approved by EIB ...... 101 Structural composition ...... 39 4 Summary ...... 104 Re-industrialization and New Industrial Policy ...... 39 Assessment ...... 40 Section C: 2.3 Competitiveness fundamentals ...... 42 Selected topics – Access to Capital, Overview ...... 42 Regional Value Chains, and Exports ...... 106 Macroeconomic competitiveness: Access to capital: Issues facing Small- and Institutions ...... 45 Medium-Sized Companies in the Baltic Sea Macroeconomic competitiveness: Region ...... 107 Macroeconomic policy ...... 47 SMEs in the BSR and the EU ...... 108 Microeconomic competitiveness ...... 48 SMEs’ access to fi nance in the BSR ...... 109 Innovation, Incentives, and the ‘Cuddly” Correlates of access to fi nance for SMEs . . . .116 Nordic model ...... 53 The BSR SME funding picture in perspective . 121 Administrative effi ciency ...... 54 Measuring credit constraints ...... 121 Competition ...... 55 Related policy papers and reports . . . . . 122 Labor Markets ...... 57 Some insights from the academic Demand Sophistication ...... 58 literature ...... 123

4 STATE OF THE REGION REPORT 2013 Summary and Policy conclusions ...... 124 Price/non-price competitiveness ...... 142 The Rise of Baltic Sea Value Chains – a bicycle Global value chains ...... 142 producer’s world tour ...... 126 Latvian case studies ...... 144 Introduction ...... 126 Bucher Schörling ...... 144 The Journey of a Bicycle from Finland to Asia Brabantia: ...... 145 and then back to the Baltic Sea Region 128 AKG Group ...... 145 Additional cases ...... 131 Ferroplan ...... 145 Conclusions ...... 133 Concluding remarks ...... 146 Why Baltic value chains might be on References ...... 146 the rise ...... 134 References ...... 135 Final observations ...... 148 Latvia’s exports: the real ‘success story’ ...... 136 ‘10 years of the State of the Region Report’ . . . 152 Introduction ...... 136 All State of the Region Reports and The diversiﬁ cation of exports: extensive other BDF publications available at: and intensive export margins ...... 138 www.bdforum.org’ ...... 152

STATE OF THE REGION REPORT 2013 5 6 STATE OF THE REGION REPORT 2013 Introduction

Ten years ago, the State of the Region Report was When analysts fi nd the future too complex to launched at the Baltic Development Forum’s Sum- predict, they resort to describing diff erent scenar- mit in Hamburg to provide an annual resource to ios. Th ese scenarios are then often associated with inform the discussions about regional collaboration an experience from the past; while history never and competitiveness. Its ambition throughout this exactly repeats itself, especially for fi nancial crises, time has been to provide facts, a framework for researchers have argued that the similarities are analysis, and commentary that can help decision much stronger than those arguing that ‘this time makers across the Region to make more informed it’s diff erent’ like to acknowledge (see the book on choices. Th e Report has also become a window into fi nancial crisis with this title by Carmen Reinhart the Region, for companies or investors considering and Kenneth Rogoff ). For Europe, a number of doing business in the Region and for politicians and scenarios feature prominently in the background government offi cials that want to learn from its ex- of many current assessments: perience. It aims to provide a balanced perspective • Japan’s lost decade(s). Following bursting on the strengths and weaknesses of the economies of the Japanese asset price bubble in the late at the ‘Top of Europe’, not to be a marketing tool. 1980’s, the country went into a deep recession In 2013, the need for a fact-rich assessment of from which it even now has not fully recovered. the Baltic Sea Region is as pertinent as ever. Five Th ere was a succession of spending programs years into a diffi cult crisis, the economic outlook and, over time, a gradually more lenient mon- for the Region remains uncertain. Th is is the case etary policy, but neither was eff ective in turn- largely due to conditions outside of the Region, paring the tide. ticularly in the rest of Europe. Th e Baltic Sea Region • Th e Baltic tiger redux? After rapid growth led might be doing better than its European peers in the to overheating based on large capital infl ows, south, but it is still deeply aff ected by the trajectory the Baltic countries went into a deep recession of the broader European economy. Th is key lesson in 2008. Th rough so-called ‘internal devalua- has become increasingly clear as the crisis has mor- tion’ with deep fi scal and wage cuts their econ- phed from a US into a global fi nancial crisis, then omies stabilised without abandoning the fi xed into a European sovereign debt, currency, and fi nan- parities of their currencies to the euro. By 2013, cial market crisis. Th e future prosperity of citizens the Baltic economies still show the scars of the in the Baltic Sea Region future will depend upon downturn, but are clearly on a path of recovery, the competitiveness of its economies relative to its largely driven by dynamic export growth. European and global economic peers. But it will also • Th ree times ‘crisis – devaluation – recov- by driven by the Region’s ability to help the rest of ery’. Following fi nancial market opening and Europe achieve a more sustainable growth path. Th e subsequent overheating, the Nordic countries Top of Europe remains a part of Europe, for better went into crisis in the early 1990s. Devalua- or worse. tion coupled with determined restructuring of the banking system and a host of other re-

STATE OF THE REGION REPORT 2013 7 Introduction

forms to increase competitiveness led to a sur- inhabitants—have continued to gain population at prisingly swift recovery. Th e Asian Crisis in a rate of 50,000 annually. But the decrease elsewhere the late 1990s followed a similar model with in the Region, especially in Russia, where the popu- growth successfully restored over time, but the lation continues to drop by 0.5% per year, was even collapse of the banking systems and bankrupt- stronger. Th e Region’s labour force reached 27.7 mil- cies of many local companies in its wake made lion employees in 2011, about 250,000 more than the experience much more traumatic. Th e Ar- the year prior. As the economies of the Region came gentine Debt Default of 2002 occurred in the out of the crisis, a larger share of the working-age midst of riots and political turmoil. Despite the population returned to the workforce. Th e total size much more messy collapse, the economy recov- of the workforce remains about 2%, or 600,000, be- ered even there, but outside of its agricultural low the peak reached in 2008. Over the last decade, sector, the competitiveness of the Argentinean however, the increase of the labour force has been economy remains in question and populism an important factor, with 1.3m more people in the dominates the political system. labour force than in 2001. Th e Region created in 2011 an annual GDP None of these scenarios fi ts perfectly well with (PPP adjusted) of around EUR1,320 billion Europe’s situation today. Europe is, among many (USD1,790 billion). Th is new record for the Region other diff erences, a larger economic space, its com- is similar to about 11% of the EU-27 economy, or mon currency a diff erent type of monetary policy roughly the size of the Italian economy. Th e Nordic structure, and its governance framework with na- countries account for 60% of the total (3% less when tional and supranational institutions unique. Still, including only the Norwegian mainland economy). the historic precedents feature in the European de- Northern Germany accounts for roughly 14.5%, bate: the optimists point to the Baltics as a sign of slightly larger than Northwestern Russia’s share of hope that domestic reforms can work within the 14%. Th e Baltics contribute close to 7% and North- context of existing European institutions. Th e pes- ern Poland the remaining 5%. Th e slow rebalancing simists argue that staying within the euro structure of economic weight towards the Baltics, Poland, and is likely to lead to a long period of suff ering, as in Russia has resurfaced, after the crisis had brought it Japan. Alternatively, they see a break-up of the Eu- to a temporary halt. rozone, with individual countries experiencing the Th e Baltic Sea Region thus defi ned overlaps full range of good, bad, and ugly as in previous with a number of administrative groupings: Th e crisis – devaluation – recovery episodes. It remains Council of Baltic Sea States matches most closely to be seen which path the European economy will the Region but has as an intergovernmental agency take. Whatever happens, the stakes for the Baltic no offi cial limitation on the relevant subregions of Sea Region are high. Germany, Poland, and Russia. Th e Nordic coun- What is the Baltic Sea Region? For our analy- tries have a long-standing collaboration with an sis, we defi ne the Baltic Sea Region – as in previous institutional base in the Nordic Council and the years – to include the Baltic countries (Estonia, Lat- Nordic Council of Ministers. In a number of areas via, and Lithuania), the Nordic countries (Denmark, the three Baltic countries, which have created some Finland, Iceland, Norway, and Sweden), northern similar structures among themselves, have become Germany (Hansestadt Hamburg, Mecklenburg- an offi cial part of this collaboration. To the north, Vorpommern, and Schleswig-Holstein), northern the Barents Euro-Arctic Council (BEAC) includes Poland (Pomorskie, Warminsko-Mazurskie, and a platform for Norway, Sweden, Finland, and NW Zachodnio-Pomorskie), and most parts of Russia’s Russia to collaborate. Th e Arctic Council stretches Northwestern Federal District (excluding the four out even further, including Denmark (Greenland) regions least connected to the Baltic Sea Region: the and Iceland from the Baltic Sea Region, as well as Republic of Komi, Arkhangelskaya oblast, Nenetsky Canada and the US in addition to the countries AO, and Vologodskaya oblast). represented in the BEAC. Th is Region is home to 57.3 million people, an- Th ere is no scientifi c way to determine the pre- other 60,000 less than last year. Th e Nordic coun- cise boundaries of the Baltic Sea Region. We pro- tries—together representing 43.5% of the Region’s ceed conservatively, including only those regions

8 STATE OF THE REGION REPORT 2013 Introduction

that appear closely integrated with other regions chains in the Baltic Sea Region. Value chains have around the Baltic Sea. Iceland and Norway are in- become an important characteristic of the global cluded because they have close relations to many economy, connecting companies and locations in countries around the Baltic Sea and are eager to par- far-away places in integrated production processes. ticipate in regional co-operation. Regions in Ger- Th e recent export growth in the Baltic countries, many, Poland, and Russia not bordering the Baltic as well as observations in other countries, suggest Sea are not included, because their economic ties that a larger part of these value chains might be with the Baltic Sea Region are limited. Th is makes locating in the Region, connecting the Baltics and the defi nition used here more restrictive than the Nordic economics. Th e two authors look at the key ones used by other institutions. For comparison, hypotheses and discuss them in view of the data the Report looks – depending on data availability available so far. Th e second part, written by Tor- – at the EU-15 (old member countries), the EU-8 björn Becker, Director of the Stockholm Institute (new central European member countries, exclud- of Transition Economics (SITE) at the Stockholm ing Bulgaria and Romania), regions within Europe School of Economics in Stockholm, Sweden, looks (Iberian Peninsula (Spain, Portugal), British Isles at the access to capital for small- and medium-sized (UK, Ireland), NAFTA (US, Canada, and Mexi- companies (SMEs) across the Baltic Sea Region. A co), Oceania (Australia, New Zealand), the Asian combination of weaker cash fl ow in a period of Tigers (Hong Kong, Singapore, Taiwan, and South weak aggregate demand and less readily available Korea), and occasionally the OECD. Where possi- bank fi nancing in the wake of the fi nancial crisis ble, the Danube Region – stretching from southern and ahead of regulatory changes aff ecting banks Germany to the Black Sea – has been included in has made access to capital again a key concern for the comparisons as well. companies and policy makers. Th e author looks Th e structure of the State of the Region Report at the available evidence to explore ways in which Broadly following the structure developed over policy might be able to help. the last few years, section A provides a discussion Th e Report closes with some refl ections on the of the recent trends in competitiveness across the way the Baltic Sea Region has changed since the Baltic Sea Region. Th e fi rst part looks at the cur- fi rst State of the Region Report was launched in rent economic climate in the Region, an important 2004. Economically, the Region has gone through infl uence on the policy environment for long-term a cycle of exuberance, crisis, and (slow) recovery. competitiveness upgrading. Th e second part pro- Compared to many of its peers in Europe, that Re- vides competitiveness diagnostics, covering data on gion has done much better overall – a testament to economic outcomes, intermediate indicators, and the generally solid foundation of competitiveness competitiveness fundamentals. of locations in the Region. However, the outlook Section B gives an update on the profi le of col- remains uncertain, in particular because of the dif- laboration across the Baltic Sea Region. Th e fi rst fi culties Europe as a whole is facing. Politically, the part tracks the activities of the main regional or- EU Baltic Sea Region strategy has laid a solid foun- ganizations and projects over the last year. Th e sec- dation for co-ordinating cross-border activities. ond part looks at the way the EU Baltic Sea Region Th e next steps will now have to look at further in- Strategy has been implemented in specifi c projects tegration of the EU Baltic Sea Region strategy with but also more broadly in the broader activities of our EU and national policies, in particular the EU countries and sub-national regions across the Baltic structural funds. As well, there are question about Sea Region. how to better engage Russia and how to reach out Section C looks at two particular dimension more eff ectively to the business community in the of the Baltic Sea Region economy. Th e fi rst part, Region. with contributions from Alf Vanags, Director of the Baltic International Centre for Economic Pol- icy Studies (BICEPS) in Riga, Latvia, and Petri Rouvinen, Research Director at ETLA, the Re- search Institute of the Finnish Economy, in Hel- sinki, Finland, looks at the state of emerging value

STATE OF THE REGION REPORT 2013 9 Section A: Competitiveness in times of macroeconomic uncertainty

10 STATE OF THE REGION REPORT 2013 This section of the State of the Region Report describes the economic performance the Baltic Sea Region has currently achieved and the Region’s underling competitiveness driving these outcomes. It provides data and analysis on the current economic climate in the Region and on indicators of competitiveness – from economic outcomes to competitiveness fundamentals.

Th e State of the Region-Report provides a perspec- and providing competition. Competitiveness tends tive on the economic health of the economies in the to change only gradually over time; while some as- Baltic Sea Region. For policy makers in the Region, pects of locational quality can be changed quickly, it aims to present key data and puts them in struc- for example through a change in regulation, many ture that supports fact-driven choices about what others take longer time periods to change, for ex- policy areas to focus on. For business leaders and ample the availability of specifi c workforce skills investors, its ambition is to provide insights into or the development of a more eff ective innovation the attractiveness of the Region as a place to do system. Th e State of the Region-Report aims to business. track the diff erent aspects of locational quality to In the short term, demand-side factors tend identify which policy areas are priorities across the to be dominant. With the productive capacity of Region. the economy largely given, the level of activity de- Policy makers and business leaders have to deal pends on the willingness and ability of consum- with the short-term and the long-term simultane- ers, companies, and the public sector to spend and ously. For policy makers, the quality of the location invest. External trade and capital fl ows infl uence is what they ultimately have to change in order to their decisions through their contribution to over- support higher levels of prosperity. But short term all demand and provision of capital. Demand tends fl uctuations in business activity can undermine to change relatively quickly and these short term their ability to do so. For business leaders, the qual- fl uctuations in business activity are widely covered ity of the location relative to the cost level for local in the business press as well as in analyses from fi - inputs – labor, supplies, etc. – is what drives the nancial institutions and government agencies. Th e longer-term profi tability of a given set of activities. State of the Region-Report provides a more narrow But short term fl uctuations in demand and costs perspective on some key trends across the Region can create cash-fl ow challenges that risk the sur- on these dimensions. vival of a company. In the long term, supply-side factors tend to be Much of the current policy debate is focused on much more important. Th ey shape the productive how to balance the needs of the short- and the long- capacity of a location. In the words of the concep- term. In the short-term, many European economies tual framework that underpins this report, this is suff er from a demand shortfall. Th e situation in the what competitiveness measured by the “the expected Baltic Sea Region is more positive, but even here level of output per working-age individual given the the levels of unemployment and growth are unsat- overall quality of a country as a place to do business”1 isfactory. In the long-term, Europe needs to address is all about. Th e openness to other locations infl u- the existing imbalances in public sector fi nances, ences locational quality by enabling specialization private sector balance sheets, and cross-border trade and current account balances. Here, too, the Baltic

1 Mercedes Delgado, Christian Ketels, Michael Porter, Scott Stern (2012), Sea Region is in a more positive situation but will The Determinants of National Competitiveness, NBER Working Paper No. 18249, NBER: Cambridge, MA. be aff ected by the rebalancing in other countries.

STATE OF THE REGION REPORT 2013 11 SECTION A Economic performance and competitiveness in the Baltic Sea Region

In the rest of Europe, the argument is between well as other indicators of economic activity, partic- those that focus on what is right in the long-term ularly on trade, investment, and innovation. Th is and those that fear that this will create short-term data are then put into the context of an assessment damage with severe long-term consequences. Most of the competitiveness fundamentals across the economies in the Baltic Sea Region do not face Region. Th e outcome indicators for 2012 show the such a harsh choice – more solid longer-term poli- signifi cant headway into which the recovery pro- cies have given them more short-term fl exibility. cess has come. Th e downturn in the rest of Europe Th is was already visible during the 2008/09 crisis, is starting to seriously aff ect the Baltic Sea Region and remains true today. economies, much as was expected last year. Un- Th e remainder of section A is organized in derlying competitiveness remains at the high levels three parts: Th e fi rst part provides an overview that the Region has achieved already for some time of the current economic climate. In the last year, Th e third part summarizes key observations the Baltic Sea Region has experienced a signifi cant from the analysis, and develops implications for slow-down of economic growth. For 2013, growth policy. Th e current economic outcomes are clearly rates are expected to stabilize at this lower level driven by the cyclical impact of conditions outside that, however, remains for ahead of the rest of Eu- of the Region, particularly in the rest of Europe. rope. A key driver of the slowdown in the Region Regional collaboration has a relatively limited role is the lower momentum of private sector consump- to play to overcome these forces but can increase tion and investment. Th e positive gap to the rest the robustness of economies in the Region. Th e of Europe continues to be driven by mutually re- data also shows the structural impact of globaliza- inforcing strengths on public fi nances, domestic tion on parts of the Region, especially the Nordic demand, and labor market conditions. But the Re- countries. Th is is a much slower process that has gion is not immune from the external drag through been going on for a while but one that policy mak- lower exports and tight credit market conditions. ers have to fi nd an answer to. Regional collabora- Th e second part tracks the competitiveness of tion can provide some of the tools that might be the Baltic Sea Region. It discusses data on econom- useful to do so. ic outcomes, components of economic prosperity as

12 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

1. Current economic climate in the Region

Short-term Growth Dynamics 2011, also saw a slow-down to between 2% and 3.5%. Sweden and Germany saw modest growth Th e Baltic Sea Region had until 2008 grown at rates of around 1%, while Denmark and Finland even close to the global average, signifi cantly above the reported a contraction. Th e only country in the Re- level of the North American and the Western Euro- gion that saw growth increase was Norway. pean economies. After a dramatic drop of econom- Slower growth in the Region as well as the sur- ic activity during the crisis, the Region recovered in rounding European economy led to a fall in in- 2010 more quickly than peer regions and retained fl ation rates, despite a continuation of highly ex- solid growth rates throughout 2011. In 2012, the pansionary monetary policies. Energy prices that pace of growth halved to roughly 1.5%, drop- stayed at a high but stable level contributed to a ping below the level of growth in North America. slower increase in price levels. Th e Baltic Sea Region was tracking the European For 2013, most countries in the Region are ex- slowdown, even if it remained at a higher level of pected to register a moderate slow-down of growth economic dynamism than its European peers. Th e rates. Th e only exceptions are Denmark and Fin- outlook for 2013 remains muted and many analysts land where for 2013 a recovery to very low posi- have in the meantime become much more skeptical tive growth is expected. Th e gap in growth rates about the recovery expected for 2014. between the fastest and slowest economy in the Re- Within the Baltic Sea Region, the variation of gion is expected to drop to less than 4%-points in growth rates dropped further in 2012. While the 2013 and close to 2.5%-points in 2014, compared gap between the fast and slowest growing economy to roughly 9.5%-points over the previous decade. in the Region had in 2009 been 19%-points, it had Th is suggests a dominance of broader business cy- dropped to 7% in 2011 and less than 5% in 2012. cle trends across Europe relative to country-specifi c Th e Baltic countries, which had seen a powerful factors. While the crisis and the immediate recov- recovery after the signifi cant crisis in 2009, saw ery were very diff erent experiences throughout the their growth fall to between 3% and 4.5%. Poland Region, the medium-term growth outlook seems and Russia, next in the regional growth tables for frustratingly muted everywhere.

Economic Growth Selected Regions 6 5 4 3 2

1 BSR

0 EU-15

-1 NAFTA -2 -3 Rate of annual change, real GDP % annual change, real of Rate -4 -5 -6 -7 2007 2008 2009 2010 2011 2012 2013e 2014e Source: EIU (2013) State of the Region-Report 2013

STATE OF THE REGION REPORT 2013 13 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Economic Growth: Baltic Sea Region countries

15 Ranked by expected 2013 growth rate: 10 % Russia Latvia 5 Estonia Lithuania 0 Norway Poland -5 Iceland BSR Sweden -10 Denmark Germany Real GDP, Rate of annual change annual Rate of Real GDP, -15 Finland

-20

Source: EIU (2013) State of the Region-Report 2013

Growth in the Baltic Sea Region continues fast one-off growth the year before. But it is very to be more driven by domestic demand than else- likely that concerns about the medium-term eco- where in Europe and the OECD. Th e dynamics of nomic outlook also aff ected companies’ investment private consumption have stayed remarkable stable decisions. over the last three years at an annual growth rate of Th e weakening investment dynamics are re- around 2.3%. For 2013 the outlook is less positive, markable given the current monetary policy envi- but still ahead of the EU-27 average where private ronment. Th e combination of low nominal interest consumption is expected to drop further in 2013. rates and quantitative easing, i.e. the provision of In the OECD average consumption growth re- large amounts of liquidity by Central Banks, that mains positive but has gradually dropped from 2% had been introduced as emergency measures in the growth in 2010 to 1% growth expected in 2013. wake of the 2008 crisis seem to be the new normal. Public consumption growth has been less impor- But even the promise of low interest rates for a con- tant but is in the Baltic Sea Region forecasted to siderable future has not been enough to drive busi- grow more noticeably in 2013. In the EU-27, how- ness investment. Part of this might be the result ever, austerity programs are likely to reduce govern- of a fi nancial system increasing margins and us- ment spending in the current year. ing liquidity to improve balance sheets; a behavior A key driver of the slower pace of Baltic Sea encouraged by regulators. But there are also signs Region growth in 2012 was the fall in private in- that companies that are not constrained in their vestment, where the growth rate dropped from 8% access to capital –large companies have been able to 3%. Th is is a signifi cant drop but compares still to tap into bond markets at favorable rates – have favorably to the OECD average where investment been reluctant to invest. Th is suggest that the main growth dropped by more than to half in 2012 to culprit has been the heightened uncertainty about reach 1.5%. A large part of this drop was due to the the medium-term economic outlook. EU-27, where investments dropped by close to -3% A short-term factor that might have weighed after growing by 1.5% the year before. Investment into companies’ investment decision is the level ca- rates in the US where in the meantime more robust pacity utilization in manufacturing. While the pic- but remain at a lower level as a share of GDP. Some ture is heterogeneous across the Region, the over- of the slowdown was the normal reaction to the all momentum points downwards in the Nordic

14 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Capacity Utilisationin Manufacturing 90 Q1-11 85 Q1-12 Q1-13 80

75 ation, in % 70

65 Capacity Utilis Capacity 60

50 Germany Sweden Finland Denmark Poland Lithuania Latvia Estonia BSR* EU-27

* Excluding Iceland, Norway and Russian Federation

Source: EU (2013) State of the Region-Report 2013

countries and Germany. Latvia is the only country defi cits in these regions. Th e Baltic Sea Region con- where the trend has been visibly positive, albeit tinues to register a current account surplus of about from a low level. 5.5% of GDP, a rate that has remained remarkably Trade had recovered strongly in 2010 after the stable over the last decade. dramatic drop during the crisis. Since then, growth Across the Baltic Sea Region, private consump- rates have come down, with Baltic Sea Region ex- tion has in 2012 picked up most in Russia, a trend ports growing more slowly than imports. Th e dy- that has been true for the last few years. In the Bal- namics in the OECD and the EU-27 were oppo- tic countries, Iceland and Norway consumption site, driven by the adjustments to current account growth was at 3% or higher. In the rest of the Region

Growth Rates of GDP Components Selected Regions

Baltic Sea Region EU-27 OECD

2012 2013e 2012 2013e 2012 2013e

Consumption

Private 2.29% 1.68% -0.64% -0.36% 1.10% 1.00%

Public 0.14% 0.68% 0.11% -0.21% 0.30% 0.10%

Investment 3.07% 2.29% -2.83% -0.75% 1.50% 2.40%

Trade

Export 1.89% 2.33% 2.13% 2.02% 2.70% 3.00%

Import 2.99% 3.10% -0.90% 1.01% 1.40% 2.50%

Source: EIU (2013) State of the Region-Report 2013

STATE OF THE REGION REPORT 2013 15 SECTION A Economic performance and competitiveness in the Baltic Sea Region

consumption barely increased, with Germany and sia, each at around 6% more. Germany, Finland, Poland the laggards at less than 1% consumption and Lithuania registered negative growth; for Fin- growth. For 2013, these two are the only ones that land the outlook for 2013 is also negative. except slight consumption growth while there will The slow-down in exports was most pro- be a modest slowdown elsewhere. Government con- nounced in Estonia and Lithuania, followed by sumption increased most in Estonia and Norway, Latvia and Sweden. Only energy exporters Russia while was relatively stable in the rest of the Region. and Norway saw their export growth pick up in Fixed investment grew at a very high rate of close 2012. Import growth slowed down most in the Bal- to 25% in Estonia for the second year in a row. In tics, Poland, and Russia. Poland was the country the rest of the Baltics, growth rates have dropped where the combination of further export growth signifi cantly between 2012 and 2011. Iceland is the and a reduction of imports drove the strongest im- other country in the Region with two-digit invest- provement in the trade balance. ment growth in 2012, followed by Norway and Rus-

Back into the fold? Renewed Baltic-Russian Economic Relations.2

The different cyclical positions of the EU and the Russian Russia has been 2 percentage points per annum, and Federation, combined with the prolonged Eurozone crisis, since 2010, almost 3 percentage points. have led to signiﬁ cant changes in terms of economic rela- One of the consequences of this is the increased im- tions between the three Baltic republics (Estonia, Latvia portance of Russia as an export market for these three and Lithuania), all members of the Soviet Union until the Baltic republics, all of which entered the EU in 2004.4 early 1990s, and the Russian Federation. Since 2007, the year before the crisis, their combined share of exports for the Russian market increased by a Different Fortunes: GDP trends. third (from 12.7% to almost 17%, from 26% in Lithuania Although the so-called “Great Recession” started in the to almost 40% in Latvia). United States in 2008, by 2010 it had mutated into an However, it is important to realise that the ongoing economic and sovereign debt crisis centred in the EU, crisis only brought into relief a process of economic re- and, more particularly, in the Eurozone.3 This has led to a integration that had actually begun as early as with the signiﬁ cant divergence in terms of growth performance be- Russian economic recovery in the aftermath of its 1998 tween the EU/EA and Russia (see Graph 1 below): since crisis. The EU-Russia growth differential of the pre-crisis 2008, the average growth differential between the EU and period was even higher, at almost 5 percentage points

0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 -5

-10

-15

-20 EU-27 EA-17 Estonia Latvia Lithuania Russia

2 By Anna Tsibulina, Lecturer, MGIMO University, Moscow, Russia, and Lúcio Vinhas de 4 Not only are they members of the EU, but Estonia joined the Eurozone in 2011, and Souza, Sovereign Chief Economist, Moody’s Investors Service, New York, USA. All usual Latvia is expected to follow suit in 2014. disclaimers apply. 3 It should be noted that non-Eurozone countries, like the UK (which benefi t therefore from the theoretical advantages of a fl exible exchange rate), are not performing any better than ‘core’ Eurozone ones, fi scally or in terms of growth.

16 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

90 80 70 60 50 40 30 20 10 0

% RU %EU

20 000 14 18 000 12 16 000 14 000 10 12 000 8 10 000 8 000 6 6 000 4 4 000 2 2 000 0 0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 EU Russia Russia/EU (%) per annum during 2000-2007. Correspondingly, the in- (measured by their GDPs) and of the distances between crease in Russian export market share for the combined markets (as a proxy for trade costs) and the Baltic states. three Baltic states since 2000 has been almost 300% This is done using yearly 2000-2012 data, and the re- (from 4.3% to 16.8%). sults are shown in Table 1 below. In other terms, what one is observing might be a Table 1: Gravity Equation Estimated and Actual Export Shares, natural renewal of economic linkages to fi gures that bet- EU and Russia. ter refl ect economic fundamentals, as economic relations Estimated Actual Exports with Russia were brought to temporarily low levels by Exports Share (%) Share (% 2012) Difference the wrenching economic adjustments observed during Russia_Dummy 33.2 16.8 16.4 the break-up of the Soviet Union and the introduction of EU_Dummy 57.7 62.7 -5.0 market mechanisms. Figure 3 below illustrates that, by Source: Estimation by the authors. showing the sizes of the Russian and EU GDPs from 1992 to 2012: the relative size of Russia’s GDP to the EU’s grew The implication of the estimated coeffi cients is that the from 1% to above 12% within this two-decade interval, simulated share of exports to Russia from the Baltic an almost 1200% increase. states as a whole should virtually double, to around a A way to tentatively assess what the optimal level third, while that of the EU should fall, albeit somewhat of, say, trade relations (which can be seen as a proxy for marginally, to somewhat below 60%. overall economic relations) of the Baltic states with the Of course, such fi gures are merely indicative, but EU and Russia might be is to use a simple ‘gravity equa- they provide support for the notion that the ongoing trend tion’ framework. A ‘gravity equation’ estimates exports of stronger economic relations between the Baltic States as a function of the sizes of these respective markets and the Russian Federation still has some way to go.

STATE OF THE REGION REPORT 2013 17 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Impact on labor markets and dic countries, Norway is close to full employ- public ﬁ nances ment with an unemployment rate of about 3%. Iceland’s unemployment has continued to fall, Unemployment and public debt were two of the and is now at less than 6%. Denmark’s unem- key casualties of the global crisis. Th ey remain criti- ployment rate is at close to 6.5% much higher cal dimensions to track how the Baltic Sea Region than in the country’s historical experience. Swe- has achieved signifi cantly better economic out- den and Finland both register unemployment comes than the rest of Europe. slightly above 7.5%. For Sweden this is relatively Unemployment, traditionally a signifi cant con- high compared to previous years, and only about cern in the Baltic Sea Region, had quickly increased 0.6%-points lower than during the height of the during the global crisis. But while unemployment global crisis. Germany, long a country suff ering then continued to increase in the rest of Europe, from high unemployment, has been able to half pushed on by the sovereign debt crisis and auster- its unemployment rate from 11% in 2005 to 5.5% ity programs, it fell back in the Baltic Sea Region. in 2012. Poland, another country with persistent In the Baltic Sea Region unemployment is stabiliz- labor market problems, has since unemployment ing at around 7.5% while it is pushing above 10% move back to almost 13%. Th is is far below the in the EU-15 average. Unemployment in North pre-crisis average but indicates that the structural American, historically the region with the lowest problems have not been overcome. In the Baltics, unemployment rates, has in 2012 dropped back unemployment levels have fallen since the crisis, below the level in the Baltic Sea Region. However, but remain at above 10% close to the EU aver- especially in the US there is much concern that the age. In Latvia, the unemployment rate has even recent drop in unemployment is largely the result increased in 2012 relative to the year before; this of working-age people dropping out of the labor could, however, also be a sign of people re-enter- force rather than of genuine job creation. ing the labor force or deciding against emigration For individual Baltic Sea Region countries as the economic situation in the country is stabi- the picture is again quite diff erent. In the Nor- lizing.

Unemployment Selected Regions 12

BSR 6 EU-15 NAFTA 4 Recorded unemployment rate % unemployment Recorded 2

0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013e 2014e Source: EIU (2013) State of the Region-Report 2013

18 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Current Unemployment Rates

70 Total 60 Youth (<25)

20 UnemploymentRate in %

0 UK Italy Malta Spain Latvia Ireland France Poland Austria Cyprus Iceland Finland Greece Estonia Norway Sweden Belgium Bulgaria Portugal Slovakia Hungary Slovenia Romania Denmark Lithuania Germany Czech Rep. Netherlands Luxembourg

Source: EIU (2013) State of the Region-Report 2013

A key challenge in many parts of the Baltic -3.5% of GDP. Estonia, Denmark, and Finland Sea Region is the high level of youth unemploy- registered the strongest deterioration of public fi - ment. In the Poland and the Baltic countries, but nances compared to 2011. also in Sweden and Finland, the youth unemploy- Debt levels in the Baltic Sea Region have sta- ment rate is above 20%. In Sweden, the unem- bilized since 2011, while they continue to grow ployment rate for less than 25 year olds is three in the EU and the NAFTA region. In southern times as high as for the average of the labor force. Europe, spending cuts are hard pressed to keep In Europe only, only Luxembourg, Romania, and pace with falling tax receipts and rising social Italy have higher rates of unemployment rate dif- security expenditures in the wake of contracting ferences across these segments of the labor mar- economies. In the US, President and Congress ket. Norway (at much lower absolute levels), Po- have been unable to reconcile their deep-seated land, and Finland follow in the Baltic Sea Region diff erences on how to bridge the structural gap with youth unemployment between 2.5 and 2.8 in the federal budget. Since early 2013 automatic times as high as overall unemployment. While spending cuts are now in place that are widely the absolute levels of unemployment are a good seen as an insuffi cient and ineff ective answer to below the levels in the Southern European crisis the country’s fi scal policy challenges. economies, there are many studies that indicate Iceland continues to suff er from the highest that unemployment in early years has a prolonged public debt level in the Baltic Sea Region, the re- eff ect on an individual’s life time career path. sults of the fi nancial sector collapse in 2008/2009. On government defi cits and debt, the Baltic 2012 was the fi rst year since the crisis in which Sea Region continues to outperform its peers. the country’s debt ratio has fallen, a trend that is Due to the signifi cant surpluses registered by the expected to continue in 2013 and 2014. Germany two natural resource exporters Russia and Nor- has at slightly above 80% of GDP the second high- way the Baltic Sea Region again ran an overall est public debt burden in the Region. Since 2010 budget surplus in 2012. Germany and Sweden debt levels have stabilized, and the constitutional had close to balanced budgets, while the rest of balanced budget rule is aiming to enable a gradual the Region reported defi cits between -2% and reduction of current debt levels. Finland was the

STATE OF THE REGION REPORT 2013 19 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Government Debt Selected Regions 100

60 BSR EU-15 40 NAFTA

Government debt as Government % of GDP 20

0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013e2014e

Source: EIU (2013) State of the Region-Report 2013

country in the Region where debt levels increased Economic sentiment the most in 2012, rising by about 5% to reach 53% of GDP. Estonia, at much lower levels of debt, had When the last State of the Region Report was pub- the second largest debt increase in 2012, followed lished in the fi rst half of 2012, economic sentiments by Denmark. For all other countries in the Region in the Baltic Sea Region had started to divert from debt levels either dropped or remained stable. the rest of Europe. Since then, however, the BSR ag-

Evolution of Economic Sentiment Baltic Sea Region vs. EU-27

120

110 Expansion

100

90 BSR Contraction 80 EU-27 Economic Sentiment Score Economic Sentiment 70

60 Jul-10 Jul-11 Jul-12 Jul-08 Jul-09 Apr-10 Apr-11 Apr-12 Oct-10 Oct-11 Oct-12 Apr-08 Apr-09 Jan-10 Jan-11 Jan-12 Jan-13 Oct-08 Oct-09 Jan-08 Jan-09

Note: BSR excluding Iceland, Norway, and Russia Source: EU (2013) State of the Region-Report 2013

20 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

gregate – calculated based on the survey data from the EU-27 average, the only country in the Bal- the EU member countries in the Baltic Sea Region tic Sea Region for which this is the case. Poland, – has largely reverted back to following the EU Finland, and Sweden are the countries where senti- trend. Until the fall of 2012 economic sentiments ments dropped the most since last year’s State of worsened, both across Europe and the Baltic Sea Re- the Region Report. Relatively to the highest levels gion. Only around the end of the year the climate reached following the 2009 crisis, the Baltic coun- has stabilized and showed then signs of improve- tries are now at between 95% and 99% of that ment. In March, the last month for which data is level, while the rest of the Region is at about 85% available, the Baltic Sea Region has then again seen of the post-crisis high, which was reached in late sentiments improve while they slightly eroded in the 2010/early 2011. EU average. Still, the overall economic sentiment indicator remains below 100 which is the dividing line between expansion and contraction. It is too early Assessment to tell which eff ects the latest turns in the European sovereign debt crisis might have on sentiments. Th ere Th e Baltic Sea Region’s post-crisis recovery has in is also no clear support from regions outside of Eu- 2012 slowed down signifi cantly. Its performance re- rope, with the US recovering at a very slow pace and mained ahead of European peers but regions else- still being unable to fi nd a solution to its own fi s- where in the world, including North America, have cal policy challenges and many emerging economies registered stronger performance. Two eff ects hit the having reverted to a slower pace of growth. Region: Th e one-off eff ects of the post-crisis recovery Across the Baltic Sea Region, only the Baltic were starting to wear off . And the increasing weak- countries register economic sentiments above 100, ness of the European economy is leaving its mark. the level signaling expectations of a continued eco- Business investment has been particularity hit nomic expansion. Lithuania and Latvia are the by these two factors. Low nominal interest rates as only countries in the Region where sentiments have the result of a continuation of the highly unusual improved over the last 12 months. Sentiments are monetary policies that are starting to become the currently the weakest in Poland and Finland. Po- new normal have not been able to overcome the land’s economic sentiment indicator is even below reluctance of companies to invest. Banks have used

Key Economic Indicators: Baltic Sea Region

2 Inflation Real GDP 0 Budget balance Current account -2

-4 Rate of annual change/Share GDP % -6

-8 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013e

Source: EIU (2013) State of the Region-Report 2013

STATE OF THE REGION REPORT 2013 21 SECTION A Economic performance and competitiveness in the Baltic Sea Region

much of the additional liquidity provided by Cen- my and its new balanced budget constitutional rule tral Banks to improve their balance sheets rather as suffi cient to manage the debt dynamics. Norway than increasing lending. And those companies that and Russia are both special cases due to their larger had suffi cient capital have kept their investments revenues from natural resource exports. Stronger low. Private consumption, a much larger part of fi scal positions have allowed governments in most GDP, has still hold up well but is forecasted to slow parts of the Region to react more forcefully to the down as well in 2013. Here fi nancial market con- 2008 crisis, and they have helped stabilized expec- ditions have been important, keeping home own- tations about future economic trends. Th is has kept ers’ payments at moderate levels. More important, domestic demand at robust levels, easing the pres- however, have been the relatively successful meas- sure on labor markets and ultimately also reduc- ures to keep unemployment at moderate levels rela- ing the burden on public budgets from lower tax tive to other parts of Europe. receipts and higher social security spending. Th e Overall, the Baltic Sea Region remains in a sig- Baltics are a special case, but have in their austerity nifi cantly better position than the rest of Europe. eff orts benefi ts from the stronger export demand Despite the challenges that aff ect the Region, it has that their neighbors in the Region provided. been able to benefi t from the positive repercussions Despite these stabilizing domestic dynamics, between solid fi scal policies, more stable domestic the Baltic Sea Region is clearly not immune to the demand, and lower unemployment. At the heart sluggish economy in the rest of Europe. Weaker were more solid government fi nances: In the Nor- export demand from what is naturally the largest dics they were the result of reforms implemented trading partner of the Baltic Sea Region is one fac- in the wake of their own crisis in the 1990s. In the tor. For the countries outside the Euro-Zone, rising Baltics they were the result of low initial levels of exchange rates add to the impact on their export debt – they did not assume any of the debt incurred industries. Financial market linkages are also pre- by the Soviet Union – but also of stringent budget sent. Changes in fi nancial market regulations and control, especially in Estonia. Poland’s debt has the uncertainty on fi nancial markets are driving been creeping up over time but stabilized below the banks to reduce their risk exposure, also in the Bal- 60% level often seen as a benchmark for sustainable tic Sea Region. Th is reduces access to capital for dept. Germany’s debt is much larger but fi nancial business investment, even if the impact is much less markets have so far seen the strength of its econo- dramatic than in the southern parts of Europe.

22 STATE OF THE REGION REPORT 2013 Introduction

2. Foundations of sustainable prosperity: Competitiveness of the Baltic Sea Region

Th e State of the Region Report aims to provide es. Much prior research had focused on generating policy makers in the Region with data and analysis generic ‘recipes’ that could be applied anywhere. But that support fact-driven policies designed to raise here, too, there is an increasing realization that the the level of prosperity that the Region can sustain focus on general benchmarks, whether through the in the medium term. It also aims to provide inves- ‘Washington consensus’ in its diff erent variations or tors and analysts looking at the Region with key the EU’s integrated policy guidelines, is problematic: metrics to understand its economic potential. their advantage is that they avoid extended political Economic research over the last few years has negotiations about what to do; their disadvantage is emphasized two important insights into the dif- that they subscribe solutions that are not fully ap- ferences of prosperity and medium-term growth propriate for any given situation. trends across countries: First, many factors infl u- Th ese two insights have led to a renewed inter- ence these ultimate economic outcomes. Much pri- est in data sets that cover that specifi c situation in or research had focused on identifying which fac- individual countries along a broad range of indi- tors matter most ‘on average’, i.e. across time and cators. Th e intention is to capture all factors that locations. But there is an increasing realization in might matter, and to provide insights into their the academic research community that the fi ndings specifi c role in a given context. Th e State of the from this work have led to misguided policy action. Region-Report draws on a number of these data In particular, they have fueled a narrow focus on sets to measure the competitiveness of the Region. single policies, whether openness, education, prop- Competitiveness is a summary term to describe the erty rights, anti-corruption, or institutional quality. overall quality of the Baltic Sea Region as a place In practice, however, successful policy reforms tend to do business given the many factors that matter. to require an integrated set of changes to unlock Th e fi gure below provides an overview of the main economic dynamism. categories of relevant factors. Second, the relative importance of the factors Data on competitiveness fundamentals is only that matter depend on location-specifi c circumstanc- one of the sources of information available to ana- Competitiveness Fundamentals

Microeconomic Competitiveness

Sophistication Quality of the of Company State of Cluster National Operations and Development Business Strategy Environment

Macroeconomic Competitiveness

Social Quality of Infrastructure Macroeconomic and Political Policy Institutions

Endowments

Natural Geographic Size Resources Location

STATE OF THE REGION REPORT 2013 23 SECTION A Economic performance and competitiveness in the Baltic Sea Region

lyze the quality of a location for business and draw Baltic Sea Region level. And it gives investors and implications for policy: Prosperity outcomes give analysts much deeper insights into the opportuni- a sense of how competitiveness is refl ected in the ties that exist in the Region. standard of living, the ultimate objective of economic policy. Intermediate indicators are analytical indicators that track the translation of competi- 2.1 Prosperity outcomes tiveness through economic activity and structural patterns into ultimate prosperity outcomes. Com- Th e central measure of prosperity we use is gross do- petitiveness fundamentals are then the root causes mestic product (GDP) per capita, adjusted by purchas- of these higher level outcomes and indicators ob- ing power parity. Additional insights into the drivers served, and are the level at which economic policy of prosperity can be derived from a decomposition that can most eff ectively intervene. Becomes the rela- separates the impact of labor productivity and labor tionships between individual fundamentals, indica- mobilization on overall GDP per capita. tors, and outcomes are multifaceted and complex, an integrated view of all three layers provides more robust insights, then overreliance on one individual Prosperity dimension of data. . As in previous years, the State of the Region Report provides data and analysis at Th e Baltic Sea Region remains one of the more pros- all three levels to support the competitiveness diag- perous regions in Europe. Its GDP per Capita (PPP nostics for the Baltic Sea Region: adjusted) level reaches 94% of the EU-27 average, Th e fi nal step of the competitiveness diagnos- compared to just above 87% in 2005 and 83% in tics is the explicit analysis of linkages across the 2000. Th e dynamics in comparison to the EU-15, three diff erent levels to identify action priorities. the more prosperous economies in the European Un- Such an analysis needs to connect specifi c prosper- ion, are roughly similar; the Region’s prosperity level ity outcomes to unique patterns of intermediate is now at 85% of this group. Heterogeneity across economic activity and particular dimensions of the Region remains large: Th e Nordic countries and competitiveness fundamentals. While a full-scale Germany are among the most prosperous countries diagnostics along these lines is beyond the scope of in Europe and globally. Th e Baltic countries, Poland, this Report, the data and analysis provided enable and Russia register at the lower range of the EU, policy makers across the Region to get a better un- with Latvia as the poorest country in the EU apart derstanding of the action priorities for improving from Bulgaria and Romania reaching a prosperity competitiveness through collaborative action at the level similar to Chile, Malaysia, and Mexico.

The Three Layers of Competitiveness Assessment

Measures of the standard of living and of their Prosperity direct components Outcomes Objectives and ultimate success indicators of economic policy

Measures of economic activity that tends to Intermediate reflect competitiveness Indicators Indicators of specific economic dynamics, not ultimate objectives

Competitiveness Measures of underlying drivers of intermediate indicators and prosperity outcomes Fundamentals Policy levers for government action

24 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Accounting for oil and gas in Norwegian and Russian GDP measures

Overall GDP measures the total output of an economy, in GDP when making cross-country comparisons. and provides in this respect an important indicator of both For this Report, we have decided to adjust the total total productivity (labor productivity times labor mobiliza- GDP (PPP adjusted) for both Norway and Russia to have tion) and prosperity. Large oil and gas sectors, however, more comparable data on prosperity and labor produc- complicate the interpretation of this data. From a productivity. In Norway, there is both data on the share of the tion/productivity perspective, the sale of oil and gas rep- oil and gas sector in GDP and a distinction between the resents the exchange of an asset, i.e. natural resources, mainland economy and total economy. We use the main- into capital, not the production of anything that didn’t land economy data, which accounts for about 80% of exist before. This exchange is not free; it is capital inten- total GDP and adjusted the data in the Conference Board’s sive. But it employs only a very small share of the labor main Total Economy Database accordingly. For Russia, force, so that measures of average labor productivity are the adjustment is more diffi cult. Direct revenues from oil huge affected by the presence of a large natural resource and gas were around 10% of GDP. But there has been extracting sector. From an income/prosperity perspec- an ongoing discussion that the offi cial numbers of the tive, many countries, including Norway and Russia, put oil and gas share in GDP might be underestimating their a share of their natural resource export revenues into a true importance, because companies in the sector shift fund. This refl ects that nature of natural resources exports a lot of their profi ts to related service providers in other as an asset swap rather than the generation of wealth. It sectors. We adjust the total GDP data in the Conference also means that this part of GDP is not available for cur- Board’s main Total Economy Database by a conservative rent consumption. Both of these factors suggest that one 15%. For both countries, we keep the adjustment fi xed has to be careful in the treatment of oil and gas activities over time; growth rates reported are thus unaffected.

Th e Region’s prosperity growth rate has slowed down to 1.7% in 2012, after reaching more than the Baltic Sea Region level. Th e Asian tigers (Sin- 3% in the previous two years. Th is slowdown has, gapore, Taiwan, South Korea, and Hong Kong), however, been less pronounced than in the rest of which had a prosperity level equal to the Baltic Sea Europe, where growth dropped by 1.8%-points Region fi fteen years ago, are now about 20% ahead (EU-15) and 2.2%-points (EU-8) respectively. in GDP per capita terms. Among European regions, the Iberian Peninsula Th e data for the Baltic Sea Region shows a has now registered fi ve years of prosperity decrease; continuation of the catch-up to average EU level it has lost close to 8% of GDP per capita during that has been visible over the last 15 years. Over this period, and 2012 was the year with the sec- the entire period, the Baltic Sea Region has re- ond largest drop at -2.2%. Th e Danube region had duced the GDP per capita level by close to 1% the largest growth slowdown in 2012, dropping every year. Unsurprisingly, the catch-up rate has -2.1%-points to register a prosperity growth rate of been highest for the Baltic countries and Poland, 0.5%. Th e group of countries most aff ected by the where it has reached close to 1.5% on average, de- European sovereign debt crisis (Portugal, Ireland, spite the deep crisis that hit the Baltics in 2009. Greece, and Spain) had the largest prosperity con- But even the Nordics, already ahead of EU-27 traction in 2012 with -2.6%; they have lost 10% of prosperity levels, gained close to 0.5% on their their prosperity level since 2007. European peers. And Germany, which had seen In the rest of the world the picture was hetero- its relative performance deteriorate until 2005 has geneous, with growth picking up in Oceania, the since then regained almost all of the relative pros- ASEAN region, and North America while slowing perity loss incurred in the previous decade. As was down in the Asian tiger economies, Latin Amer- discussed in last year’s Report, this data suggests ica, and among the BRICS countries. Prosperity not only that the Baltic Sea Region has created growth levels were still highest in the BRICS at the conditions for catch-up, but that its leading 5.4%; there prosperity is now at roughly 25% of economies are also on a higher growth path than

STATE OF THE REGION REPORT 2013 25 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Prosperity over Time Selected Regions 8%

-2% BSR Ratechange of % annual -4% GDP GDP per capita (PPP adjusted) EU-15 EU-8 -6% NAFTA

-8% 1998 2000 2002 2004 2006 2008 2010 2012

Source: Conference Board (2013) State of the Region-Report 2013

their European peers. Whether the same is true Within the Baltic Sea Region, Norway, Ice- for the Baltics and Poland remains to be seen. But land, and Sweden register the highest prosperity since their prosperity is only at 50% resp. 65% of levels, followed by Germany, Denmark, and Fin- the EU-27 level at the moment, the traditional land. Poland and Estonia lead the group of lower catch-up mechanisms will be suffi cient to drive prosperity countries in the Region, followed by robust growth for quite some time. Lithuania, and fi nally at similar levels Latvia and

Baltic Sea Region Prosperity Catch-Up Annual Change of GDP per Capita (PPP adj) relative to EU-27 4%

-2% Nordics

-4% Baltics Rest of Region

-6% BSR

-8% 1996 1998 2000 2002 2004 2006 2008 2010 2012

Note: Norway and Russia levels adjusted for natural resource sector; Luxembourg excluded Source: Conference Board (2013) State of the Region-Report 2013

26 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Prosperity Dispersion Within Cross-National Regions 1995-2012 6

5 EU-27*

Baltic Sea Region 3

2 EU-15* Richest to Poorest Country per Region to Poorest Country Richest Ratio of GDP (PPP adjusted) per Capita, per Capita, of Ratio GDP adjusted) (PPP

Note: Norway and Russia levels adjusted for natural resource sector; Luxembourg excluded Source: Conference Board (2013) State of the Region-Report 2013

Russia. Prosperity dispersion across the Region re- has constantly dropped and is now down to slightly mains signifi cant. But the overall pattern of catch- more than three times. Th ese dynamics are diff er- up continues to reduce prosperity diff erences. Be- ent from the rest of Europe. Among the EU-15, a fore 2000, prosperity levels in the richest country group of relatively homogenous Western European in the Region, Norway, were more than fi ve times countries, the ratio of richest to poorest countries as high as in the poorest country, Latvia. Th is ratio has increased to two by 2012. Among the broader

Prosperity Level and Growth Selected Countries

$50 000 Other Norway BSR OCEANIA Iceland Sweden Germany $40 000 Denmark NAFTA BRITISH ISLES ASIAN TIGERS EU-15 Finland Baltic Sea Region EU-27 $30 000 IBERIA PIGS

DANUBE EU-8 Estonia $20 000 Poland Lithuania Latvia Russia $10 000 GDP (PPP adjusted) per Capita, 2012 adjusted) per (PPP GDP

$0 Baltic Sea Region -8% -6% -4% -2% 0% 2% 4% 6% 8% GDP (PPP adjusted) per Capita Growth, in Note: Norway and Russia levels adjusted Source: Conference Board (2013) %, 2012 to 2011 State of the Region-Report 2013

STATE OF THE REGION REPORT 2013 27 SECTION A Economic performance and competitiveness in the Baltic Sea Region

group of the EU-27 it remains at 4.2. Historically are many non-income related factors that matter this level of prosperity dispersion is still nothing as well. Overall, it turns out that across the Baltic unusual. But the convergence under way among Sea Region these other data sources confi rm rather EU countries since 2000 remains more perma- than qualify the relative ranking of countries based nently disrupted since the 2008 crisis. on GDP per capita. More prosperous countries in In terms of the growth rate of GDP per capita, the Region also tend to have lower inequality and the Baltic countries remained on top in the Baltic higher life satisfaction. If anything, the inclusion Sea Region. Growth rates did, however, drop sig- of these two measures suggests that the diff erences nifi cantly, leaving Latvia as the country with the in the quality of life across the Baltic Sea Region fastest prosperity growth at 5%. Latvia’s prosper- are larger than a pure GDP analysis would suggest. ity levels remains about 10% below its 2007 high mark. Lithuania (95% of the 2008 maximum) and Estonia (98% of 2007) have already regained more Prosperity accounting of the ground lost during the recession. Russia, Norway, Poland, and Iceland registered prosperity Prosperity can be mathematically decomposed in la- growth between 2% and 3.5%. For Norway and bor productivity and labor mobilization. In this Re- Iceland these were historically high rates, while port, we operationalize these concepts through GDP Poland and Russia had reached higher growth in per hour worked (PPP adjusted) and hours worked previous years. Sweden, Germany, Denmark, and per capita. Th e data on hours worked is not very reli- Finland registered between 0% and 1% prosperity able, especially for Russia and the Asian countries, growth, a clear deterioration compared to the solid but gives a directionally interesting perspective. growth in 2011. Compared to other regions, especially in Eu- Last year’s State of the Region Report discussed rope, the Baltic Sea Region continues to do better additional perspectives on inequality and life sat- on labor mobilization than on labor productivity. isfaction that give further insights in the quality Oceania remains to be the only peer region that of life across the Baltic Sea Region. We reproduce outperforms the Baltic Sea Region on both dimen- the inequality data below; no new data has become sions; the Danube region is again the only one to available since last year. While economic activity perform worse on both. Th e EU-8 continues to lag as measured by GDP per capita is important, there signifi cantly behind on labor productivity, but has

Prosperity Decomposition Selected Cross-national Regions in 2012

GDP per Capita Employment- Productivity- (PPP) Factor Factor (PPP)

Oceania Asian tigers Core Euro-zone NAFTA Oceania Oceania British Isles EU-8 EU-15 Core Euro-zone Baltic Sea Region British Isles Asian tigers =xNAFTA NAFTA EU-15 British Isles EU-27 EU-27 Danube Region Iberian Peninsula Baltic Sea Region EU-27 PIGS Baltic Sea Region PIGS EU-15 Iberian Peninsula PIGS Asian tigers Danube Region Core Euro-zone Danube Region EU-8 Iberian Peninsula EU-8

Note: Working hours for Russia are estimated Source: Groningen Growth and Development Centre and The Conference Board (2013), authors’ calculations State of the Region- -Report 2013

28 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Prosperity Decomposition Baltic Sea Region Countries in 2012

GDP per Capita Employment- Productivity- (PPP) Factor Factor (PPP)

Norway Russia Norway Iceland Iceland Germany Sweden Estonia Sweden Germany Poland Denmark Denmark =xBaltic Sea Region Finland Finland Sweden Iceland Baltic Sea Region Finland Baltic Sea Region Poland Norway Poland Estonia Denmark Lithuania Lithuania Latvia Estonia Latvia Lithuania Latvia Russia Germany Russia

Note: Working hours for Russia are estimated Source: Groningen Growth and Development Centre and The Conference Board (2013), authors’ calculations State of the Region -Report 2013 again move slightly ahead of the Baltic Sea Region reliable data on hours worked). Th e Nordic coun- on labor mobilization. All other regions are strong tries combine equally strong productivity with a in one but weaker in the other dimension. much more solid labor mobilization record. Th e Within the Baltic Sea Region, Germany and Baltic countries and Poland rank all relatively low Russia continue to report the most diverse perfor- on labor productivity. Estonia and Poland have mance across the two components of prosperity. reached more robust labor mobilization which Germany ranks second in the Region on produc- drives their higher overall performance. tivity while it does worst on labor mobilization. For Labor productivity across the Baltic Sea Re- Russia the pattern is exactly the opposite (with less gion, measured by GDP (PPP adjusted) per hour

Labour Productivity Growth over Time GDP (PPP-adjusted) per hour worked 7,50%

BSR EU-15 5,00% EU-8 NAFTA

2,50% Rate of annual % Rate of annual change 0,00%

-2,50% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

STATE OF THE REGION REPORT 2013 29 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Productivity Level and Growth

$70 This graph is different if compared to the Word document Other BSR $60 Germany Norway

EU-15 Sweden $50 NAFTA Denmark Finland Iceland

$40 Baltic Sea Region

$30

EU-8 Poland Lithuania Estonia $20 Latvia Russia

GDP (PPP adjusted) per Hour worked, 2012Hour adjusted) per (PPP GDP $10

$0 Baltic Sea Region -2% -1% 0% 1% 2% 3% 4%

Note: Norway and Russia levels adjusted GDP (PPP adjusted) per Hour Source: Conference Board (2013) Worked, in %, 2012 to 2011 State of the Region-Report 2013

worked, increased by 1.4% in 2012, a signifi cant and is below their average for the decade (0.7% and slowdown relative to last year. Within Europe the 1.3%). Across the Region, only Iceland and Norway Iberian Peninsula performed best at 2.1%, while re- registered 2012 productivity growth ahead of their gions in rest of Europe grew more productivity more average productivity growth rate over the previous slowly at rates between 0.3% and 1.6%. Among inten years. ternational peers performance varied between 0.1% Labor mobilization in the Baltic Sea Region, in North America and 2.1% in Oceania. measured by annual hours worked per capita, has Within the Baltic Sea Region, Norway contin- essentially been fl at in 2012. Th e Region continues ues to register the highest level of labor productivity, to rank second on hours worked per capita among measured by GDP per hour worked. Th e country’s the European regions tracked, closely behind the 2.4% productivity growth in 2012 was the highest EU-8 Central European countries. Changes in la- for a decade (Norwegian and Russian productivity bor mobilization were generally low in 2012, with and productivity growth data is biased by the large the exception of the Iberian Peninsula where they oil sector). In terms of long-term trends in productiv- dropped by 30 hours, or almost 5%. Outside of ity growth Norway still ranks lowest in the Baltic Sea Europe the increase in labor mobilization in the Region. Germany, the country with the Region’s sec- NAFTA area signals the slow recovery underway in ond highest productivity level, registered at 0.4% the North America. Th e net eff ect of positive job crea- lowest annual productivity growth among its Baltic tion and a lower share of the working age popula- Sea Region peers. Within the EU-27, the UK and tion actively searching for a job has, however, been Greece performed much worse with a productivity modest compared to previous recoveries. decrease of more than 1%. Th e Baltics, Poland, Rus- Within the Baltic Sea Region, labor mobiliza- sia, and Iceland all registered solid 2012 productivity tion levels had before the 2008 crisis clustered in growth, despite slower growth rates than last year three clearly distinguishable groups: Th e Iceland, (Estonia, which had negative productivity growth Estonia, and Latvia with labor mobilization rates in 2011, was the exception). Denmark and Finland around 1000 hours per capita and year, Germany both registered disappointing productivity growth with low rates at 650, and the rest close to 800. Since at 0.5% and 0.1% respectively. For both countries then, labor mobilization levels have started to be dis- this was a further deterioration compared to 2011 tributed much more equally in a range between 700

30 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Labour Utilization over Time Selected Regions

950 BSR

900 EU-15

850 EU-8

800 NAFTA

750 Oceania

700 British Isles

Annual hours workedper capita 650 Iberian Peninsula 600

Note: Russia data estimated at 2000 hours per employee and year State of the Region-Report 2013 Source: Groningen Growth and Development Centre and The Conference Board (2013), authors’ calculations and 900. Th ere were relatively limited changes in has left a deep mark, despite the recovery in terms of 2012, largely confi ned to the Baltic countries which GDP. Th e other countries, i.e. the rest of the Baltics, all gained about 1% labor mobilization. Sweden, Po- Denmark, and Iceland, are at around 90% of their land, and Germany are now at their highest level of historical top levels. Th is is broadly similar to (at the labor mobilization since 1995; Russia, Norway, and lower end) the group of European countries most se- Finland are close. For Latvia, labor mobilization is verely hit by the sovereign debt crisis-countries and conversely only at 73% of the 2007 level; the crisis (at the higher end) the NAFTA countries.

Labour Utilization over Time Baltic Sea Region Countries 1100

1050

1000 Iceland 950 Estonia Poland 900 Latvia 850 Sweden Norway 800 Finland 750 Denmark

Annual hours worked per capitaperAnnualworked hours 700 Lithuania Germany 650

600 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: Groningen Growth and Development State of the Region-Report 2013 Centre and The Conference Board (2013)

STATE OF THE REGION REPORT 2013 31 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Assessment In the longer-run, the dynamics of productive capacity growth will play a stronger role. Here the Th e Baltic Sea Region’s prosperity growth has in data now suggests that the Baltic Sea Region re- 2012 slowed down signifi cantly. Its performance mains on a robust catch-up path. Th e Region is remained ahead of European peers but regions else- consistently growing faster than its key European where in the world, including North America, have peers that in many ways represent the most natu- registered stronger performance. ral comparison group. Th is pattern is true for the In the short-run, the lower demand growth Baltic countries, suggesting that the overheating has to be accommodated on the supply side. So crisis of 2008 was a deep downturn but not a sign far, slower labor productivity growth has been the of a fundamentally fl awed growth model. But it is key mechanism to do so. Labor utilization has still also true for the most advanced parts of the Baltic remained stable, a key factor in this still more fa- Sea Region, suggesting that they are on a con- vorable labor market performance of the Baltic Sea sistently higher growth path than their European Region compared to its European peers. While the peers. labor productivity performance has been muted Th e crisis had increased the high level of eco- everywhere, the North American labor market nomic heterogeneity that characterizes the Baltic showed small signs of improvement while Southern Sea Region. Diff erent countries had been aff ect- Europe suff ered from a signifi cant deterioration in ed in highly diff erent ways, and diff ered in their labor market conditions. ability to react. Th e recovery partly refl ected these Whether the current trends in the Region are diff erences, with those hit the hardest bouncing sustainable depends on the length of the GDP back the strongest. But the slowdown in growth growth slowdown and the development of wages. in 2012 was much more evenly felt across the Re- As long as companies continue to report solid prof- gion. All countries were aff ected by the weaker its, they can deal with a temporary weakening in overall conditions in the European economy, and productivity growth. If, however, demand drops one-off eff ects from the post-crisis adjustment lost more permanently and wage costs start to increase, in importance. a stronger labor reaction is likely.

32 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

2.2 Intermediate indicators of Region) reached slightly more than $1trn. Th is is economic activity about $30bn or 2.8% less than in 2011, a drop that is equivalent to more than the entire annual Prosperity is created, when competitiveness fun- exports from Estonia. Exports have thus been one damentals give rise to economic activities that ul- of the clearest indicators of the 2009 crisis (when timately result in wealth. Th is section includes an exports dropped by 25%), the subsequent recov- analysis of fi ve groups of intermediate indicators of ery in 2010 and 20122 (with +13% and +17% ex- economic activity to gain insights into the underly- port growth respectively), and now the renewed ing competitiveness of the location. Due to the ear- slowdown in economic dynamism. lier data of this year’s Baltic Development Forum Th e Baltic Sea Region has in 2012 continued Summit, most of the international data sets cover- to lose global market share. Th e speed of market ing these indicators have not yet been updated. We share loss has picked up, but has not reached the focus on capturing key data from the existing data, pace of the 2009/2010 crisis years. While these including the recent data on exports and investments latest trade fi gures are consistent with a structural that was not available for last year’s Report. loss of market position by the Baltic Sea Region, it is very likely to also be aff ected by the temporary impact of the slowdown in Europe, still by far the Trade largest market of the Baltic Sea Region. Th e Region continues to do better on services, Th e Baltic Sea Region is dominated by small open where export values have been slightly growing. economies with relatively highs level of trade inten- Th e Baltic Sea Region is more oriented towards sity (the ratio of exports and import values relative service exports than both the EU-27 and the world to GDP). Total trade is expected to reach 89.5% of economy overall. But even for the Baltic Sea Re- GDP in 2013, virtually equivalent to the historical gion goods trade continues to be about three times high mark reached in 2008. as large in terms of overall value, despite the lower Th e total value of exports from the Region exports in 2012. in 2012 (including cross-border trade within the

Trade Intensity of the Baltic Sea Region

40 Exports Imports Trade in % ofTrade GDP 35

30 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013*

Source: EIU (2013) State of the Region-Report 2013

STATE OF THE REGION REPORT 2013 33 SECTION A Economic performance and competitiveness in the Baltic Sea Region

World Export Market Shares Baltic Sea Region 8% Goods Services 7% TOTAL

5% World market shares

3% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: WTO (2013) State of the Region-Report 2013

In terms of individual countries across the cry below the 33% export growth registered in Baltic Sea Region, Lithuania and Latvia where the 2011. Finland saw its growth contract by 8%; the only economies in addition to the oil and gas ex- country had already registered the lowest export porters Russia and Norway that registered grow- growth in the Region in 2010 and 2011. Den- ing exports in 2012. For Lithuania the growth mark, Germany, and Sweden registered exports was at 6%, for Latvia at 5.3% - for both a far between 4% and 5% below the previous year.

Export World Market Shares Over Time Baltic Sea Region Countries 1,4% Sweden 1,2% Norway

1,0% Denmark

0,8%

0,6% Germany (North)

Finland 0,4% Russia (NW) World Export Market Share, 2012 Export World

0,2% Poland (North) Lithuania Estonia 0,0% Iceland Latvia -0,090% -0,070% -0,050% -0,030% -0,010% 0,010% 0,030% 0,050% Change in World Export Market Share, 2011 - 2012 Note: Bubble size reflects absolute export value in 2012 Source: WTO (2013) State of the Region-Report 2012

34 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Last year’s change have further reinforced the European economic crisis aff ects the Baltic Sea trends of the last decade, where the most developed Region, countries in the Baltic Sea Region have continuously lost market share. Th is was a process that started at around 2003/2004, when the global economy Foreign Direct Investment regained its footing following the IT/Telecom bubble at the beginning of the decade. Foreign direct investment (FDI) continues to be an Most exports from the Baltic Sea Region con- important way through which the Baltic Sea Re- tinue to be destined for markets nearby, as is the gion participates in the global economy. Th e inter- case in most economies around the world. Th e national FDI databases, maintained by UNCTAD, share of intra-Baltic Sea Region (BSR) trade has have not been updated to include 2012 data. Th e stayed at roughly 19% of exports relatively stable available data suggests, however, that the global over the last decade. Th e Baltic countries, Esto- trend has been strongly negative, with overall FDI nia and Latvia in particular, rely heavily on trade infl ows dropping by close to 20% and in Europe with other countries in the Region, a pattern that by around 35%. has even increased in recent years. Roughly 70% In the Baltic Sea Region, Denmark, Germa- of all exports go to markets in Europe, a share ny, and Poland saw FDI infl ows drop by around that has slightly dropped over the last decade. Ice- 80%, while for Sweden the reduction was more in land and Poland rely most on European markets line with the EU-wide trends. Th e value of inward with traditionally more than 80% of their exports investment stocks has in the meantime developed going to EU member countries. Russia has due to more positively in individual countries within the its geography and focus on oil exports the lowest Baltic Sea Region, but even here the trend was less share of its exports going to the EU; but even for encouraging than in 2011. Th e improvement in the Russia the share of EU member countries in its inward FDI stock is likely to be a refl ection of the overall exports is above 50%. Th is large role of stronger growth of Baltic Sea economies driving Europe in the Baltic Sea Region’s trade is a key stronger profi ts in these affi liates of foreign compa- transmission channel through which the current nies in the Region.

Change in Inward FDI Position Selected BSR Countries 60% Latvia 50% Lithuania Estonia 40% Sweden Finland 30% Denmark

20%

10% Annual Change in %

-10%

-20% 2005 2006 2007 2008 2009 2010 2011 2012

Source: National Central Banks (2013) State of the Region-Report 2013

STATE OF THE REGION REPORT 2013 35 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Th e data up to 2011 indicated the strong FDI mies on a catch-up path that should capture larger intensity of Baltic Sea Region countries. It also in- FDI infl ows. dicated that while the Region’s position as an inves- Among Baltic Sea Region countries, there are tor abroad remains strong, its relative attraction for three groups of countries with distinct patterns of foreign investors is slowly receding. Th is gap is not FDI activity: Poland and the three Baltic countries as strong as for the EU or for NAFTA overall, but remain largely active as destinations for inward it is getting increasingly visible. Compared to these FDI. In Iceland, Norway, Russia, and Sweden in- large regions, the Baltic Sea includes more econo- ward and outward FDI are roughly balanced. Den-

Baltic Sea Region FDI Flows

12%

FDI outflow - annual FDI outflow - 3-year average 10% FDI inflow - annual FDI inflow - 3-year average

World market share 4%

0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: OECD (2012), author’s analysis. State of the Region-Report 2012

FDI Stocks over Time Selected Regions 60%

50%

40%

BSR Outward BSR Inward 30% EU Outward EU Inward 20% NAFTA Outward NAFTA Inward FDI Stocks as share of GDP

10%

0% 2001 2003 2005 2007 2009 2011 Note: 2011 data for Belgium, Mexico, Norway, Slovak Republic, and the US not available; for these countries the FDI stock to GDP ratios is assumed stable between 2010 and 2011 Source: OECD (2012), author’s analysis. State of the Region-Report 2012

36 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

mark, Finland, and Germany have foreign FDI Region follows more closely the North American stakes that are signifi cantly larger than the inward trends, albeit at a higher level. FDI that they have attracted. Among Baltic Sea Region countries, Estonia registered the highest increase in investment rates in 2012. Estonia has at 27% the highest share of in- Domestic Investment vestment in GDP in the Region, slightly ahead of Russia, Latvia, and Norway. In the Baltic countries, Upgrading of the capital stock remains an impor- Iceland, and Denmark the investment rate remains tant way to improve productivity. Higher capital signifi cantly below its average over the last ten years. intensity is one important factor, the changes in technology and operational practices driven by new equipment are another. Th e share of capital invest- Innovation ments tends to be high when countries still have a relatively modest capital stock, but have created Creating new products, services, and ways to pro- conditions in their economies where the profi tabil- vide them to consumers is critical for future value ity of adding new equipment is high. generation, increasingly so as countries become Th e Baltic Sea Region rate has for many years more prosperous and move to the global knowledge had an investment rate below the level of the EU- frontier. Innovation on which productivity growth 15. Since 2006, however, the Region’s investment is based stretches from academic invention to new rate has surpassed its advanced European peers, if patents and, ultimately, new types of business ac- initially only by a small margin. Th e gap increased tivity. While many of the indicators used to track already in 2011 and has now opened up even more innovation are biased towards academic research, in 2012. Th e outlook for 2013 suggests that this they still contribute to the understanding of the trend will continue, based both on rising invest- competitiveness profi le of a location. Th e EU’s In- ment intensity in the Baltic Sea Region and falling novation Union Scoreboard provides a broad range investments in the EU-15. In both regions invest- of data on innovation outcomes. While the data ment growth is actually falling, but in the Baltic comes with a time-lag (depending on the indicator Sea Region less so than overall GDP. Th e Baltic Sea the latest data now available is from between 2008

Domestic Investment over Time Selected Regions 30 BSR EU-15 NAFTA

15 Gross investment GDP of % in investment Gross

Source: EIU (2013) State of the Region-Report 2013

STATE OF THE REGION REPORT 2013 37 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Innovation Outcomes Baltic Sea Region vs. EU 2

PCT patents applications relative to GDP

PCT patent applications in societal challenges relative to GDP 1,5 Licence and patent income relative to GDP

Community trademarks relative to GDP

Share of scientific publications 1 among world's top 10% most EU Average cited publications Community designs relative to GDP

Sales of new to market/to firm

Performance of BSR compared to EU average = 1 innovations relative to turnover 0,5 2005 2006 2007 2008 2009 2010 2011

Source: IUS (2013), author’s analysis State of the Region-Report 2013

and 2011), the time series indicates that the out- lications with co-authors from other countries (not come patterns are highly stable over time. shown on the graph); a refl ection of the outward ori- Th e Baltic Sea Region (excluding Russia, which entation but also the small size of the countries in is not covered by this source) excels in patenting in- the Region. On license income the Region does out- tensity, which is strong both relative to population perform peer countries, but the advantage has been size and to the size of the economy. Th is is the case eroding over time. In most other dimensions of infor patenting in general but also for patents in areas novation performance, here measured in terms of the related to what the EU calls ‘societal challenges’, here use of trademarks and designs relative to GDP and largely issues related to energy effi ciency and the en- the quality of scientifi c publications, the Baltic Sea vironment. It also ranks very high on scientifi c pub- Region matches the EU average. In the sales share of

Entrepreneurship in the Nordic countries Entrepreneurship, especially high growth entrepreneur- many new entrants. Norway, followed by Sweden, also ship by so-called ‘gazelles’, is an important feature of outperformers the OECD average on the share of gazelles, dynamic economies and as innovation rates a leading measured as companies with employment growth of at indicator of future economic performance. Internation- least 20% annually over a set period, while here Iceland ally comparative data on high-growth entrepreneurship ranks far lower. Finland doesn’t rank high on the share of is hard to get but a recent study provides interesting in- Gazelles among new entrants, but has the highest share sights into the current situation in the Nordic countries. of Gazelles to reach at least 50 employees by the end of The Nordic countries have particularly accessible fi rm the measurement period. In total, Gazelles created about level statistics that enable such analysis. 45,000 jobs between 2006 and 2009 – equivalent to On most indicators tracked in the study, the Nordic about 15% of total the net job creation in the Nordic coun- country does on average as well or slightly better as the tries during this period. OECD average. But there are signifi cant country-specifi c For more background see: Glenda Napier, Petri Rou- differences: Norway and Denmark have more than 20% vinen, Dan Johansson, Thorvald Finnbjörnsson, Espen higher entry rates of companies (new companies rela- Solberg,Katrine Pedersen (2012), The Nordic Growth tive to the stock of existing companies) relative to their Entrepreneurship Review 2012, Nordic Council: Copen- international peers, while Finland only registers half as hagen,

38 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

innovations, it even underperforms. Except for Structural composition patenting, the trend has been slightly downward across the indicators captured by this analysis. Two years ago the State of the Region Report took Across the Baltic Sea Region countries, the Nor- for the fi rst time a closer look at the structural com- dic EU members and Germany rank above the EU position of economies in the Region. Th e Region is average on almost all of the indicators. Finland has home to a signifi cant manufacturing sector, which below EU average community designs; Sweden e a drives strong exports in many products from metal smaller share of sales from innovations; and Germa- manufacturing industries, the automotive industry, ny has smaller license incomes. Norway and Iceland and production technology. Th e Region also has come close on many of these indicators, with lower a signifi cant position in biopharmaceuticals and positions in the indicators closer to market activities. communication technologies, often associated with Estonia performs exceptionally strong on patenting high levels of R&D, as well as in forest products and quiet high on trademarks, but not in other areas. and some food processing sectors, often associated Last year’s Report discussed the isolation of Estonia’s with low levels of R&D. Not surprisingly given the science-based industries from the rest of its economy. geographic nature of the Region, transportation Latvia, Lithuania, and Poland rank below the EU and logistics plays a signifi cant role in many of its average on all indicators, with stronger positions on parts. On all of these dimensions, the diff erences those indicators that are closer to market activity. across the Region are signifi cant.

Re-industrialization and New Industrial Policy

The debate about specialization patterns has taken a sig- However, although there are a few high-profi le cases, like nifi cant turn in the wake of the global economic crisis. In Google’s decision to produce a new piece of technology the years prior to the crisis, there was a wide consensus in the US rather than in China, there is at least so far that low- and medium-tech industries were increasingly no evidence of larger scale change across the economy a burden on the economies in which they operated. Ger- beyond the cyclical recovery following the recent crisis. many, for example, ranked consistently low in these types In the academic literature, too, there has been a renewed of assessments because of its large ‘medium-tech’ auto- interest in industrial policy (e.g., Rodrik, 2004; Aghion et. motive industry. During the crisis, all sectors struggled 2011), but these new arguments in favor of government as world trade collapsed. But since then it has become efforts have also triggered strong arguments against. apparent that locations with a signifi cant industrial base In the Baltic Sea Region, there has so far been much fi nd it easier to recover. less active focus on developing industry. A signifi cant The European Commission has through an updated number of economies in the Region already have an communication on industrial policy in October 2012 set industry-share above the EU average, and Germany and the objective of having industry to account for 20% of Lithuania already reach the 20% share set out in the EU’s European GDP by 2020. In order to achieve this goal, 2020 strategy (the other countries with above average in- the Commission proposes investments in six technology dustry shares are Poland, Finland, Estonia, and Sweden). areas of importance for wide swaths of industry, improve- See: European Commission (2012), A Stronger Eu- ments in regulations to enable market access and reduce ropean Industry for Growth and Economic Recovery, bureaucracy for entrepreneurs, measures to enhance ac- COM(2012) 582 fi nal, Brussels. cess to capital, and programs to provide relevant work- Philippe Aghion, Julian Boulanger, and Elie Cohen force skills. Individual countries, like France, have made (2011), Rethinking Industrial Policy, bruegel policy brief announcements on reindustrialization. In the US, too, re- 2011/4, Brussels. industrialization is high on the political agenda. There, Dani Rodrik (2004), Industrial Policy for the Twenty- the large scale production of shale gas has, through its First Century,” Working Paper Series rwp04-047, Harvard impact on energy prices, created a powerful economic University, John F. Kennedy School of Government: Cam- driver for the resurgence of energy-intensive industries. bridge.

STATE OF THE REGION REPORT 2013 39 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Export World Market Shares By Cluster Baltic Sea Region Countries 18% Forest Fishing 16% Products Products

14%

12% Furniture Marine Power 10% Equipment Generation

Heavy 8% Machinery

World Export Market Share, 2012 Export World 4% Biopharma- ceuticals 2% Communications Equipment 0% -10% -8% -6% -4% -2% 0% 2% 4% 6% Change in World Export Market Share, 2011 - 2012 Note: Bubble size reflects absolute export value in 2012 Source: WTO (2013) State of the Region-Report 2012

In terms of its exports, the Baltic Sea Region re- consists predominantly of small, open economies. mains dominated by relatively traditional industries. Internationalization can take diff erent forms: it can Outside of oil and gas, the Region has its strongest happen to exports, and it can happen to foreign di- world market positions in fi shing and forest prod- rect investment. Companies decided which of these ucts. In areas like biopharmaceuticals and com- modes are most profi table in a certain context. Lo- munications equipment it is a signifi cant exporter, cations are aff ected through the impact this has on but has lost position over time. Th is is also true for jobs and wages. If world markets are growing fast marine equipment, a cluster category in which the than markets at home (which is true for all advanced Region used to be very strong. In some other cluster economies, including the Baltic Sea Region), it is categories, like heavy machinery, production tech- likely that a more FDI-driven internationalization nology, and automotive, the Region has meaningful model might exert stronger pressure on domestic la- exports and broadly kept is existing market position bor markets. but is not overly specialized relative to peers. In the Baltic Sea Region there is an increasing dichotomy in the modes of internationalization that individual countries take. Th e Nordic Assessment countries and Russia are getting increasingly FDI driven, while for the rest of the Region trade is an Th e current pattern of the Baltic Sea Region’s per- at least as important and often more dynamically formance on intermediate indicators of economic growing instrument of internationalization. Th is is activity refl ects a combination of longer-term struc- visible for the 2004 – 2011 period, with the data tural trends and shorter-term cyclical factors. for the years prior and after (where only trade data Th e longer-term trends for the Baltic Sea Region is consistently available) showing an even stronger point towards structural changes that will test the diff erence. In 2012 and 2013, Germany, Poland, capabilities of the Region. Globalization leads to in- and the Baltics have seen their trade intensity grow creasing internationalization of economies. Th is is signifi cantly more than the Nordics and Russia. especially true in a region like the Baltic Sea, which Between 2000 and 2004, the Nordics (plus Poland

40 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Modes of Internationalization Baltic Sea Region Countries, 2004 - 2011 200% Estonia

Lithuania 150%

Latvia Iceland Denmark 100% Poland Germany BSR

Trade Intensity Trade Finland Sweden

50% Norway (Exportsof + Imports% GDP) in Russia

0% 0% 20% 40% 60% 80% 100% 120% 140% 160% 180% FDI Intensity Source: EIU(2013), UNCTAD (2013) (Outward and Inward FDI Stock in % of GDP) State of the Region-Report 2013

Reliance on the EU-27 Market Baltic Sea Region Countries

90%

60%

30% Share of Exports going to EU-27 countries,2012 0%

Source: Eurostat (2013), EC (2013) State of the Region-Report 2013

STATE OF THE REGION REPORT 2013 41 SECTION A Economic performance and competitiveness in the Baltic Sea Region

and Estonia) saw their FDI intensity grow much 2.3 Competitiveness fundamentals faster than the rest of the Region. Th is data pattern is consistent with the Baltics Prosperity outcomes and the economic activity meas- and Poland operating as increasingly internation- ured by intermediate indicators are ultimately driven alized economies with a signifi cant attractive- by the competitiveness fundamentals in an economy. ness of export platform activities. It is consistent Th e complex mix of fundamentals can be organized in with Germany using outsourcing and the pull of two broad categories: macroeconomic and microeco- its large home market to continue to support a nomic factors. Macroeconomic factors set the general large export-oriented, highly internationalized context for fi rms but do not aff ect productivity and in- economy. It is consistent with Nordic economies novation directly. Th is group includes both the quality that are competitive as a home base for globally of social and political institutions and the quality of active companies, but see their attractiveness in macroeconomic policy. Microeconomic factors have a global value chains slowly erode to a smaller set direct impact on the productivity with which compa- of activities around research and market testing. nies can transform inputs into economic value. Th is And it is consistent with a Russian economy that group includes the quality of the business environ- creates capital for investment but sees trade ham- ment, the presence and dynamism of clusters, and the pered by trade barriers and low attractiveness as a sophistication of companies. location for business. Whether these hypotheses are accurate refl ections of reality remains to be tested further. But they are reasonable enough for Overview its implications to be seriously analyzed by policy makers throughout the Region. Th e Baltic Sea Region remains a highly competitive Th e shorter-term trends are driven by the Eu- part of the European and global economy. Finland, ropean crisis. In trade, it aff ects exports to what are Sweden, and Norway all rank among the top fi ve the main markets for all Baltic Sea Region coun- countries according to the WEF Global Executive tries. Th e Baltics, which sell mostly to each other Opinion Survey data.5 Germany comes close be- and to the rest of the Baltic Sea Region, are the hind within the top, followed by Denmark ranked least aff ected. Natural resource exporters Norway twelve. Estonia (25th) and Iceland (28th) broadly and Russia also follow diff erent dynamics, even kept their position, which puts them close to econ- though for Norway in particular Europe is by far omies like France, Chile, and Malaysia. Lithuania the dominant market. For the rest of the Region (46th) has surpassed Poland (47th) and Latvia (51), the slow-down in the other parts of Europe have a but the diff erences between these three are small. signifi cant impact. Th ere is a direct eff ect from the Th ey all rank at a level of economies like Slovenia, lost sales to these markets. And there is an indi- China, Turkey, and South Africa. Russia contin- rect eff ect on companies’ and consumers’ sentiment ues to come in last in the Region, now ranked 99th about economic prospects that further reduces eco- globally, with an overall level of competitiveness nomic activity. between Kenya and Bolivia. Overall, the Baltic Sea Region continues to do Relative to their level of prosperity, Finland, better than many of its European peers. But the Sweden, Germany, and Estonia register high levels challenges in managing the structural changes in of overall competitiveness. Th is suggests a poten- the global economy are already visible. And the im- tial for growth but also the existence of structural pact of the short-term downturn that has much of barriers that keep these countries from realizing the rest of Europe in its grip is becoming increas- higher levels of prosperity. For Denmark, Poland, ingly visible in short term economic activity levels Lithuania, and Latvia competitiveness and prosper- in the Region. ity are broadly balanced – but at diff erent levels of prosperity. Russia and to a much smaller degree also Norway have their natural resource wealth to

5 The latest available data has been collected in the ﬁ rst half of 2012. We use the country-averages for that year and for the aggregation the method outlined in Delgado, Mercedes, Christian Ketels, Michael Porter, Scott Stern (2012), The Determinants of National Competitiveness, NBER Working Paper.

42 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Overall Competitiveness 2012 Selected Countries

+ Baltic Sea Region countries Competitiveness Score, 2012 Italy oatia - India Chile Israel Qatar Brazil Spain China Latvia Oman Japan Bolivia Russia Ireland Turkey Austria France Poland Mexico Iceland Cr Finland Greece Estonia Norway Ukraine Canada Sweden Belgium Bulgaria Vietnam Portugal Hungary Slovenia Thailand Australia Malaysia Romania Mongolia Denmark Lithuania Germany Colombia Indonesia Singapore Switzerland Korea, Rep. Korea, Netherlands South Africa Luxembourg Saudi Arabia New Zealand New United States United Taiwan, China Taiwan, Czech Republic Czech United Kingdom United Slovak Republic Slovak Hong Kong SAR Kong Hong United Arab Emirates Arab United

Source: Unpublished data from the Global Competitiveness Report (2012), author’s analysis. State of the Region-Report 2013 sustain prosperity levels above what their underly- ranked among the ten most competitive countries ing competitiveness could support. in the world since 2001, the fi rst year for which In the top group, Finland, Norway, and Ger- comparable data is available. Following the change many saw their positions improve relative to 2011. in government in late 2001, Danish executives For Finland, this is the fi rst time since 2006 that have become highly critical with the quality of the the country regains the leading global position. policy making process, and about some areas of Th e improvements in a number of areas of tradi- microeconomic competitiveness in which govern- tional strengths, like the quality of the political ment infl uence is particularly direct, like taxation process and demand sophistication, were moder- and government procurement. ate. But they are remarkable for a country in which In the upper middle group, Estonia continues the globally most well-known company is going to benefi t from its robust macroeconomic policies through a period of dramatic downsizing. Norway as well as limited bureaucracy, strong communica- has made real headway in some areas of microeco- tions infrastructure, and open markets. In macroe- nomic competitiveness, in particular innovative conomic policies the country is on it way back to its capacity and the context for strategy and rivalry. It strong pre-crisis position, but has still some ground is the fi rst time that the country’s microeconomic to regain. Iceland’s main strength continues to be competitiveness ranks among the global top ten. its social infrastructure and political institutions, Th is is particularly impressive given the negative despite the deterioration in the assessment of the impact of resource wealth on competitiveness in political system that the crisis brought about. Th e many other countries. Germany benefi ted from country’s communication infrastructure keeps its further improvements in the assessment of the so- high marks, and the fi nancial market infrastruc- phistication of its companies but also gradual im- ture is slowly regaining some ground. provements in a number of dimensions of business In the lower middle group, Lithuania’s gains are environment quality. largely driven by the recovery of its macroeconomic Sweden lost slightly, Denmark more signifi - policies. Th ere are also improvements in some di- cantly. Sweden’s position eroded gradually on many mensions of microeconomic competitiveness, espe- dimensions of business environment quality. For cially company sophistication and activities related Denmark, this is the fi rst time the country is not to the collaboration between fi rms, academia, but

STATE OF THE REGION REPORT 2013 43 SECTION A Economic performance and competitiveness in the Baltic Sea Region

also the labor market partners. Poland has roughly factor input conditions. Looking at more narrow kept its position, with limited gains in microeco- dimensions of competitiveness, more important nomic competitiveness undone by a small deterio- diff erences emerge. Particular strengths are the in- ration in macroeconomic competitiveness. Latvia novative capacity of fi rms, high internet penetra- has continued the improvements in macroeconomic tion, a larger degree of tertiary enrollment, and low policy and otherwise stabilized the gains made last nominal tariff rates. Among the weaknesses are a year in other dimensions of competitiveness. number of factors shaping the context for strategy For Russia, 2012 brought some improvements and rivalry, including taxation, business regulation, in competitiveness, but not enough to compensate barriers to trade and invest, and labor market rules. for the signifi cant drop in the year before. Th e most Other challenges are the soundness of banks, the signifi cant normalization – on a still very low level quantity of available suppliers, and the quality of – was registered in the assessment of the political road infrastructure. institutions. Russia reaches relatively similar rank- Th is overall profi le hides the important dif- ings across all dimensions of competitiveness, with ferences that exist across countries in the Region. somewhat lower positions in areas of microeco- Finland, the most competitive economy globally, nomic competitiveness. has strengths across the board. Sweden and Nor- Th e Region has on the aggregate level retained way as well as, at a lower level, Estonia, Poland, its relatively balanced portfolio of strengths and Latvia, and Russia are all strongest on macroeco- weaknesses. Basic health and education is the only nomic policy, followed by institutional factors and area in which the Region signifi cantly improved its then the aggregate of microeconomic fundamen- position, More signifi cant problems are the context tals. Denmark shows a similar pattern, but with for strategy and rivalry and some dimensions of institutional factors ranked lowest. Germany and

The Baltic Sea Region’s Competitiveness Profile 2012

GDP pc (22) Micro (28) GCI (24) Macro (23)

Social Infra- National Business Company Operations Macroeconomic and Strategy (27) structure and Pol. Environment (29) Institutions (24) Policy (25)

Related and Supporting Political Institutions Industries (32) (31)

Demand Conditions Rule of Law (29) (31)

Significant Context for Strategy and Human Development advantage Rivalry (34) (20) Moderate advantage

Neutral Factor Input Conditions (24) Moderate disadvantage

Comm. (18) Logistic. (32) Capital (33) Significant disadvantage Innov. (23) Skills Admin (35)

Source: Unpublished data from the Global Competitiveness Report (2013),author’s analysis. State of the Region-Report 2013

44 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Lithuania register the opposite pattern, with dis- Within the Region, there continues to be tinct relative advantages in microeconomic com- huge heterogeneity in terms of institutional qual- petitiveness, followed by social infrastructure and ity. While the Nordic countries remain global political institutions, and macroeconomic policies leaders in this area, Denmark has seen a signif- with a signifi cant gap. icant deterioration in its ranking in 2012. Th is drop is strongly driven by a lower assessment of the quality of the political institutions, but also Macroeconomic competitiveness: those dimensions of the rule of law where short Institutions term policy choices have a direct impact. Th e survey respondents clearly took a negative view on Th e Baltic Sea Region gets traditionally solid marks the initial months of the new Danish government on the quality of its institutional structures, a posi- that had come into offi ce just a few months be- tion that has been confi rmed in the data for 2012. fore. Over time such strong reactions often mod- It ranks strongest on the basic health and educa- erate, so it will be interesting to see how Danish tional services that public institutions provide. Th e business leaders view the situation in 2013. Fin- rankings on the rule of law and on political institu- land and Sweden switched positions, both with tions are somewhat lower but continue to put the very moderate changes that are within the normal Region in the upper 25% of all countries for which variance of survey results. Norway pushed to a data is available. position just ahead of Sweden, registering modest Many indicators of institutional quality change improvements in all three components of social only slowly over time, especially those related to infrastructure and political institutions. Germany human development. Political institutions are the follows, with a signifi cantly more positive view area where perceptions are most volatile. Th is is of political institutions. Th is is quite remarkable also the area where there has been a slightly more given the strains that the EURO-crisis puts on the negative view on the performance of the Baltic Sea German political system. Quite clearly, German Region, with the deterioration in 2012 confi rming voters remain overall satisfi ed with the way their a similar trend from previous years. In the other institutional structures deal with these challenges. areas the average performance of the Region has Iceland’s position remains almost unchanged. Th e stayed virtually unchanged. relatively poor ranking on political institutions re-

Social Infrastructure and Political Institutions Ranking of Baltic Sea Region Countries, 2012

Finland Norway Sweden Germany Denmark Iceland SIPI 1 5 6 101315 Political institutions 165121629

Rule of law 1 6 9 121514

Human development 4109 7135

BSR Estonia Lithuania Poland Latvia Russia SIPI 24 28 47 48 49 99 Political institutions 31 27 70 67 69 125

Rule of law 29 26 49 47 50 121

Human development 20 34 41 45 46 63

Source: Unpublished data from the Global Competitiveness Report (2012), author’s analysis. State of the Region-Report 2013

STATE OF THE REGION REPORT 2013 45 SECTION A Economic performance and competitiveness in the Baltic Sea Region

mains a result of the deep frustrations generated Medvedev, has led to continued frustration about by the fi nancial crisis in the country, for which the state of the political system. the political class was seen to carry signifi cant re- An important indicator of institutional quality sponsibilityoming recent national elecy pathsaw is the presence of corruption. Th e pattern revealed dramatic losses for the left-leaning alliance that in the WEF executive opinion survey data is re- took over after the crises. A return of the coali- fl ected here as well: Nordic countries and here also tion that governed between 1991 and 2007 now Germany among the global leaders, the rest of the ms nowto be the most likely outcome. Estonia Region more heterogeneous with Russia lagging continues to lead the group of the Eastern Euro- far behind. Russia made some further progress in pean countries, still with some distance towards 2012, possibly refl ecting the stronger stance that the other Baltic countries and Poland. All four the political leadership is taking in some high pro- countries have seen a clear deterioration in the fi le cases of corruption even among top offi cials. views about the quality of their political institu- Latvia, too, made some gains after having lost some tions. While the diff erences will diff er from coun- positions in 2011. For most of the other countries try to country, they indicate the diffi cult political in the Region, the changes were small. tests that they all face in the current economic In Sweden, the discussion about Swedish com- environment. Russia, too, has seen its ranking on panies using bribery abroad to gain business gained political institutions fall, while it gained some po- visibility in the case of partly government-owned sition in the rule of law and human development. TeliaSonera. While companies from the Nordics Last year’s strong drop on political institutions, generally have strict policies against bribery, the likely to be infl uenced by the switch in positions case raised questions about their actual behavior in between President Putin and Prime Minister countries where corruption is widespread.

Corruption Perception Index 2012

Denmark Finland Sweden Other Low Norway Iceland Germany BSR

Estonia Poland Lithuania Latvia Level of Perceived Corruption Perceived of Level Russia

High

-20 -15 -10 -5 5 10 15 20 Worsening Corruption Decreasing Corruption

Source: Corruption Perception Index (2012) State of the Region-Report 2013

46 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Macroeconomic competitiveness: ania remain offi cially committed to join the Euro- Macroeconomic policy Zone at some point, with Lithuania targeting a 2015 entry. Iceland, Poland, Norway, Sweden, and Th e Baltic Sea Region’s solid overall macroeco- Russia follow diff erent versions of infl ation target- nomic policy has been one of the key assets it was ing, using slightly diff erent targets and infl ation able to build on in its robust response to the global measures. In Iceland there are strong voices that economic crisis. It is now put to another test as the argue for joining the Euro-zone in conjunction diffi cult economic situation in the rest of Europe with the application to become a member of the again raised the question as to whether govern- European Union. But while some view this as the ments should use fi scal policy to respond. Mon- appropriate response to the fi nancial crisis Iceland etary policy is already at historically lenient levels, experienced in 2009, others are more skeptical and is likely to stay at this level for some time. about this solution. In Poland the Prime Minister Underlying monetary policy regimes diff er sig- has confi rmed has intention to join the Euro-zone. nifi cantly across the Region. Germany, Finland, But an eventual referendum is facing an increas- and Estonia are part of the Euro-Zone, where the ingly skeptical Polish public. European Central Bank (ECB) sets monetary pol- Infl ation rates across the Region edged down- icy based on an infl ation rate target of “below, but wards throughout 2012 as the economic climate close to, 2% over the medium term.” Denmark, deteriorated. For 2013 the forecast is in most Latvia, and Lithuania set monetary policy to keep countries for stable or slightly lower infl ation the exchange rate to the Euro stable, essentially rates, largely driven by the expected weak dyna- shadowing ECB policy. Latvia has in March 2013 mism in economic activity. In Denmark and Lat- offi cially asked to join the Euro Zone by 2014. Th e via, interest rates were lowered in the summer of government is fi rmly committed to this goal, while 2012, following the move by the European Cen- the public has become skeptical and the opposition tral Bank. When the market pressure on the Euro is pushing for a referendum. Denmark and Lithu- seemed to be receding in early 2013, the Danish

Macroeconomic Policy Indicators 2012

Denmark Estonia Finland Germany Iceland Latvia Lithuania Norway Poland Russia Sweden

Fiscal Policy Government budget balance (in % of GDP) -3.60 -2.40 -1.90 0.10 -3.20 -2.60 -3.60 13.40 -1.80 0.00 0.00 Government debt (in % of GDP) 48.00 7.90 53.90 81.50 125.10 43.10 36.00 32.30 53.70 7.80 38.90 Monetary Policy InŇaƟon (annual change in %)) 2.40 3.90 3.20 2.13 5.20 2.40 3.00 0.60 3.60 5.07 0.90

BSR EU-27 NAFTA

Fiscal Policy Government budget balance (in % of GDP) 1.06 -3.91 -6.40 Government debt (in % of GDP) 43.42 85.97 71.30 Monetary Policy InŇaƟon (annual change in %)) 2.35 2.62 2.30 Source: EIU (2013), author’s calculations State of the Region-Report 2013

STATE OF THE REGION REPORT 2013 47 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Central Bank raised rates somewhat to defend the a business cycle, ranging from -0.5% of GDP in stable exchange rate between the Danish Crown Denmark to +1% in Sweden. Norway aims for and the Euro. In Sweden, the Monetary Policy a defi cit in its budget before returns from its oil Committee remains deeply divided. One group fund of no more than 4% of GDP. Russia has a argues for a more restrictive monetary policy to target for spending related to the revenues from counteract a buildup of private sector debt and oil exports. Germany has a constitutional ban for housing prices. Th e other calls for a more lenient public sector defi cit that will come in place fi rst interest rate policy to revive sluggish growth and at the federal and then the regional level over the address the relatively high level of unemployment. coming years. Poland has set itself an upper limit Riksbanken did reduce interest rates in December for public sector debt at 60% of GDP. It also has 2012 as the economic outlook was becoming more a short-term target for expenditure growth to be negative. In its April meeting it then kept rates below CPI + 1%. stable but signaled that interest rates are likely to Denmark followed a more expansionary fi s- remain at a low rate for a longer period to come. cal policy in 2012 to regain growth momentum, Poland lowered its interest rate in March 2013 as largely using a change in the early-retirement the concerns about a slowdown in the economy system to achieve a one-off push to private sec- were rising. In Russia, the President of the Cen- tor spending. Th e budget defi cit increased to more tral Bank left offi ce after a long period in which than 3.5% and the government is now trying to he had gained a reputation for anti-infl ationary achieve a lower defi cit for 2013. Sweden has seen policies. With the former Minister of Economic its public sector surplus fall in 2012, and the dis- Development Nabiullina now taking his position, cussions surrounding the recent spring budget there are speculations as to whether Russia might indicate that the government is considering the adopt a more growth-oriented monetary policy need for more expansionary measures should the under her leadership. economic outlook deteriorate. Finland had a defi - A key challenge for monetary policy is the bal- cit of close to 2% in 2012 and has introduced a ance between growth, infl ation, and the danger of number of tax increased that came into eff ect in speculative bubbles as the result of an unsustaina- 2013 to reduce the fi scal shortfall. Lithuania has ble debt buildup. A recent analysis of the European reduced its defi cit somewhat in 2012 and is target- Commission suggests that the Baltic Sea Region ing a 2.5% defi cit in 2013. Latvia, too, improved needs to keep an eye on the debt dynamics in the its fi scal balance and is now aiming for a defi cit of private sector.6 Denmark and Sweden stand out 1.3% of GDP in the current year. Th e government with private sector debt levels above 200% of GDP. saw enough fi scal room to reduce a number of tax Germany and Latvia also come high on some of the rates, reversing some of the tax increases that had specifi c debt measures used by the Commission. In been implemented during the crisis. Estonia had terms of the sustainability to service the debt, the a defi cit in 2012 after a surplus the previous year analyses single out Denmark, Estonia, and Latvia and is now targeting a smaller defi cit for 2013. are singled out as the most problematic cases, fol- Russia’s budget remains balanced due to the sig- lowed by Finland and Sweden, nifi cant oil revenues; with these, the government On fi scal policy, the position of the Baltic Sea budget defi cit would stand at -10% of GDP. Region remains overall solid with average public sector defi cits and debt levels moderate compared to other countries. Most countries in the Microeconomic competitiveness Region have a formal fi scal policy framework to guide medium-term policy planning and anchor Th e Baltic Sea Region benefi ts traditionally from expectations about the course of fi scal policy. Th e its balanced position with solid levels of company majority of the Nordic and Baltic countries have sophistication and business environment quality, a target for the average public sector defi cit over with particular strengths in a number of factor input conditions. Th e latest data, collected largely in 6 Carlos Cuerpo, Inês Drumond, Julia Lendvai,, Peter Pontuch and Rafal Raciborski the fi rst half of 2012, confi rms this view. (2013), Indebtedness, Deleveraging Dynamics and Macroeconomic Adjustment, Economic Papers 477, European Commission: Brussels

48 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Physical infrastructure have taken towards the quality of their country’s (Logistical, Energy, Communication) competitiveness. Th e Baltic countries, especially Latvia, have seen the strongest overall improve- Physical infrastructure, both for transport and ment. Particularly air transport infrastructure has communication, remains overall solid across the received higher marks; an encouragement to Lat- Baltic Sea Region, despite some further slight slip- vian policy makers that had to intervene when Air page in 2012. Th e position is somewhat weaker for Baltic, the largest carrier in the Baltics, got into logistical infrastructure, where there is also sig- fi nancial trouble. Poland received a boost on the nifi cantly more heterogeneity across the Region. perceived quality of its road system. While still Th e Region’s transportation infrastructure gets seen as a weakness, this could signal that the sig- particularly high grades for its ports and railroads. nifi cant investments under way in the country to Executives in the Region have a positive view of upgrade the road infrastructure are starting to railroads, despite the absence of high-speed trains make a meaningful diff erence. and the remaining weaknesses of the rail system Th e World Bank’s Logistical Performance In- in the Baltics. Road infrastructure continues to be dex is based on a survey of international freight ranked somewhat lower, largely because of weaker forwards and other sources. Th e data on the Re- rankings for Norway, Poland, and Russia Last gion confi rms an overall solid position but also a year’s State of the Region-Report provided a more deterioration of the Region’s position versus glob- detailed discussion of the physical infrastructure. al peers. Th e Region ranks best on logistical com- Denmark was the only country in the Region petence and customs procedures, with somewhat that saw across the board deteriorations in the as- weaker scores on infrastructure and, surprisingly, sessment of its transportation infrastructure com- competence on international shipments. Strik- pared to last year. Largely this is a refl ection of the ingly, Denmark ranks signifi cantly better in the generally more critical view that Danish executives World Bank assessment, and also registers a much

Physical Infrastructure Baltic Sea Region Countries

Indicator EE LV LT DK FI IS NO SE GE PO RU

Logistical infrastructure 44 43 33 20 524361978183

Quality of roads 60 97 35 26 936802410108 134

Quality of railroads 39 33 17 30 5 92 44 24 6 79 34

Quality of port infrastructure 19 42 26 21 6 7 24 11 9 105 89 Quality of air transport 68 37 71 29 10 9 14 28 799102 infrastructure Quality of electricity 60 51 43 9 18 3 12 15 31 46 81 supply Quality of domestic transport 32 39 26 16 324591947284 network: business ICT infrastructure 17423213113 8 7 104846 Internet access in 3 25 20 24 219 16 42 61 71 schools Mobile phone subscribers per 24 8013368 71504627315 100 population Percentage of households 30 43 47 6 12 1 2 5 9 33 51 with computer Internet users per 100 23 32 39 6 7 1 2 4 12 40 57 population Telephone lines per 100 34 51 55 20 64 6241427140 population

Note: Numbers in red and green indicate a change of ten ranks or more down resp. up since 2011. State of the Region-Report 2013 Source: Unpublished data from the Global Competitiveness Report (2013), author’s analysis.

STATE OF THE REGION REPORT 2013 49 SECTION A Economic performance and competitiveness in the Baltic Sea Region

World Bank Logistical Performance Index 2012

3. Finland (+8)

4. Germany (-3)

5. Denmark (+11)

12. Sweden (-9)

22. Norway (-10)

25. BSR (-5)

30. Poland (-1)

32. Iceland (+9)

58. Lithuania (-13)

65. Estonia (-22)

76. Latvia (-39)

Of 155 countries 95. Russia (-3)

Source: World Bank (2013), author’s analysis. State of the Region-Report 2013

ICT Development Index Top 50 Countries IDI Score, 2011 9

8 Baltic Sea Region

Source: ITU (2013) State of the RegionReport - 2013

50 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

more positive trend. Th is is likely to be driven by the decision to abandon nuclear energy will have the early date at which the World Bank collected negative eff ects on energy prices on the reliability its data, but might also be driven by the diff erent of supply. In the fall of 2012, the Lithuanian pub- focus of their study, which puts transportation in- lic voted against a plan to replace the decommis- frastructure in the context of relevant administra- sioned Ingalina nuclear plant. tive procedures and specialized services off ered by logistical companies. Th e information and communication infra- Skills and education structure is well developed across the Region, and continues to rank high internationnies. Th ere is Th ere is a wide recognition that a highly skilled also a large degree of regional integration, with the labor force is critical for the economic future of leading Nordic operators active across most parts of the Baltic Sea Region, and that high skill levels the Region. While there is variation in terms of the have been an important foundation for the solid access and usage of ICT infrastructure as measured economic performance of the Region so far. But by, for example, the ITU’s ICT Development In- the survey data from business executives refl ects dex, the diff erences across countries in the Region clear concerns about whether the Region remains are smaller than in other areas. ahead of its global peers on this dimension. While Energy has been a topic of previous State of the the overall educational system is viewed as quiet Region-Reports and a recent report by the Pan-Eu- solid, there are concerns about both math and sci- ropean Institute provides a detailed documentation ence education and about management training of the most recent trends (Paulina Wilk, Cross-bor- at universities in the Region. Th e data on educa- der energy infrastructure in the Baltic Sea Region, tional performance, discussed in more detail last 7/2012, PEI: Turku). Th e report shows a growing year, shows that while the Region includes some level of interconnectedness between the diff erent of the countries that rank highest globally, it also parts of the Region, with additional linkages hav- has other countries that struggle, at least in rela- ing been created recently or currently under dis- tion to their level of economic performance. Fin- cussion, especially between the Nordics and the land remains ranked very high, consistent with Baltics but also Poland and Lithuania. Overall, the the data on educational attainment discussed in quality of electricity supply in the Region continues more detail in last year’s Report.7 Germany, one to receive a solid score. Germany saw its position of the countries with such challenges, showed an erode, possibly due to increasing concerns whether encouraging improvement in the assessment of

Skills and Education Baltic Sea Region Countries

Indicator EE LV LT DK FI IS NO SE GE PO RU

Skills and education 42 73 35 31 3 20 28 17 30 58 67

Quality of math and 21 62 16 49 22243 33 20 70 50 science education

Quality of management 48 72 54 28 6 24 16 12 22 84 107 schools

Availability of scientists 71 123 54 32 1 19 39 5 22 56 97 and engineers

Tertiary enrolment 26 34 16 13 3 15 14 17 55 20 12

7 “Finnish Lessons”, by Pasi Sahlberg, provides a detailed account of the choices made in the Finnish educational system for those who want to learn more.

STATE OF THE REGION REPORT 2013 51 SECTION A Economic performance and competitiveness in the Baltic Sea Region

business leaders. Whether these better rankings Th ere are more challenges in the quality of the refl ect a fundamental improvement, or just a tem- research conducted, and in the ability to attract porary blimp, remains to be seen. economic activities related to the exploitation of new ideas in the Region. Across the Baltic Sea Region, the heterogene- Innovation infrastructure ity in terms of innovative capacity remains high. Th e Nordic countries and Germany all rank high, The quality of the innovation infrastructure despite some marginal loss of position in individual across the Baltic Sea Region continues to be high; indicators. Sweden ranks among the top ten coun- there are only marginal changes in the most re- tries in Europe on all dimensions; Denmark has cent data published in the European Innovation lost some position in the assessment of human re- Scoreboard compared to previous years. Th e Re- sources. Th e Baltic countries and Poland lack be- gion scores on average relatively balanced across hind. Estonia provides a good fi nancing environ- the diff erent dimensions of the innovation system. ment and strong linkages between companies and Th is suggests that the challenge is not primarily the related research activities; Lithuania ranks also related to an inability in translating scientifi c re- relatively well on human resources and fi nancing search into marketable products and services, as but less so on linkages. Russia, not covered in this is sometimes assumed. On linkages between the database, remains to have legacy assets in its scien- academic and the private sector and also on fi rm tifi c system, but struggles to connect them to its investments the region does, in fact, do quite well. company base.

Innovation in the Baltic Sea Region BSR Rank among European countries

Enablers Firm Activities Outputs

Human resources Firm investments Innovators New doctorate graduates per 9 Business R&D expenditures (% of 6 SMEs introducing product or 10 1000 population aged 25-34 (±0) GDP) (±0) process innovations (% of SMEs) (+2 ) Percentage population aged 30- Non-R&D innovation expenditures 14 SMEs introducing product or 12 34 having completed tertiary 13 (% of turnover) (+6) process innovations (% of SMEs) (+1) education (+2 ) Percentage youth aged 20 -24 having attained at least upper 21 secondary level education (+1) Linkages & entrepreneurship Economic effects SMEs innovating in-house (% of 11 Open, excellent and attractive Employment in knowledge - SMEs) (-1) research system intensive activities (% of 16 Innovative SMEs collaborating with 12 International scientific co- workforce) (±0) publications per million 12 others (% of SMEs) (-2) population (±0) Public-private co-publications per 9 Contribution of medium and high- 25 Scientific publications among top million population (-1) tech exports to trade balance (-1) 10% most cited publications 14 worldwide (±0)±0) Intellectual assets Knowledge-intensive services Non-EU doctorate students as % 10 PCT patents pplications per billion 6 exports (% of total service 10 of all doctorate students (-1) GDP (±0) exports) (±0) PCT patent applicationsin societal 5 New-to-market and new-to-firm 17 Finance and support challenges per billion GDP (+1) sales (% of turnover) (+3) Public R&D expenditures (% of 6 Community trademarks per billion 13 Licence and patent revenues 8 GDP) (+0) GDP (+2) from abroad (% of GDP) (+2) 8 8 Venture capital (% of GDP) (-3) Community designs per billion GDP (+2)

Note: Coloring indicates relative strengths and weaknesses; numbers in brackets are changes relative to last available year Source: Innovation Union Scoreboard (2013), author’s analysis. State of the Region-Report 2013

52 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Ranking of Baltic Sea Region Countries

Linkages & Human Research Finance and Firm Intellectual entrepre- resources systems support investments assets neurship

Sweden 172355

Denmark 14 4 6 7 3 2

Finland 31335106

Germany 13 12 10 4 8 3

Iceland 30 6 1 2 1 15

Estonia 18 21 4 6 14 13

Norway 9 2 12 30 16 19

Poland 19 31 20 18 32 24

Lithuania 11 27 13 14 27 28

Latvia 24 34 21 32 31 20

Source: Innovation Union Scoreboard (2013), author’s analysis. State of the Region-Report 2013

Innovation, Incentives, and the ‘Cuddly” Nordic model

The Nordic model has found many admirers over the last Importantly, the innovation followers can grow at the same few decades, seeming to provide a combination of high rate as the innovation leader, because they beneﬁ t from the levels of economic success with a high level of social knowledge externalities the innovation leader generates. cohesion and equality. A recent paper aims to provide a Furthermore, the innovation leader might enjoy lower levels theoretical model that aims to explain how this combina- of social welfare (because of inequality) than its peers with tion is possible, but also how it depends on the presence ‘cuddly’ incentives but will decide to keep its cut-throat in- of another country, i.e. the U.S,. with much more cut-throat centives because abandoning them would leave both itself incentives that deliver economic performance but also in- and all other countries worse off. equality. The paper has gained some interest in Nordic The paper makes an interesting contribution to the policy circles. debate about different economic models and the interde- The model argues that new ideas can be obtained pendencies among them. But it has also some features in two different ways: Either through the acts of innova- that upon closer examination Nordic policy makers might tors domestically, or through participating in innovations not like: It puts the Nordic countries into the position of a abroad through international knowledge-spillovers. The free-rider on the U.S. innovation system. And it argues that domestic propensity to innovative is a function of the in- all efforts to achieve excellence in the Nordic innovation centives, with high incentives, i.e. high rewards for those system(s) are in vain; innovation policy should instead fo- that develop a valuable new idea, delivering higher rates cus squarely on achieving maximum absorption from the of innovation. The equilibrium in this model has the in- innovation activities going on in the U.S. teresting property that it creates an innovation leader, i.e. For more background see: Daron Acemoglu, James A. the U.S., that has high innovation and high inequality, Robinson, Thierry Verdier (2012), Can’t we all be more like and innovation followers, i.e. the Nordic countries, that Scandinavians? Asymmetric growth and institutions in an in- have lower domestic innovation but also low inequality. terdependent world, NBER Working Paper No. 18441, Boston.

STATE OF THE REGION REPORT 2013 53 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Financial Markets Sweden are skeptical, seeing no benefi ts in subor- dinating their functioning regulatory system to a Th e overall ranking on fi nancial market infrastruc- European system with much less insights into the ture for the Baltic Sea Region identifi es this as an local context. Part of the context for this discussion area of slight disadvantage. Key weaknesses are is the large size of the Swedish banking industry concerns about the soundness of banks in parts of relative to the size of its economy. Another country the Region, and some weaknesses in the regulato- that has recently attracted the attention of Euro- ry environment. Relative to last year there are few pean policy makers is Latvia. A large share of its signifi cantly challenges; only in the area of venture deposits is owned by foreigners, especially Russians capital availability did the Region register a drop of and citizens of other countries in the Common- seven ranks. A key overall issue remains the discus- wealth of Independent States (CIS). In Brussels this sion about the access to capital, especially for SMEs. has created fears about a scenario like in Cyprus, Th e lenient monetary policy should provide amble even though the Latvian authorities point out that capital, and support economic activity in the Region. their banks are much better capitalized and their But the deleveraging following the fi nancial crisis banking supervision more transparent and robust. and the changes in banking regulation are working in the opposite direction. Much of the capital made available by Central Banks has been used to repair Administrative efﬁ ciency banks’ balance sheets. And the low interest rates have benefi ted home owners and large companies Th e effi ciency of the public administration and with access to bond markets, but have done little for the bureaucratic burden imposed through rules SMEs in need of new bank fi nancing. and regulation remains overall a slight disadvan- Stockholm remains the Region’s fi nancial capi- tage for the Baltic Sea Region. Business executives tal. Copenhagen, Oslo, and Helsinki follow at a complain especially about the administrative bur- distance, with a largely national role. A key issue den associated with government regulation and remains the nature of regulation of the fi nancial the time required to start a new business. Th e pro- market industry. At the European level there are cedures for taking taxes, however, were assessed discussions about a banking union that will give a much more positively. Changes relative to last year central regulator signifi cant powers. Countries like were minimal.

Financial Market Infrastructure Baltic Sea Region Countries

Indicator EE LV LT DK FI IS NO SE GE PO RU

Financial market 39 64 80 29 4 65 8624 49 113 infrastructure

Venture capital availability 36 56 76 94 11 60 6 4 32 90 79 Regulation of securities 43 70 49 23 2 54 10 16 26 30 112 exchanges Domestic credit to private 4041582 32293814285668 sector Ease of access to loans 63 94 101 62 5 69 12 6 38 90 75 Financial market 36 62 71 25 11 96 12 19 17 50 101 sophistication Financing through local 61 105 73 59 87591222 57 100 equity market Protection of minority 64 86 89 39 1505 920 79 131 shareholders’ interests Getting Credit Legal rights 411 8711274163274111112 index (WB ) Soundness of banks 35 99 94 90 61288 237358127

54 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Doing Business in the Baltic Sea Region

Dealing with Trading Starting a Getting Registering Getting Protecting Paying Enforcing Resolving Overall Construction Across Business Electricity Property Credit Investors Taxes Contracts Insolvency Permits Borders

Denmark 5 338 146 2332134 3410

Norway 6 43 23 14 7 70 25 19 21 4 3

Finland 11 49 34 21 24 40 70 23 6 9 5

Sweden 13 54 25 9 35 40 32 38 8 27 22

Iceland 14 45 40 1 9 40 49 41 82 3 11

Germany 20 106 14 2 81 23 100 72 13 5 19

Estonia 21 47 35 52 14 40 70 50 7 31 72

Latvia 25 59 113 83 314 7052162433

Lithuania 27 107 48 75 5 53 70 60 24 14 40

Poland 55 124 161 137 62 4 49 114 50 56 37

Russia 112 101 178 184 46 104 117 64 162 11 53

Source: World Bank (2013) State of the Region-Report 2013

Diff erences on administrative infrastructure Doing Business data, not yet updated in 2013, remain large across the Region. Finland and Esto- broadly confi rms the assessments based on the WE nia top the ranking, followed by Sweden, Iceland, survey. For Denmark, however, it shows the sig- and Norway. As in other dimensions, Denmark has nifi cantly more positive position prior to the recent also here lost signifi cant position and now comes change in opinion. behind this leading group; whether this remains the case over time remains to be seen. Germany and Latvia follow at around the Regional average; Competition for Germany this represents a signifi cant improvement. Poland and then Russia remain far behind. Most markets in the Baltic Sea Region are open After a signifi cant deterioration in the Polish score but also relatively small. Formal trade barriers in and clear improvements in the Russian score the the Baltic Sea Region are low. Th e EU’s internal two countries are now only six ranks apart. market covers most of the Baltic Sea Region, in- Th e effi ciency of the public administration and cluding most of the trade with the EFTA members the bureaucratic burden imposed through rules Iceland and Norway. Th e WEF data shows that ri- and regulation remains overall a slight disadvan- valry remains somewhat lower than openness; most tage for the Baltic Sea Region. Business executives likely a result of the modest country size that limits complain especially about the administrative bur- the incentives for foreign companies to enter the den associated with government regulation and Region. Overall the intensity of local competition the time required to start a new business. Th e pro- has been perceived as increasing in 2012, driven by cedures for taking taxes, however, were assessed the Baltics, Germany, and Denmark and Finland, much more positively. Changes relative to last year countries where stagnant demand might have driv- were minimal. en companies to compete more vigorously. Nor- Th e World Bank’s Doing Business index pro- way and Germany were the two countries with the vides additional perspective on the quality of ad- strongest improvement in the context for strategy ministrative infrastructure across the Region. Th e and rivalry overall.

STATE OF THE REGION REPORT 2013 55 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Competition: Rivalry and Openness Baltic Sea Region Countries

Indicator EE LV LT DK FI IS NO SE GE PO RU

COMPOSITE RANK 22 44 49 23 11 62 15 12 14 42 126

Rivalry Low market disruption from 62 49 75 32 6 21 22 10 5 37 130 state-owned enterprises Effectiveness of antitrust 34 79 102 11 4 43 10 7 13 74 115 policy (Low) Extent of market dominance (by business 57 52 87 82289 11 20 1 17 93 groups) Intensity of local 22 52 41 25 54 84 31 27 6 28 117 competition Openness

(Low) Tariff rate 777776577772 Prevalence of foreign 11 47 86 43 16 134 36 38 34 69 129 ownership Prevalence of trade 14 27 23 30 6 74 59 21 33 81 113 barriers Quality of FDI rules 19 84 111 79 32 135 67 41 56 102 126

Economic Freedom in the Baltic Sea Region Rank 2013 (Change Dimension in rank since 2012) Property rights 25 (0)

Trade freedom 21 (+6)

Financial freedom 31 (0)

Freedom from corruption 29 (+3)

Business freedom 25 (+4)

Investment freedom 34 (+1)

OVERALL 38 (+5)

Monetary freedom 55 (+8)

Labour freedom 116 (-7)

Fiscal freedom 139 (+2)

Government spending 152 (0)

Source: Heritage Foundation (2013), author’s analysis. State of the Region-Report 2013

56 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Th e Heritage Foundation’s Economic Freedom Th e combination of solid company profi ts and a index gives a broad but also clearly ideologically- period of very limited wage growth have, however, driven perspective on the ability of the private sec- increased the focus on achieving more meaningful tor to compete freely on the markets of the Baltic wage hikes. In Germany, there has also been a clear Sea Region. Th e Baltic Sea Region rank on their shift towards the introduction of minimum wages index continues to be somewhat below its position in a number of sectors, a policy that was highly on other dimensions of competitiveness, largely criticized in the past. driven by the larger role of the government in the Governments in the Nordics and – following Nordic economies. But in 2012 there was a slight the labor market reforms in the early 2000s – also improvement in most categories of economic free- in Germany have made more use of so-called ac- dom measured. tive labor market policies, a set of instruments advocated by the OECD. Th is has led to highly diff erent patterns of labor market reaction to the Labor Markets crisis. In Germany many companies held on to their staff , making us of public programs that al- Labor markets in the Baltic Sea Region have highly lowed them to use working hours with some of heterogeneous structures that are not well captured the costs covered by the social security system. In by some of the international assessments that rank the Nordics companies had to face more of the them as highly infl exible. Especially in the Nor- costs, and reacted more strongly by reducing staff dic countries and in Germany labor unions remain numbers. Th ere are also signifi cant diff erences much more powerful than in many other OECD across countries in the Region in terms of the countries. However, the relations between these regulations applying to labor market entrants ver- labor unions and the employers tend to be much sus those applying to workers within unemploy- better than elsewhere. Labor unions have fully ment employment contracts. Th ese diff erences are acknowledged the realities of small open econo- widely seen as a key driver of the huge diff erences mies, where the negotiations about wages always in youth unemployment across the Region dis- happen within the context of global competition. cussed in earlier sections of this Report.

Labor Markets: Regulation and Incentives Baltic Sea Region Countries

Indicator EE LV LT DK FI IS NO SE GE PO RU

Regulation Cooperation in labor- 30 72 62 314115915 84 115 employer relations Pay and productivity 11 28 21 44 57 67 78 75 41 35 56

Incentives (Low) Distortive effect of taxes and subsidies on 28 43 95 66 15 61 48 24 71 56 123 competition (Low) Impact of taxation on incentives to work and 21 114 124 126 85 106 60 103 61 81 113 invest Note: Numbers in red and green indicate a change of ten ranks or more down resp. up since 2011. State of the Region-Report 2013 Source: Unpublished data from the Global Competitiveness Report (2013), author’s analysis.

STATE OF THE REGION REPORT 2013 57 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Sophistication of Demand Baltic Sea Region Countries

Indicator EE LV LT DK FI IS NO SE GE PO RU

Demand sophistication 28 67 50 32 225108 979106

Stringency of environmental 23 52 32 7 2 19 10 8 1 35 102 regulations

Presence of demanding 32 101 64 59 3 14 21 13 33 96 118 regulatory standards

Buyer sophistication 106 98 97 53 34411 10 7 87 59

Government success in ICT 11 52 35 31 6 20 10 14 21 105 108 promotion

Laws relating to ICT 4574318 2 3111121987102

Government procurement of advanced technology 51 99 102 78 16 39 19 10 15 96 117 products

Demand Sophistication mark criteria for size and specialization the Region is somewhat underrepresented among the list of Demand conditions, in particular the sophistication leading European clusters. At least partly this is of demand, are a critical driver of innovation. Th e likely to be driven by the Region’s fragmentation Baltic Sea Region continues to rank high on buyer into a number of relatively smaller economies. Ger- sophistication and the stringency of environmental many, the largest economy with parts in the Baltic and consumer regulation. While environmental Sea Region, ranks highest globally on the overall regulations continue to be seen as tough, in many measure of related and supporting industries, while countries in the Region the quality of other regula- especially the Nordics rank far below their ranks in tions has been perceived to fall. In Poland, Estonia, other dimensions of competitiveness. Latvia, and Demark this led to a drop of around 40 In terms of the indicators tracked on clusters, ranks; in Germany it was about 20 ranks. the evidence is mixed. Th e state of cluster development is been seen to have deteriorated in a number of countries. But on a number of the dimensions that Cluster presence are usually associated with dynamic clusters, the picture is seen as broadly stable or even improving. Research over the last decade has provided robust Th e Baltic Sea Region has over the last few statistical evidence that the presence of clusters, i.e. years become home to a wide-range of cluster ef- regional agglomerations of companies and other forts receiving government support of some kind. institutions in industries connected through diff er- Th is adaption of cluster-based policies has often ent types of linkages and spill-overs, are associated been driven by individual agencies or subnational with higher levels of overall regional economic per- regions that saw potential in this policy instru- formance. ment, even when there remained signifi cant skepti- Last year’s Report the presence of regional cism in other parts of the government system, es- clusters across the Baltic Sea Region in comparison pecially in Ministries of Finance. Many of these to the Region’s overall position in Europe. With programs have grown out of existing policies for in- roughly 50 regional clusters that meet some bench- novation, regional development, or SME support.

58 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Related and Supporting Industries Baltic Sea Region Countries

Indicator EE LV LT DK FI IS NO SE GE PO RU

Related and supporting 40 79 55 20 13 33 14 15 160115 industries Local availability of specialized research and 43 78 45 23 8 29 12 9 2 32 80 training services Availability of latest 37 51 35 27 167211 95 128 technologies Local supplier quality 36 54 42 16 6 32 11 12 2 46 118 State of cluster 82 104 112 33 15 41 12 18 3 92 119 development Extent of collaboration in 30 83 46 18 3 22 11 12 4 76 103 clusters Local supplier quantity 61 113 52 32 85 111 46 48 225115

COUNTRY PROGRAM Denmark Innovation Networks Denmark

Estonia Cluster DevelopmentProgram

Finland OSKE – Centres of Expertise Program

SHOK – Strategic Centres for Science, Technology and Innovation

Germany Competence Networks Germany

Zentrales Innovationsprogramm Mittelstand – Netzwerkprojekte (ZIM NEMO) Spitzencluster Program

Iceland Regional Growth Agreements (Vaxtarsamningur)

Strategic Research Program for Centres of Excellence and Research Clusters Latvia Cluster Program

Lithuania InnoClusterLT

Norway Norwegian Centres of Expertise (NCE)

ARENA

Poland Polish Cluster Support

Sweden Vinnvaext

Where these funds are important, EU structural coming to an end, and the authorities have not yet funds have often played a signifi cant role in fi nanc- announced what will follow. ing these eff orts. At the Baltic Sea Region level, both private- Denmark has just announced a new clus- sector driven eff orts like Scanbalt and public-sector ter policy, integrated into its overall innovation driven eff orts like StarDurst have a strong cluster strategy published in 2012. Norway is planning focus; both are profi led in Part B of this Report. to launch the launch of a new cluster program, A new Baltic Sea Cluster Development Center with the details currently being discussed. A major (BSCDC) has in late April been launched on the Finnish program with signifi cant cluster-aspects is Danish island of Bornholm.

STATE OF THE REGION REPORT 2013 59 SECTION A Economic performance and competitiveness in the Baltic Sea Region

The Baltic Sea Cluster Development Center

Opening conference of the Baltic Sea policies. Also, effective cluster development and Cluster Development Centre cluster management requires hard and soft cross- On 25 April the Baltic Sea Cluster Development Centre disciplinary skills. The complexity is skills require- (BSCDC) offi cially opened its doors as a knowledge and ment; absence of formal cluster education; and business hub for cluster development leaders and other need for learning-by-doing provides a string argu- cluster practitioners in the Baltic Sea Region. The opening ment for pooling – and communicating – cluster of BSCDC took place in connection to a cluster develop- development skills and good transferable practices ment seminar on 24-25 April on the island of Bornholm. from across the Baltic Sea. Cluster development leaders from the following regions have contributed to the establishment of the 2. Through cluster-to-cluster cooperation fertilize inter- BSCDC: The regions of Pomerskie and Warmia-Mazury nationalisation of in particular SME’s and start-up in Poland; Kaliningrad region and St. Petersburg in Rus- tourism cluster companies. The rationale is that be- sia; the region of Southwest Finland and Turku; the Pärnu cause of clusters geographic concentration, cluster county in Estonia; the Jurmala district in Latvia; the re- stakeholders – including regional and local authori- gion of Klaipeda in Lithuania; the Oresound Region and ties and institutions – are close to the companies Malmoe, Sweden, and the Greater Copenhagen Region operating in “their” cluster. As a result, cluster de- and Bornholm, Denmark – and many more, refl ecting the velopment organisations are well positioned to ad- nature of BSCDC: The BSCDC is an open platform and a dress specifi c internationalisation challenges and platform that fl exible enough to respond to differences in opportunities of “their” cluster companies, in fact demand for knowledge building and learning on good often more so that national trade promotion organi- cluster management practices – and to, through cluster- sations. In practice the BSCDC will utilize the link- to-cluster linkages, inspire and accelerate business-to- ages and bridges appearing through cooperation on business cooperation and trade in the Baltic Sea Region. cluster management as gateways for business-to- BSCDC will organize conferences, conduct research, business cooperation in the Baltic Sea Region. and focus in particular on matchmaking and mentoring to: 3. Facilitate networking and cooperation also across 1. Address the challenge that while the cluster devel- different kind of clusters (branches/sectors) in the opment approach may conceptually be rather easy Baltic Sea Region. The rationale for this cross- to comprehend “How to actually and practically go cluster-fertilization effort is that there is increasingly about it” is often far more challenging. The reason strong evidence that cross-cluster cooperation play for this is that clusters and cluster initiatives does a particularly important role for technology develop- not fi t in neatly into any one particular policy but ment, innovation and creativity. However, there is a rather should be expressed through a number of shortfall in knowledge and systematic approaches

60 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

for how effectively to facilitate such cross cluster As of 1 May 2013 Lars Albæk will head the BSCDC Secre- cross sector cooperation. The BSCDC will through tariat on Bornholm with support from Cluster Coordinator, its network build knowledge in this area and inspire Hanne Nisbeth and International Cluster Advisor, Thomas its partners to replicate/adapt successful practices. Winther.

Company Sophistication Germany, Finland, and Sweden make up three of the top fi ve countries globally on the quality Prosperity is ultimately created in companies. of company operations and strategy. Th e Baltic While the business environment conditions dis- Sea Region has in 2012 overall strengthened its cussed above defi ne the context in which compa- position on this set of indicators. But the develop- nies operate, this is where the value creation hap- ments are mixed, with Norway, Lithuania, and pens. And while this process occurs on its own in Germany gaining position while Denmark and the market, it does not always happen quickly or Estonia saw some slippage. Th e key strengths without detours. Creating competitive companies are in operational practices, and this is also the takes time, often more time than reforming the area where on average the clearest gains were reg- business environment once the right type of politi- istered. Internationalization remains a key chal- cal choices have been made. lenge for companies from the Baltics, Poland, and Company sophistication has especially in Russia, while it is a key strength of especially Ger- the Nordics and Germany for some time been a man and Finnish companies. key pillar of the countries’ competitive strengths;

Company operations and strategy

Indicator EE LV LT DK FI IS NO SE GE PO RU Company operations and 40 68 39 11 3 25 13 5 2 66 110 strategy Strategy and operational 44 69 39 13 4 25 18 5 3 64 115 effectiveness Firm-level technology absorption 36 81 48 19 5 1 9 2 17 108 137

Company spending on R&D 45 79 70 12 5 31 19 6 3 90 74 Nature of competitive advantage 75 69 45 7 4 46 23 11 3 93 117

Value chain breadth 75 80 38 17 8 36 39 5 1 52 119

Capacity for innovation 31 64 41 14 3 19 12 5 4 59 66 Production process sophistication 48 68 44 17 4 20 11 8 2 45 104

Extent of marketing 56 71 37 25 16 22 10 9 4 41 98 Degree of customer orientation 37 47 32 7 31 23 29 6 12 42 125 Organizational practices 35 54 43 3 1 24 8 6 12 63 94

Extent of staff training 46 52 68 16 2 20 9 10 5 71 82 Willingness to delegate authority 34 71 57 1 5 9 3 2 13 75 99 Extent of incentive compensation 38 69 24 18 10 74 58 30 8 55 75 Reliance on professional management 31 45 50 9 1 21 4 11 17 80 104 Internationalization of firms 68 90 48 21 8 14 16 15 4 77 122

Prevalence of foreign technology licensing 60 96 56 29 2 31 7 17 11 88 122 Control of international distribution 81 88 34 19 18 8 31 21 3 78 115 Source: Unpublished data from the Global Competitiveness Report (2012), author’s analysis.

STATE OF THE REGION REPORT 2013 61 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Business Culture and Values in the Baltic States

By Maija Kale, Director of the Centre for Sustainable neurs have co-operated with local authorities on mat- Business, Stockholm School of Economics in Riga ters of business development, donated money to char- ity, sponsored the arts, cultural, or sporting activities, Recent research by the Centre for Sustainable Business and collaborated with scientifi c and research instittions, at SSE Riga, covering entrepreneurs in all three Batic considerably less often than entrepreneurs in the Batic sStates, captures ‘portraits’ of businesspeople in the sStates in geutions. Lithuanian entrepreneurs have pro- Batic sStates and tries to capture their understanding of vided health insurance coverage to employees, invested ‘sustainability’ in the region. ‘Sustainability’, as a buz- fi nancial resources in employee professional develop- zword, has experienced a broad re-awakening after the ment, and co-operated with local authorities on matters economic and fi nancial crisis in 2008. Nevertheless, of business develpment, more frequently than others in its all-inclusive framewokpushes the quetion,: ‘What is the Batic sSopment. Entrepreneurs from Estonia have co- meant by sustainability in a region in which tax avoid- operated with national authorities on matters of business ance, corruption, and a shadow economy are “socially develpment, more frequently in comparison to other Baltic acceptable norms”?’ couopment. Research indicates that reputation, to a large ex- While ‘tracing sustainability’ reveals a rather similar tent, could be the driving force behind the sustainability level of moderate or weak engagement in the topic across paradigm in the Baltic region, since a majority of the re- the Batic sStates, it is not possible to state that entre- spondents (58%) held the opinion that a large percent- preneurs from the Baltic States are very similar in their age of the entrepreneurs from the Baltic States pay great general business values and practices. More similarities importance to a company’s reputation. Meanwhile, just from the evaluation results and opinions can be seen be- 1/3 of respondents held the opinion that a majority of tween the entrepreneurs from Lithuania and Latvia, while entrepreneurs in their countries observe the principles of entrepreneurs in Estonia often have very different values sustainable development, but 20% are confi dent that the and practices in comparison with other Baltic countries. principles of sustainable development are observed by Overall, it was clear that various negative business prac- only a few entrepreneurs. Results in each separate Baltic tices are rarely admitted to by entrepreneurs working in country do not differ widely. They do, however, differ ac- Estonia, but more freqently– in Latvia and Lithuania. En- cording to secor: tThe most vulnerable, in terms of sus- trepreneurs in Latvia, more frequently than representa- tainable business practices, is the construction industry. tives of other countries, stated that a majority of entre- While ‘sustainable business practices’ could mean preneurs pay ‘salaries in envelopes’ and that their daily anything from environmental consciousness, to improve- activities do not match what has been announced to the ment of industry standards, to testing the extent to which public. Lithuanian entrepreneurs, more frequently than entrepreneurs in the Baltic States are investing in em- entrepreneurs in other countries, admitted that in their ployee training, the results show that a total of 37% of country a majority of entrepreneurs give bribes and gifts. the entrepreneurs in the Baltic States stated that, in the From all the negative business practises surveyed in the previous year, they had invested fi nancial resources in questionnaire, Estonian entrepreneurs mentioned giving employee training activities regarding sustainable devel- bribes/gifts, paying ‘salaries in envelopes’ and cheating opment. The percentage of enterprises that have made on taxes considerabl less, in comparison to Latvian and such investments is similar in all three Baltic countries. Lithuanian entrepreneurs. The fact that fi nancial resources have been invested in The research poses the question of how to tackle employee training activities for sustainable development sustainability-related issues in complex business en- was more often stated by representatives of the service vironments in which shadow economies and bribery and industrial sectors, as well as by representatives of prevail. It is clear that a ‘sustainable business practice’ big companies, but less frequently by those working in could fi rst be viewed as a rules-based business in a well- the trade sector and in small companies. functioning business environment. When analysing other forms of ‘sustainable business See the full report at http://www.sseriga.edu/en/cen- behaviour’, the research illustrated that Latvian entrepre- tres/centre-for-sustainable-business/research-series/

62 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Assessment Finland and Norway are the other countries in the Region that have seen improvements in com- Th e competitiveness of the Baltic Sea Region re- petitiveness rankings, but for them in a positive mains solid and largely unchanged compared to direction. For Finland this is a remarkable achieve- previous years. Th e economic outcomes, in par- ment given Nokia’s painful restructuring process ticular the level of prosperity reached, are well sup- that leads to many job losses and has clear implica- ported by current competitiveness fundamentals. tions for R&D and exports. Th e current crisis is Company sophistication, communication infra- a real test as to whether Finland has over the last structure, innovation infrastructure, and human few years been able to create an attractive business development stick out as advantages, while the environment beyond Nokia. Th e 2012 data gives degree of actual market rivalry, the level of admin- reason for some guarded optimism. Norway has istrative effi ciency, and some other dimensions of continued its rise in the competitiveness rankings. factor input conditions remain relative disadvan- While the country clearly benefi ts from its oil and tages. gas reserves, there are not many examples of loca- Th e Region continues to be characterized by tions that have managed to create a competitive signifi cant diff erences in business environment business environment when having access to large conditions, driving the equally high diff erences revenues from natural resource wealth. Norwegian in economic performance discussed earlier in this executives might be too generous in their views, Report. Th e survey-driven competitiveness data driven by the benevolent economic climate in the captures short-term changes in perceptions as well country. But even if the improvements in competi- as long-term changes in underlying business envi- tiveness are not as high as suggested by the survey ronment quality. For Denmark, it seems likely that responses, they are still a signifi cant achievement. the signifi cant drop in 2012 was driven by short In the other countries in the Region, the chang- term changes in the sentiments of business execu- es have been more modest. Sweden has lost some tives. Th e worsening of scores was visible across momentum; the weakening economic situation as many individual indicators, which suggests that well as discussions about the country’s future eco- survey respondents took a generally more skeptical nomic course might be taking their toll. Iceland view towards Denmark as a place to do business. is on its slow but sustained path to recovery, with Whether the 2012 data signals a more fundamen- improvements especially visible in the fi nancial tal re-evaluation of Denmark’s competitiveness markets. But the views towards the political system remains to be seen. A normalization of scores in remain negative, with no change in trend visible. 2013 seems at least likely, but the negative view of Th e Baltic countries have stabilized their po- business leaders can have a real negative impact sition; they have made up some of the losses sus- on business activity and, ultimately, activities that tained during the crisis but clearly not all. Poland strengthen competitiveness. is seeing its position under pressure. While there Germany and Russia have registered the strong- are improvements in some areas, like parts of the est positive change in their competitiveness rank in physical infrastructure, the overall assessment has 2012. For Germany, positive sentiments due to the gotten slightly more negative. It is becoming clear better economic performance than in many other that Poland’s more robust performance during the EURO-zone countries might have played a role; crisis was not the result of high competitiveness, the country’s ranks increased in all categories based but of other factors (large local market, large catch- on survey data, while they deteriorated slightly for up potential, proximity to Germany) that are not the macroeconomic policy indicators driven by sta- suffi cient to draw future growth. tistical data. For Russia, a normalization after the deterioration during the crisis might play a role in explaining the recent improvements. But there is also a sense from the data that while there is criti- cism of the functioning of the political system there are perceived improvements in the functioning of the administration.

STATE OF THE REGION REPORT 2013 63 SECTION A Economic performance and competitiveness in the Baltic Sea Region

3. Summary

During 2012 the European crisis has started to ful- tive to previous years. Where there are changes, ly arrive in the Baltic Sea Region. Th e outlook for they are largely driven by short-term changes in 2013 is now fragile, and most governments are pre- economic conditions and sentiment. In Denmark, paring themselves for a prolonged period of slower for example, the perceptions of business leaders growth. Th e key driver of these developments is the have become more skeptical across the board once European sovereign debt crisis, and the impact it the new government took offi ce and some of its has on demand as well as fi nancial market condi- measures created public opposition. In Finland, tions. Another factor was the slowing down of the the assessment has been much more positive de- one-off growth eff ects as the Region was recover- spite the challenges facing Nokia and a number of ing from the 2009 global crisis. Th e initial eff ect in tax increases implemented in early 2013. Sweden 2012 was largely on investments; company became has marginally lost position, whether due to the signifi cantly more reluctant to expand capacity. For combination of short- and long-term economic 2013, however, consumption will also be aff ected, challenges or some fatigue with the center-right especially if the labor market eff ects of the slow- government coalition preparing for its second re- down are becoming more visible. election campaign remains to be seen. Germany Th is time around, the external shock has been has further strengthened its position, with the sol- felt relatively symmetrically across the Region. All id economic performance clearly having a positive countries are dependent on European market con- impact. Iceland has stabilized but the scares that ditions, and country-specifi c factors have played the meltdown of the fi nancial system has left re- less of a role. With no quick recovery in sight for main clearly visible, especially in the views of the the European economy, the weak external demand political system. Th e Baltics and Poland remain is likely to weigh on Baltic Sea Region growth pros- in a relatively solid position that is in line with pects for some time. While the still much healthier their current level of prosperity. But to achieve a economic situation within the countries of the Re- higher growth rate they will need to additional gion relative to the rest of Europe will help, it is answers for upgrading their competitiveness. Rus- unlikely to be able to drive much more than a sta- sia is entering a diffi cult phase: the growth drivers bilization of growth rates at a modest level. of recent years – rising oil prices, ample spare ca- Apart from these cyclical factors, the Report pacity, and stable macroeconomic policy – are ei- also highlights how the dynamics of globalization ther gone or no longer suffi cient to secure growth. are continuing to shape the Baltic Sea Region. New growth dynamics have to come from com- Two diff erent modes of internationalization seem petitiveness upgrading, and while there are some to be emerging. Germany, Poland, and the Bal- small improvements visible, the concerns about tics are strongly export-driven, engaging in global the ability of the political system to deliver change value chains at diff erent stages (Part C of this seem to be growing. Report discuss the latest trends in this direction What does all this imply for collaboration on some more). Th e Nordics are more FDI-driven, competitiveness upgrading across the Baltic Sea attracting knowledge-seeking investment but Region? Last year’s Report suggested that attention otherwise engaging in international value chains should focus on three categories of activities: through activities located abroad but owned from • Activities with signifi cant cross-border externali- the Nordics. Both models are emerging to the ties; this includes areas like market integration, specifi c conditions in the diff erent parts of the large scale investments in transportation and Region - part given by nature, part by govern- science infrastructure, and networks of clus- ment policy. While both can support high levels ters. Successful action requires the coordina- of prosperity, they create diff erent types of chal- tion of activities at the level of the Region. lenges for economic policy. • Knowledge exchange and common learning; this Th e underlying competitiveness of the Region includes areas like education policy, labor mar- remains strong, with no dramatic changes rela- ket policy, administrative reforms, anti-cor-

64 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

ruption measures, and innovation policy. Here All three areas remain highly relevant now. Cross- successful action needs to be drive by country- border externalities remain high and while some specifi c circumstances. But the cultural prox- eff orts are underway for coordinated action, more imity of neighboring countries makes the expe- could be done. Th is will require the coordination rience across the Region an important source of of national policies, not just a focus on common knowledge and ideas. positions towards regional eff orts supported by the • Shared knowledge infrastructure; the countries EU. Common learning does take place but here, in the Baltic Sea Region are all exposed to the too, there is room for more. Many of the existing same changes in the global economy. And they linkages are bilateral or connected to the EU. Th e all face the need to devise fact-driven economic Nordic Globalization initiative provided a good ex- strategies that focus their policy actions on de- ample for how a common knowledge infrastructure veloping distinct competitive advantages for to track and discuss competitiveness issues in the their country. A common competitiveness ob- Region could look like. servatory and an exchange on how to organize policy design and implementation in this context could be an important area for collaboration across the Region.

STATE OF THE REGION REPORT 2013 65 SECTION A Economic performance and competitiveness in the Baltic Sea Region

Think small - insights from the small advanced economy experience

By David Skilling For one thing, small advanced economies have performed well over the past few decades on a range of Many of the Baltic Sea Region (BSR) economies have outcome measures. Growth rates have been relatively done well over a sustained period of time. And relative strong, with the small advanced economy group holding to many other European countries, the BSR economies their share of global GDP constant over the past few dec- are recovering more effectively from the crisis. Economic ades while most of the larger advanced economies have growth rates look better, fi scal balances are moving in lost share. And many small advanced economies have the right direction, and the economies seem to be well- responded effectively to the crisis. regarded by fi nancial markets and other third parties. The The specifi c ways in which these small economies Baltics are held up by many as a role model in fi scal have generated this strong performance vary. Across the consolidation, and the Nordic model rated a recent cover small economy group, we observe a variety of policy ap- story in the Economist. proaches (on tax, regulation, industry policy, and so on). However, as previous State of the Region reports (as But there are some important underlying commonalities. well as third party commentary from the OECD and oth- Small advanced economies share an acute exposure to ers) remind us, there are a range of medium-term, struc- the global economy, with much larger internationally- tural challenges that need to be addressed by economies exposed shares of their national economy. They have in the region. Sluggish productivity growth, an aging been major benefi ciaries of globalisation, but need to be population and associated long-term fi scal pressures, thoughtful in terms of how to manage the risks and expo- and declining international market share in key sectors sures that global exposure generates. are just a few of the issues that have been identifi ed. Indeed, successful small economies tend to oper- And so the relatively strong performance of the re- ate in a more deliberate, purposeful manner in terms of gion should not lead to complacency. Governments in aligning policies to position themselves appropriately in the region should be focused on absolute performance, the global economy. The way in which small advanced and ensuring that their economies are delivering the best economies around the world are interpreting the interna- economic and social outcomes possible. In terms of tional environment and are responding to it is a potential how best to do this, much can be learned from the policy source of insight for BSR economies. debates and experiences from other economies in the Many small advanced economies see the emergence region given the many similarities of these economies. of a more challenging international environment, which But one of the salient characteristics of many econo- complicates the task of responding to the various chal- mies in the BSR region is that they are small. This mat- lenges that they face. Competitive intensity is increasing; ters. Small economies are not simply scaled-down ver- the international economic and political environment is sions of large economies, and policy settings that are becoming more turbulent, which is a particular issue for appropriate in large countries may not be appropriate for small, open economies; and the global environment is small countries. And so in addition to learning from oth- becoming more complex for small countries with a weak- ers in the region, the experience of other small advanced ening of multilateral institutions and the growth of big economies can provide useful policy guidance in terms power politics (what President Barroso calls ‘a world of of how to respond to the emerging challenges and op- giants’). portunities. In order to sustain their success, small economies I defi ne small advanced economies as the IMF ad- need to pursue an even more serious, deliberate ap- vanced economies with populations of less than 10 mil- proach to their positioning in the global economy. In- lion. Of the 34 IMF advanced economies, 18 are small on deed, many small economies are thinking through how this defi nition, including countries such as New Zealand, best to respond to these emerging realities. The current Singapore, Israel, and Hong Kong, as well as many Euro- international small economy debate and experience sug- pean economies. Despite the differences between these gests three areas that are likely to be relevant to econo- countries, they share much in common. mies in the BSR.

66 STATE OF THE REGION REPORT 2013 SECTION A Economic performance and competitiveness in the Baltic Sea Region

• Competitive strategy. Successful small countries small economies are increasingly thoughtful about have tended to make investment in human capital their international market profi le, both deliberately and innovation a core part of their economic strat- rotating their export market presence towards high egy. This needs to continue and intensify, given growth markets as well as managing the risks of the increased competitive intensity in the global high exposures to particular markets. economy (including from emerging markets). Small economies need to form a clear view as to Many of these small economy policy debates seem to me the source of the next generation of growth – on to be relevant in the BSR, with many similar issues on the what basis can they compete – and to invest behind table in the region. For this reason, a more systematic it. Structured conversations are underway in many approach to capturing these small country insights, and small economies to develop such a perspective, in- developing a deeper understanding of peers outside the formed by a view of changing global dynamics and immediate region, would add signifi cant value. current strengths. Given that small economies are This could involve a deliberate program of policy and likely to only have a handful of activities in which outcome benchmarking BSR economies against other they are world-class, getting this judgment correct small advanced economies, as well as structured quali- is of signifi cant importance. tative analysis to understand the policy approach and • Risk management. Small economies need to be experience of these small economies. Developing rela- very thoughtful about managing global risk expo- tionships with policy-makers and thinkers in other small sures because of their higher degree of openness countries is likely to be valuable. Indeed, increasingly, as well as by their relative lack of diversifi cation. small economies are fi nding it useful to talk to each other The recent experience of the crisis, and the expec- about the many issues that they have in common. tation of greater turbulence in the future, has in- Dr David Skilling is Director at Landfall Strategy creased the strategic importance that many small Group, a Singapore-based advisory fi rm that focuses on countries place on economic risk management. small advanced economies [www.landfallstrategy.com, Small economies are thinking hard about issues twitter @dskilling]. This piece draws on themes from such as fi scal consolidation to strengthen their bal- David’s talk at the 2012 BDF conference in Copenhagen. ance sheets, managing their current account to reduce their international exposure, debating how to manage exchange rate risk, as well as considering broader exposures (such as the risk profi le of their economic structure). There is a view across many small economies that the best competitive strategy can be undone if there is not a structured approach to risk and resilience. • International market strategy. The returns from export markets, and from outward investment activities, are a major driver of overall economic performance for small economies. This is an area of increasing policy attention. In the context of a lack of progress at the WTO, small economies have been in the vanguard of signing FTAs to ensure ongoing market access to important, high growth markets. This is a particular issue for economies outside the EU. More broadly, small economies are trying to balance the need for greater regional integration (to bulk up and to manage risks) with a desire to maintain the policy autonomy that supports agility. And

STATE OF THE REGION REPORT 2013 67 Section B: Collaboration in the Baltic Sea Region

68 STATE OF THE REGION REPORT 2013 This section of the State of the Region Report describes the patterns of regional collaboration across the Baltic Sea Region. Following the tradition of past Reports, it proﬁ les the activities and current plans of key regional organizations and networks. It then comments on the further evolution of the EU Baltic Sea Region Strategy Process, including information on the progress made in some of the ﬂ a g s h i p p r o j e c t s .

Europe is in a diffi cult of process of fi nding a new EU mainstream. All of this makes it hard for the balance on how to collaborate. For many, a sustain- Baltic Sea Region to take a common position in the able solution to the current crisis requires a new debates about Europe’s future architecture, despite look at Europe’s institutional architecture, espe- the principal consensus on the type of policies that cially in the areas of macroeconomic policy what should be pursued.. role should the European institutions play versus Within the Baltic Sea Region, collaboration the national level? And how can individual coun- does in the meantime continue with remarkable tries get an appropriate refl ection of their positions ease. Th e focus is on activities to upgrade the mi- in the policies of EU institutions? Th ese questions croeconomic foundations of competitiveness and have been on the European agenda since the inte- addressing common environmental challenges, all gration process started fi ve decades ago. But they areas where collaboration provides direct benefi ts have received more intense recognition during the to all participants. Th e coordination among dif- current crisis which is perceived to have tilted pow- ferent activities is further increasing, with the EU er from nations to EU institutions, in particular the Baltic Sea Region Strategy as a natural organizing ECB and the European Council, and within the factor. A key challenge is now to ensure that the fu- latter towards the representatives of the strongest ture EU budget for the upcoming program period economies, in particular Germany. Th e European does open programs like the EU structural funds integration project is under pressure but it is also for joint activities in the Region. fi rmly on its rails, despite the crisis. Th is part of the 2013 Report gives an update Th e Baltic Sea Region is no integrated entity on the state of collaboration on competitiveness in the context of the current dynamics within the upgrading across the Baltic Sea Region. Th e fi rst European Union. Not all countries are members section provides an overview of activities that have of the EU, and not all of the EU members are part been pursued by regional organizations over the of the Euro-Zone. Th ose that are tend to support last few months. Th e second section tracks the evo- the German position, together with Austria and the lution of the EU Baltic Sea Region strategy process. Netherlands, but are much less visible in the public Th e third section than profi les the activities of the debate. Th e Baltics remain fi rmly on course to the leading public sector international fi nancial institu- Euro-Zone, with Estonia already there and Latvia tions (IFIs) in the Baltic Sea Region. Th is part of soon to be joining. But the Polish public has be- the Report is heavily based on the contributions come much more skeptical, and there is no support made by the organizations, networks, and projects for Euro accession in Sweden either. Many of the described – we would like to thank them for their Nordics and Baltics also have strong sympathies for willingness to describe their activities in this con- the UK, which seems to be drifting away from the text.

STATE OF THE REGION REPORT 2013 69 SECTION B Collaboration in the Baltic Sea Region

1 Regional networks and initiatives

Th is section provides an overview on the activities on the 5th of April. A Business and Financial Com- that have been pursued by key regional organiza- munities of the Baltic Sea States Forum was held tions over the last year through individual and col- on the 6th of April. Th e Russian Presidency culmi- laborative initiatives. It is based on material pro- nates with the 18th Ministerial Session, June 5-6, vided by the organizations. Kaliningrad, back to back with the CBSS Mod- ernization Programme (SEBA) and a Conference entitled Creativity and Cooperation, June 7-8, Ka- 1.1 Governmental organizations liningrad, Russian Federation. One of the newest avenues for the Council Th e Council of the Baltic has been the continued development of the Pi- Sea States (CBSS; www. lot Financial Initiative (PFI) and its correspond- cbss.org) was created in ent Memorandum of Understanding which was 1992. Th e CBSS provides signed during the 9th Baltic Sea States Heads of an intergovernmental Government Summit in Stralsund, May 2012 in platform for regional co- the presence of Igor Shuvalov, First Deputy Prime operation between the eleven Minister of the Russian Federation. Th e subse- countries of the Baltic Sea Region as well as the quent signing of the agreement between the banks European Commission. It works through network - the German KfW Bankegruppe and the Russian and project based activities and aims to boost the Vneshekonombank (VEB) on long-term fi nancing competitive edge of the region. Th e fi ve priority ar- for small and medium-sized enterprises (SME) in eas for the organization are; environment and sus- the fi eld of modernization and innovation took tainability, economic development, energy, educa- place in Moscow at the Hotel Baltschug Kemp- tion and culture, and civil security and the human inski on 16th November. Th e signing was in the dimension. course of the Russian-German Interstate Summit Th e Russian Federation holds the CBSS Presi- Consultations and was designed to build on the dency for 2012-2013. One of the key characteristics Memorandum. Th e signing was in the presence of the Presidency was the principle of continuity. of German Vice Chancellor Philipp Rösler and Th e main focus was placed on modernization and reinforced the continuation between the German innovation, especially clusters of growth and the and Russian Presidencies of the CBSS on the mat- establishment of a Public-Private Partnership (PPP) ter of innovation and investment, network. In the fi rst phase KfW intends to provide Th e Russian Federation hosted several high- Vnesheconombank with long-term loans, for on- level sessions beginning with the 21st Baltic Sea lending to projects approved by the Steering Com- Parliamentary Conference, 26-28 August, St. Pe- mittee consisting of representatives of the PFI tersburg and followed by the 5th CBSS Conference Partners. It is envisaged that the Initiative will be of Ministers of Transport, December 5, Moscow. extended to other fi nancial institutions from the Saint Petersburg held the Baltic Sea Week between CBSS region who wish to join the PFI as well. A 19 - 23 March, involving a series of events which $110 million dollar money transfer agreement was was followed by Th e Conference of the Heads of signed for the purpose of fi nancing projects in the the Baltic Sea States on environmental protection Kaliningrad Region and the regions of St. Peters- (Baltic Sea Summit) which took place in St. Pe- burg (Leningrad), Novgorod, Pskov as well as in tersburg, April 5-6, 2013 Th e conference was held the City of Saint Petersburg. Th e fi nancing will fo- within the Year of the Environment in Russia and cus on sustainable development and modernization the Russian Federation Presidency of the Council in the fi eld of municipal and regional infrastruc- of Baltic Sea States (CBSS). A high-level segment ture, energy effi ciency, ecology, climate protection for Prime Ministers of CBSS Member States took and comprehensive development. Th is was the fi rst place presided over by Prime Minister Medvedev agreement rolled out in the frame of Pilot Financial

70 STATE OF THE REGION REPORT 2013 SECTION B Collaboration in the Baltic Sea Region

Initiative (PFI) under the umbrella of the Council Stralsund, Germany, on 30 – 31 May 2012. Th e of the Baltic Sea States (CBSS). Th e signing cer- planned timeframe of the facility is 5 March 2013 emony of the credit agreement for the fi rst project until 2015, with a continuous open call for appli- under the Pilot Financial Initiative (PFI) was signed cations. Th e main purpose of the CBSS Project in mid-December in the presence of the Commit- Support Facility is to co-fi nance the development tee of Senior Offi cials and Observer States repre- and implementation of Baltic Sea macro-regional sentatives. Vnesheconombank and KfW Banken- cooperation projects, to support cooperation in a gruppe entered into this Credit Agreement under fl exible way, and to pave the way for larger regional the Program of the Council of the Baltic Sea States cooperation projects in the future, funded by much (CBSS) on 12 December, 2012. Th e Credit Agree- bigger funds existing in the region which would in ment on extending local currency counter value of turn bring added value for the Baltic Sea region, 65 million US dollars by KfW to Vnesheconom- show impact in regional cooperation and foster bank is aimed to support an essential moderniza- long-term partnerships. Th e PSF in brief: tion of the urban solid waste system in the City of • Th e projects should be transnational in charac- St. Petersburg. In the framework of this public-pri- ter and aim to have a sustainable outcome vate partnership project modern waste sorting and • Th e maximum amount of co-fi nancing granted recycling facilities will be installed, thus increasing is 50 000 euros waste treatment effi ciency and overall waste treat- • Th e project proposals may be initiated by a va- ment quality. Th e investment payoff will result in riety of legal entities of CBSS Member States, a signifi cant decrease of climate and environmental as well as CBSS Expert Groups and CBSS Net- stress, which will lead to sustainably improved liv- works ing conditions for the population of St. Petersburg. PFI is a fi rst step to an open fi nancial platform, One of the major developments that have had which is intended to attract fi nancial partners and an impact on the structure and operations of the fi nancial resources for projects in the geographic CBSS is the EU Strategy for the Baltic Sea Region. area of the CBSS. Meetings between the parties Th e CBSS and its various expert groups and net- of fi nancial institutions in the region are ongo- work bodies are increasingly utilized as facilitators ing and further inclusion was stressed recently by of cooperation among EU and non-EU Member Prime Minister Medvedev in his speech in April. States for some of the strategy’s actions - notably Th e fi nancing program of Vnesheconombank is in the fi elds of sustainable development, economic implemented by means of providing the wide net development, and civil security and crime. On 22 of bank-partners in the North West of Russia with February 2013, European Commission dissemi- fi nancial resources through MSP Bank, a daugh- nated the reviewed Action Plan of the EU Strategy ter company of Vnesheconombank which focus on for the Baltic Sea Region EUSBSR. the support of the existing business projects pri- Since the revision, the CBSS Secretariat is even oritizing the modernization of manufacturing and more involved in the European Union Strategy for innovations. In line with these eff orts CBSS also the Baltic Sea Region with formal roles as Priority organized an international conference Fostering Area Coordinator for PA Secure jointly with Swe- Small and Medium Enterprises (SMEs) in the Baltic den tackling emergency preparedness from an all Sea Region: Financing, Public Private Partnership, hazard approach. PA Secure is a new priority are Innovations, which took place in Kaliningrad on dealing with land-based civil protection matters November 22. Its objective was to focus attention and was formulated on the basis of the work done of small and medium business, fi nancial institu- within fl agship project 14.3 as well as based on rec- tions and authorities on long–term fi nancing and ommendations from the EU Member State civil support to SMEs in the sphere of modernization protection authorities operating in the Baltic Sea and innovation in the Baltic Sea region. region. It is also joint Horizontal Action Leader Additionally to the PFI the CBSS has devel- with the Turku Process for HA Neighbours, where oped the CBSS Project Support Facility. Th e CBSS the fl agship project Balticlab is one of the actions Project Support Facility (PSF) which was also aimed at young emerging talents in the creative created at the 9th Baltic Sea States Summit in industries - this action is jointly undertaken with

STATE OF THE REGION REPORT 2013 71 SECTION B Collaboration in the Baltic Sea Region

the Swedish Institute. Th e CBSS Secretariat is also Task Force against Traffi cking in Human Beings responsible for HA Sustainable and Bio-economy (TF-THB) is continuing with its current fl agship with the Nordic Council of Ministers dealing ADSTRINGO which focuses on traffi cking for with the Bio-economy area. Under PA Crime the labor exploitation.

Balticlab Network – Young Entrepreneurs around the Baltic Sea

Recently, there have been many discussions about the need to support and utilise young entrepreneurs and those involved in creative industries as an important export driver and reviver of national branding and growth in the countries of the Baltic Sea Region. Balticlab is a new concept created by the CBSS and the SI to address what we recognised as a relative lack of networks bringing young talented entrepreneurs and creative industries from the region together, but also provide them with a platform for working together more concretely on a April, Nida in May and Kaliningrad in June 2013. The regional level. The aim of Balticlab Project Development participants will be provided with the tools, coaching and Programme this spring is thus to create a link between perspectives needed to manage macro-regional cross- individuals with potential to drive change and innovation border collaborations in areas related to their own inter- and the policy-making / policy-enacting community en- ests, but with a link to the themes addressed by the Euro- gaged in Baltic Sea Region territorial co-operation. pean Union Strategy for the Baltic Sea Region (EUSBSR) A group of 19 individuals from the Balticlab Network and the South Eastern Baltic Area Modernisation Partner- of 67 participants, formed during a networking weekend ship (SEBA) initiative. These may include contemporary in December 2012, have been invited to form working culture, media, fostering entrepreneurship, innovation, cy- groups to develop project prototypes that link their per- ber-crime, tourism and people-to-people contacts. Balti- sonal interests with the need to foster integration in the clab is a ﬂ agship project of the EUSBSR under Horizontal region. The programme participants, who come from Lith- Action Neighbours. See www.balticlab-online.eu for more uania, Poland, Russia and Sweden, will meet and work information. during the interlinked programme modules in Malmö in

Since the Prime Ministers identifi ed Globali- zation in 2007 as a new priority, totally 22 initia- Th e Nordic Council of Ministers (NCM; www. tives have been implemented and most of them norden.org) is the platform for inter-governmental are completed. Th ese initiatives were intended to cooperation between the Nordic countries. NCM develop the Nordic model, increase competitive- has a broad range of activities within 11 diff erent ness, and to promote the Region as a pioneer in Ministerial Councils. Traditionally, the areas of tackling globalization. In October 2011 the Nor- Education & Research, Culture, and Innovation dic prime ministers commissioned the ministerial cover over half of the total budget of about 1 000 councils to develop a number of tangible areas in million Danish kronor yearly (approx. 130 million which the Nordic countries can work together to Euros). Over the last few years, collaboration on generate Green Growth and Prosperity. Th e prime competitiveness, green growth and welfare issues ministers› proposal priorities Nordic test centers for has become even more in focus. green solutions; education, training and research

72 STATE OF THE REGION REPORT 2013 SECTION B Collaboration in the Baltic Sea Region

for green growth; fl exible consumption of electric- (the fi fth freedom) is being prepared. In addition, ity; green-technology norms and standards; green NCM plays an active role in involving Russian procurement in the public sector; techniques and partners in the projects, for instance in a project methods for waste treatment; the integration of en- on BSR City Branding. It is our ambition that the vironmental and climate considerations into devel- Nordic region and the Baltic Sea Region as a whole opment aid, and funding for green investment and will benefi t from this work. companies. Th ese projects have been developed and started up during 2012 or 2013. VASAB is an intergovern- In 2013 a special budget for prioritized initia- mental co-operation pro- tives has been introduced under the Ministers of viding a ministerial plat- Nordic Cooperation. Th e priority-budget contents form and expert network a chairmanship-part, in order to increase the chair- for 11 Baltic Sea Region manships possibility to launch new initiatives, and countries to coordinate a part for new, big prioritized initiatives. In 2013 spatial planning and development - the EU coun- the Swedish chairmanship will prioritize the areas tries Denmark, Estonia, Finland, Germany, Latvia, of; Youth unemployment, Quality if working-place Lithuania, Poland and Sweden as well as Norway, learning, Competitiveness of the Nordic Mining Russia and Belarus. It is guided by the conference Industry and Black carbon emissions. During 2013 of ministers and steered by the Committee on Spa- the main other initiatives in the priority-budget are tial Planning and Development of the Baltic Sea Green Growth and Prosperity, Sustainable Nordic Region where German regions adjacent to the Bal- Welfare, Climate friendly building, and Culture tic Sea and Russian North West regions and city of and Creativity. St. Petersburg are also represented. Chairmanship While the NCM focuses on collaboration among of VASAB follows the pattern of CBSS: Russia is the Nordic countries, it works very actively with its the current chairing country and from 1 July 2013 neighbors in the Baltic Sea Region. Th e cooperation chairmanship will be transferred to Finland. More with Estonia, Latvia and Lithuania and with North- information can be found at www.vasab.org west Russia take place in areas of common Nordic- Th e last VASAB 7th Ministerial Conference on Baltic respectively Nordic-Russian interest. Educa- 16 October 2009 has endorsed the new VASAB Long tion, research and innovation are important areas in Term Perspective for the Territorial Development of the Nordic-Baltic cooperation. Together with Russia the Baltic Sea Region (LTP) that includes a num- NCM in 2012 launched a new joint eff ort in the ber of actions. Th e LTP covers policies for which the fi eld of education and research. NCM is strongly transnational cooperation in spatial planning may committed to the Northern Dimension and con- contribute substantially. Th ese policies include urban tributes actively to the implementation of the Action networking and urban-rural cooperation, internal Plan for the EU Baltic Sea Strategy. Th e Northern and external accessibility as well as maritime spatial Dimension and the EU Baltic Sea Strategy are in- planning and management. Th e recent VASAB ac- tegrated in the policy of NCM for cooperation with tivities are concentrated towards overcoming of the its neighbors in the Baltic Sea Region. In addition, important challenges specifi ed by LTP and imple- the NCM’s cooperation with Poland and Germany mentation of LTP in order to ensure the commonly is being developed. agreed goal - achieve territorial cohesion perspective Th e NCM has taken the lead in a horizontal in the Baltic Sea Region by 2030, i.e. the region is action on bioeconomy as well as in several fl agship a well-integrated and coherent macro-region, and it projects of the EU Baltic Sea Region strategy. In has overcome the socio-economic development di- addition the NCM strives to keep the strategy high vides between its individual parts and turned the on the political agenda of the region. Among the global challenges into assets. fl agship projects led by NCM are cooperation in Being aware of the increased use of coastal and the areas of forestry, plant genetic resources, vet- maritime areas, need for application of maritime erinary contingency planning and culture and spatial planning is being encouraged by VASAB creative industries. A fl agship project in the fi eld of already since Ministerial Conference of 2001. Th e infrastructure for the free movement of knowledge concept and methodologies of MSP have been de-

STATE OF THE REGION REPORT 2013 73 SECTION B Collaboration in the Baltic Sea Region

veloped by several pilot projects, like BaltCoast and VASAB has also contributed to the discussion Plancoast. In 2010, a Joint Working Group on mar- of the territorial cohesion concept in the European itime spatial planning was established with HEL- Union. With the aim to facilitate measuring of COM and it is operating as a regional platform to territorial cohesion within the Baltic Sea Region, promote long-term sustainable management and VASAB has initiated also the ESPON 2013 Pro- planning for the whole Baltic Sea in the cross- gramme project – “BSR-TeMo - Territorial Moni- border context. Th e HELCOM-VASAB MSP WG toring for the Baltic Sea Region”. Th is project shall has elaborated and adopted Baltic Sea Broad-scale support evidence informed territorial development Maritime Spatial Planning Principles that serves and cohesion in the Baltic Sea Region by develop- as guidelines for development of maritime spatial ing an indicator based monitoring system. Th is plans across the Baltic Sea. monitoring system shall comprehend a policy di- Consequently, VASAB also contributes to the mension, related to the promotion of territorial co- implementation of the EU Strategy for the Baltic hesion in the Baltic Sea Region, and a methodologi- Sea Region (EUSBSR) and it`s Action Plan. In col- cal dimension aimed at developing a tool (indicator laboration with HELCOM, VASAB is a Horizontal based) for monitoring the territorial development Action leader for the HA “Spatial planning”, i.e., en- in the Baltic Sea Region. Th is will contribute to in- couraging the use of maritime and land-based spatial creased knowledge and understanding of territorial planning in all Member states around the Baltic Sea cohesion processes in the BSR and at the same time and develop a common approach for cross-border allow for a comparison and benchmarking with cooperation. A Flagship project of the Horizontal other European regions and macro-regions. It will Action PartiSEApate – Multi-level Governance in also support the contribution of the BSR to smart, MSP (Maritime Spatial Planning) throughout the sustainable and inclusive growth in Europe as men- Baltic Sea Region is being carried out. Th e project tioned in the EU2020 Strategy (http://www.espon. idea has raised from the BaltSeaPlan project and eu/main/Menu_Projects/Menu_ScientificPlat- its main goal is to develop a pan-Baltic approach to form/bsr-temo.html). Th e project involves seven marine topics that have a spatial dimension that go partners with a Lead Partner Nordregio - Nordic beyond the national borders (i.e. nature protection Center for Spatial Development, Sweden and runs areas, grid connections, shipping lanes) and thus to from February 2012 to January 2014. create a transnational framework for multi-level gov- Th e specifi c trait of VASAB is active involvement ernance in MSP. Project will develop a concept for of non-EU partners in discussing regionally impor- an institutional framework for MSP and governance tant topics. For example, VASAB together with model for coherent planning of cross-border issues Ministry of Regional Development of Russia, Com- (including transnational consultation, MSP data ex- mittee for External Relations of Saint Petersburg and change network), which will provide input to policy International Centre for Social and Economic Re- decisions taken at the ministerial level in the BSR search - Leontief Centre organized a Round Table countries. VASAB is involved in the project as one of “Integrated Development of Rural and Urban Areas: the project partners. Th e project builds on the results Experience of the Baltic Sea Region” during the XI of existing network, the HELCOM-VASAB MSP Annual Forum of Strategic Planning Leaders in St. WG, and the completed Baltic projects: PlanBoth- Petersburg, 22-23 October 2012. nia, BaltSeaPlan, PlanCoast, East-WestWindow and BaltCoast where VASAB played a substantial role. The Baltic Sea States Altogether 11 partners from almost all BSR coun- Sub regional Co-opera- tries have joined the project. A lead partner is Mari- tion (BSSSC) is a politi- time Institute in Gdańsk, Poland. Th e HELCOM- cal network for regional VASAB MSP WG has assumed the role of Project authorities in the Baltic Advisory Group. Th e project received co-fi nancing Sea Region. Th e BSSSC from the EU Baltic Sea Region Programme 2007– co-operates closely with other Baltic Sea and Eu- 2013, it`s duration is from June 2012 until Septem- ropean organizations in order to promote the ber 2014. Relevant results of the project will be pre- common interests of the regions around the Baltic sented at VASAB Ministerial Conference in 2014. Sea towards national authorities, EU institutions

74 STATE OF THE REGION REPORT 2013 SECTION B Collaboration in the Baltic Sea Region

and others. In 2013-2014 the chairmanship of the • cohesion policy (e.g. preparations of the future BSSSC is held by the Helsinki-Uusimaa Region, programming period and establishing a plat- Finland. Th e EU Strategy for the Baltic Sea Region form for exchanging experiences on cohesion (EUSBSR), entrepreneurship and innovation will policy implementation in the regions) be cross cutting themes that will be addressed dur- • transport and infrastructure issues (e.g. im- ing the chairmanship. proving connectivity, strengthening accessibil- Th e EUBSR has since its establishment guided ity and promoting the transport corridors of the actions of the BSSSC and its regions and the the BSR). BSSSC has been an active player in the development and implementation of the strategy. Several Th e BSSSC Annual Conference, the organization’s events like the European Commission’s consulta- main forum for exchange of ideas and interests, tion on the EUSBSR in 2008 and the fi rst Annual will be held in Helsinki the 17th-18th of October Forum of the EUSBSR in 2010 have been organ- 2013, where the 20th anniversary of the organiza- ized back-to-back with the BSSSC Annual Con- tion also will be celebrated. ferences, and the opportunities have been used to promote and lobby for a regional view on the Th e Union of the Baltic EUSBSR. Th e key messages of the BSSSC state- Cities (UBC; www.ubc. ments concerning the Strategy have been included net) is the leading organisa- in the Joint position on the implementation of the tion of cities and local au- EU Strategy for the Baltic Sea Region adopted by thorities in the Baltic Sea the Baltic Sea States Subregional Cooperation, B7 Region. It was founded Baltic Islands Network, Baltic Development Fo- in Gdansk in 1991, and is rum, CPMR Baltic Sea Commission, Euroregion one of the fi rst pan-Baltic Baltic and Union of the Baltic Cities in April 2012. organisations born after the cold war. UBC counts Co-operation with other Baltic Sea organiza- among its members big cities such as St. Peters- tions has traditionally been very important for the burg, Tallinn, Riga, Vilnius, Helsinki, Malmö and BSSSC. In addition to the Joint position on the im- others, but also many middle-sized and smaller plementation of the EU Strategy for the Baltic Sea towns. It has altogether more than 100 fee-paying Region, the renewal of the Declaration of common members, including Russian and Norwegian cit- interest by the Committee of the Regions (CoR), ies. Th e bi-annual Congress of UBC (1-4 October, B7, UBC, Euroregion Baltic (ERB) and Euroregion 2013 in Mariehamn, Åland Islands) elects an Ex- Pomerania was signed in 2012. While the regional ecutive Board, comprising of the President, three council of Helsinki-Uusimaa also holds the secre- Vice-Presidents and one member city from each tariat of the CPMR Baltic Sea Commission, the country. Th e Board meets normally three times a secretariats of the two organizations will be com- year. Th e General Secretariat is hosted by the City bined during 2013-2014. of Gdansk in Poland. During the Helsinki-Uusimaa chairmanship UBC has two main goals: to promote, through six policy areas will be highlighted by the BSSSC. co-operation and exchange, the sustainable devel- Th e policy area work will be done in diff erent opment and prosperity of its members and their in- working groups, which the chairmanship will sup- habitants, as well as to ensure that the interests of port and develop. Focus will be laid on: the Baltic Sea Region are listened to in the capitals • maritime policy (e.g. maritime spatial planning and in Brussels. Th e member cities co-operate on a and maritime safety) wide range of political, economic, social, cultural, • energy and climate issues (e.g. renewable en- and environmental issues. UBC promotes the ex- ergy sources) change of know-how and experiences between the • youth aff airs (e.g. youth entrepreneurship and cities through seminars, courses, and publications. youth unemployment) Its many projects are carried out through thirteen • Northern and Arctic Dimension (e.g. the Bar- thematic Commissions. Th ey are hosted by diff er- ents and the Norwegian Sea issues and the ent member cities, thus engaging them in practical North-East Passage as a transport corridor) activities of the UBC.

STATE OF THE REGION REPORT 2013 75 SECTION B Collaboration in the Baltic Sea Region

Th e EU Strategy for the Baltic Sea Region has In 2012, the main agenda of BaltMet acknowl- provided a very useful framework for regional co- edged the need for: operation, and the concept of multi-level govern- • further investment in the European macro- ance can signifi cantly boost joint eff orts. UBC has regional strategies, especially in the Europe- defi ned participation in the EUSBSR implementa- an Union Strategy for the Baltic Sea Region tion as its priority, and is in many ways involved (EUSBSR); in it. • transnational co-operation frameworks with UBC has also trimmed its own organisational Russian partners structures and political culture in order to respond • long-term implementation of the common to the new possibilities and challenges. It has start- goals agreed upon in previous position papers ed to implement its Communication and Market- and resolutions. ing Strategy. A new Commission on Local Safety Baltic Metropoles Network is strongly commit- has been created, to promote co-operation and ted to taking action to support the implementation exchange between cities in land-based threats and of the EUSBSR, together with all administrational hazards. UBC has co-operated closely with many levels of general public powers and other organisa- BSR organisations, especially the Baltic Develop- tions and networks in the Baltic Sea Region, such ment Forum and BaltMet. as Council of Baltic Sea States (CBSS), the Baltic Sea States Subregional Co-operation (BSSSC), the Baltic Sea Commission of the Conference of Pe- ripheral Maritime Regions (CPMR) and the Union of Baltic Cities (UBC), thus enhancing the multi- level governance structures in the region. BaltMet acts together with BDF as the hori- Th e Baltic Metropoles Network (BaltMet; www. zontal action leader of HA Promo, responsible for baltmet.org) represents ten capitals and large met- the pooled promotional collaborations both outside ropolitan cities from around the Baltic Sea Region. and inside the region. Th e role of HA Promo is to Th e main goal of the network is to promote in- collect information and communicate about vari- novativeness and competitiveness of the Baltic Sea ous branding and regional identity building actions Region by engaging cities, as well as academic and and to boost cross-sectoral branding co-operation business partners, in close co-operation. In 2013- in the EU Strategy for the BSR. 2014, the Chair of the Network is the City of Hel- Th e EU Strategy for the Baltic Sea Region pro- sinki. Th e chairmanship is comprised of three cit- vides a framework for co-ordination and collabo- ies: Helsinki (current chair), Berlin (future chair) ration, but also a long-term perspective for BSR and Warsaw (past chair). branding and identity building eff orts. Th is frame- Baltic Metropoles Network (BaltMet) was es- work needs to be fi lled with content and projects, tablished in 2002, during the Danish EU presi- and it is up to the diff erent pan-Baltic, national, dency. Th e Copenhagen Resolution set the agenda regional and local actors to do this across the vari- of co-operation of Baltic metropolises: the request ous priority areas in a co-ordinated, inclusive and for EU enlargement, the engagement of North- collaborative manner. Western Russia and the enhanced co-operation of Major metropolises of the region have a long- Baltic metropolises in terms of brain circulation, term interest in mainstreaming the structures and upgrading higher education in the region, cluster processes of the EUSBSR and to contribute to the interchange, integration and new infrastructure. focused target-setting of the revised EUSBSR Ac- In the past ten years, Baltic Metropoles Net- tion Plan. work has made major eff orts in striving for these BaltMet invites partner cities and other stake- goals. Th e commitment of Baltic metropolises to holders of the EU Strategy for the Danube Region contribute to the overall competitiveness of the Re- (EUSDR) to co-operate with their counterparts gion is crucial, as the role of cities as key drivers for within the EUSBSR in order to support the con- growth has become more and more important over tinued development of the macro-regional strate- the past decade. gies in Europe and the involvement of non-EU

76 STATE OF THE REGION REPORT 2013 SECTION B Collaboration in the Baltic Sea Region

countries in this co-operation. BaltMet empha- (RBGC) and One BSR. Th e RBGC Project sises the importance of Northern Dimension and creates a co-operation and transport service of having Russia as a partner in the transnational platform that observes the needs of both the co-operation programmes of the European Union transport sector and customers in line with with respect to the next EU programme period green growth corridor principles. RBGC brings 2014-2020. benefi ts for cities and regions, transport sector BaltMet strongly supports eff orts to implement and citizens by improving the competitiveness transnational and cross-border infrastructural pro- and economic potential of the Region. Project jects in the EUSBSR, and calls for fi nancial means partnership consists of 21 Partners, represent- targeted at developing the missing links in the BSR ing cities, regional authorities, and research in- transport corridors, such as in Rail Baltica, in Via stitutes, as well as e.g. ministries and national Baltica and in the Fehmarn Belt. Here, special railways as associated organisations. RBGC is emphasis has to be on safeguarding the balanced linked to the wider concept of Rail Baltica – a development of corridors on both sides of the Bal- railway that will connect the Eastern Baltic Sea tic Sea Region. Mayors of the Network with Cities Region from north to south, branching from along the BSR transport corridors commit them to St. Petersburg, Helsinki, Tallinn, Riga, Kaunas the implementation of vitally important supporting and Warsaw to Berlin. Th e Region gains new investments in the cities, such as logistics centres, economic potential as the major business hubs intermodal freight terminals and combined passen- will be connected with North-West Russia and ger transport terminals. the EU core. BaltMet regards the clean Baltic Sea as an issue ONE BSR Project functions as an umbrel- of great importance for the citizens of the Region la project and calls together actors who market and therefore encourages all cities and passenger themselves as part of the Baltic Sea Region. In harbors to build adequate port reception facilities in the absence of a strong common brand, the pro- order to receive sewage waters from passenger ships ject aims to search for common commercial and operating in the Baltic Sea Area. ‘Adequate facili- cultural characteristics with a concrete ‘hands-on’ ties’ should be defi ned in common understanding approach, pointing out these characteristics as the with ports, authorities responsible for treatment of ‘elements of the Baltic Sea Region brand’. With the wastewater, vessel owners and environmental au- budget of EUR3 million, and in co-operation with thorities. Cities shall make it possible for received 17 partners and many associated ones, the project wastewater to be purifi ed in treatment plants. enhances the marketing of the Baltic Sea Region BaltMet recognises the need to facilitate both outside and inside of the region. internationalisation of fast growing, innovative small- and medium-sized enterprises (SME) Euroregion Baltic (ERB) is a all over the Baltic Sea Region, with the sup- platform for cross-border co- port of leading science parks and clusters of operation of eight regions from the Region, and by advocating for the removal Denmark, Lithuania, Poland, of barriers to the functioning of the internal Russia and Sweden in the market. Metropolises commit their respective Euroregion Baltic southeast of the Baltic Sea cities to the further development and wider use Region. The ERB was the of support instruments, like innovative public fi rst Euroregion to have formally included a partner procurement, advisory and marketing sup- from the Russian Federation. port schemes and actions, as well as fi nancial ERB initiates joint activities contributing to instruments, in order to develop a supportive the development of the whole Baltic Sea Region environment for innovative and creative small- and with particular attention to the South Baltic and medium-sized enterprises. BaltMet also area. Th e signifi cance of the cooperation has been supports sustainable labour mobility and talent refl ected by joint political initiatives resulting, retention in the Baltic Sea Region. among others, in the attraction of funds to sup- Two major projects are currently running, port the cooperation area, implemented strategic those being the Rail Baltica Growth Corridor projects based on the ERB Joint Development Pro-

STATE OF THE REGION REPORT 2013 77 SECTION B Collaboration in the Baltic Sea Region

gramme, and improved intercultural dialogue ben- bour markets. Th ey also discussed the possible role efi tting the integration processes in Europe. of Euroregion Baltic to take in the future so that ERB stakeholders believe that added value of employability and youth employment could be im- their cooperation is refl ected it by the two factors: proved in the ERB cooperation area. As a result, ERB is a tool to tackle common challenges ob- ERB Task Force was established with the clear served by its members, as well as a strengthened mandate to develop a basis for a stronger coopera- political leverage in the cross-border cooperation tion on labour market issues within ERB, with a of the Baltic Sea Region. Joint activities carefully focus on improving the labour force mobility and designed in the rolling biannual action plans, are to combat youth unemployment. In autumn 2012 streamlined into the three strategic focus areas: ERB became a formal observer at the Baltic Sea lobbying activities, strategic actions, and exchange Labour Forum, platform promoting social dialogue initiatives. and tripartite structures and cooperation as a crucial element of sustainable economic growth and social development in the Baltic Sea Region. On 25th February 2013 ERB organised a seminar on labour market in South-East Baltic Sea Region gathering politicians – members of ERB Executive Board and experts – members of the Labour Market Task Force and representatives of employment services in the ERB cooperation area. Th e participants of the seminar adopted a resolution which indicates main actions for ERB. Th ese are: an improvement of the labour force mobility and combat against youth unemployment. ERB Labour Mobility Task Force presented statistics concerning labour market in ERB member regions In 2012 ERB stakeholders have concentrated and analysis of regional development strategies re- their actions around the following four commonly garding to aims of the employment policy. Th ey faced challenges: facilitating the cooperation of also discussed the youth unemployment pack- actors dealing with labour mobility, cooperation age recently launched by the European Commis- around water issues, fostering B2B cooperation sion as well as the fi nancial instruments available with focus on clusters, innovation and SME inter- through the Swedish Institute. Moreover, they nationalisation, as well as supporting youth coop- proposed to facilitate networking in ERB by es- eration within ERB Youth Board. Th eir lobbying tablishment of EURES regional teams that would eff ort has been largely centred around the South exchange information, do research, make analysis Baltic Cross-Border Cooperation Programme. of labour market and support employers and job- On 13th June 2012 ERB gathered its members seekers. Finally, ERB will continue to participate in in Nexø, Bornholm for the 3rd Annual Forum en- international social dialogue thanks to its member- titled: “Cooperating to meet common challenges ship in Baltic Sea Labour Forum and act as a facili- in the Baltic Sea Region”. Around 60 participants tator of cooperation between projects implemented from the national, regional and local levels around on its area. the Baltic Sea region congregated to gather new ERB Water Core Group has acted as an ex- knowledge about the current situation concerning perts’ body in the implementation of the MO- labour markets, and in particular unemployment MENT project which has now been running over among the youngest of our citizens, prevailing in three years and the project is currently in its fi nal the EU, Baltic Sea Region and ERB member re- stage. Th e core of the project has been the estab- gions. Th e regional representatives heard some of lishment and tests of seven Water Users Partner- the best examples of eff orts made jointly by dif- ships (WUPs) in Lithuania, Russia (Kaliningrad ferent actors in the Baltic Sea Region in order to Oblast), Poland and Sweden. WUPs have meant counter-act the worsening conditions on our la- a new approach of water management through

78 STATE OF THE REGION REPORT 2013 SECTION B Collaboration in the Baltic Sea Region

strong local stakeholder involvement. Th e WUP at the beginning of June, including contact with method has its strength in engaging stakehold- the CBSS and SEBA project. Th ese contacts were ers were action is required, i.e. on the local level, followed up during the Forum of Partner Regions so that local knowledge can guide and determine in Kaliningrad and with the leader of the EUSBSR what measures are needed for the specifi c location Priority Area Tourism. Currently, the initiative is and its unique features. Regardless which measure being shaped into a Baltic Sea Cluster Develop- is to be implemented it has proven that without lo- ment Centre which will help to grow the competi- cal knowledge and commitment the success rate of tiveness of regional economies and their key indus- accomplishing well-functioning measures becomes tries/clusters, as well as to support companies - in much more challenging. particular SMEs and start-ups - in accessing new Th e MOMENT project has built strong rela- business partners and markets in the Baltic Sea Re- tionships with several important Baltic actors, in- gion. In the coming months, ERB will continue cluding the EUSBSR coordinators of the priority cooperation with Business Link Greater Copen- area NUTRI. Th is has resulted in that the Euro- hagen and other relevant actors in order to work pean Commission, following a proposal from the towards the establishment of an exchange platform MOMENT project, has written in “Water Users of good practices for cluster development managers Partnerships” in the EUSBSR Action Plan. It is in the South Baltic Area and Baltic Sea Region, as said that this is a strategically interesting measure, well as towards facilitating joint projects in order to worthy of support. It opens thus a possibility to ob- improve SME internationalisation, innovation and tain the status of a so-called fl agship project. Th e exports. A preliminary project proposal to apply to Helsinki Commission, HELCOM, has expressed the Seed Money Facility under the EU Strategy to itself in favour of what they call the “MOMENT develop the concept of the Baltic Sea Cluster De- approach”, which refers to the work of Water Users velopment Centre is under preparation. Partnerships as a method of river basin water man- In 2012 ERB members continued to support agement. Furthermore, Ramboll Management car- youth in their cooperative activities by fi nancing ried out a comprehensive independent evaluation the participation of regional youth representatives of the MOMENT project with focus on its Water in the work of ERB Youth Board, ERB task forces Users Partnerships. In the conclusions, Ramboll on labour mobility and EU cohesion policy, and expresses a fi rm belief that Water Users Partner- ERB Water Core Group. In order to strengthen the ships can be spread to other areas around the Baltic youth cooperation within ERB a project was devel- Sea and work as a successful model of managing oped jointly with Kumulus (EVS hosting organi- water through local participation. sation in Kalmar) on the one hand, and Europe A meeting with the Europe Enterprise Net- Direct Bornholm and Association Elblag Europa work representatives and business support organi- (sending organisations) on the other, and success- sations from the cooperation area was held on 9th fully submitted to the European Voluntary Service February 2012 in Älmhult (södra Småland). Al- at the end of last year. Th e volunteer has currently though interest was identifi ed for closer links be- begun work, making sure tight links will be main- tween the actors, no source of fi nancial assistance tained with the young people involved in the work were available at that time. Th e contacts initiated in of ERB Youth Board coming from Denmark, Lith- February were followed by the visit from Business uania, Poland, Russia and Sweden. In this coop- Link Greater Copenhagen to Warmia and Mazury eration platform, the volunteer will work on youth (Poland) in May 2012. Th ese visits were based on unemployment issues and help to strengthen the two important foundations: 1. closer links between cooperation between the youth in the involved re- companies and business support institutions will gions. contribute to economic development of Bornholm In its lobbying eff orts ERB actively promotes a and Warmia and Mazury, and 2. creation of prac- greater role of the European Territorial Cooperation tical dimension of economic cooperation between within the EU Cohesion Policy, advocating for the these regions has to become a model of diverse co- equal importance of cross-border cooperation along operation of partners in Euroregion Baltic. A simi- maritime borders to that along land borders. ERB lar visit was later organized to Kaliningrad (Russia) was a key actor in the establishment of the South Bal-

STATE OF THE REGION REPORT 2013 79 SECTION B Collaboration in the Baltic Sea Region

tic Cross-Border Cooperation Programme in 2007 In order to promote development in the Baltic and since then has actively participated in its imple- Sea region SI provides fi nancial support to initiate, mentation, both as a partner in projects co-fi nanced strengthen and support action-oriented collabora- by the Programme, and as a member in the Steering, tions and partnerships for cross-border projects. In Monitoring and Joint Programming Committees. 2012 aid in the amount of SEK 33 million (€ 4 mil- ERB supports the continuation of the South Baltic lion) were granted 12 diff erent three-year projects Cross-Border Cooperation Programme in the new with established partnerships in the prioritized ar- fi nancial perspective, including all the ERB member eas of health, environment, energy, regional devel- regions (with all NUTS 3 level regions involved in opment and innovation. Th is is the fi rst year for the current programme). ERB has been arguing that this type of project funds which will be evaluated the inclusion of the whole ERB area will reinforce annually. the strategic programming and eff ectiveness of the SI has long provided seed funding to help initi- programme, and hereby strengthen the performance ate projects. In 2012 SI granted funding of no more and added value of the projects to be implemented. than SEK 440 000 (€ 53 000) to 52 projects. Fund- Taking part in the current discussions on the future ing is granted to, for example, establish new net- of the Programme, ERB stresses the need for an open works or expand and strengthen existing networks, dialogue involving local and regional actors in order prepare an application for EU funding or conduct to defi ne a specifi c profi le of the programme. Such a feasibility study in areas relevant to the Baltic a profi le should address well the most urgent joint Sea Strategy and the region. A survey conducted challenges within the programme area and be en- in 2012 indicated that 74 per cent of seed funding forced by carefully selected thematic priorities with recipients have gained new information relating to a strong and clear focus. As a result of discussions the EU Strategy for the Baltic Sea Region, and 89 and careful considerations of the regional challenges, per cent feel that their participation has provided ERB partners believe these thematic priorities should them with new skills and tools that can be used in include: protecting the marine environment of the international cooperation. Baltic Sea, promoting resource effi ciency, as well as Another form of financial support is the enhancing the competitiveness of small and medium third-country component which involves Russia enterprises. and EU’s eastern neighbours (the Eastern Part- nership countries) in on-going EU collaborations Th e Swedish Institute otherwise open only to EU member states. Th e re- (SI) is a public agency lations and cooperation between the countries in that promotes inter- the region are expected to expand and deepen as est and confi dence in cooperation with Russia and Eastern Partnership Sweden around the countries are tied more closely to the on-going EU world. Th rough strategic communication and the cooperation. creation of lasting and active relations with people, SI also arranges a series of leadership pro- organisations and businesses in other countries, SI grammes in order to create long-term relationships seeks to increase Sweden’s contribution to interna- and build lasting, active networks between young tional cooperation and development. and potential future leaders. We have developed SI puts a lot of emphasis on the Baltic Sea Re- a layered project management training that is ap- gion and the goal is to develop partnerships and plicable to the thematic areas of the Strategy for relationships that contribute to a positive and sus- the Baltic Sea Region. Th e crises management pro- tainable development of the entire region – environ- gramme is designated a fl agship project. mentally, economically and socially. A key part of BalticLab is a leadership programme and a fl ag- this work lies in supporting the implementation of ship project of the Horizontal Action Neighbours the EU Strategy for the Baltic Sea Region, as well within the EU Strategy for the Baltic Sea Region. as in developing relations with EU’s eastern neigh- Th e Swedish Institute operates the programme in bours. SI creates opportunities for cooperation by partnership with the Council of Baltic Sea States making it easier for organisations and individuals (CBSS) in the framework of the South-eastern Bal- to collaborate across borders. tic Area Modernization programme (SEBA).

80 STATE OF THE REGION REPORT 2013 SECTION B Collaboration in the Baltic Sea Region

SI is open to additional strategic partnerships gration between the countries of the Baltic Sea re- in the region and welcomes the increased interac- gion. Th rough counselling, information drives and tion and planning with other stakeholders in the active participation in strategic EU projects such as region. By providing fi nancial support for coopera- InnoHeat and the two fl agship projects 14.3 and tion projects, leadership training, and partnerships ONE BSR – SI contributes to a strong and coher- with strategic players and events, SI promotes inte- ent Baltic Sea Region.

The BSR StarDust project

Mobile Viking’s partners Hermia and the award-winning Demola concept started up in Tampere, Finland. Comfort in Living are planning for a big innovation BSR Stars, a group of projects managed by Vinnova, the camp in Copenhagen in July 2013 bringing together Pol- Swedish Innovation Agency, aims to speed up innovation ish wood technology specialists, Danish design compa- in the Baltic Sea Region using transnational cooperation nies, Swedish furniture entrepreneurs and Latvian design to create strengthened competitiveness and sustainable students. The aim of the camp is to develop prototypes, growth. Linkages between universities, clusters and in- products and services that improve the quality of life for novative companies are developed through projects and elderly people in their homes, specifi cally in their kitch- new opportunities for fi nancing transnational coopera- ens. tion. Active for Life has had a number of local and inter- Some major steps for BSR Stars have been taken in national matchmaking workshops targeted to companies 2012-2013, when launching two joint calls: BONUS Inno- working with business concepts aiming to maintain and vation Call and the BSR Innovation Express call. A lot of improve the quality of life of the ageing population. Active time and effort have been required to create these fi nanc- for Life supports the companies in creating innovative, ing opportunities for transnational cooperation support- globally competitive and effective transnational service ing the EU Strategy for the Baltic Sea region. BSR Stars models and business concepts. has identifi ed a need for a pre-study facility and fl exible The national maritime clusters involved in MarChain fi nancing possibilities for the projects and networks work- have divided the project in different focus areas, for in- ing in the region. stance green corridors and light weight ships. The overall One new project joined the BSR Stars umbrella pro- aim is to use hardening regulations on maritime transport gramme during 2012: BSR Food Cluster Network. It helps to fi nd new sustainable solutions and business opportu- small and medium-sized food producing companies in nities. their international activities and efforts. The network is Clean Water combines competences of BSR coun- built up with partners in Finland, Germany, Poland, Esto- tries’ innovation milieus, clusters and SME-networks nia, Latvia, Lithuania, Sweden and Denmark. around water protection (wastewater treatment, hazard- The fi ve sub-projects within StarDust, a BSR Stars ous chemical substitution). During the last year the coop- project part-fi nanced by the ERDF Baltic Sea Region (BSR) eration platform has been strengthened and the coopera- Programme, is proceeding their work preparing strategic tion with the Russian company Vodocanal has increased action plans focusing on their long term strategy: Mobile opening up for more extensive business exchange. Vikings have started to write Business Roaming Agree- Stardust has strengthened its partnership by attract- ments between all the partners opening up for companies ing new partners and fi nanciers: the partners received and clusters in the network to use each other’s offi ces more than 8 MEUR as add-on investment, 15 research and networks, creating a global network facilitating the institutions and six new cluster and business develop- access to new markets. In Skåne a new open innovation ment organization joined as associated partners since platform have opened for companies and students from last year. the entire region. The inspiration comes from one of the

STATE OF THE REGION REPORT 2013 81 SECTION B Collaboration in the Baltic Sea Region

1.2 Non-governmental and public- • Each day a company portrait highlighted private organizations • Product and company news in ScanBalt News (nearly 20.000 subscribers) and on www.scan- ScanBalt® fmba (www.scanbalt.org) balt.org promotes the development of ScanBalt • Portraits in ScanBalt News and on www.scan- BioRegion as a globally competitive balt.org health and bio economy. ScanBalt is a • CEO interviews and industry opinions in not for profi t member driven associa- ScanBalt News and on www.scanbalt.org tion of clusters, networks, companies, • Portraits distributed in the ScanBalt BioRegion research institutions, hospitals, public network authorities and other organizations. ScanBalt pro- • Invitations to present at ScanBalt press study vides support and service to the members; promote tours public-private collaborations and partnerships and • Individualized solutions upon agreement strengthen ScanBalt BioRegion as an open in- • ScanBalt Business promoted at events, confer- novation market in order to enhance innovation, ences, fairs etc employment and economic growth. It assists to • Supports ScanBalt BioRegion to be a globally educate train and attract talent and facilitate the competitive health and bio economy mobility of people and ideas. ScanBalt’s strategy for 2012 – 2015 “ScanBalt Health Economy provides an opportunity to make BioRegion: Smart Growth, Sustainable Develop- BSR a global front-runner. In October 2009, the ment and Specialization on Top of Europe towards ScanBalt Health Region (SBHR)1 became a fl ag- EU 2020” defi nes three focus areas to promote the ship project within the EU Baltic Sea Region strat- development of the ScanBalt BioRegion as a glob- egy. Its mission is to promote health of the citi- ally competitive health and bio economy: zens, reduce costs of the health care systems and • EU BSR Strategy and EU2020 strengthen health economy in BSR • Visibility and Internationalization A serious challenge facing BSR health econ- • Member Services and Organizational Develop- omy is related to clinical trials. Clinical trials are ment towards triple helix 3.0 and cluster excel- an indispensable part of clinical research, which in lence turn, is essential to develop medicinal products and improve medical treatment. Without clinical trials Each focus area is supported by actions lines, which there would be no new medicines, no further de- are revised according to needs and opportunities. velopment of existing medicines and no evidence- Th e strategy intends to further strengthen support based treatments with medicines. Th e research and service to the members; enhance decentraliza- associated with pharmaceutical development con- tion, regional involvement and specialization and ducted by the pharmaceutical industry is worth strengthen ScanBalt BioRegion as a leaver to im- 27.4 billion € in Europe. A substantial part of the plement the EU Baltic Sea Region strategy and industry revenue is spent on research and develop- EU2020 objectives. ment and clinical trials stand for more than half of ScanBalt Business www.scanbaltbusiness.com drug development costs. In EU approximately 60 was launched May 2013, leveraging fi nancial sup- % of the clinical trials are sponsored by the phar- port from the European Union. ScanBalt Business maceutical industry and 40 % by other stakehold- assists clients to build awareness and visibility in ers such as academia. the Baltic Sea Region and globally. Th is is done by However, clinical research activities are today applying various platforms and tools supporting increasingly located outside Europe. According to ScanBalt Business to accomplish the task including the EU Commission the number of clinical trial ScanBalt News (nearly 20.000 subscribers), www. applications has decreased by 25 % from 2007 scanbalt.org and the ScanBalt BioRegion network to 2011 while the costs and bureaucracy have existing since 2001. Individualized solutions can increased. Th e same decreasing trend is seen in be designed and negotiated upon demand. Some the BSR with the exception of academic trials in

features of ScanBalt Business: 1 www.scanbalt.org/projects/scanbalt+health+region

82 STATE OF THE REGION REPORT 2013 SECTION B Collaboration in the Baltic Sea Region

Denmark. Th e problems related to recruitment of project based in the North German state of Meck- suffi cient number of subjects has been identifi ed lenburg-Vorpommern. Baltic Amber promotes as one of the reasons for the decrease in clinical exchanges and cooperation’s to more eff ectively trial activities. It is diffi cult for BSR countries to combat the spread of multi-resistant bacteria on compete alone with e.g. populations in Asia. Col- a transnational level. Th e approach rests upon the laboration between BSR countries could substan- understanding that multi-resistant bacteria do not tially increase the competitiveness of the region in stop at country borders. Th ey rather present a seri- a global context. ous danger to health care systems worldwide. With ScanBalt has in 2012 and 2013 put focus on this approach, Baltic Amber is one of the grass root the critical issue of clinical trials via a number of projects piloting the comprehensive intention of a articles, sessions and discussions. In early 2013 it is Baltic Sea region-wide health initiative.2 being further explored in a dialogue between pri- Another project working within the SBHR vate and public stakeholders which concrete initia- umbrella is Eco4Life. Partners from Szczecin in tives are necessary in order to complement existing Poland, Klaipeda in Lithuania and Greifswald in trans-national eff orts in order to maintain and at- Germany as well as the associated partners promote tract clinical research and trials in BSR. the regional potential and bundle their strengths SBHR has launched the project “Baltic Sea to create a strong and competitive South Baltic Re- Health Region - Business acceleration support and gion by mobilizing cross border cooperation in sci- training bridging innovative SMEs and health care ence and business (www.eco4life.info/). Promoting organisations to strengthen BSR Health Economy” Green Hospitals and setting up a Baltic Diabetes (acronym “BSHR HealthPort”). BSHR Health- Cluster are among the key issues in Eco4Life. Port is focused on the following challenges of the ScanBalt is partner in the project “Submariner” Health Economy: having the task to ensure that a stable network is • Insuffi cient exploitation of ideas from health available after the project fi nanced by the Baltic Sea care researchers and practitioners. programme 2007 – 2013 has been fi nalized. eTh • Procurement practices that limits access of project evaluates and leverages new technologies SMEs to the BSR health care market. and knowledge about the use of marine ecosystems • Insuffi cient innovation competencies of health in and environmentally friendly and economically care providers and SMEs and cultural diff er- attractive way for the Baltic Sea Region to become ences across the Baltic Sea Region. a model region for sustainable sea management. Submariner is coordinated by the Marine Institute Th e BSHR HealthPort, coordinated by ScanBalt, of Gdansk.3 Submariner in 2013 became a fl agship is co-funded by the Baltic Sea Region programme in the EUBSR strategy, priority area 7 “Innova- 2007-2013 and encompasses 9 partners together tion”. Th e key role for the fl agship is to implement with 15 associated partners. A HealthPort Innova- the recommendations from a road map released by tion Competition is launched to boost the com- the project “Submariner”. mercial utilization of ideas arising from the clinical In order to strengthen ScanBalt BioRegion environment and healthcare research. Awards were ScanBalt liaison offi ces in 2012 became a formal granted to the winning ideas at the 10th ScanBalt part of the ScanBalt organisation. Th e liaison of- Forum in September 2011 and at the 11th ScanBalt fi ces are currently the Healthy Ageing Networks Forum 2012. Th e award winners are now receiving of Northern Netherlands (HANNN), Biobaltica tailor made support in order to prepare them for in Gdansk, Tartu Biotechnology and Biopeople entrance on the market. A key delivery of BSHR in Denmark. Th e role of the liaison offi ces is to HealthPort is a health economy innovation agenda strengthen direct regional involvement and out- for ScanBalt Health Region which will promote an come, promote decentralization and target specifi c innovation system for health economy and intro- thematic issues. duce a self-sustainable business support and service model to be implemented by ScanBalt.

Baltic Amber “Baltic Alliance against Multi- 2 www.hicare.de/hosting/bcv/website_en.nsf/urlnames/hicare_ index?OpenDocument&nav=hicare_index Resistant Bacteria” is related to the HICARE 3 www.submariner-project.eu/

STATE OF THE REGION REPORT 2013 83 SECTION B Collaboration in the Baltic Sea Region

Th e 11th ScanBalt Forum 2012, 20 to 23 No- year, conferences and smaller seminars are organ- vember in Tampere, was organized by the Baltic ised in order to get a close and private exchange Institute of Finland and Tampere University of of views on important developments and topics in Technology, Department of Biomedical Engineer- the region. Baltic Development Forum is chaired ing and BioMediTech. Th e 12th ScanBalt Forum by Hans Skov Christensen, former CEO of Dan- 2013, 16 to 18 October in Gdansk is being organ- ish Industri. Th e Baltic Development Forum ised by the Intercollegiate Faculty of Biotechnol- Honorary and Advisory Boards consist of high- ogy University of Gdańsk - Medical University of level political dignitaries and prominent business Gdańsk, ScanBalt, Innovation Synergy and PRO executives representing the entire Baltic Sea Re- SCIENCE Poland Ltd. See more at http://www. gion. BDF’s mission is to promote the Baltic Sea bioinnovation.pl/en/home.html Region as an integrated, prosperous and internationally growth competitive region and act as a facilitator for achievement of that goal. BDF is under 2012/2013 contributing to regional collaboration across the Baltic Sea Region in a number of ways: Th e EU co-fi nanced transport pro- BALTIC SEA CHAMBERS OF COMMERCE ASSOCIATION ject intends to demonstrate how multi-level govern- BCCA the Baltic Sea Chambers of Commerce ance models, tools and approaches can contribute to Association (BCCA) is an organization of 50 a better alignment of transport policies in the BSR. Chambers of Commerce across the Baltic Sea Re- Th is is expected to increase commitment of public gion. Since 2002 the Presidency and General Sec- and private stakeholders to achieving greener and retariat of the BCCA has been with the Chamber more effi cient transport in the Baltic Sea Region, in of Commerce and Industry of Southern Sweden in line with the objectives of the EUSBSR. BDFs role is Malmö. Its main task is to give the business com- to facilitate the policy dialogue among stakeholders. munity of the region a common voice. BDF as editor-in-chief launched the NewsWave In 2012 a project focusing on a new digital agen- online platform www.newswave.eu under the da of the BSR was developed in collaboration with umbrella of the EU-fi nanced ONE BSR (WP6), the BDF and was presented at the BDF Summit in emphasizing independent journalistic news on all Copenhagen. Some of the ideas, notably about open levels – to the citizens, policy-makers, business, data, has been pursued during 2013. Th e issue of ed- stakeholders, experts and the creative community ucational renewal has also been addressed. A better of the region. Th e overall objective of the website focus on quality and integrated university systems is to improve information exchange and cross-bor- has been the key elements in this context. der communication between the countries of the region, especially the countries that form part of the EU’s macro-region in the BSR. Th e main aim in 2013 is to get the website fully developed and known throughout the region. Th e 15th Baltic Development Forum (BDF) Th e Baltic Development Forum (BDF; www. Summit “New Realities – New Opportunities” will bdforum.org) is an independent networking or- take place in Riga on 29-30 May (www.bsr2013. ganisation for business, governments, regional or- eu). Th e main focus of this year’s event will be on ganisations, academia, and the media to discuss competitiveness, investment and business develop- and collaborate on issues of regional importance. ment and the role of the Baltic States in improv- BDF has members from large companies, major ing the Baltic Sea Region’s overall competitiveness cities, institutional investors and business asso- and growth opportunities. To become smarter and ciations in the Baltic Sea Region. Over the years greener, public-private partnerships are essential. BDF has proved its vital role as a meeting plat- By improving framework conditions, these partner- form between top politicians and private sector ships’ can for instance help to focus and optimize representatives, most notably occurring during sustainable infrastructure investment, which is key the annual Summits. In addition, throughout the to kick-starting wider economic growth in the Re-

84 STATE OF THE REGION REPORT 2013 SECTION B Collaboration in the Baltic Sea Region

gion, benefi tting the European economy at large. BDF is increasingly being recognized as one BDF is working closely together with the Latvian of the best think-tanks in the world in the fi eld Government as co-hosts of the Summit, which co- of regional economic development. Th is position incides with the Latvian Presidency of the Baltic is further being established and improved during Council of Ministers, and a meeting of the three 2013 with the new edition of the Political State of Baltic Prime Ministers will open the event. Together the Region Report, which is built upon the con- with our Latvian partners and business organizations tributions and recommendations from the Baltic from the whole Baltic Sea area, private companies, Sea Region Th ink-tank Deep Water representing investment promotion agencies, BDF will organize a wide network of academics from all parts of the seminars and a matchmaking event (Baltic Business Baltic Sea Region. Th e idea is to complement this Arena - BBA) that will present the new realities and State of Region Report with a political dimension. opportunities in the Baltic region. BBA is a fl agship A third report of the research network will be pre- project within the EU Strategy for the BSR. Top- sented at the Summit in Riga. Prof. Bernd Hen- ics such as the increase of cross-national cooperation ningsen, Humbolt will head the work and Tobias and fl ows of investment in areas of infrastructure, Etzold, Stiftung Wissenschaft und Politik, will be energy, innovation, research and development, and editor of the report which will have app. 15 articles IT solutions on a regional level will be discussed. including a country chapter of the 12 countries in Th e Baltic Sea Award was established in 2007. the Region. Nordic Council of Ministers is co-fi - Last year in Copenhagen, the Award was given nancing the report. Th e Konrad Adenauer-Stiftung to Prof. Lars Börjesson, Chalmers University of will through its Riga offi ce help fi nancing a meet- Technology, Gothenburg who initiated the process ing of the researchers (the Deep Water research that has led to the formation of European Spalla- network) in Riga. tion Source Centre in Lund, Sweden. Th e award BDF will produce a report on regional iden- had been sponsored by Confederation of Danish tity as part of its formal role as Horizontal Action Industry. Th is summer it is awarded for the 7th Leader of the EUSBSR. Th ereby, BDF follow up consecutive year. Th e event takes place at the BDF on the report “On Identity – No Identity” that was Gala dinner on 29th of May during the 15th Baltic presented in 2011. Prof. Bernd Henningsen will be Development Forum Summit, which this year is BDF’s academic advisor and he will identify the being held in Riga, Latvia. Th e Baltic Sea Award is co-writers of the report. assigned to individuals or organizations that have BDF is diversifying its structure in terms of es- fulfi lled one or several of the following criteria: tablishing a Competitiveness Council and smaller • Made an extraordinary contribution to Baltic advisory groups of which the Advisory Group on Sea Region development the Digital Agenda is a fi rst of its kind. Th e aim of • Played a leading role or been a role model in the BSR Competitiveness Council is to be agenda the region’s economic development setting as regards to regional and European eco- • Strengthened economic cooperation between nomic growth. The Competitiveness Council the countries in the region should improve the ability to articulate and launch • Developed new business concepts and research initiatives/proposals for economic growth and im- programs proved competitiveness. Th e Council will consist of • Capitalized on competitive advantages in the top CEOs from the private sector, infl uential poli- region in a new and innovative way ticians, distinguished economists and researchers • Made a contribution to the improvement of the from the region. regional challenges within climate, energy and A Digital Agenda Action Plan for the Baltic environment Sea Region had been presented and discussed at • Linked innovators and local universities in the the 14th BDF Summit/EC’s 3rd Annual Forum trade and industry in Copenhagen June 2012. It had given direct in- • Concretely supported existing and growing re- puts to the Danish EU Presidency and the Euro- gional clusters pean Commission on the further development of a • Attracted and stimulated regional driving Digital Single Market in Europe, confi rming that forces the BSR has the potential to take a leading role in

STATE OF THE REGION REPORT 2013 85 SECTION B Collaboration in the Baltic Sea Region

the deepening of a European Single Market. Th e nology in close cooperation with partners in Kalin- Digital Agenda is one of the fl agship initiatives of ingrad studied the concrete pilot cases and the report the EU 2020 strategy to create growth and jobs in will provide a good overview of what is the situation, Europe. One of the top priorities in the strategy what can be done and under what conditions. is the creation of a digital single market, whereby barriers between Member States in the digital area are reduced or removed. BDF intends to follow up on the “Priorities towards a Digital Single Market in the BSR” report from June 2012. BDF will enhance an already established connection with the European Commission about how the BDF initia- Th e Baltic Institute of Finland (BIF; www.baltic. tive can be aligned with EU initiatives such as the org) is a leading collaborative body for the Baltic Connecting Europe Facility (CEF) and EU Digi- Sea Region in Finland. Since its launch in 1994, tal Agenda. Furthermore engage in joint activities the institute has promoted co-operation in the and conferences with BDFs members and partners, Baltic Sea Region and contributed actively to the such as Microsoft, Stockholm City, Danish Minis- international network of collaborators in the re- try of Business & Growth, Swedish Tilvaxtverket gion. BIF promotes collaboration projects in the etc. BDF will focus on the Nordic/Baltic strength Baltic Sea Region and facilitates the participation positions within ICT and how we can inspire the of Finnish organisations. Th e Baltic Institute of rest of Europe in bringing out the economic poten- Finland is a network-based organisation, and its tial of the sector. principal focus is on planning and co-ordinating BDF will convene 2-3 meetings on the BSR tangible collaborative projects and maintaining an Investment Promotion Agencies (IPA) throughout extensive network of collaborators in the Baltic Sea 2013 in order to fi nd common interests and shared Region. priorities in their work of attracting more invest- In 2012, BIF was involved in 18 collaborative ments to the region. BSR IPAs initiative under the projects in the Baltic Sea Region and organized ONE BSR project will strive to strengthen the per- dozens of events in the Baltic Sea Region and Brus- ception of the BSR as a coherent region, attractive sels. As in previous years, BIF focused on innova- to foreign investors. BSR IPAs enables active and in- tion and economic co-operation in its projects. terested public-sector organisations to meet regularly BIF has been involved in the EU Baltic Sea Re- to discuss cooperation opportunities and ultimately gion Strategy process since 2005. BIF is strongly in- attract more investments which will lead to higher volved in the implementation of the strategy and its competitiveness and prosperity in the region. fl agship projects. It is leading one fl agship project BDF maintains and develops close links to Rus- (BSR InnoShip), and in 2012 it was also involved sian partners in the Baltic Sea Region. In December in three innovation- and SME development-related 2011 the European Commission approved BDF of fl agships: BSR Stars, BSR QUICK and Baltic Sup- an energy effi ciency project in Kaliningrad entitled ply. Th e EUSBSR fl agship projects have provided a Rensol. Th e project began in early 2012 and is in- stronger policy framework, better EU-level dissem- cluded in the framework of the Northern Dimen- ination channels, and better co-ordination between sion Environmental Partnership. BDF will lead the diff erent actions and stakeholders. implementation of activities aimed at identifi cation A BIF-lead EUSBSR Priority Area 4 (clean of best available fi nancial practices and for reaching shipping) fl agship “BSR InnoShip - Baltic Sea the best results we will try to mobilize our relevant co-operation for reducing ship and port emissions network – international fi nancial institutions, pri- through knowledge and innovation-based compet- vate banks and companies – and together outline itiveness” combines environmental and economic recommendations. Th e project is fi nalizing its 1st aspects. It aims to decrease atmospheric emissions phase and a report on Nordic solutions to improve of shipping and port operations. Leading maritime energy effi ciency in buildings as well as adaptation of stakeholders from all BSR countries are represented the solutions to the local context in Kaliningrad, will among the project’s 19 partners and 24 associated be soon published. Lappeenranta University of Tech- partners. Th e EUR3.6 million project is funded by

86 STATE OF THE REGION REPORT 2013 SECTION B Collaboration in the Baltic Sea Region

the EU Baltic Sea Region Programme 2007-2013 valuable contribution to minimise the environmen- and will be implemented in 2010-2013. tal impact of elderly daily life activities. BSR InnoShip aims to fi nd innovative solutions Th e project “TRES - Towards Regional spEcial- and incentives in implementing the sulphur directive isation for Smart growth spirit” is led by Fundación revision. Without these solutions, shipping, as well TECNALIA Research & Innovation, Spain. TRES as economies around the Baltic Sea that depend on aims to mobilise the innovation potential and ca- shipping, could face very high costs after the direc- pacity of regions towards smart growth. TRES will tive enters into force on 1 January 2015. also foster a clearer understanding of the role regions In 2012, an interactive platform, Clean Ship- have to play in EU2020 and to better face new op- ping Currents, was developed in BSR InnoShip. portunities by creating collaboratively and pushing Clean Shipping Currents serves as a rapid public- clusters for change. TRES brings together a good private information-sharing platform around the representation of the EU’s diverse innovation geogra- Baltic Sea Region and acts as a compendium of phy and multiple ways of addressing the innovation knowledge, receiving material from major schol- challenges and paradigms. arly institutions and the private sector in the Baltic Th e third project, “SMART EUROPE - Smart Sea Region. In 2012, other BSR InnoShip activi- strategies to create innovation-based jobs in regions ties included cost effi ciency estimations of abate- of Europe”, is led by Province of Flevoland, Neth- ment techniques and of international ship emission erlands. In SMART EUROPE, project partners regulations, projections of emissions of shipping, from 11 European countries will exchange policies and a ship emission measurement fi eld campaign and instruments for identifying and supporting the carried out in St. Petersburg ports. Furthermore, main regional economic actors that can generate various clean shipping events have been organized job opportunities in the innovation-based sectors in diff erent locations in the Baltic Sea Region. Th e of their economy. Both 36-month projects will be BSR InnoShip solutions have been also promoted implemented in 2012-2014. in connection with various major BSR events, in- On the national level, BIF, together with a cluding BDF Summit, as well as through the politi- Finnish management consulting fi rm MDI Ltd., cal processes of HELCOM. consulted southern Finnish regions in their BSR- In the EUSBSR Priority Area 4, BIF is also in focused smart specialisation strategy processes dur- charge of a European Commission-funded project ing the year 2012. “Strengthening stakeholder engagement, dissemi- One of the key 2012 BIF activities contributing nation and coordination of joint activities in the to the EUSBSR was the hosting of the 11th Scan- EU Strategy for the Baltic Sea Region Priority Area Balt Forum in Tampere, Finland on 20-23 Novem- 4.” Th e idea is to support the ongoing actions in the ber 2012. From all over the ScanBalt BioRegion, Priority Area 4 in their common goal to make the over 120 people gathered in Tampere Hall to dis- Baltic Sea Region a model area for clean shipping. cuss the current state and future prospects of health In 2012, various stakeholder events were organised, and life sciences in the region, and to gain fresh including a workshop on no-special-fee systems for contacts and perspectives. Th e ScanBalt Forum in ship-generated wastes in the Baltic Sea area in Co- Tampere was particularly interested in opening the penhagen on 5 November 2012. ScanBalt community up to new opportunities in BIF contributes to European-wide promo- the growing Russian health and life science fi eld. tion of the EUSBSR and dissemination of BSR best practices on innovation policies and instruments by partnering in three EU INTERREG IVC programme projects. Th e INNOVAge project (2012-2014), led by Marche Regional Authority, Italy, aims to help older people live independently for longer in their own homes by increasing their The Pan-European Institute (PEI), founded autonomy and by emerging of new ‘technological in 1987, is an academic research center at Turku supply chains’ associated with new developments, School of Economics, University of Turku, Fin- like independent living and eco-innovation, with a land. PEI analyses the economic development in

STATE OF THE REGION REPORT 2013 87 SECTION B Collaboration in the Baltic Sea Region

the Baltic Sea region countries, the Arctic region in which the Centre disseminates information and and Eastern Europe, with a particular focus on organizes events related to the region. Russia, Belarus and Ukraine. In 2012, Centrum Balticum opened interactive PEI’s research activities have recently concen- webpages and a databank in order to help the dis- trated on issues such as maritime cluster, FDI, re- semination of the Baltic Sea region-related infor- gional development, innovation, and energy in the mation in Finland and abroad. Th is year Centrum Baltic Sea region. Th e PEI staff has frequently acted Balticum has begun to publish a new Baltic Sea as experts for both Finnish and foreign institutions, Policy Briefi ng Series. Th e Baltic Sea Policy Brief- such as the Prime Minister’s Offi ce, several Finn- ing is an international forum for experts, who want ish ministries and the Parliament of Finland, the to view events, studies, developments and future European Commission, the European Parliament, trends from the Baltic Sea Region standpoint. Th e and the United Nations. Centre publishes also a weekly Baltic Sea region Since 2004, PEI has published Baltic Rim Econ- column, called Pulloposti, in Finnish. Currently, omies (BRE) review, which focuses on the develop- several thousand Finns interested in the Baltic Sea ment of the Baltic Sea region. Over 1000 leading region aff airs receive these columns written by the experts, including EU commissioners, ministers, top professionals in their fi elds. Moreover, the Cen- members of parliaments, CEOs of leading corpora- tre has recently started to sponsor the Baltic Rim tions, academics, and researchers, have contributed Economies review, which is distributed to 80 dif- an article to the review (www.utu.fi /pei). ferent countries. PEI also provides some half dozen courses Centrum Balticum organizes annually the Bal- in English at Turku School of Economics under tic Sea Forum, which gathers hundreds of Finland’s the subject heading of international business. Th e leading experts on the Baltic Sea region. In 2013, courses are particularly related to the Baltic Sea re- the Baltic Sea Forum is arranged for a sixth time, gion and Russia, such as “Business in the Baltic Sea and this year the forum focuses on Russia and new Region”, “Th e Development of EU-Russian Eco- challenges in the Baltic Sea Region. In addition to nomic Relations”, and “Investment Opportunities the national forum, the Centre organizes smaller in Eastern Europe”. events, such as luncheon seminars with the ambas- In 2012, PEI celebrated its 25th Anniversary sadors of the Baltic Sea region states as well as other by organizing a high-level seminar “Th e Baltic countries and the Baltic Sea region brainstorms Sea region 2025” at Turku School of Economics, with the Finnish researchers and media. Turku, Finland. Th e seminar dealt with the Baltic Th e Centre participates in international pro- Sea region’s future challenges and opportunities in jects as a coordinator, a disseminator of informa- the fi elds of security, economy and environment, tion and an organizer of events. At the moment, for and gathered together policy-makers, corporate de- instance, Centrum Balticum co-ordinates on the cision-makers and representatives of the Academia behalf of the City of Turku the Baltic Sea Chal- of over 10 diff erent countries. lenge initiative, which is a collaborative environmental eff ort with the City of Helsinki. Th e Cen- tre is also a partner in an international consortium SmartComp, which develops the competitiveness of the region in general and shipbuilding in particular. Th e Centre supports the activities of its Centrum Balticum (http://www.centrumbalti- sister organization, the Protection Fund for the Ar- cum.org/en/) is Finland’s premier think tank on chipelago Sea. Centrum Balticum also contributes the Baltic Sea region. Th e Centre was established to the Turku Process, a process aiming at bringing by the City of Turku together with four other Finn- Russia’s Baltic regions into closer interaction with ish cities, three universities based in Turku, and the the EU’s Baltic Sea region policy. Regional Council of Southwest Finland in 2007. Centrum Balticum together with the main Finn- ish research institutes and researchers specializing in the Baltic Sea region form a national network,

88 STATE OF THE REGION REPORT 2013 SECTION B Collaboration in the Baltic Sea Region

2 The EU Baltic Sea Region Strategy

In this section, the European Commission provides at Strategy level; however, the work on setting an update on recent developments within the con- targets and indicators at priority area and hori- text of the EU Strategy for the Baltic Sea Region zontal action level will be continued in 2013; (EUSBSR) and a number of the key project clusters • the roles and responsibilities of the main imple- supported through the EU’s Interreg Program for menting stakeholders (Commission, national the Baltic Sea Region are profi led. contact points, priority area coordinators, horizontal action leaders, etc.,) have been clearly defi ned; 2.1 EUSBSR – EU Commission Update • some rearrangements of priority areas and horizontal actions have been made. Th e updated Action Plan includes a new priority area ‘Cul- ture’ and the former sub-priority areas ‘Edu- cation’, ‘Tourism’ and ‘Health’ became fully- fl edged priority areas; Responding to the request of the General Aff airs • the number of horizontal actions was decreased Council in its Conclusions (November 2011) ‘to to fi ve focusing on spatial planning, multi-level review the EU Strategy for the Baltic Sea Region governance, cooperation with neighbouring (EUSBSR) by early 2012’, the Commission pub- non-EU countries, branding and regional iden- lished a Communication on the EUSBSR in March tity, as well as on sustainable development and 2012. Th e Communication 1) specifi ed three over- bio-economy; all and mutually reinforcing objectives for the • the revised Strategy and its Action Plan (the Strategy: ‘Save the Sea’, ‘Connect the Region’ and new objectives, targets and indicators) are fully ‘Increase Prosperity’, 2) provided concrete propos- in line with and contribute to the objectives of als for the setting of measurable indicators and the Europe 2020 Strategy; targets for each objective, 3) clarifi ed the roles and • the involvement of regions, as well as region- responsibilities of the main stakeholders of the al and pan-regional organizations have been Strategy. In June 2012, the General Aff airs Council strengthened: several regions, for example, Re- endorsed the revised EUSBSR as presented in the gion Västerbotten and Kalmar, City of Turku Commission’s Communication (March 2012) lead- (Finland) and regional and pan-regional or- ing to changes in the Strategy and its Action Plan. ganizations such as the Baltic Metropoles Net- Aiming to refl ect the new focus of the Strat- work, the Baltic Development Forum, the Nor- egy (introduction of three objectives, targets and dic Council of Ministers, the Council of Baltic indicators at Strategy level), the EUSBSR Action Sea States Secretariat, the Baltic Sea NGO Plan has been reviewed at the second half of 2012 Network, the Visions and Strategies around the and adopted at the end of February 2013. Th e re- Baltic Sea (VASAB) and the Helsinki Commis- vised Action Plan comprises 17 priority areas and 5 sion (HELCOM) have been appointed priority horizontal actions, about 100 fl agship projects and area coordinators or horizontal action leaders. 40 potential fl agship projects. Th e main changes in the Action Plan are the following ones: In order to facilitate the implementation of the • the structure of the Action Plan has been modi- EUSBSR and support the preparation of projects fi ed from four pillars to three objectives – ‘Save addressing challenges listed in the EUSBSR Action the Sea’, ‘Connect the Region’, and ‘Increase Plan, the EUSBSR Seed Money Facility became Prosperity’; operational in February 2013. Th e facility focuses • targets and indicators have been introduced on the preparation phase of project applications at Strategy level, as well as priority area and contributing to the three objectives of the Strategy. horizontal action level in coherence with and Th e preparation phase funded by the Facility covers complement those targets and indicators fi xed the planning of the ‘main project’ activities and the

STATE OF THE REGION REPORT 2013 89 SECTION B Collaboration in the Baltic Sea Region

budget, as well as investigation of potential future holders of the EUSBSR and the EUSDR, as well as funding sources. It also enables networking activi- independent assessments of external experts from ties aimed at building strategic partnerships and ex- the environment; innovation and competitiveness; change with the responsible priority area co-ordina- spatial planning; and governance perspectives and tors and horizontal action leaders of the EUSBSR other relevant material (implementing reports, aca- Action Plan. If the main project focuses on invest- demic literature and etc.) have been used. ments, the Facility can also support preparation of Th e assessment of macro-regional strategies pre-investment studies. Approximately EUR1.3 mil- reveals several key important aspects: 1) the need lion has been allocated to the Facility. Investitions- of prioritization and concentration on several truly Bank Schleswig-Holstein, which is also the manag- macro-regional issues which require cooperative ac- ing authority of the Baltic Sea Region programme tions and cannot be satisfactorily addressed by any for 2007–2013, was appointed to manage it. country acting alone. 2) Th e need to embed the priorities of macro-regional strategies in all relevant existing national, regional and EU policy frame- The updated EU Baltic Sea Region works and funding sources (not limited only to the Strategy Cohesion Policy programs, especially European territorial cooperation) to ensure that a macro- Objectives and Priority Areas regional strategy is a ‘living’ strategy that brings benefi t to the people living in specifi c geographical area. Now, when preparation phase for the next Agri Innovation Bio Ship Market SME (2014–2020) programming period is taking place, Hazards Safe Culture Health ±0) is the right moment from the beginning to en- Nutri Secure Toursim Education sure that the priorities of macro-regional strategies Increase Save the sea Connect the region prosperity would be taken into account in designing the relevant EU, regional, national programmes. 3) Long- term high-level political commitment towards the

Transport Crime macro-regional strategies and its translation into Energy concrete actions is crucial in ensuring the success of macro-regional strategy. Also the strategy should Horizontal Actions be more run by Member States / regions concerned, Spatial Neighbours Involve Sustainable Promo rather than Commission. It is worth noting that the Commission is put- ting a lot of eff orts to embed the EUSBSR in the Responding to the request of the General Aff airs relevant future (2014–2020) policy frameworks at Council in its Conclusions (April 2011) ‘clarify EU, national and regional levels. Several meetings the concept of macro-regional strategies, to evalu- involving key stakeholders of the EUSBSR, man- ate their value added and submit the outcomes to aging authorities on embedding of the EUSBSR the Council and the European Parliament by June into future (2014–2020) programs, with specifi c 2013’, currently the Commission is undertaking an focus on country-specifi c ones, have been organ- evaluation on the added value of macro-regional ized in Arlanda (Sweden) on 11 January, 2013 and strategies. An evaluation of two existing macro- Espoo (Finland) on 11 April 2013. Th is is espe- regional strategies –the EUSBSR and the EU Strat- cially crucial at the current stage (drafting process egy for the Danube Region (EUSDR) – aims to of programs), as the objectives and priorities of the provide information on their eff ects to date and an EUSBSR, contrary to the current (2007–2013) important input in developing the further macro- programing period, could be taken into account regional strategies. Th e results of evaluation will be from the beginning of the design phase. published in the Commission’s Communication by the end of June 2013. In assessing the added-value of macro-regional strategies the results of the survey of the key stake-

90 STATE OF THE REGION REPORT 2013 SECTION B Collaboration in the Baltic Sea Region

2.2 Impressions from the EU Interreg small and medium sized enterprises in the Baltic program Sea region. Th e projects represented in the cluster have Th e Interreg program is the traditional EU fund- a total participation of 195 project partners and ing instrument to support cross-border projects. Th e range from projects supporting the fi nancing of in- projects supported have recently been organized in novations, strengthening the cooperation between four project clusters to enhance coherence and en- SMEs and other innovation stakeholders like uni- able a better alignment of the project work with the versities and research institutes to investing in the EU Strategy for the Baltic Sea Region. Th ese project innovation in the long run, by improving qualifi ca- clusters focus on Innovation for SMEs, the environ- tions and educational systems. Th e ten projects of ment, transport, and energy effi ciency. Th e fi rst three the cluster are: of these clusters are profi led in this section. • BSHR HealthPort4, coordinated by ScanBalt, brings together innovative SMEs and health care organisations to strengthen the Health Economy and fi ght the bottlenecks in health care innovations. Th is sector is not only a cost Innovative companies are the key for a competitive for society but also as a driver of a competitive Baltic Sea Region. In particular small and medium- and knowledge based health economy. Tack- sized enterprises (SMEs) are the backbone and the led are the insuffi cient exploitation of ideas driving force of the social and economic develop- from health care researchers and practitioners ment of the area. Over 99% of all enterprises in the and procurement practices that limits access of region are SMEs, providing up to 70% of all jobs. SMEs to the health care market. Between 2002 and 2010 about 85% of net new jobs • Baltic Supply5, a project led by the Bremen were created by small and medium sized enterprises, Ministry of Economic Aff airs, Labour and most patents registered by this group, establishing Ports, aimed at strengthening the supply econ- it the most signifi cant growth driver. However, due omy. Th is project was unique since a sister pro- to relative high tax and social costs in the Baltic Sea ject was implemented at the same time for the Region, the local companies cannot compete with North Sea Region, North Sea Supply Connect. other countries in terms of prices, but only with high Both projects joined forces to set up a Euro- quality products and services. To stay competitive pean Business Support Network6, that off ers on the global market versus low labour cost coun- support to SMEs offl ine and online. Th e online tries like China, the regional enterprises must cre- platform, that is also linked to the Enterprise ate products and services of high quality and exploit Europe Network is still growing and active af- their full innovation potential. ter project end, hosted and administrated by To share best practices, learn from previous pro- the Hanse-Parlament. jects and identify the future needs, the Baltic Sea • BSR QUICK7, coordinated by the Hanse-Par- Region Program initiated the cluster “Innovation lament with 40 formal partners and 42 associ- in SMEs” in September 2012 bringing together 15 ated partners one of the biggest projects, bridg- partners from 11 countries, representing 10 inno- es the so far missing institutional link between vation projects that are or have been co-fi nanced the academic world and SMEs by establishing by the European Union within the framework of the Baltic Sea Academy at the very beginning INTERREG IVB. Almost all of these projects are of the project in 2010. Th is unique network of also Flagship Projects of the EU Strategy for the 15 universities and polytechnics realizes tan- Baltic Sea Region (Priority Area 7, 8 and 12). gible R&D solutions and transfer of innova- Th e cluster is coordinated tion and create trainings and study curricula by the Hanse-Parlament, an specifi ed to the needs of SMEs in the region. organization of 50 Chambers of Already during the project concrete invest- Crafts, Commerce and Industry 4 www.scanbalt.org established 1994 with the com- 5 www.balticsupply.eu 6 www.eubizz.net mon objective to promote the 7 www.bsr-quick.eu

STATE OF THE REGION REPORT 2013 91 SECTION B Collaboration in the Baltic Sea Region

ment plans and R&D solutions for more than from Latvia, Sweden, Poland, Germany, Nor- 680 SMEs were realized, training courses and way and Belarus cooperate and communicate study courses developed and put into action. on regular basis using the created Internet plat- Th e Baltic Sea Academy is cooperating very form. Th e network helps business incubators closely with the Hanse Parlament, building a to off er business support services based on best powerful innovation platform between SMEs practice examples in the region. representatives like chambers and universities • QUICK IGA12, led by the Hanse-Parlament, for the benefi t of the companies in the region. identifi ed the lack of available personnel as one • BONITA8, led by the University of Bremen, of the hindrances for innovation growth. Also aimed at bridging the knowledge gaps be- studies have shown, that a higher diversity of tween universities, laboratories, industrial ac- work force positively infl uences the innovation tors and policy makers. Th e project has a focus climate in a company. Th us the project is sup- on the scientifi c technology transfer. Th e ISO/ porting the reintegration of elderly employees IEC15504 standard based model innoSPICE in companies and promoting a higher rate of as a result of the project provides the base to female employees and female entrepreneurship. improve the processes of organizations work- Th e project implements a north-south transfer, ing in the fi eld of innovation, knowledge- and learning from Nordic countries that have for technology transfer. example a much higher percentage of female • JOSEFIN9, represented by Teknikdalen, iden- employees than for example Poland. tifi ed lack of access to suitable fi nance as a • BSRInnoReg13, led by the Baltic Institute, main barrier to internationalization for innova- improved strategic know-how of business de- tive SMEs from the Baltic Sea Region. Th e goal velopment organisations operating outside of the project was to promote innovation and metropolitan areas. Th e project helps busi- internationalization in SMEs by facilitating ness development organisations to develop better access to fi nance. Th e project was based their business and innovation support services on two main pillars; the individual coaching of for small and medium-sized enterprises. Th e SMEs and the provision of fi nancial support. project brought local and regional decision- • BSRStars10, coordinated by Vinnova, brings makers together to discuss global economic together diff erent stakeholders from the Baltic challenges and agree on an Innovation Poli- Sea Region and started to promote SMEs in cy Memorandum fi ve areas. Th e overall objective is it to fi nd new • BASIC14, represented by Technopol, build a answers for societal challenges that the people “Baltic Sea Archipelago of Innovation”. Th e around the Baltic Sea are facing. Increasing objective is to create a seamless working envi- water pollution and an ageing population are ronment for fast growth innovative companies, just two examples of those. One of them is can embedded in a reliable network of leading Sci- be considered a good example for smart spe- ence Parks and clusters. Emphasis is given to cialization is “Comfort in Living”, linking Pol- identify, select, train and coach SME-gazelles; ish wood technology with Danish design and to provide them harmonized access to mar- Swedish furniture entrepreneurs. Th e project kets and to connect them for access to fi nance develops products and services that improve for internationalization and growth. During the quality of life for elderly people in their the project a Market access guide for SMEs homes, and has developed a strategic action was compiled with market access information plan until 2020. about all BSR countries.. • IBINET11, represented by Riga Planning Au- • During the run of the cluster, two projects that thority, enhancing the cooperation of business support high-tech innovations in SMEs joined: incubators in the region. Now more than seven PlasTep15, focused on objective to push plasma business incubators and technology centres based cleaning technologies of atmospheric air

8 www.bonita-project.eu 12 www.quick-iga.eu 9 www.joseﬁ n-org.eu 13 www.baltic.org/bsrinnoreg 10 www.bsrstars.se/stardust/ 14 www.basic-net.eu 11 www.ibi-net.eu 15 www.plastep.eu/

92 STATE OF THE REGION REPORT 2013 SECTION B Collaboration in the Baltic Sea Region

and water treatment to a visible practical ap- Agro Business Park, Denmark (Baltic Manure, Bal- plication and ScienceLinks16, a network be- tic Compass); Baltic Environmental Forum Lithu- tween leading research facilities of photon and ania (Baltic Compass, COHIBA); JTI – Swedish neutron sources and their users. Institute of Agricultural and Environmental Engi- neering (Baltic Compass); Knowledge Centre for Th e cluster is not oriented at the past only, but also Agriculture, Denmark (Baltic Deal); MTT - Agri- elaborating the future needs when it comes to boost Food Finland (Baltic Manure, Baltic Compass, Be- the innovative capacities in SMEs around the Bal- ras Implementation); Södertälje Municipality, Swe- tic Sea Region. For this purpose a survey has been den (Beras Implementation) ; Tallinn University of conducted in spring 2013 that is currently in the Technology, Estonia (Baltic Compass, COHIBA); evaluation process. Th e future recommendations Technical University of Hamburg, Germany will be published in autumn 2013 (www.bsr-inno- (SMOCS); Technical University of Lodz, Poland vation.eu). Besides a comprehensive printed pub- (Waterpraxis); Union of the Baltic Cities, Finland lication, a summarized policy paper will be intro- (PURE, Presto); and the University of Rostock, duced to political stakeholders. Germany (Baltic Manure). First interesting fi ndings indicate that there is a Upon initiative of the programme, the partners very high interest not only in innovations concern- – all concerned with the quality of the Baltic Sea ing products, but also soft or organizational inno- waters –have formed a cluster to satisfy the need for vations seem of particular importance for compa- more visibility for individual project results and to nies in the Baltic Sea Region. Again it seems, that ensure closer cooperation as the problems and also the countries south of the Baltic sea, like Germany, their solutions are intertwined. Baltic Impulse aims Poland or Lithuania are interested to learn more to gather the existing projects results, fi nd syner- about how Nordic countries, like Norway or Swe- gies between them and highlight the bridging ele- den, boost entrepreneurship and also use the in- ments and themes between the project fi elds. Bal- novation potential of every employee by allowing tic Impulse organises workshops in order to collect diff erent working climates. Remarkable is also that and exchange experiences from the partnership. the lack of qualifi ed personnel seems to be a major A synthesis report will be produced based on the barrier for innovation growth in companies, asking workshop outputs. Th e main theme of the report is for improved qualifi cation and education systems. Sustainable Resource Management. Examples of the region wide projects are Baltic Impulse is an envi- (http://www.helcom.fi /projects/en_GB/projects/): ronmental project cluster • Baltic Compass includes a list of prioritized fi nanced by the Baltic Sea agri-environmental measures and a survey of Region Programme 2007- their usage and the mapping of erosion and 2013 and operational be- phosphorus vulnerable areas tween September 2012 and • Baltic Deal develops guidelines for water- September 2013. Th ere are catchment based advisory methods – ”bottom 15 partners in the cluster, and they represent their up processes”, and enables the sharing of infor- involvement in the projects Baltic Compass, Bal- mation about the best and most eff ective envi- tic Deal, Baltic Manure, BERAS Implementation, ronmental practices COHIBA, PURE, PRESTO, SMOCS or Water- • Baltic Manure generates a united database of praxis. Th e partnership for saving the Baltic Sea unprocessed and processed manures, soils (P Waters consists of fi fteen partners coordinated by supply) and manure-based energy potentials, the Baltic Sea Action Group, Finland (Baltic Com- and develops recommendations for environ- pass). Other members are SYKE, Finnish Environ- mentally sound manure management technol- ment Institute (Baltic Compass, COHIBA, Wa- ogy chains terpraxis, Baltic Manure, Beras Implementation); • BERAS Implementation develops a concept Århus University/ENVS, Denmark (Waterpraxis); and demo farms for Ecological Recycling Ag- HELCOM (PURE, Baltic Compass, COHIBA); riculture

16 http://www.science-link.eu/

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• COHIBA aims to develop cost-eff ective water Th e green corridor concept, promoted by the quality monitoring practices European Commission in the EU Strategy for the • PURE and PRESTO are about transnational Baltic Sea Region and in the EU Freight Transport investments to reduce nutrient load to the Bal- Logistics Action Plan, became a particular area of tic Sea, the enhancement of phosphorus re- interest for the cooperating projects. In late 2009 moval at selected municipal wastewater treat- they drew agreement on joint green transport corri- ment plants, and better handling of sewage dor activities with the Swedish government (Minis- sludge through recovering nutrients try of Enterprise, Energy and Communications) as • SMOCS focuses on a participatory approach the latter, pursuant to the Commission guidance, for guideline comprising knowledge and prac- took an initiative to facilitate the establishing of tice regarding the handling alternatives for ‘green transport corridors for freight’ in the Baltic dredged sediments. Sea Region. Th e purpose of the agreement was to • Waterpraxis creates institutional arrangements specify the division of labour and harmonisation for implementation of Water Framework Di- measures in tackling the concept in the forthcom- rective and the eff ect for integrated water man- ing years. agement. Th rough several open workshops and seminars on scaling the green corridors concept and applying it in practice, the cooperation group extended to, altogether, cover about 12-14 transnational and cross-border projects representing the Baltic Sea, North Sea and Central Europe programme areas, Th e thematic cluster of transport projects under the the Commission (DG MOVE, DG REGIO), co- Baltic Sea Region Programme has its origin in the ordinators of Priority Area Transport in the EU umbrella cooperation (www.transportcluster.eu). Strategy for the Baltic Sea Region, secretariat of As early as in 2009 the three transnational pro- the Northern Dimension Partnership on Transport jects: TransBaltic, EWTC II (East West Transport and Logistics and – from time to time – interna- Corridor II) and Scandria signed a letter of under- tional fi nancing institutions (e.g. EIB, NIB). standing to cooperate and to coordinate thematic Th is so called umbrella, animated by Trans- activities. Baltic, became an informal meeting place to share TransBaltic was endorsed by the BSR Pro- experience on investigating and testing transport gramme authorities as a strategic project on account greening solutions, plan joint events to disseminate of, inter alia, a distinct macroregional dimension of work results, and develop joint standpoints on EU activities. For that reason, it was felt that TransBal- transport and regional policies. In eff ect, the um- tic might provide support to the two other (corri- brella cooperation helped develop a Macroregional dor) projects by setting a macroregional context of Transport Action Plan – a strategic document with their investigations in the specifi c (southern) part policy actions aimed to create better interfaces be- of the Baltic Sea Region, with such aspects as: glob- tween the national transport networks and make al trends in transport patterns, implications of the the sustainable multimodal transport system in the revised EU transport policy for sustainable growth Baltic Sea Region more resilient to future trends in the BSR, relations with the EU neighbouring and challenges (www.transbaltic.eu). countries etc. Importantly, the umbrella cooperation has Also, TransBaltic was expected to generalise raised awareness of the participating projects that results of EWTC II and Scandria as possible mac- the target groups identifi ed by each of them indi- roregional solutions addressing specifi c transport vidually are in fact shared and that certain policy- development challenges and policy trends. Further, related aspects may be addressed with a ‘stronger TransBaltic off ered to arrange a forum for EWTC voice’ when doing so in unity. Th is allied approach II, Scandria and other corridor projects from vari- induced by the umbrella cooperation has been perous parts of the BSR to discuss fi ndings with public ceived a notable catalyser of policy changes at the and private stakeholders and thereby receive guid- upper governance tiers. Th ese have resulted in: (1) ance for further work. incorporation of the green corridor concept in the

94 STATE OF THE REGION REPORT 2013 SECTION B Collaboration in the Baltic Sea Region

TEN-T guidelines, and (2) fostering of a network Th e cluster features certain bundled activities, of green transport corridors (instead of loose cor- like: cooperation platform, green corridor bench- ridors) as a fl agship and desired aim in the Priority marks, dialogue with policy stakeholders, fi nan- Area Transport in the EU Strategy for the Baltic cial mechanisms for investments in BSR transport Sea Region. and logistics; and input to the next programming Th e bottom-up formed umbrella cooperation period. Discussion papers, reports and interfacing won acknowledgment of the BSR Programme au- sessions (e.g. think-tanks) are meant to map the thorities and – upon completion of the three found- individual fi ndings in the thematic areas, compile ing projects (TransBaltic, EWTC II and Scandria) them and process towards joint solutions. in late 2012 – received an invitation to set up a Th e component of green corridor benchmarks formal thematic cluster for the one-year period. features so called blueprints - in other words: gen- Th e cluster – operating on the programme grant – eralised solutions for the green corridors, which is established by eight leading organisations of the stem from the market needs, are customised to the former umbrella projects (TransBaltic, EWTC II, transport and logistics specifi city of the BSR, and Scandria, Rail Baltica Growth Corridor, BSR In- are benefi cial for the sustainable regional develop- noShip, Amber Coast Logistics, Baltic.AirCargo. ment in the BSR. Th ey will be prepared based on Net and Bothnian Green Logistics Corridor). In individual deliverables (such as: Green Corridor addition to the formal partnership, several other Manual, business cases for the green transport, projects take part in the cluster meetings and con- Travel Planner, common service model for logistics tribute to the thematic work. Th e cluster contin- centres, information broker system, guideline and ues the umbrella cooperation formula. It aspires management plan for regional logistics integration to strengthen complementarities and synergies etc.), enriched with questionnaire results and com- of individual results, provide a joint and harmo- municated to the policy and business groups. nised contribution to the EU Baltic Sea Strategy Th e cluster cooperation has reached the mid- and the EU transport and cohesion policies, and to term stage and will be concluded in September promote a corridor approach in strategic transport 2013. Its preliminary results in the context of planning in the BSR at the EU, macroregional, na- transport greening policies will be presented at the tional and regional levels. Th ereby, the cluster en- policy conference held in Brussels on 4 June 2013. sures better visibility of the BSR Programme to a broader public and the wider practical application of the programme outcomes.

STATE OF THE REGION REPORT 2013 95 SECTION B Collaboration in the Baltic Sea Region

3 International Financial Institutions in the Baltic Sea Region

3.1 Nordic Investment Bank also provides loans to local banks as intermediaries for on-lending to small- and medium-sized compa- Th e Nordic Investment Bank (NIB) is a regional nies, or to fi nance investments in smaller-scale pro- multilateral fi nancial institution in the Baltic Sea jects, such as local renewable energy. Region with eight member countries: Denmark, Es- In 2012, the infrastructure and telecom sec- tonia, Finland, Iceland, Latvia, Lithuania, Norway tor was the largest recipient, receiving one third of and Sweden. Th e main part of NIB’s lending is tar- the new loans, directed towards road construction, geted at the bank’s member countries, as well as at railways, ports, broadband and mobile phone net- the neighbouring area, with annual commitments in works. Over time, the largest sector of activity for support of investments in the Region on the level of NIB is energy. EUR1.8-2.4 billion over the last three years Security of supply and environmental sustainability are key challenges for the energy sector in Approved 2010 2011 2012 the Baltic Sea Region. Enhanced integration of re- Denmark 137 271 229 gional energy transmission in electricity and gas is Estonia 39 0 65 a necessity for an eff ective market, and this requires Finland 658 460 271 investments in interconnectors, pipelines and dis- Latvia 21 14 20 tribution systems. A further increase of the share Lithuania 20 21 87 of renewable energy is also dependent on improved Poland 74 130 0 regional transmission capacity. NIB is participating Sweden 642 283 1109 in a number of priority projects, among others in the context of the Baltic Energy Market Intercon- Iceland 0 51 0 Norway 120 545 553 nection Plan. Th e implementation and development of re- Russia 150 68 110 newable energy systems and technologies is also a TOTAL 1861 1843 2444 priority area for NIB. Th e most important renewable energy sources with regard to their energy NIB provides long-term complementary fi nanc- potential are hydropower (mainly focusing on in- ing, based on sound banking principles, to projects creased effi ciency in existing plants), biomass (usu- that strengthen competitiveness and enhance the ally with a combined heat and power output), wind environment. All project proposals are evaluated power (both land-based and off shore) and geother- against the mandate outlined in the bank’s strat- mal power. egy, announced in 2006. Only those that obtain a In the area of climate change, since 2008 NIB high enough mandate rating are accepted for fur- has been operating a special lending programme: ther consideration. the Climate Change, Energy Effi ciency, and Re- High mandate fulfi lment is, in NIB’s experience, newable Energy facility (CLEERE). In 2012 the achieved particularly well in certain sectors of the programme, which had been increased several economy, namely environment, energy, transport, times, reached full utilization at EUR4 billion for logistics and communications, and innovation. In projects addressing climate change mitigation and addition, the bank also lends to projects in the man- adaptation, primarily in the energy sector, but also ufacturing and service sectors. NIB defi nes loans to in industry and transports. projects with signifi cant direct or indirect positive NIB takes part in regional co-operation fora environmental impacts as environmental loans, re- with the aim of supporting the implementation of gardless of the industrial sector in which they occur. priority projects. Th e key issue from the fi nanc- In net terms, environment-related lending accounted ing perspective is to be able to identify bankable for 32% of agreed-upon loans in 2012. Th e Bank investment components. As experience shows, the

96 STATE OF THE REGION REPORT 2013 SECTION B Collaboration in the Baltic Sea Region

process from the strategy level to concrete imple- EUR500 million in a special Baltic Sea Environ- mentation is frequently complicated. At best, strat- ment Financing Facility (BASE) to provide loans egies and policies provide clear guidance and help supplementing the financing through national to set priorities, which in turn create a good basis budgets and EU structural and cohesion funds, in for investment decisions and resource mobilisation, order to fi nance measures that reduce pollution. but this requires a targeted eff ort. Two thirds of this envelope has so far been allo- Th e EU Strategy for the Baltic Sea Region has cated. established a framework for this co-operation, lay- To support the preparation of BSAP-related ing down priority areas and identifying fl agship projects, NIB and the Nordic Environment Fi- projects. Th e revised priorities set out by the Strat- nance Corporation (NEFCO) took the initiative egy, with its strong emphasis on the fi elds of envi- to establish a special trust fund, the “BSAP Fund”, ronment, energy and transport, correlate well with which was set up in 2009 with donor contribu- the aims of NIB, providing a good basis for the tions, initially from Sweden and Finland, amount- bank to be involved in supporting the implemen- ing to some EUR11 million. Th e purpose of the tation of the strategy. NIB is co-operating closely fund, managed jointly by NIB and NEFCO, is to with EIB and other partners in this respect. assist, through grants for technical assistance, the In the wider regional context, the Northern development of bankable projects that support the Dimension, based on an equal partnership between implementation of the BSAP. Th is fi rst phase of the the European Union, Iceland, Norway and Russia, has been fully committed and several projects are creates an important platform for co-operation. In currently in implementation. particular, the specifi c partnerships established under the Northern Dimension provide a framework for concrete activities. NIB plays an active role in 3.2 European Investment Bank the Northern Dimension Environmental Partner- ship (NDEP), which is co-ordinating the fi nancing Th e European Investment Bank’s lending volumes of environmental projects with cross-border eff ects in the Baltic Sea Region increased signifi cantly in in the Baltic Sea Region, the Barents region and 2008-2009 as the EIB responded to the fi nancial Northwest Russia, with projects benefi tting from crisis. In 2010 and in 2011 the lending volume fell grants from the NDEP support fund. In addition corresponding to the pre-crisis level. In 2012 the to Russia, Belarus has recently been approved as a lending was back at the same level as before the country of operations for the NDEP, and the fi rst crisis. Th e aggregate lending volume in the region emission reduction projects with EBRD and NIB over the fi ve past years amounts to EUR 47.4bn. as lead institutions have been agreed to. Th e total volume of approved loans in 2012 to the Th e most recent partnership is the Northern BSR was EUR 7.8bn (EUR 8.9bn in 2011). Dimension Partnership on Transport and Logistics Th e single most dominating country is Poland, (NDPTL). Its purpose is to facilitate co-operation which received almost 48% of the EIB loans grant- on and implementation of regionally important ed in the Baltic Sea Region in this period, followed transport infrastructure and logistics projects, with by Sweden 15% and the concerned Bundesländer a focus on removing bottlenecks from relevant cor- in Germany 13%. Th e most signifi cant sector in ridors. Implementation of such projects is expected Poland in terms of volume is the transport sector to benefi t from close collaboration with the IFIs, in- which received 56% of the EIB loans to Poland. cluding in relation to PPPs that can provide an eff ec- Th e remaining part was evenly distributed among tive mechanism for harnessing private sector compe- other sectors. In the other Baltic Sea Region coun- tence and funding capacity in support investments. tries, i.e. in the three Nordic countries Denmark, NIB supports the work of HELCOM in imple- Finland and Sweden, the most dominant sector is menting the Baltic Sea Action Plan (BSAP), which the industry. Th e EIB’s lending objectives support has been included as one of the priorities in the EU the activities in the region in line with the three Strategy for the Baltic Sea Region. Th e aim of the objectives of the EU Strategy for the Baltic Sea Re- plan is to restore the ecological health of the Bal- gion, namely to save the sea, to connect the region, tic marine environment by 2021. NIB has set aside and to increase prosperity.

STATE OF THE REGION REPORT 2013 97 SECTION B Collaboration in the Baltic Sea Region

EIB lending in the Region 2008-2012 Signatures 2008 2009 2010 2011 2012 EU Denmark 379.5 421.7 387.0 155.0 224.2 Estonia 87.0 841.5 75.0 183.0 122.4 Finland 710.0 1 145.0 1 000.8 1 403.2 544.2 Germany (1) 1 620.0 1 615.0 1 249.0 746.0 1 055.4 Latvia 860.0 285.0 100.0 36.0 100.0 Lithuania 10.0 1 169.0 47.0 10.5 3.2 Poland 2 837.0 4 783.9 5 563.9 5 279.1 4 440.4 Sweden 1 311.4 1 135.0 2 607.8 707.6 1 131.6 Candidate Countries Iceland 0 170.0 0 70.0 0 EFTA Norway 0 0 50.0 100.0 204.2 Eastern Europe Russia 0 132.5 250.0 100.0 0 Total 7 814.9 11 698.6 11 330.5 8 790.4 7 825.6

(1) In the German Bundesländer included in the Baltic Sea Region: Berlin, Brandenburg, Hamburg, Mecklenburg-Western Pomerania and Schleswig-Holstein.

Most of the EIB-fi nanced projects in the region (1) convergence, (2) regional competitiveness and support the EU Strategy for the BSR, many pro- employment, and (3) European regional coopera- jects being classifi ed as fl agship projects or projects tion in the EU. directly supporting the EU´s key objectives of the Th e rationale of the convergence objective is to Strategy. promote growth-enhancing conditions and factors An important part of the EUSBSR is the re- leading to real convergence for the least developed orientation of existing EU funded programmes in Member States and regions. Th ose regions eligible the region to make them support the strategy. Th e for such support are in EU terminology referred EIB co-fi nancing of EU funded programmes has to as “convergence regions”. In the Baltic Sea Re- been a vehicle in promoting a number of important gion, Estonia, Latvia, Lithuania, Poland and two investments in this fast growing region. Th e EIB German Bundesländer (Mecklenburg-Western Po- has approved a number of projects or programmes merania and the Northeast part Brandenburg, the that are fully or partly co-fi nanced with EU Struc- NUTs region Brandenburg-Nordost) are defi ned tural Funds. For the 2007-2013 programming pe- as convergence regions. Outside the convergence riod, EIB has up to date approved 15 Structural regions, the regional competitiveness and employ- Programme Loans (SPLs) with a total amount of ment objective aims to strengthen competitiveness, EUR 5.7bn in the BSR. As the EIB on average fi - attract investment and boost employment. Devel- nances on average 13% of the total project cost in opment programmes help regions to anticipate and the case of SPL, the EIB fi nancing supports a total encourage economic change through innovation investment cost of EUR 44bn in the region, which and promote the knowledge society, entrepreneur- is a major contribution to growth and employment ship, environmental protection and improved ac- in the BSR. Public investments included in these cessibility. More and better jobs are being support- programmes have been essential to counter-act the ed by adapting the workforce and by investing in economic and fi nancial crises. In a period with a human resources. weakened private sector, the investments in public In the EU Member States of the Baltic Sea Re- infrastructure have created new employment and gion, the EIB also provides fi nancing to small and spurred competitiveness in the region. medium-sized enterprises (SMEs) through credit In the 2007-2013 programming period the lines extended to local fi nancial intermediaries. Th e key objectives of the European Fund for Regional EIB funds are on-lent by these intermediaries to Development (ERDF), the European Social Fund eligible SMEs to help cover their capital expendi- (ESF) and the Cohesion Fund are to contribute to ture and working capital requirements.

98 STATE OF THE REGION REPORT 2013 SECTION B Collaboration in the Baltic Sea Region

Table. EU Funds co-ﬁ nancing in the Baltic Sea Region and EIB support 2007-2013 programming period Project cost Approved EIB Signed EIB loan’s share of Country Name of operation EUR m loans EUR m EUR m total project cost (%) Approved programmes Estonia EU Funds Co-Financing 2007-2013 (EST) 4 331 550 550 13% Latvia EU Funds Co-Financing 2007-2013 (LV) 5 834 750 750 13% Lithuania EU Funds Co-Financing 2007-2013 (LT) 9 564 1 132 1 132 12% Poland EU Funds Co-Financing 2007-2013 (PL) 20 855 2 130 2 000 10% Poland Mazovia Regional Infrastructure* 400 180 176 45% Poland Poznan Municipal Infrastructure* 209 81 81 39% Poland Poznan Municipal Infrastructure III* 333 145 145 44% Poland Gdansk Municipal Infrastructure II* 368 145 145 39% Poland Kraków Urban Infrastructure* 214 96 29 45% Poland Lodz Regional Infrastructure* 323 106 106 33% Poland Lodz Municipal Roads* 240 71 70 30% Poland Lublin Municipal Infrastructure* 386 126 126 33% Poland Malopolska Regional Infrastructure* 318 38 38 12% Poland Rzeszow Municipal Infrastructure* 231 69 69 30% Poland Szczecin Municipal Infrastructure III* 185 75 75 41% Poland Szczecin Municipal Infrastructure IV* 126 58 58 46% Poland Toruń Municipal Infrastructure* 189 67 19 35% Poland Zachodiopomorske Regional Framework* 284 84 84 30% Total approved projects 44 390 5 903 5 378 13% * Partly co-ﬁ nanced with the Structural Funds regional and municipal investment framework operation.

In a communication from the European Commis- gy transmission lines have also been high on the sion in 2012 the new overall objectives of the EU agenda. Th e EIB has also supported a large number Strategy for the Baltic Sea Region have been refor- of research, development and innovation projects mulated, and each objective has been accompanied in the Baltic Sea Region. In some countries of the by indicators and targets: to save the sea, to connect region RDI has become one of the most important the region, and to increase prosperity. Th ese three sectors for EIB fi nancing. All these factors brought objectives match closely with most of the priorities together pave the way for a green growth in the given to the EIB by the 27 EU Member States. As region. Th e Bank´s fi rm objective - while contribut- the Bank’s mandate is to support EU policy, the ing to the implementation of the EU Strategy for EIB has a special responsibility to contribute to the the region - is to remain the single most active mul- success of the EU Strategy for the Baltic Sea Re- tilateral fi nancing institution in the area and one of gion. It does so by supporting the implementation the leading lenders to fl agship projects. of the Baltic Sea Strategy in various ways, such as A number of special initiatives are of particular by fi nancing wastewater treatment plants in places relevance in the context of the Baltic Sea Strategy. that were classifi ed by the Helsinki Commission Th ese are the JASPERS (Joint Assistance to Sup- as hot spots, that is point sources of massive pol- port Projects in European Regions) programme, the lution. Within the framework of the Northern Di- JESSICA (Joint European Support for Sustainable mension Environmental Partnership, the Bank has Investment in City Areas) initiative, the JEREMIE co-fi nanced several high-priority projects to clean (Joint European Resources for Small and Medium- up pollution in the St Petersburg region. sized Enterprises) initiative, and the activities of Th e EIB has likewise fi nanced infrastructure EPEC (the European PPP Expertise Centre). Th e to integrate parts of the Nordic-Baltic area into a European Investment Fund, EIF, the risk-fi nancing larger Baltic Sea Region. EIB loans have gone to arm of the EIB Group, is active in the Baltic Sea bridges, tunnels, port facilities and railway links. Region by providing equity instruments, SME guar- Improved and safer energy production and ener- antees and fi nancial engineering products for SMEs.

STATE OF THE REGION REPORT 2013 99 SECTION B Collaboration in the Baltic Sea Region

JASPERS (Joint Assistance to Support Projects Mazovia (PLN 160m), Pomerania (PLN 236m), in European Regions) is a partnership between Silesia (PLN 250m), West Pomerania (PLN 149m) the European Commission (DG Regional Policy), and Wielkopolska (PLN 313m). By year-end 2012, the European Investment Bank (EIB), the Euro- UDFs operating under the above EIB Holding pean Bank for Reconstruction and Development Funds had signed agreements with close to 100 (EBRD) and KfW Bankengruppe (KfW). JAS- projects supporting sustainable urban transforma- PERS supports the implementation of cohesion tion in the Baltic Sea Region. Th is has so far in- policy in the programming period 2007-2013 by cluded energy effi ciency improvements as well as providing the twelve countries that joined the EU the creation and redevelopment of public spaces between 2004 and 2007 with specialist expertise and the support of transport, tourism, leisure, busi- for the preparation of projects to be submitted for ness incubation, offi ce, educational, medical and grant fi nancing from the Structural and Cohesion cultural facilities. Funds. Approximately EUR 354bn is available in Th e JEREMIE initiative off ers EU Member grants for the budgetary period 2007-2013. JAS- States, through their national or regional Manag- PERS activities in the Baltic Sea Region concern ing Authorities, the opportunity to use part of their the three Baltic States and Poland. Under the Bal- EU Structural Funds allocations to fi nance small tic Sea Strategy, JASPERS is willing to provide and medium-sized enterprises by means of equity, support in preparing fl agship projects to be co-fi - loans or guarantees, through a revolving Holding nanced with EU funds, at the request of a Member Funds, which acts as an umbrella fund. Th is initia- State and if agreed by DG Regio. JASPERS has tive was developed by the European Commission over 25 staff members in the EIB Offi ce in Warsaw and the European Investment Fund, which is part working in the Baltic Sea Region’s new Member of the EIB Group. Th e European Investment Fund States, in addition to those working in the Vienna (EIF) has successfully implemented JEREMIE and Bucharest external offi ces and at headquarters activities in both Latvia and Lithuania which has in Luxembourg, for a total of over 100 staff mem- involved investing over EUR 250m into the SME bers. As at 31.12.2012 the three Baltic States and fi nancing through selected fi nancial intermediar- Poland had submitted a total of 120 applications to ies. In addition, EIF has launched a EUR 100m the EC with the preparation support of JASPERS. Fund of Funds programme under the name of the JESSICA is an initiative developed by the Eu- ‘Baltic Innovation Fund’ in full partnership with ropean Commission and the European Investment the national agencies of LGA (Latvia), INVEGA Bank, in collaboration with the Council of Europe (Lithuania) and KredEx (Estonia). Th ese two types Development Bank (CEB). Member States are of investment initiative have contributed to a sig- given the option of using some of their EU grant nifi cant improvement in the private equity and funding, their so-called Structural Funds for the venture capital market development process across 2007-2013 operational programmes, to make re- the Baltic States. In addition, as a result of regional payable investments in projects forming part of an and national Evaluation Studies conducted by the integrated plan for sustainable urban development. EIF in Poland, the local authorities are proceed- With JESSICA the EIB has two roles in the Bal- ing to implement six diff erent JEREMIE Holding tic Sea Region. First, it assists Member States and Funds, at present without further EIF involvement. national authorities upon request through evalua- EPEC, the European PPP Expertise Centre is tion studies with assessing the potential for loans, a joint initiative of the European Investment Bank, guarantees and equity for urban development and the European Commission and European Union preparing the framework for the implementation Member States and Candidate Countries. It works of JESSICA. Secondly, it acts as the JESSICA to strengthen the capacity of its public sector mem- Holding Fund, to channel Structural Funds into bers to enter into public-private partnership (PPP) Urban Development Funds (UDFs) on behalf of transactions. It off ers a platform for PPP task forces national authorities in support of urban projects. in EU member and candidate countries to share Currently in the Baltic Sea Region, the EIB is act- experience and expertise, analysis and best practice ing as JESSICA Holding Fund in Lithuania (EUR relating to PPP transactions. Public authorities in 227m) as well as for 5 Holding Funds in Poland: Denmark, Finland, Latvia, Lithuania, Poland and

100 STATE OF THE REGION REPORT 2013 SECTION B Collaboration in the Baltic Sea Region

Germany are EPEC members. Th ey actively sup- the New Entrants Reserve (NER) set up for the port EPEC activities and their interest focuses on third phase of the EU Emissions Trading System the following areas of EPEC work programme: PPP (ETS). Th e funds from the sales are to be distrib- investment planning and project preparation, com- uted to projects selected through two rounds of bining EU funds and PPPs, the accounting and calls for proposals, covering 200 and 100 million statistical treatment of PPPs, and PPPs for trans- allowances respectively. NER300 is one of the European networks and energy effi ciency. world’s largest funding programmes for innovative ELENA – European Local ENergy Assistance low-carbon energy demonstration projects. Th e - is part of the EIB’s broader eff ort to support the programme acts as a catalyst for the demonstration EU’s climate and energy policy objectives. Th is of environmentally safe carbon capture and stor- joint EIB-European Commission initiative helps age (CCS) and innovative renewable energy sources local and regional authorities to prepare energy ef- (RES) technologies on a commercial scale within fi ciency or renewable energy projects by providing the European Union. Th e sale of emission allow- funds for technical assistance. In the Baltic Sea Re- ances is administered by the European Investment gion two projects have been signed up to date for a Bank. In the Baltic Sea Region the Commission total amount of EUR 5.5 million. One contract has has proposed fi ve schemes for awards to date, three been signed with City of Malmö concerning new in Sweden, one in Finland and one in Poland, for a tramway lines in Malmö, Helsingborg and Lund, total amount of EUR 225m. supporting a total investment of EUR 421m. Th e RSFF – Risk Sharing Finance Facility, is an second contract is signed with Region Zealand in innovative investment based facility established Denmark concerning investments in energy effi - by the Commission and the EIB that creates ad- ciency and renewable energy, supporting total in- ditional fi nancing capacity in support of eligible vestment cost of EUR 62m. RDI activities. In the period 2010 to 2012 EIB has NER300 is so called because it is funded from contributed EUR 814m for 12 projects under RSFF the sale of 300 million emission allowances from in the Baltic Sea region.

Examples of project loans recently approved by EIB

Lahti Waste-To –Energy-Plant, Finland combined heat and power (CHP) High energy demand during long winters and tough envi- technology. Conventional thermal ronmental standards pose severe challenges for the city plants release excess heat from of Lahti’s energy company. That is why it is building one the power-generating process into of the world’s most modern plants for converting waste rivers, lakes or the atmosphere. into heat and electricity, with the support of the EIB. The CHP process works differ- Surrounded by vast forests, the city of Lahti shares ently. It makes productive use of an inland climate with eastern Finland’s picturesque and the heat by pumping it into district sparsely populated thousand lakes region. Cold winters heating networks, which are com- with abundant snowfall make the area a prime location mon in the Nordic countries. for winter sports. On a bright September day, At the same time, Lahti is a modern, prosperous city Lahti Energy took a further step in with a population of 100 000 situated an hour’s journey CHP technology and launched the from the Greater Helsinki region. A centre for renewable world’s most advanced waste- energy research, Energon, forms the core of a strong en- driven CHP facility. “Finland is a vironmental cluster. It is thus no surprise that municipal- world leader in CHP technology. owned Lahti Energy aims to provide a reliable supply of About a third of all electricity is energy while continuously reducing emissions. What is produced in such plants compared with 10 percent or more unusual is that, since the late 1990s, Lahti Ener- less in Europe as a whole. And the city of Lahti is at the gy has become an international centre of excellence in forefront,” Finnish state radio announced on the occasion.

STATE OF THE REGION REPORT 2013 101 SECTION B Collaboration in the Baltic Sea Region

Using waste from businesses and households in the main strategies defi ned by the RUFS 2010 in order to Lahti and Helsinki as fuel, the new facility will process promote a sustainable growth is the development of an 250 000 tons annually, generating 90 megawatts of attractive, high-capacity, effi cient public transport system heat and 50 megawatts of power. This is considerably that is accessible to all, building on the existing resources more than in existing plants thanks to a new process in order to eliminate capacity shortcomings and improve of gasifi cation and incineration at high temperatures and service quality. high steam pressure. The EIB is fi nancing close to half the The Tvärbanan light rail was inaugurated in January investment (EUR 75m) with the remainder being provided 2000 to provide an orbital, rapid transport connection by the Nordic Investment Bank, the Finnish government linking the radial commuter train and underground lines and Lahti Energy. running through the city centre. Initially it ran between “This is the world’s fi rst energy-from-waste power Gullmarsplan and Liljeholmen and was later extended to station to operate with gasifi cation technology,” said Alvik (autumn 2000) and to Sickla Udde (August 2002). Lahti Energy’s managing director Janne Savelainen, add- The number of passengers carried by the Tvärbanan light ing that it will curb emissions by partially replacing a rail has been steadily increasing in the past years to the coal-fi red plant and sharply reduce landfi ll disposal in current 50 000 passengers/day, refl ecting the strong de- the region. “The amount of waste needs to be reduced mand for the line. and recycling and reutilisation of material needs to be The project area, despite being densely populated, maximised. From the materials left over, it is in everyone’s still presents development opportunities, especially in interest to separate that part which can be burnt and use Solna, which has been at the top of the fastest growing it as effi ciently as possible in energy production, just like Swedish municipalities in the past years. The Compre- Lahti Energy does,” Savelainen said. hensive Plan for Current and Future Solna 2006-2025 The Lahti project, which was completed in 2012, is foresees the development of new housing, offi ce and contributing to the Europe 2020 goals for smart sustain- commercial areas, including Solna Business Park and able and inclusive growth by supporting energy effi cien- Solna Centrum, which will be connected through the new cy, waste reduction, cuts in CO2 emissions, R&D and Tvärbanan light rail extension to Solna. The extension will innovation. also link the existing commuter and underground stations in the area. Tvärbanan Solna, Sweden The new Solna branch, together with the expected EIB provided EUR 323m to Stockholm County Council demand increase and future plans to develop further ex- for the project, which consists of a 6.8 km extension of tensions of the Tvärbanan light rail, make the upgrade of the Tvärbanan light rail between Alvik and Solna in the the existing Tvär- Stockholm metropolitan area, the upgrading of the ex- banan necessary isting light rail line (13.2 km) and the construction of a in order to provide new depot at Ulvsunda to replace the existing one, and the adequate ca- the acquisition of new rolling stock in order to satisfy the pacity and speed planned increase in capacity. The project is located in and allow for a Stockholm County, the most populated county in Sweden more effi cient op- with 26 municipalities and around 2 million inhabitants eration of the ex- in 2011, thus representing more than 20% of the coun- tended line. try’s total population. Public transport is widely used in Stockholm, accounting for 70% of the total number of PKP Polskie Linie Kolejewo SA, Poland journeys in 2010. The European Investment Bank (EIB) has provided two The Regional Development Plan for the County of loans amounting to EUR 165 million to the Polish Railway Stockholm (RUFS) 2010 constitutes the basis for devel- Company PKP: opment of Stockholm County in the midterm (year 2030) • EUR 100 million to fi nance the upgrading of 58 km and long term (year 2050) horizons. The plan’s shared of railways and signalling enhancement on a 42 km vision for the county is to become Europe’s most attrac- section between Warsaw and Lodz; tive metropolitan region. The RUFS 2010 forecasts that the • EUR 65 million to support the modernisation of a 32 county’s population will increase to 2.4 million inhabit- km-long section of the E59 railway line connecting ants by 2030 and to around 3 million by 2050. One of Wroclaw and Poznan.

102 STATE OF THE REGION REPORT 2013 SECTION B Collaboration in the Baltic Sea Region

research also envisaged in the forthcoming Agendas of Europe 2020 as well as Horizon 2020. Finland scores very high on many international rankings relating to competitiveness generally, as a result of strong performance in R&D, innovation and the education system. Finland’s innovation performance continues to be very strong: Finland, alongside Sweden, Denmark and Germany make up the European ”leading group”, scoring well above the EU average. This success story is partly a result of the Finnish national innovation system, developed early, relative to other OECD countries and based Copyright:© Metro Warszawskie Sp. z o.o. on the (so-called) “triple helix” of university, industry and government. Centres of Expertise (CoEs) are at the core The loan of EUR 100 million will fi nance the modernisa- of the country’s regional development and regional inno- tion of 58 km of twin track line between Warszawa Za- vation system strategies. CoEs are designed to develop chodnia and Miedniewice to the speed of 160 km/h, and regional innovation systems, capitalising on local assets installation of signalling equipment on a 42 km section of and know-how and promot- the already improved line between Miedniewice and Lodz ing collaborative public- Widzew. The upgrading of the line between Miedniewice private projects; to do so, and Lodz Widzew to the speed of 160 km/h was already CoEs mostly use science accomplished in 2008. The loan of EUR 65 million will parks as their operational contribute to the upgrading of a 32 km-long section of platforms. Currently, there the twin track railway line from Poznan to Czempin in the are 31 science parks ex- South-West of Poland, which is part of the E59 European isting operating in Finland, Rail Corridor connecting Malmo in Sweden with Ostra- hosting in total some 2,200 va in the Czech Republic through Poland via Szczecin, companies and organisa- Poznan, Wroclaw and Chalupki. The modernised line will tions. make it possible to use trains operating at a maximum With some 600,000 © Technopolis Science Parks 2012 speed of 160 km/h. This section forms the second part floor square meters of of the planned modernisation of the 164 km of the E59 premises for leasing, occupied by 1,300 companies and between Wroclaw and Poznan, which is expected to be other entities, Technopolis is Finland›s largest company completed by 2016. that specialises in providing operating environments for The EIB funds will help to upgrade the railway lines high-tech companies and is one of the largest technol- along the key transport corridors in Poland, contributing ogy centre operators in Europe. It currently operates a to an increase of transport safety and speed and improv- nationwide network of science parks in Espoo, Vantaa, ing the environment by promoting environmentally friendly Jyväskylä, Lappeenranta, Oulu, Tampere and Kuopio. The modes of transport. The current loans are a continuation tenant mix in the science parks is diversifi ed including of the EIB’s successful cooperation with PKP Polskie Linie established larger Finnish corporates as well as private Kolejowe S.A. Including the current loans, the Bank has high-tech companies, small start-ups and universities provided loans to PLK totalling EUR 1.4 billion to fi nance thus allowing and stimulating interaction and fl ow of railway modernisation projects across Poland. knowledge amongst them. The expansion into Estonia (through a joint venture in which Technopolis has a 51% Technopolis Science Parks II, stake) and Russia (St. Petersburg) is part of the promot- Finland and Estonia er’s growth strategy aiming at increasing the company›s Technopolis Science Parks II ( Finland, Estonia), amount- geographical coverage and diversifying its customer ing to EUR 70 m, is a cross-border project concerning the base, both through acquisitions and expansion of exist- design and construction of premises for high-tech coming operations. It is expected that it would also result in panies, universities and research institutes in existing and faster, better and more cost-effi cient internationalisation new Technopolis Science Parks in Finland and Estonia. processes for the small technology based fi rms. The project supports the ability of SMEs to benefi t from

STATE OF THE REGION REPORT 2013 103 SECTION B Collaboration in the Baltic Sea Region

4 Summary

Th e Baltic Sea Region continues to benefi t from an does not yet provide the solution to some of the key exceptionally strong network of projects and insti- challenges that Region is facing: tutions that span the Region. Th e possible benefi ts • Clear, measurable objectives are an important from taking such a macro-regional approach, i.e. instrument to better manage the Strategy and moving beyond the traditional bilateral collabora- to help communicate the benefi ts to political tion between individual neighbors, is becoming and private sector leaders, two constituencies evident in the evaluation that the European Com- that have to be won or re-won to enable the mission is currently conducting. strategy to achieve its full impact. But these Th e EU Strategy for the Baltic Sea Region, objectives should be derived from a systematic, which reached the end of its fi rst phase in 2012, regular analysis of the Region and its strategic has been a critical element in enhancing the coor- priorities. Th e factual foundation created in dination among the many eff orts under way, and such a process can then inform the selection of in orienting them towards a clear set of objectives activities as well as provide the background for relevant for the Region. Th e awareness of the need an assessment of the strategy’s impact. Th e po- for collaboration has clearly increased; many of the litical nature of the action plan process might challenges that exist in this part of Europe can only be one of the reasons for the limited private sec- be achieve together. And especially the EU-funded tor involvement. Interreg program for the Baltic Sea has received a • While the EU Strategy has helped to better clear framework for making decisions in line with structure the existing Interreg program, its the needs of the Region and the activities of other full impact rests on making it an integral part entities. of other EU and national policies. With the Th e review of the EU Strategy has also made EU budget period soon starting, it is critical clear where progress is still limited. Truly new pol- to making sure that the relevant programs, in icy initiatives driven by the regional eff ort are few. particular the Structural Funds and the Hori- Th e impact on policies that do not have a direct zon 2020 activities, can be aligned with the EU focus on Baltic Sea Region collaboration remains Baltic Sea Region strategy. Th at requires in- limited. And the engagement of the private sector cluding the relevant language into the national is still low; the argument for why Baltic Sea Region operational programs currently developed for collaboration should be something companies in the structural funds, and it requires making the Region should worry about has so far not been sure that the operational regulations for other made successfully. programs allow for a meta-regional perspective. Th e revised strategy and action plan put for- • Integration is not only a matter of operational ward by the European Commission in 2012 and alignment; it also requires a systematic ap- developed further in collaboration between the proach for how policy goals are related to each Commission and the national representatives in other. Th e Europe 2020 strategy provides an the High-Level Group will drive some changes in overall framework, the new Smart Specializa- the way the strategy process proceeds. Th ere have tion Strategy is an example of a European strat- also been some adjustments in the action plan egy in a particular policy fi eld, the national structure, reframing one of the objective areas to reform programs set out the activities of indi- become a cross-cutting activity and adding a few vidual member countries, etc. With the respon- activity areas to one of the three overall objectives. sibility for these diff erent strategies and for the Th ere will be a number of operational targets that implementation of the Baltic Sea Region strat- can be used to measure the success of the Strategy egy often in diff erent hands, more structure for in a more transparent way. aligning them would be helpful. Th e revised strategy provides a solid platform • While the EU Strategy for the Baltic Sea Re- to address some of the weaknesses identifi ed. But it gion is primarily focused on the EU member

104 STATE OF THE REGION REPORT 2013 SECTION B Collaboration in the Baltic Sea Region

countries in the Region, the scope for collabo- full power of the existing structures for collabora- ration clearly involves the neighbors as well. tion in the Region, and focus them on the issues Th e collaboration with Russia always stands most critical for its future competitiveness. Th is in the overall context of the political relations might not require new institutions, but it requires between Russia and the EU. Th e practical ex- the existing coordination mechanisms to be more perience, for example in the Russian CBSS visibly empowered. Th ey need to be able to not only Presidency, shows how joint activities in the organize the activities directly focused on regional Region can work if it is based on a shared un- collaboration, but be able to achieve coordination derstanding of the objectives. And CBSS has, across other policy areas as well. Some steps in this as this Report shows, taking a very active role direction have been made, especially at the national in the EU Baltic Sea Region strategy action level in some countries in the Region. Interesting plan. But with the many institutions active in new ideas have also been discussed at recent meet- this fi eld, CBSS, the Northern Dimension, and ings of the National Contact Points, Priority Area a range of fora focusing on the Arctic, it will Co-ordinators and Horizontal Action Leaders, i.e. be important to create a better understanding the ‘extended management team’ of the EU Strat- for how these diff erent mechanisms can work egy for the Baltic Sea Region. Th e Region needs to eff ectively together. build on these examples to create a structure that allows fact-driven policies on regional issues, well An underlying issue for the Region is how to create integrated with other activities at the EU and na- an institutional architecture that can mobilize the tional level.

STATE OF THE REGION REPORT 2013 105 Section C: Special Topics – Access to Capital, Regional Value Chains, and Exports

106 STATE OF THE REGION REPORT 2013 Access to capital: Issues facing Small- and Medium-Sized Companies in the Baltic Sea Region

By Torbjörn Becker, Director of the Stockholm Institute of area for SMEs that should be addressed. In the Transition Economics at the Stockholm School of Economics area of access to fi nance, the EU stresses developing markets for risk capital, micro-credit and mez- Introduction zanine fi nance as well as improving the payment Small and medium-sized enterprises (SMEs) are the culture in Europe to reduce insolvencies resulting focus of many growth- and job creation-focused from late payments of invoices. Th e EU has also policy discussions today, and the growth poten- made substantial amounts of funding available tial and access to fi nancing of SMEs has been the to support SMEs through the CIP, the Cohesion topic of many academic papers. In the past, much Policy and the Agricultural fund. It also highlights of this discussion centred on development strate- the role of the EIB to work in this area and channel gies for countries in catch-up phases of economic EU funds to SMEs. development, while more developed countries of- Th e EU’s policy on SMEs and access to fi nance ten focused on larger-scale industrial projects to was outlined as the global fi nancial crisis hit fi rms, promote growth and employment. However, over banks and households across the world, including the past few decades, more developed countries the EU and the Baltic Sea Region (BSR). Th e re- have shifted their focus to SMEs and entrepreneur- covery has been uneven, and fi nancial institutions ship more generally. In 2005, the EU published its have struggled in many countries. Against this Modern SME policy for Growth and Employment in backdrop, this chapter will look at SMEs and their connection with the midterm review of the Lisbon access to fi nance in the BSR and contrast this with agenda and followed up with a Small Business Act the situation in the rest of Europe. Th e fi rst part of for Europe (SBA) in 2008, where it is stated that: the chapter provides some basic numbers on SMEs in the Region, before looking more closely at how “Our capacity to build on the growth and in- SMEs themselves assess their situation with regard novation potential of small and medium-sized to access to fi nance and related issues. eTh report enterprises (SMEs) will therefore be decisive for then looks at how the state of access to fi nance in the future prosperity of the EU.” diff erent countries is related to other economic factors, and discusses some more general issues on In the SBA, the EU also states the goal of creating SME access to fi nance that have been analysed in a “world-class environment for SMEs”. Th is should the (policy-oriented) academic literature. Based on be achieved by cutting red tape and creating a busi- this overview of data and theories related to SMEs ness-friendly environment for SMEs, where access and their access to fi nance, the chapter ends with a to fi nance is highlighted as one potential problem discussion of policy implications.

STATE OF THE REGION REPORT 2013 107 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

SMEs in the BSR and the EU ‘small enterprises’ have 10-49 and ‘medium-sized enterprises’ have 50-249 employees. Th e overwhelming majority of companies in the Th e focus on SMEs comes from an interest BSR and the EU (99%) fall into the SME category, in boosting growth and employment, so the fi rst as defi ned by the EU: an independent company question is to what extent SMEs have contributed with fewer than 250 employees, less than EUR50 to growth (as measured here by value added) and million in turnover, and a balance sheet of less employment in recent years (covering the crisis pe- than EUR43 million. Within the group of SMEs, riod), in comparison with large companies of over ‘micro-enterprises’ have fewer than 10 employees, 250 employees.

Figure 1. Value added and employment in SMEs and large companies, BSR* vs. EU ex BSR (Indices with 2005=100) Value added, BSR Employment, BSR 160 140

140 120 120 100 100 250 + 250 + 80 80 50 - 249 50 - 249 10 - 49 60 10 - 49 60 0 - 9 40 0 - 9 40

20 20

0 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2005 2006 2007 2008 2009 2010 2011 2012 2013

Value added, EU ex BSR Employment, EU ex BSR 160 140

140 120

120 100 100 250 + 250 + 80 80 50 - 249 50 - 249 60 10 - 49 10 - 49 60 0 - 9 40 0 - 9 40

20 20

0 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: EU Annual report on SMEs, author’s calculations * Note: The BSR ﬁ gures do not include Norway, Iceland and Russia due to data limitations. Indices are based on the sum of value added and employment, respectively, in all countries for each region. Th e fi gures confi rm that SMEs are hugely due to being more capital intensive and/or more important for both value added and employment profi table. throughout the entire EU, including the BSR. Th e strength of the BSR relative to the rest of SMEs accounted for around 55% of value added the EU is also evident in these fi gures. In terms of and 65% of employment of all companies in the value added, the BSR is expected to have experi- BSR, compared to 62 and 68% in the EU exclud- enced a cumulative growth of 35% between 2005 ing the BSR countries. Th is translates into over 26 and 2013, despite the 2009 dip. Over the same time million people employed by SMEs in the BSR and period, employment has grown by a more modest over 61 million in the rest of the EU. It can also 15%, which still amounts to over 1.5% annually. be noted that larger companies generally generate Th e corresponding numbers for the rest of the EU more value added per employee, which could be are 13% and -2%, respectively, for value added and

108 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Figure 2. Value added and employment shares of SMEs in the BSR*

40 Value added

30 Employment

Source: EU Annual report on SMEs, author’s calculations * Note: The BSR ﬁ gures do not include Norway, Iceland and Russia due to data limitations. employment growth. In other words, the SMEs in SMEs’ access to ﬁ nance in the BSR the BSR have been signifi cantly more successful in contributing to growth and employment than their In the discussion of strategies to promote growth peers in the rest of the EU. and employment among SMEs, access to fi nance, Th e growth rates for small and medium-sized or rather lack thereof, is regularly argued to be an enterprises have been higher than for micro-enter- important constraint that requires policy action. prises and large companies in the BSR. Th is mid- To study the fi nancing situation of SMEs in the dle range has experienced value added growth of BSR, we use the most recent and comprehensive over 40% and employment growth of close to 20%, dataset that is available today, the Survey on the while micro-enterprises and large companies have Access to Finance of Small and Medium-sized En- experienced around 30% value added growth and terprises (SAFE), which is a joint data collection 10% employment growth over the same time pe- initiative, started in 2008, between the ECB and riod. In the rest of the EU, it is micro-enterprises the European Commission. Th e full survey is con- that have had faster value added growth, at 17% ducted in 38 countries, and in addition to the 27 compared to the average of 11% in companies in European Union countries, other countries of the the other size groups. European Free Trade Association (EFTA) or par- Th e importance of SMEs varies somewhat ticipating in the Entrepreneurship and Innovation across the countries in the BSR, with Estonia be- Programme (EIP) are also included in the survey. ing the country with the highest SME shares of Th e survey was conducted from June to July 2009, value added (78%) and employment (72%) in the and again from August to October 2011. Th e sur- region. However, all of the BSR countries included vey size varies between countries, and among the here have value added shares of over 50%%and em- BSR countries the sample size goes from 100 in Es- ployment shares of over 60% for SMEs. Overall, tonia to 1,000 fi rms in Germany. Th e focus here is SMEs account for a somewhat lower share of value on the most recent 2011 data. Later in this chapter, added and employment gains in the BSR compared the limitations of these data and proposals for ad- with the rest of the EU, but SMEs are clearly still ditional data collection will be discussed, but cur- very important in all the BSR countries and their rently this is the best data set available to address future success a crucially important policy issue for the issue of fi nancing of SMEs in the BSR and the growth and employment in the region. EU more generally.

STATE OF THE REGION REPORT 2013 109 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Figure 3. Net increase of key company indicators last 6 months (Share of SMEs indicating increase minus SMEs reporting a decrease)

60,0

50,0

40,0

30,0

20,0

10,0

0,0

-10,0

-20,0 Turnover Profit -30,0 Net interest income (negative means increased expenses) -40,0

-50,0 Denmark Estonia Finland Germany Iceland Latvia Lithuania Norway Poland Sweden BSR EU ex BSR Other Europe Source: SAFE 2011 and author’s calculations * Note: The BSR ﬁ gures do not include Russia due to data limitations. “Other Europe” includes Albania, Croatia, Israel, Liechtenstein, Former Yugoslav Republic of Macedonia, Montenegro, Serbia, Switzerland, and Turkey. Regional averages are an unweighted average of shares in each country.

SMEs in all of the countries in the BSR except ing problems with access to fi nance. At the other Estonia had seen an improvement in turnover and end of the spectrum, Finnish and Swedish SMEs profi ts, but increasing interest expenses, in the 6 are least worried about access to fi nance with less month period preceding the survey. We can only than 8% reporting that this was the most pressing speculate about to what extent the situation in Es- problem facing them. tonia was connected to the adoption of the Euro at Th e other most pressing issues facing compa- the time, but being the only country where SMEs nies in the BSR are competition and fi nding cus- saw their interest expenses reduced, this could have tomers. While competition can be a very serious been a contributing factor. Compared with the rest issue for individual SMEs, it is far from clear that of the EU and other European countries, all of the this is a problem for the economy as a whole; com- indicators were signifi cantly better on average for petition is something that is encouraged in mar- SMEs in the BSR. However, fi nancing became ket economies and an important driving force for more expensive for SMEs in all regions, including growth and employment. However, if competition the BSR, and the more general question is really to mainly comes from companies in other countries, what extent fi nancing is a problem for SMEs. it becomes a more diffi cult policy issue for the BSR, When SMEs where asked what the most press- and is another important issue to study. Problems ing issue was for their company, access to fi nance with fi nding customers can possibly also be linked came in third place on average for SMEs in the to competition, but also to a general lack of de- BSR, with around 15% of SMEs reporting this to mand. Th is is another important issue for policy be the most pressing issue. Th is is similar to the makers to consider and relates to the heated discus- situation in the rest of the EU, whereas other Euro- sion of austerity versus stimulus by governments, pean countries have more diffi culties with fi nanc- which features prominently in the economic policy ing, and the issue ranks second for SMEs there. In debate today. Th is section focuses on the issue of fi - two of the BSR countries, Estonia and Iceland, ac- nancing, but later in this chapter, the links between cess to fi nance is ranked as the most pressing issue fi nancing and the more general economic situation facing fi rms, with almost 30% of companies hav- will be discussed.

110 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

We will now look closer at the sources SMEs many, this peaks at 5% while in Estonia, almost no use to fi nance themselves. Th e fi rst step is to see if SMEs managed without external funding. In con- internal or external funding sources dominate the trast, an average 60% of SMEs rely exclusively on picture. Strikingly, only 3% of SMEs across the external funding and another 20% use a mixture BSR manage to fi nance themselves exclusively with of external and internal funding. Th e remaining internal funds when they needed funding; in Ger- SMEs (less than 20%) did not use any fi nancing in

Figure 4. What is the currently the most pressing problem your ﬁ rm is facing?

100 %

90 %

80 % Other + no answer 70 % Regulation 60 % Availability of skilled staff or 50 % experienced managers Costs of production or labour 40 % Access to finance 30 %

Competition 20 %

Finding customers 10 %

0 %

Source: SAFE 2011 and author’s calculations

Figure 5. Use of internal and/or external funding during the last six months

100 %

90 %

80 %

70 %

60 %

50 % Did not used any source of financing Used both internal funds and external financing Used only external financing 40 % Used only internal funds

30 %

20 %

10 %

0 %

Source: SAFE 2011 and author’s calculations

STATE OF THE REGION REPORT 2013 111 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

the period in question. Th e message here is that a Finnish SMEs used this as a funding source, while majority of SMEs did need some type of funding, only around 15% of Estonian, Latvian and Norwe- and very few could manage this with solely internal gian SMEs did. Th ere is also a signifi cant use of eq- funds. In other words, access to external fi nancing uity funding in many BSR countries, but also great is indeed very important for SMEs. However, this variation around the 20% average. In Denmark, in itself does not mean that external funding was close to half of the SMEs raised equity capital, com- problematic during this period, but suggests that pared to only 2-3% in Estonia and Poland, and less access to fi nance is an important issue for SMEs. than 10% in Germany. Th is may refl ect how devel- Th e 28% average use of retained earnings or oped local equity markets are but could also refl ect sale of assets in the BSR SMEs in the more detailed the fi nancial strength of existing owners, who are breakdown of funding sources correspond to the able to put in extra equity capital when needed. above numbers on internal funding. Over 60% of

Figure 6. Use of different ﬁ nancing sources during the last six months

70 Retained earnings or sale of assets Equity Grants or subsidised bank loan 60 Leasing etc

0 Denmark Estonia Finland Germany Iceland Latvia Lithuania Norway Poland Sweden BSR EU ex BSR Other Europe

70 Bank overdraft, credit line Bank loan Trade credit 60 Other loan

0 Denmark Estonia Finland Germany Iceland Latvia Lithuania Norway Poland Sweden BSR EU ex BSR Other Europe Source: SAFE 2011 and author’s calculations

112 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Figure 7. Net increase in availability of different types of ﬁ nancing over the past six months

20 Bank overdraft, credit line Bank loan Trade credit Equity 15

-5

-10

-15 Source: SAFE 2011 and author’s calculations

Figure 8. Change over the past six months in factors that affect availability of ﬁ nancing

40 Economic outlook Public financial support Firm-specific outlook 30 Willingness of banks Willingness of investors

-10

-20

-30

-40 Denmark Estonia Finland Germany Iceland Latvia Lithuania Norway Poland Sweden BSR EU ex BSR Other Europe Source: SAFE 2011 and author’s calculations

Leasing, hire-purchases and factoring has been ing, or some other factor is hard to know. Icelan- the most frequently used funding category in the dic SMEs use this source less than other countries BSR, with more than 40% of SMEs using these in the BSR, at 22%, while Estonian SMEs are the methods across the Region. To what extent this most frequent users of this funding source, at 58%. popularity refl ects effi cient markets for these servic- In the rest of the EU and in other European coun- es, a lack of supply of regular bank lending, tax or tries, this funding source is less frequently used, regulatory factors, a desire for collateralised lend- at 30 and 17% respectively. Grants and subsidised

STATE OF THE REGION REPORT 2013 113 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

bank loans account for a minor share of funding highly correlated, so that in a country where one for SMEs in most BSR countries, except for Es- factor is negative, the others also tend to be nega- tonia, where almost 40% of fi rms have access to tive, and vice versa. Th e overall picture in the BSR this funding source compared to the average of just is relatively neutral, whereas the rest of the EU is above 10% in the BSR as a whole. facing diffi culties on all fronts, according to the On the more regular debt fi nancing side, SMEs surveyed SMEs. across the BSR use bank overdrafts and credit lines, In around half of the cases, SMEs in the BSR and trade credit most frequently, with both fund- (and other regions) took loans because they needed ing sources used by around 30% of fi rms. Th e use working capital, while around 40% borrowed to of trade credit seems to be strongly correlated with fi nance capital investments like buildings, equip- use of retained earnings, which may suggest that ment and vehicles. In less than 5% of fi rms were where companies are relatively cash-rich, they can loans used to fi nance research and development also aff ord to off er fi nancing to their customers. and innovation. Th e ‘other’ category includes pro- Bank loans are slightly less frequent, with 24% of motion, training, acquisitions and unspecified fi rms reporting having used this in the same pe- uses. Overall, it seems that many SMEs used debt riod. Th is is less frequent than in the rest of the EU fi nancing more to survive and support existing op- and non-EU European countries, where over 30% erations than to invest in future products and ser- of SMEs used bank loans. vices. Alternatively, SMEs only do R&D when they In this period, there was relatively little change have their internal funds to spend on this. in funding availability in the BSR on average, but Th is somewhat gloomy picture on the use of the average hides a worsening in Iceland and im- loans should be complemented by the fact that over provements in Latvia and Lithuania. In the rest of 50% of SMEs in the BSR did not take any loans the EU, funding availability declined for all types in the past two years. Th e next 20% of SMEs took of funding. Th is picture is strongly correlated with relatively small loans, of less than EUR100,000, changes in all of the factors that are thought to af- while EUR1,000,000 loans were taken by only fect the availability of fi nancing, ranging from the 5% of SMEs. Around 80% of the loans came from overall economic outlook to banks’ willingness to banks, whereas families and micro-fi nance institu- lend. Th ese factors are also in and of themselves tions accounted for the remaining 20% on average.

Figure 9. Reasons for taking last loan

Working capital 40 Capital investment R&D Other 30

0 Denmark Estonia Finland Germany Iceland Latvia Lithuania Norway Poland Sweden BSR EU ex BSR Other E Source: SAFE 2011 and author’s calculations

114 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Figure 10. Application success, bank loans

100 %

90 %

80 %

70 %

DK/NA 60 % Applied but was rejected

50 % Applied but refused because cost too high

Applied but only got a limited part of it 40 % [BETWEEN 1% AND 74%]

Applied and got most of it 30 % [BETWEEN 75% AND 99%] Applied and got everything 20 %

10 %

0 %

Source: SAFE 2011 and author’s calculations

Figure 11. Net change in the past six months of conditions of bank ﬁ nancing (rescaled so negative is worsening for all indicators)

50 Interest rate Fees etc Size of loan 40 Maturity Collateral etc 30

-10

-20

-30

-40

-50 Denmark Estonia Finland Germany Iceland Latvia Lithuania Norway Poland Sweden BSR EU ex BSR Other Europe

Source: SAFE 2011 and author’s calculations

Latvia stands out somewhat in that both families loans. Overall though, lending to SMEs mainly and micro-fi nance institutions were more impor- comes from banks in the region. tant, and together accounted for around 45% of

STATE OF THE REGION REPORT 2013 115 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Figure 12. Importance of various policy measures for future ﬁ nancing (Share of companies answering 8-10 on a scale of 1 to 10)

90 Loan guarantees Export credits Business support services 80 Equity investment measures Tax incentives Making existing measures easier to obtain 70

0 Denmark Estonia Finland Germany Iceland Latvia Lithuania Norway Poland Sweden BSR EU ex BSR Other Europe Source: SAFE 2011 and author’s calculations

When SMEs went to banks to ask for loans, the increase in interest rates and fees were sub- 65% got the loan they asked for in the BSR. In stantially larger in the EU. Iceland, Latvia and Lithuania, countries that were In order to improve fi nancing opportunities more severely hit in the crisis, this number is lower, in the future, almost half of the SMEs in the BSR at around 50%. However, in Latvia and Lithuania, would like to see policy makers introduce more an additional 15-25% of the SMEs got most of the tax incentives. In Latvia, 80% of SMEs think loan they asked for. In the end, only around 10% this is a good policy measure, whereas only 25% of loan applications were straight out rejected and of Norwegian SMEs think that it is important an additional 5% of SMEs did not take the loan to improve access to fi nance in the future. eTh they applied for because they considered the cost second most important issue is loan guarantees, to be too high. In total, around 15% did not get a which is an issue mentioned by over one third of loan from the bank in the BSR. Th is is more or less the SMEs in the BSR. Th is is similar to the share the same share of SMEs that reported that access of SMEs in the region that think that existing to fi nance was the fi rm’s most pressing issue earlier. measures should be made easier to access, in con- Before we take the above numbers as evidence trast to introducing new measures. that the fi nancing situation looks reasonable for a large majority of SMEs in the region, it is useful to look at the conditions that are attached to the Correlates of access to ﬁ nance for SMEs loans that were accepted. Th e conditions include the interest rate, other fees associated with the Th e above section has provided a relatively detailed loan, as well as other conditions, like collateral description of various aspects of SMEs’ access to fi - requirements, maturity and size of the loans. On nance. However, to discuss policy implications, it is average, interest rates and fees worsened, as did useful to also look at other economic variables that collateral requirement, while maturity and loan are correlated with SMEs’ access to fi nance. For ex- size improved. Th is picture is relatively consistent ample, the crisis and its macroeconomic aftermath across countries in the BSR and the EU, although are likely correlated with how SMEs in diff erent

116 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

countries and regions can fi nance themselves. Th is access to fi nance for SMEs. Most of the non-BSR could possibly be viewed as cyclical factors to the countries on the chart are above the BSR regression extent the crisis can be handled by regular macro- line, which means that their problems with access to economic counter-cyclical policies. However, there fi nance are associated with somewhat higher growth are also more long-term structural issues, such as rates in domestic credit than is the case in the BSR. institutions and regulations, that aff ect credit mar- Nevertheless, economy-wide credit growth is impor- kets more generally and thus SMEs’ access to fi - tant for SMEs’ access to fi nance, both in the BSR nance. Th is short section will make no attempt to and in other regions. make a full scientifi c account of all possible factors Th e general economic outlook was ranked that correlate with SMEs’ access to fi nance, but above as an important issue for SMEs’ access to rather show some interesting correlations that are fi nance and fi nding customers (which is likely re- useful for the policy discussion. lated to overall economic conditions) was the most Th e fi rst correlation to investigate is between the pressing issue facing SMEs in most BSR countries. share of SMEs that report that access to fi nance is a Th e strong positive correlation between average major problem, and the countries’ domestic credit GDP growth rates and the shares of successful growth since the start of the crisis in 2008. Th e linear loan applications in the data therefore comes as trend computed for BSR countries indicates a strong no surprise. Again, it seems that BSR countries are negative correlation between the variables, which relatively well off compared to other regions in that means that in countries with low or negative credit they have better success with loan applications for growth, SMEs have a harder time accessing fund- a given growth rate, compared with other EU and ing than in countries with more rapid credit growth. non-EU countries in Europe. Still, being in a faster Compared to other regions, the BSR has had some- growing economy improves the chances of getting what lower credit growth and less of a problem with a loan in all regions.

Figure 13. Domestic credit growth vs. SMEs’ access to ﬁ nance

5 BSR 0 EUxBSR 0 5 10 15 20 25 30 35 40 Other Lin. (BSR) -5

-10

Domestic credit avg growth2008-11 -15

-20

-25 Share of SMEs with problem to access finance

Source: SAFE 2011, IMF, and author’s calculations

STATE OF THE REGION REPORT 2013 117 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Figure 14. GDP growth vs. successful loan applications

1 BSR 0 EUxBSR 0 102030405060708090100Other Lin. (BSR) -1

-2 GDP avg growth 2008-11 GDP avg growth

-3

-4

-5 Share of successful loan applications

Source: SAFE 2011, IMF, and author’s calculations

Figure 15. Unemployment vs. successful loan applications

20 BSR EUxBSR 15 Other Lin. (BSR)

Unemployment (2010) 10

0 0 102030405060708090100 Share of successful loan applications

Source: SAFE 2011, IMF, and author’s calculations

Th e link to economic activity and demand in employment goes beyond 15%. Although the BSR the economy is also illustrated by the correlation is doing better than the rest of the EU according with unemployment. Th e regression line indicates to many indicators, unemployment is not an area that, on average, the share of successful loan ap- where the BSR can claim great success, with sev- plications goes from around 90% in countries eral countries still having double-digit unemploy- where unemployment is 7% to a mere 30% as un- ment numbers.

118 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Th e issue of how governments’ fi nancial situa- cit that needs to be fi nanced, SMEs have a lower tion aff ects the private sector is the subject of much success rate when applying for loans. Th is is obvi- academic work and features prominently in the ously a correlation, and not necessarily a causation policy debate. Th e scatter plot reveals that there is between government defi cits and reduced funding a strong positive correlation between the govern- for SMEs. It may well be the case that both vari- ments’ balances and the share of successful loan ables are aff ected by a macroeconomic slump that applications in all regions. Th is implies that where puts pressure on government fi nances at the same the government is running a large structural defi - time as SMEs are doing worse and becoming less

Figure 16. Central government structural balance vs. successful loan applications

0 0 102030405060708090100

-2

-4

BSR -6 EUxBSR Other Lin. (BSR) -8

Govt balance avg 2008-11 -10

-12

-14 Share of successful loan applications

Source: SAFE 2011, IMF, and author’s calculations

Figure 17. Insolvency procedures vs. access to ﬁ nance

140

120

100

80 BSR EUxBSR 60 Other Lin. (BSR)

40 Insolvency ranking(low=good)

0 0 5 10 15 20 25 30 35 40 Share of SMEs with problem to access financing Source: SAFE 2011, World Bank, and author’s calculations

STATE OF THE REGION REPORT 2013 119 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

creditworthy. Nevertheless, it is another signal that and many countries use the Euro or have fi xed access to funding for SMEs is linked to the more exchange rates to the Euro. Related to this is also general macroeconomic picture in most countries to what extent the banks are foreign-owned since across the region and elsewhere in Europe. this may aff ect many aspects of the banking sec- Not only macroeconomic factors correlate tor including effi ciency, funding availability, and with fi nancial conditions facing SMEs in the the desire to develop other parts of the domestic region. Institutional and regulatory factors also fi nancial system. contribute to how banks and fi nancial markets To illustrate how some of the domestic market operate. Th is is illustrated here by the correlation indicators correlate with SMEs’ problems with ac- between SMEs that have problems with access to cess to fi nance, the fi gures below show correlations fi nance and how countries rank in terms of ef- with the share of foreign banks in domestic markets fi cient insolvency procedures, as measured by the as well as the sizes of domestic bond and equity Cost of Doing Business indicator on insolvency, markets. Here, the regression lines are based on all which is produced by the World Bank group. In observations, not only those of the BSR countries, the countries with poor institutions and regula- since the data set is more limited. Th is limitation of tions to deal with insolvencies, access to fi nance the data also implies that the correlations are not as is a problem for a larger share of SMEs than in robust as in the previous scatterplots. countries with good institutions. Th e fi rst fi gure shows how the share of foreign Another important structural factor is how banks in the domestic banking market correlates well-developed local capital markets are, since this with the share of SMEs that think that access to could impact SMEs’ access to fi nance. Th is is an is- fi nance is the most pressing problem they face. Th e sue that has received a lot of attention in emerging positive correlation implies that a larger share of market countries. In these countries a large share foreign owned banks is associated with a higher of foreign fi nancing has been seen as potentially share of SMEs that have problems accessing fi - risky since it exposes countries to the risk of sudden nancing. Although this is not necessarily a causal stops of international capital fl ows that can have relationship, it corresponds to the notion that for- serious real economic consequences. In the EU it is eign banks prioritised their home markets in the a bit less clear what the relevant ‘domestic’ capital aftermath of the crisis. At the same time, we have market is, since there is free movement of capital seen in the previous fi gures that access to funding

Figure 18. Share of foreign banks in domestic banking systems vs. access to ﬁ nance 120

100

BSR 60 EUxBSR Other Lin. (All) 40 Share of foreign banks foreign of Share

0 0 5 10 15 20 25 30 35 40 Share of SMEs with problem to access finance Source: SAFE 2011, IMF, and author’s calculations

120 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Figure 19. Size of domestic capital markets vs. access to ﬁ nance

BSR 40 EUxBSR Other Lin. (All) 30

Size bond mkt Size of domestic 20

0 0 5 10 15 20 25 30 35 40 Share of SMEs with problem to access finance Source: SAFE 2011, IMF, and author’s calculations is also related to the general macro economic situa- The BSR SME funding picture in tion and to the extent that foreign banks just hap- perspective pen to have a more signifi cant presence in countries that are hit harder by the crisis for other reasons, this could give rise to a spurious correlation. Never- Measuring credit constraints theless, there is at least weak support for the notion that banks cut lending more in its foreign markets Th e chapter has focused on what can be learnt than in their home markets. about SMEs’ access to fi nance in the BSR from the Th e next two charts illustrate how develop- extensive 2011 SAFE survey. Although the SAFE ing local capital markets may help with access to survey data is the most comprehensive available, it fi nancing in general. Although the correlations does have some signifi cant limitations that need to between the size of domestic equity and bond be pointed out before we move on the policy con- markets with problems accessing fi nancing are clusions. First of all, the data for the BSR countries relatively weak, they have the expected negative are only available for two years, 2009 and 2011. orientation. Th is means that in countries with Th is obviously limits any studies of how the fi nanc- larger domestic bond and equity markets, fewer ing situation has changed over a longer time period. SMEs report problems with access to fi nance. It is Th e other signifi cant concern is that data on SMEs hard to draw any specifi c conclusions for the BSR in the regular fi nancial market statistics that na- since the data are insuffi cient, but it seems that, in tional authorities and international organizations general, there may be a positive eff ect on access to publish is limited. For example, domestic credit is fi nance for SMEs from developing local bond and not broken down, so it is impossible to see what equity markets. Th e mechanism behind this could share goes to SMEs in a consistent way across time be both direct and indirect in the sense that it is and countries. In other words, we are not able to not clear if SMEs themselves use domestic capital say if or how credit to SMEs has actually changed markets, but if larger companies do while reduc- over time and across countries. Th ere are of course ing their bank lending, this may lead to increased also limitations with outcome or supply side data availability of bank fi nancing for SMEs if banks’ on fi nance because it only shows outcomes and lending is constrained due to their own capital or does not provide the detailed understanding of, funding situation. for example, when SMEs applied but were denied

STATE OF THE REGION REPORT 2013 121 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

credit. Nevertheless, not having the possibility to fulfi l their loan commitments. Survey data that is examine the overall outcome data is a serious limi- based on SMEs’ perceived constraints does not take tation. Th ere are many variables that researchers into account if rationing is rational, in the sense of would like to have data on to better understand the banks only providing loans to projects with posi- fi nancial situation of SMEs, and Udell presented tive risk-adjusted returns. Th ere is research that an extensive data wish list at his keynote speech at suggests that credit constrains are indeed correlat- the ECB workshop on “Access to fi nance of SMEs: ed with fi nancial indicators, which would indicate what can we learn from survey data” in 2011. that survey-reported credit constraints could be ra- Th ere have been studies that try to disentan- tional from the lender’s perspective. When policies gle supply and demand factors that determine the are designed, we need to know more about how amount of fi nancing that actually goes to SMEs default rates diff er between companies of diff erent for EU countries other than the BSR countries size. For example, Basel II regulations gave special that we look at here. Th e main result from this treatment to retail and SME loans due to a pre- work is that the demand for credit is driven by sumed smaller exposure to systemic risk. However, macro factors such as GDP growth while sup- in an empirical paper based on Swedish data, this ply is aff ected by fi nancial variables such as sov- is shown to not be the case. Instead, loans to SMEs ereign spreads.1 For the BSR countries and the were more risky than loans to larger companies.3 other European countries, we also saw that there is a strong correlation between GDP growth and SMEs access to fi nance. Related policy papers and reports In general, it is diffi cult to know if supply or demand are constraining factors when we look at Th e OECD has recently published an extensive outcome data, but at the same time, it is important report on SMEs’ access to fi nance, where the to know where the constraints are to be able to say three Nordic BSR countries are included in the credibly if there is a credit crunch that warrants data and analysis. One interesting aspect of this government actions. Th ere have been a few studies report is that it includes data on the share of bank that try to identify credit crunches and one strategy loans that go to SMEs. However, the defi nition of is to look at negative shocks to banks’ credit supply SMEs loans diff er across countries and the data that cannot be explained by the quality of borrow- also show substantial variation across diff erent ers or banks’ opportunity cost of providing risky OECD countries between 2008-2010 that is a bit loan. Th is has been done for Germany, where the hard to understand. For the three BSR countries authors found little support for the idea that there included in the report, SMEs accounted for 92% is a credit crunch in this crisis, with one explana- of loans in Sweden, 9% in Denmark, and 20% in tion being that the absence of a credit crunch was Finland in 2009. Th e share for Sweden looks im- the result of public sector equity support to the fi - plausibly large and is not consistent with a recent nancial sector.2 paper that found that large fi rms dominate banks’ Measuring credit crunches in a convincing way portfolios in Sweden.4 SME loan growth also requires that there be good data on borrowers, in- varied substantially; in 2008 SME loan growth cluding their default rates. However, default rates was 7.2% and -13.7% in Sweden and Denmark and non-performing loans broken down on fi rms of respectively, while in 2010, SME credit in Den- diff erent sizes are not available in an easily accessi- mark grew by 23% in contrast with a fall of 22% ble and consistent format across countries. Without in Finland. this type of information, it is hard to know how, for Th e loan conditions in terms of interest rate example, increased bank lending to SMEs would levels and spreads were also very diff erent between aff ect fi nancial stability. Perhaps it is rational for the three Nordic BSR countries, where Danish banks to constrain some SMEs’ access to fi nance SMEs saw only a modest decline in interest rates because they are a poor credit risk and would not 3 Tor Jacobson, Jesper Lindé and Kasper Roszbach, 2005, “Credit Risk versus Capital 1 Sarah Holton, Martina Lawless, and Fergal McCann, 2011, “Firm Access to Finance Requirements under Basel II: Are SME Loans and Retail Credit Really Different?”, Sverige in the European Crisis”, mimeo Central Bank of Ireland. Riksbank Working Paper No. 162. 2 Horst Rottmann and Timo Wollmershäuser, 2011, “A Micro Data Approach to the 4 Leonard I. Nakamura and Kasper Roszbach, 2010, “Credit ratings and bank Identiﬁ cation of Credit Crunches”, mimeo, Ifo Institute for Economic Research. monitoring ability”, Philadelphia Fed Working paper No. 10-21.

122 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

during the crisis, partly due to a large increase in Some insights from the academic spreads, while in Finland and Sweden, interest rates literature were reduced much more and spread increases were relatively modest. However, it is not clear that the Th ere is a vast literature on banking, fi nancial de- interest rate development in Denmark was a sign of velopment, and SMEs as separate research areas, as something being wrong with bank lending, since well as their intersections. Th is short section will during this period, there was a rapid increase in highlight a few fi ndings that can help us better un- bankruptcies that was not seen in the other two derstand the fi nancing situation for SMEs in the countries. BSR, and also guide the policy discussion below. Th e EIB has also recently published a paper Th e SAFE data set does not allow us to investi- that looks at the fi nancing situation of SMEs.5 gate how fi rm characteristics relate to SMEs fund- Th e paper looks at issues such as lending standing themselves with internal and external funds, re- ards and loan conditions. Overall, the data indi- spectively. Understanding this may be useful when cate that lending standards for SMEs and larger trying to target public support programmes. From companies tend to move in tandem over longer the fi nance literature, the pecking order theory time periods, even if quarter-by-quarter tighten- of capital structure suggests that fi rms with more ing can diff er. In the most recent period covered available internal funds use less external funding, by the data, the third quarter of 2012, SMEs ex- which means that leverage declines when profi ts in- perienced less of a credit tightening than larger crease. In a study of SMEs in Eastern Europe, this companies, while loans with longer maturity ex- theory was supported and it was further concluded perienced a greater tightening than short-term that older and larger fi rms used less external fund- loans. Overall, the changes in credit standards ing on average. Th is suggests that the availability between 2010 and 2012 were largely explained of external funding is particularly important for by expectations regarding the general economic small and young fi rms.6 Th is result is also related outlook, and industry- and fi rm-specifi c factors. to the result, in a paper from the ECB, where the Again, this seems consistent with the correlation authors studied SMEs in the crisis and concluded between GDP growth and access to funding that that small and young fi rms suff ered more when we documented earlier. credit standards were tightened.7 Although lending standards have tended to Many academic studies support the view that follow in tandem between SMEs and larger com- SMEs have less access to formal funding sources, panies, the interest rate spreads between small and that this may hamper their growth prospects. and large loans can be substantial, and was, ac- It is also generally agreed that fi nancial and insti- cording to ECB data, in the range of 200-250 ba- tutional development would be useful to alleviate sis points in 2012. Th is was a signifi cant increase growth constraints faced by SMEs. However, fi - from the 150 bps spreads seen in 2010. Also, in- nancial development can to some extent be linked terest rates and maturities vary greatly between to bank size, and a greater share of foreign banks, countries in Europe, which again is likely con- and this is sometimes viewed as problematic for nected to the general economic situation in the SMEs if we think that they are more dependent on respective countries. relationship banking that is more often associated Th ere has also been a signifi cant shift in the with smaller local banks. Research has shown that, source of venture capital since 2009, with govern- at the beginning of the 20th century, a variety of ment agencies now dominating in the area of VC local fi nancial institutions emerged in response to a funding. Providing capital to potential growth-en- need among SMEs to fi nd fi nancing. Th ey were not hancing fi rms is clearly seen as an important policy very sophisticated intermediaries but were able to in many places. Th e eventual impact and cost ef- gather information and savings locally that could fi ciency of these government initiatives is not yet be used to extend loans to SMEs that were too clear, and will likely be an interesting area for fu- 6 Mateev, M., Poutziouris, P., & Ivanov, K., 2013, “On the determinants of SME ture research. capital structure in Central and Eastern Europe: A dynamic panel analysis”, Research in International Business and Finance, 27(1), 28–51. 7 Artola, Concha; Genre, Veronique, 2011, “Euro area SMEs under ﬁ nancial 5 Helmut Kraemer-Eis, Frank Lang, Salome Gvetadze, 2012, “European Small constraints: Belief or reality?”, CESifo working paper: Monetary Policy and International Business Finance Outlook”, EIB Working Paper 2012/16. Finance, No. 3650.

STATE OF THE REGION REPORT 2013 123 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

small or young to get funding from larger banks.8 per argues that this important diff erence can be a Th is type of result supported what, for some time, result of the incentives created by guarantee pro- was the consensus view that SMEs would suff er in grammes, where government support is only pro- countries that lacked small local fi nancial institu- vided when fi rms fail. Th is could aff ect screening tions. However, more recent studies challenge the and monitoring by banks, which in turn leads to conventional wisdom that large and foreign banks increased defaults.12 do not cater to SMEs. Th ey rather suggest that large and foreign banks also view SMEs as core customers and manage to provide them with funding and Summary and Policy conclusions services through the use of new technologies and risk management systems.9 SMEs play a very important role in the BSR and Several papers have focused on lending tech- the EU more generally when it comes to creating niques, rather than on institutions that provide value added and employment, with more than loans. One observation is that the use of diff erent 26 million people employed by SMEs in the BSR lending techniques varies greatly between countries alone. Th e focus on SMEs and removing obstacles and is likely a result of diff erences in institutional that impede their growth in the region is therefore and regulatory conditions. Given that diff erent not surprising. Restricted access to fi nance has been lending techniques are more or less well suited to identifi ed as one key area among policy makers. A SMEs, this also means that the availability of credit close look at the data on access to fi nance among for companies of diff erent sizes is aff ected.10 As we SMEs in the region showed that the situation varies have seen above for the BSR, leasing and factoring substantially along several important dimensions is a major funding source for SMEs. According to among the BSR countries, and between the BSR some researchers, leasing and factoring, as well as and the EU more generally. Th e overall picture is better credit information systems that contribute that a large majority of SMEs do have access to fi - to a more competitive banking sector, can also help nancing and that banks play a key role in providing improve the funding situation for SMEs.11 the funding. However, access to fi nance still ranks When banks and fi nancial markets in general as the third most pressing issue facing SMEs in the are seen as failing to deliver the loans and fi nancial region; loan conditions have worsened for many services demanded by SMEs, many governments fi rms and spreads on small loans have increased. have introduced programmes to support SMEs. Also, alternative sources of funding based on dif- However, the success of diff erent government ini- ferent lending technologies than traditional bank tiatives to provide fi nancial support to SMEs is still loans play a very important role when it comes to not well understood. One recent paper that makes funding SMEs. a contribution in this regard looked at a French In terms of more concrete policy advice, the program that provided upfront subsidisation of fi rst issue that should be addressed is the availa- loans to SMEs and concluded that it worked well bility of data on SMEs’ fi nancial situation. eseTh in alleviating credit constraints without raising data should at a minimum include the shares of default rates. SMEs that benefi tted from this pro- domestic credit that goe to SMEs, and better data gramme were, on average, able to generate returns linking access to fi nance to fi rm-specifi c fi nancial well above market interest rates. Th is is in contrast indicators to judge if credit constraints are justi- with some fi ndings regarding programmes that offi able on business grounds or constitute a market fer guarantees (instead of upfront subsidisation), failure. Th e ultimate wish list for improving the where default rates increased signifi cantly. Th e pa- available data is considerable, but this would be a useful start. 8 Cull, Robert, et al., 2006, “Historical fi nancing of small-and medium-size It is also clear that access to fi nance for SMEs enterprises.” Journal of Banking & Finance 30.11 (2006): 3017-3042. 9 De la Torre, Augusto, María Soledad Martínez Pería, and Sergio L. Schmukler, 2010, is closely linked to the macroeconomic situation, “Bank involvement with SMEs: beyond relationship lending.” Journal of Banking & Finance 34.9, 2280-2293. including the state of government fi nances and 10 Berger, Allen N., and Gregory F. Udell., 2006, “A more complete conceptual borrowing needs, as well as institutional and regu- framework for SME fi nance.” Journal of Banking & Finance 30.11, 2945-2966. 11 Beck, Thorsten, and Asli Demirguc-Kunt. 2006, “Small and medium-size enterprises: Access to fi nance as a growth constraint.” Journal of Banking & Finance 12 Bach, Laurent, 2012, “Are Small Businesses Worthy of Financial Aid? Evidence 30.11, 2931-2943. From a French Targeted Credit Program.”, mimeo, Stockholm School of Economics.

124 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

latory factors that impact the functioning of fi nan- tive sustainable funding sources that address insti- cial markets. Given the diversity of the countries tutional weaknesses and the specifi c circumstance along these dimensions, the policy recommenda- facing young and small SMEs (such as lack of col- tions in this area clearly cannot be one-size-fi ts-all, lateral and credit history) should be encouraged. but require detailed analysis of the country-specifi c When it comes to more specifi c government or circumstances. EU programmes to support credit to SMEs, it is However, one key macro indicator that directly important to identify if the lack of SME funding aff ects access to fi nance for SMEs is overall credit is a demand or supply problem, and to what ex- growth, which is linked to the aforementioned fac- tent perceived supply constraints are rational from tors but also to the health of the banking system. a business risk perspective. Providing more loans In countries with undercapitalised banks, access to to SMEs that are not sustainable in the long run fi nance will be limited across the board and in such is not in the interest of countries, even if it may be an environment, small and young fi rms are likely in the interest of individual business owners or fi - to suff er disproportionally. Improving their access nancial institutions. It is also important to consider to fi nance will therefore crucially depend on eff orts the incentive eff ects diff erent support programmes to restore the level of capital in the banking system. have for borrowers and lenders; for example, guar- Developing domestic fi nancial markets could antee programmes may look tempting from a fi scal be important in some countries, not only because policy perspective, since there is no upfront fi nanc- SMEs could fund themselves there, but to provide ing required, however, the fact that support is only larger companies an alternative to bank funding provided when projects or SMEs fail may distort and thus make banks more inclined to cater to incentives and lead to worse outcomes than with- SMEs. Identifying alternative lending techniques out these programmes. Instead, upfront fi nancial and removing obstacles to creating such alterna- support in terms of subsidised loans and equity tives should also be part of strategies to improve capital injections in fi nancial institutions seems access to fi nance for SMEs. For example, leasing to have worked relatively well in alleviating credit and factoring is a major funding source for SMEs constraints and generating good returns on invest- today, and innovations that contribute to alterna- ed capital.

STATE OF THE REGION REPORT 2013 125 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

The Rise of Baltic Sea Value Chains – a bicycle producer’s world tour Matias Kalm, Mika Pajarinen, Petri Rouvinen & Timo Seppälä Th e initial motivation for outsourcing and off shoring was labour cost arbitrage, i.e., shifting (manual) labour tasks from higher- to lower-wage Introduction countries. Locational factors – such as the availability of certain skills and proximity to end mar- Worldwide liberalisation and deregulation took kets – later grew in importance. place between the mid-1980s and mid-1990s. Th is, GVCs are surprisingly common. Today, over complemented with continuous improvements in 50% of global trade in goods and over 70% of digital technologies and logistics, brought about ge- services trade are related to intermediate inputs ographically dispersed Global Value Chains (GVCs) (OECD, 2012). Intra- and inter-fi rm GVCs in- in the 1990s (manufacturing) and in the 2000s (ser- volving multinational enterprises account for as vices). Armed with four decades of data, Johnson much as 80% of global trade (UNCTAD, 2013). and Noguera (2012) observe the growing prevalence Th e OECD (2012) notes that, “while most studies of GVCs, and, in particular, of those GVCs operat- on GVCs have focused on Asia, Europe shows a ing within geographic regions. Kenney (2012) notes comparable if not higher level of participation in that “there is a regionalization dynamic at work”, in GVCs.” Th e considerable changes elsewhere seem which, for example, the Baltic and eastern European minor, when compared to the drastic and continu- countries increasingly specialise in serving western ing changes the Baltic Sea Region has seen in re- European and Russian markets. cent decades. Nakamura et al. (2012) highlight the

Figure 1: The GVC participation index (the higher the value, the more deeply a country is engaged in global value chains).

Norway

Lithuania

Estonia

Sweden

Finland

Russia

Latvia

Denmark

Poland

Germany

Czech Rep.

Ireland

China

0 10203040506070

Source: OECD (2012), on the basis of the December 2012 release of the OECD ICIO database. The values are from 2008.

126 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

importance of EU enlargement and note that for- (OECD, 2012).2 Th is index measures the extent to eign direct investment (FDI) tends to be bilateral which a country is engaged in global value chains; in the Baltic Sea Region. For instance, over 60% the higher the value, the more deeply a country of foreign-owned companies in Estonia originated is engaged. As Figure 1 indicates, both the Baltic from other countries in the Baltic Sea Region; near- states and their Nordic neighbours are deeply (and ly 40% were Finnish or Swedish and nearly 10% reasonably evenly) engaged in GVCs. Th e fi gures were Latvian or Lithuanian (in 2011 according to for China and the US – which are included in Fig- Eesti Statistika). In a recent survey by the Confeder- ure 1 for purposes of comparison – suggest that ation of Finnish Industries (EK, a survey conducted larger economies have a tendency to be less engaged in November 2011), Russia, Estonia, and Sweden in GVCs because of the scale and scope of their were considered to be the three most prominent domestic markets. targets for further international expansion. In addi- Th e OECD (2012) also calculates a distance to tion to FDI, cross-country integration takes other fi n a l d e m a n d across six industries. Th e lower the forms: for example, some 16,000 Estonians work value, the closer a country is to the fi nal use of the in Finland (in 2010 according to Statistics Finland). industry’s output(s). Th us, a higher value indicates Th e OECD and the WTO have made sub- that a country is more upstream in the value chain, stantial progress in measuring international trade i.e., it is more likely to provide intermediate goods in value-added terms,1 and the GVC participation and services for the later stages of value chains that index has been calculated on the basis of this work are located in other countries.

Figure 2: Distance to ﬁ nal demand in the electronics industry (the lower the value, the closer the country is to ﬁ nal use).

Sweden

Finland

Denmark

Poland

Germany

Norway

Russia

Estonia

Latvia

Ireland

Czech Rep.

China

0,0 0,5 1,0 1,5 2,0 2,5 3,0

Source: OECD (2012), on the basis of the December 2012 release of the OECD ICIO database. The values are from 2008.

1 See, e.g., OECD-WTO Database on Trade in Value Added. First estimates: 2 The GVC participation index is a percentage share deﬁ ned as the value of foreign 16 January 2013. The standard practice of measuring trade in gross value terms inputs and domestically-produced inputs used in third country exports relative to the makes little sense in the era of GVCs. country’s gross exports.

STATE OF THE REGION REPORT 2013 127 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Figure 2 shows a country’s distance to fi nal de- the answer is ‘yes’ to a certain extent, which often mand in the electronics industry. Th e distance is makes value chains outside the electronics industry shortest for the three Nordic countries and longest regional rather than global in nature, as the bicycle for the three Baltic states. Th us, as a broad gen- case below illustrates. eralisation for the electronics industry, the Baltic States provide intermediate goods and services to their Nordic neighbours, which then interact with The Journey of a Bicycle from the ultimate customers/users. Finland to Asia and then back to Tiits and Kalvet (2012) consider in detail how the Baltic Sea Region the division of labour between Baltic and Nordic countries has played out in the telecommunications Th e design of a bicycle has changed little since the equipment industry.3 Th ey note that the Baltic 1890s (Galvin & Morkel, 2001). How bicycles are States have had a considerable role, although Erics- manufactured, however, has changed drastically in son and Nokia have been the region’s locomotives. recent decades. Vertical integration of manufactur- In 2000, nearly 30% of Estonia’s total exports con- ing has nearly disappeared. Today, brand holders sisted of telecommunications equipment; since that and main contractors can purchase each compo- time, this percentage has dropped to under 5% be- nent, and sub-assembly is undertaken in intensely cause of changes in corporate strategies and market competitive global markets. conditions.4 We analyze a women’s bicycle produced by In the era of GVCs, however, exports are an a 100-year-old Finnish family-owned company, impartial measurement of global engagement. Tiits Helkama Velox. In 2007, Helkama Velox off shore and Kalvet note that, “Today, Ericsson Estonia pro- outsourced the production of the model in ques- vides telephony and data communications systems tion by moving production from Finland to Cam- planning, integration and maintenance services to bodia. In 2008, the company ordered samples various clients.” With respect to Ericsson’s innova- from a potential Vietnamese outsourcing partner; tive activity, these authors acknowledge the contin- in 2009, it transferred production to an Indonesian uing central role of its Swedish home base but also partner. Because of rising costs in Asia, Helkama note the gradual build-up of Baltic competencies: Velox began to explore alternatives. In 2012, it con- “… some middleware solutions have been devel- tracted with a Lithuanian company and is likely to oped for Ericsson mobile telephone networks in Es- maintain its production in the Baltic Sea Region tonia.” Th e bankrupt outsourcing company Elcoteq for the foreseeable future. Th e bicycle’s trip around had signifi cant 2G and 3G telecommunications the world is illustrated in Figure 3. equipment manufacturing in Estonia.5 Th e facility Figure 4 illustrates the framework of our anal- continues to operate, although it is now owned by ysis. We consider the same bicycle by the same Ericsson. Tiits and Kalvet (2012) conclude, “… it is company delivered to a Finnish retailer for fi nal still obvious that Ericsson’s contribution to Estonia’s sale through the company’s distribution centre in foreign trade is massive.” Hanko, Finland. Th e only factor we alter in our Th e production of electronics is exceptionally analysis is the bicycle’s assembly location, i.e., modular; the high price to weight ratios of both whether it is Finland, Lithuania, or Indonesia. inputs and outputs make rapid transportation by We study in detail the value chain that enables air economically viable. However, is the electronics a consumer to be able to purchase a Helkama Velox industry a special case with respect to the unbun- bicycle at a retailer in Finland. We determine the dling of value chains? In this paper, we suggest that value added by actors, functions, and geographies separately for all direct and indirect tangible and 3 Tiits and Kalvet (2012) also study the case of Skype, which is not discussed here; intangible inputs (including capital expenses and the authors note therein (with legitimate pride), “… Skype’s success is strongly a result of Estonia’s engineering talent.” the contributions of supporting functions, such as 4 Ericsson and particularly Nokia were hurt by the entry into the mobile market of the iPhone (Apple) in January 2007 and later by devices based on the Android platform top management). In principle, we do not stop with (Google). New competitors, such as Huawei from China, have further intensiﬁ ed Helkama Velox’s fi rst-tier vendors and suppliers; in- competition in network equipment. In the 2000s, electronics assembly shifted towards Asia. stead, we follow tangible inputs to the point when 5 Elcoteq ﬁ led for bankruptcy protection in Luxembourg on October 6th, 2011. Ultimately, it was unable to compete with Foxconn and others. raw materials were extracted from the earth’s crust,

128 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Figure 3: How a Helkama Velox bicycle went to Asia and returned to the Baltic Sea Region (points indicate assembly locations).

Hanko 2006 Lithuania 2012

Vietnam Cambodia 2008 2007 Indonesia 2009

Source: Kalm and Seppälä (2012).

Figure 4: The framework of our bicycle case analysis.

Sales through retailers Finland

DistribuƟon center Hanko, Finland

Manufacturing Finland,, Lithuania or Indonesia

Source: Kalm and Seppälä (2012).

STATE OF THE REGION REPORT 2013 129 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

and we follow intangible inputs all the way to the product is assembled in Indonesia but only 3% generation of original ideas and concepts. when it is assembled in Lithuania.6 Th e value Our initial analysis in this spirit concerned added (excluding assembly) of the brand holder a Nokia N95 smartphone (Ali-Yrkkö, Rouvinen, and co-ordinator Helkama Velox is highest when Seppälä, & Ylä-Anttila, 2011), which Nokia as- the bicycle is assembled in Lithuania and lowest sembled in Beijing, China and in Salo, Finland. when it is assembled in Finland; however, the dif- For this smartphone, we concluded that assembly ference between 28% and 20% is not nearly as location had little eff ect on the value captured by drastic as the diff erence in the direct assembly Finland, the country in which Nokia is headquar- cost suggests.7 tered. Assembly cost was identical in the two loca- With respect to the geography of value added tions and amounted to approximately 2% of the to the product, Finland captured two-thirds of pre-tax fi nal purchase price; other aspects of the the value added when fi nal assembly was in Fin- value chain remained largely intact regardless of land (Figure 6). Moreover, Finland continued to assembly location. capture as much as 58% of Made in Lithuania In the manufacture of a bicycle, the assembly or Made in Indonesia bicycles. Finland’s share cost varies considerably and aff ects other stages in remains signifi cant because of Helkama’s role as the value chain. In Lithuania and Indonesia, as- brand owner and because of local distributors’ sembly accounted for only 2% of the total value signifi cant contribution (one-fourth), regardless added to the product (Figure 1). However, in high- of the country of origin. In Figure 6, the value er-cost Finland, the cost of assembly amounted to captured by EU countries other than Finland 16% of the total value added. jumps considerably more than Lithuania’s share Focusing on fi nal assembly alone is, however, for assembly because, as opposed to electronics, an excessively narrow perspective on manufactur- Helkama Velox’s outsourcing partner uses local ing. Outside vendors (including both fi rst- and and regional sources for inputs. higher-tier suppliers, but excluding the assembly In manufacturing a bicycle, off shoring to Asia partner in this case) account for one-third of the did not off er cost savings and also introduced new value added in Finland, nearly 40% in Indone- demand and fi nancial risks. With assembly in Lith- sia and over 40% in Lithuania. Furthermore, lo- uania, Helkama Velox gained both fl exibility and gistics absorbs 9% of the value added when the profi tability.

Figure 5: Value-added percentages by participant and function for a bicycle across three assembly locations.

Vendors 33,3% 37,0% 41,8%

2,3% Assembly 15,6% 2,3%

26,5% Helkama 20,5% 27,9% (brand owner) 8,9% Logistics 5,5% 2,7%

Distributors 25,2% 25,2% 25,2%

Finland Indonesia Lithuania

Source: Kalm and Seppälä (2012). 6 With Lithuanian assembly, the shipment cost is included in the contract price. 7 Furthermore, this calculation ignores any additional co-ordination costs associated with outsourcing.

130 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Figure 6: Value-added percentages by country/region for a bicycle across three assembly locations.

Rest of the world 9,5% 10,3% 10,7%

Asia 10,6% 10,7% 21,5% Other EU-27 12,6% 20,7% 8,9%

Finland 67,3% 59,3% 57,9%

Finland Indonesia Lithuania

Source: Kalm and Seppälä (2012).

As the bicycle case study shows, the co-ordina- Additional cases tor often captures a large share of the overall value added, which is attributable to intangible assets, Besides the above illustrative example of a bicycle’s such as the brand. As with virtually all consumer value chain, we have conducted forty cases consid- goods (and sometimes also with business-to-busi- ering the consequences of geographically dispersed ness goods), the share of wholesale and retail dis- production (Ali-Yrkkö, 2013; Ali-Yrkkö & Rou- tributors is also substantial. As far as the geography vinen, 2013). Below a few remarks on some of the of value added is concerned, this case also draws at- remaining cases. tention to the roles of local higher-tier subcontrac- In the case of a Nokia N95 smartphone (Ali- tors (the fi rst-tier subcontractor is Helkama Velox’s Yrkkö, Rouvinen, Seppälä, & Ylä-Anttila, 2011), Lithuanian outsourcing partner). value added is largely detached from the assembly Our bicycle has travelled far in only six years. location. Services internal to the multinational cor- Th e voyage was assisted by the modular and stand- poration, returns on intellectual property rights, ard nature of the product. Many other processes and other intangible aspects of the global value and products, including those of all ten business- chain largely determined, where value added was to-business investment goods we have also stud- created and captured. ied (see below), are more complex and often ben- Our smartphone case study provides insights efi t from the tacit knowledge of the individuals for a point in time. Seppälä and Ali-Yrkkö (2013) involved. Additionally, although these processes consider three similar feature phones across time move geographically, they move less frequently and (the Nokia 3310 in 2000, the Nokia 1100 in 2003, over shorter distances. Nevertheless, it is the ba- and the Nokia 1200 in 2007). Th eir analysis sic nature of GVCs – perhaps unintentionally – to shows the rapid decline in price of a given feature introduce new domains of competition as previ- set and the gradual shift of tasks towards develop- ously integrated value chains are dismantled. Th is ing countries. Th is shift concerns not only physi- requires continuously upgrading national compe- cal components and assembly but also design and tencies and dynamic labour markets, in addition other intangible aspects. For instance, the Nokia to intense ‘creative destruction’ among local busi- 3310 was designed end-to-end in Denmark and nesses, to enable the resources released to fi nd new Finland. Th e Nokia 1200 was designed in China, uses in due time. although Denmark still assumed responsibility for the hardware and software platforms. Over

STATE OF THE REGION REPORT 2013 131 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

time, China’s role increased substantially from be its profi t-and-loss center, and the remaining being just an assembly location. units should generate a going market profi t. Some In addition to mobile phones, we consider four fi rms (incorrectly) used their assembly units as other consumer electronics products (the company profi t centers. In these cases, re-locating assem- and its products cannot be named due to confi den- bly also meant re-locating profi ts. More appropri- tiality), which reveal the signifi cant role of transfer ately, some fi rms used their headquarters or par- pricing. Th e parent company in Finland owned the ent companies as profi t-and-loss centers. In these brand and relevant patents but the vast majority of cases, the parent company typically owned most the profi ts were captured by the company’s sales intellectual assets and bore most of the risks. In units in other countries. Consequently only 5–17% these cases, re-locating assembly had less impact of the total value was captured in Finland. Howev- on the home country. er, the company had misinterpreted OECD (2010) In addition to the engineering product cases transfer pricing guidelines. Because the parent and Nokia’s phones, we have analyzed foodstuff s company carried most of the risks and owned all and textile products. A chocolate bar and a bag relevant intellectual property, the parent company of rye bread were among the eight analyzed food- should have captured any excess profi ts. When we stuff s. Th ese cases highlight the considerable role recalculated the geographical breakdown of value of wholesalers and retailers, capturing on average added using more appropriate transfer prices, the 38% of the total value added, which is approxi- value-added share of the home country increased mately the same as the brand owner’s share. In the to 42–66% (with direct implications for, e.g., meas- case of the four textile products, a brand owner had ured national GDP). outsourced production to a contract manufacturer In addition to the bicycle, we have analyzed that captured 7% of the total value added. Whole- a dozen other electrical, mechanical, and preci- salers and retailers captured half of the value added, sion engineering products, primarily targeting and the brand holder captured one-third of it. global business-to-business markets. Ten of these Our remaining cases in our analysis were one- cases involved assembly both in Finland and in off s. In the case of a piece of two-by-four inch sawn a lower-cost location, typically China (but in a timber, 100% of the value added was created and few cases, the location was elsewhere, e.g., in captured in Finland. Had the tree trunks been Eastern Europe). As the assembly location moved imported from Russia, a common practice in the off shore, Finland’s share of value added declined early 2000s, Finland’s share would have declined by between 11 and 49 percentage points. Th us, to 55%. Our cases also included other wood-based unlike in the smartphone case, off -shoring had a products. Th e analyses of these products revealed considerable negative impact on Finland. Th is is that the value added in physical activities – includ- explained by three factors. First, unlike in elec- ing raw material supplies and processes towards tronics, a large fraction of outside sourcing took the fi nal product – varied between 56% and 67%, place near the assembly location. Th is was also whereas the value added in the remaining, more true for some supporting service functions. For intangible activities varied between 33% and 44%. example, in some cases the fi rms employed local Th e value capture in forest-based products is driven sales and marketing staff and performed location- by raw materials and related processing to an ex- specifi c R&D due to, e.g., national idiosyncra- ceptional degree. sies in building codes. Furthermore, assembly Whitevector is a social media monitoring and and other functions, particularly R&D, were in research company headquartered in Finland. It has some cases interrelated: the fi nal refi nements in minor equipment and rent expenses, and its sales the product design were made interactively on the are almost equal to its value added, virtually all of factory fl oor. Second, the role of intellectual prop- which is captured in Finland. Another analyzed erty (IP) varied. While some products or their service case concerned a translation and localiza- production processes were patented, others did tion service. Although the company in question not embody formal IP rights. Th ird, the location employed freelance translators located outside Fin- of the profi t center varied. According to interna- land, the home country’s share of value added ex- tional treaties, the fi rm’s risk-carrying unit should ceeded two-thirds.

132 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Conclusions tion and customer-specifi c tailoring, both of which emphasise intangible elements (such as brands) Th e Economist (2013) observes that “… off shoring are growing. Software and other aspects of ICT in its traditional sense, in search of cheaper labour (such as sensors) are more likely to be embedded anywhere on the globe is maturing, tailing off and in products, and there is greater focus on product to some extent being reversed. Multinationals will life cycles and after-sales service. Finally, consum- certainly not become any less global as a result, but ers have shown a keen and growing interest in en- they will distribute their activities more evenly and vironmental and social sustainability (such as ap- selectively around the world, taking heed of a far propriate working conditions). All-in-all it can be broader range of variables than labour costs alone.” said that manufacturing is becoming more com- Th is shift to a more carefully considered ‘smart plex and moving away from cheap replication and sourcing’ is potentially good news for the Baltic low-skilled labour. Sea Region.8 Our forty case studies (Ali-Yrkkö, 2013; Ali- Global value chains (GVCs) depend on the Yrkkö & Rouvinen, 2013) suggest there are three exact real-time co-ordination of their operations, ways to capture ‘over-sized’ wages and profi ts in which means that speed, fl exibility, and reliability GVCs. First, it pays to be the orchestrator and/or are of utmost importance. Simultaneously, ever- brand owner of a value chain. All forms of intel- intensifying competition maintains continuous lectual property rights (IPRs) appear to earn good pressure on costs. Korinek and Sourdin (2011) es- returns. It should be noted, however, that IPRs timate that each additional day of delay caused by are also costly, risky, and time consuming to nur- border procedures reduces trade by approximate- ture and/or acquire. Second, controlling the inter- ly 4%. Furthermore, quality problems are easily face to the immediate customer and the ultimate magnifi ed by geographic dispersion, because these user creates negotiating power, which is evidenced problems may only be noticed in the next stage in how monetary rewards are distributed. On the of the value chain (which may be substantially other hand, these activities can require substan- later), and re-delivery times are longer than with tial capital, for example maintaining a chain of co-location. retail locations. Th ird, in several cases, we are able Change in geographical dispersion is one de- to identify so-called ‘gate-keepers’ that earn well; velopment, but the nature of both manufacturing such entities may provide a key input or control a and services is also changing. A substantial portion crucial raw material, for example. In terms of job of the manufacturing function in today’s busi- assignments, these three areas translate to high- ness environment typically involves service tasks; level service tasks that are typically considered to in higher-cost geographies, pure manufacturing have a supporting role (such as fi nance) and to with no embedded intangible or service is becom- the creation and management of intangible assets ing rare. Services, which were previously thought (such as R&D and legal functions). to be doomed to slow productivity growth, are in- Compared to outsourcing and off shoring to creasingly traded. In fact, the distinction between Asia, the Baltic Sea Region enjoys several advan- manufacturing and service products is rapidly be- tages; all of the countries in the region have rela- coming meaningless. tively well-functioning legal systems and contract With advances in robotics and new technolo- enforceability, both tangible and intellectual prop- gies – such as 3D printing – manufacturing de- erty rights are well-protected and respected, cur- pends less on low-skilled labour, i.e., the type of rency regimes are stable, and there is cultural simi- labour that has traditionally been the core advan- larity among the countries in the region. tage of large emerging economies.9 Niche produc- Near-shoring in the Baltic Sea Region also of- fers the benefi ts of reasonable transportation costs

8 The Economist (2013) also compiles a revealing statistic about the future and short delays. Our case studies suggest that tendencies in outsourcing that is based on studies by three consultancies. Although approximately one-fourth of multinationals are planning to move activities to a low-cost inventory-carrying and logistics costs, in addi- country and another one-fourth are moving activities between low-cost countries, tion to time delays, make a signifi cant diff erence another one-fourth are either returning to or moving between high-cost countries. The remaining companies are presumably staying in their current locations. in global value chains. In manufacturing, these 9 Furthermore, wages in coastal China have been growing at a rate of over 10% a year for quite some time. costs are often greater than the direct cost of fi nal

STATE OF THE REGION REPORT 2013 133 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Why Baltic value chains might be on the rise

• Costs and risks of global, as opposed to regional, gal, and political strengths of the Baltic Region have value chains are rising. become more appreciated. • Physical production is changing in ways that reduc- • The discussion on offshoring and outsourcing is es the relative importance of cheap manual labor. moving from mantras to smart sourcing, i.e., to • Both goods and services offering are increasingly in more careful consideration of locations other than complexity and gaining intangible dimensions, both China and India. of which strengthen interconnections within value • Environmental issues of global value chains, such chains that are assisted by geographical proximity. as emissions related to logistics, are no longer ig- • The handicaps of emerging countries are becoming nored, which reduces China’s attractive as the world more obvious. By ﬂ ip side the economic, cultural, le- factory.

assembly that earns the “Made in” label. In Baltic day activities; and sensible and effi cient regulation value chains, shipping times are measured in days – and taxation. or in hours (e.g., Helsinki–Tallinn) – instead of the Should the Baltic Sea countries seek more weeks and months that deliveries from Asia might intra-region interaction, related policies must be require. Because demand conditions can change aligned. As Agafonov and Bitinas (2010) state, this rapidly, lengthy delivery times are also a business has not always been the case: “Legislation risks in risk. Baltic have increased due to quite often changes Time is also important in setting up a foreign of terms and rules. In particular, changes of state operation. Referring primarily to the BRIC coun- regulations and laws, tax levels and transportation tries, McKinsey (Manyika et al., 2012) notes that rules bring about additional costs...” “it can take seven to ten years for even the most Multinational enterprises seek out cost advan- successful multinationals to break even in new tages and other benefi ts of geographical dispersion emerging markets”, which makes entry both costly but simultaneously desire the operational fl exibility and risky. Making a cross-border entry into the and resilience that accompany proximity. Th e Bal- Baltic Sea Region would presumably take approxi- tic Sea Region may potentially off er the ‘sweet spot’ mately half that time. in this balancing act; the area has not yet exploited GVCs lead to deepening specialisations across all of the opportunities that regional value chains economic actors, which increases overall well-be- off er, although co-operation might substantially ing, in principle. However, it remains unclear how help the region’s businesses and countries to suc- these improvements are distributed. Th e desire of ceed in global competition. all countries, individuals, and organisations is to shift to higher value-added activities in GVCs and to create higher GDP per capita, wages, and prof- References its.10 National policies that support this endeav- our include the following: extensive investment in Agafonov, Y., & Bitinas, S. (2010). Risk Manage- education and social well-being that is designed to ment in Baltic Logistics. Journal of Business incentivise the population to seek new economic Management, 3, 123–130. opportunities, fostering intense competition (and Ali-Yrkkö, J. (2013). Mysteeri avautuu: Suomi creative destruction) among businesses and organi- Globaaleissa arvoverkostoissa. Helsinki: Talousti- sations within the country; a keen focus on devel- eto (ETLA B257). oping infrastructure and other indirect conditions Ali-Yrkkö, J., & Rouvinen, P. (2013). Implications that support businesses and citizens in their day-to- of Value Creation and Capture in Global Val- ue Chains: Lessons from 40 Grassroots Cases. 10 The Baltic states have had some success in this respect: their outward foreign ETLA Reports, forthcoming. direct investment and the increasing international presence of ingenious brands may be considered evidence of this.

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Ali-Yrkkö, J., Rouvinen, P., Seppälä, T., & Ylä-Ant- Francisco, Seoul: McKinsey Global Institute, tila, P. (2011). Who Captures Value in Global McKinsey Operations Practice. Supply Chains? Case Nokia N95 Smartphone. Nakamura, H. R., Olsson, M., & Lonnborg, M. Journal of Industry, Competition and Trade, (2012). FDI in the Post-EU Accession Baltic Sea 11(3), 263–278. Region: A Global or a Regional Concern? Baltic Economist. (2013). Here, there and everywhere. Th e Journal of Economics, 12(2), 89–108. Economist, 406(8819), 3–5. OECD. (2012). Policy dialogue on aid for trade: Map- Galvin, P., & Morkel, A. (2001). Th e Eff ect of Prod- ping global value chains. Paris: Organisation for uct Modularity on Industry Structure: Th e Case Economic Cooperation & Development, TAD/ of the World Bicycle Industry. Industry and In- TC/WP/RD(2012)9. novation, 8(1), 31–47. OECD. (2010). Transfer Pricing Guidelines for Mul- Johnson, R. C., & Noguera, G. (2012). Proximity tinational Enterprises and Tax Administrations. and Production Fragmentation. American Eco- Paris: Organisation for Economic Cooperation nomic Review, 102(3), 407–411. & Development. Kalm, M., & Seppälä, T. (2012). Palaako tuotanto Seppälä, T., & Ali-Yrkkö, J. (2013). Th e Changing Aasiasta Suomeen? Case Polkupyörä. ETLA Dis- Geographies of Value Creation in Global Value cussion Papers, 1287. Chains: Evidence from Mobile Telecommunica- Kenney, M. (2012). Where Is Value in Value Net- tions. Mimeo, ETLA, Th e Research Institute of the works? In D. Breznitz & J. Zysman (Eds.), Finnish Economy. Twenty First Century Manufacturing (pp. 17–51). Tiits, M., & Kalvet, T. (2012). Nordic Small Coun- Vienna: United Nations Industrial Development tries in the Global High-Tech Value Chains: Th e Organization (UNIDO). Case of Telecommunications Systems Produc- Korinek, J., & Sourdin, P. (2011). To What Extent tion in Estonia. Tallinn University of Technology, Are High-Quality Logistics Services Trade Facili- Working Papers in Technology Governance and tating? OECD Trade Policy Working Papers. Economic Dynamics, 38. Manyika, J., Sinclair, J., Dobbs, R., Strube, G., Ras- UNCTAD. (2013). Global Value Chains and Devel- sey, L., Mischke, J., Remes, J., Roxburgh, C., opment: Investment and Value Added Trade in the George, K., O’Halloran, D., & Ramaswamy, S. Global Economy (A preliminary analysis; Advance (2012). Manufacturing the Future: Th e Next Era unedited version). Geneva: United Nations Con- of Global Growth and Innovation. London, San ference on Trade and Development.

STATE OF THE REGION REPORT 2013 135 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Latvia’s exports: the real ‘success story’ Alf Vanags ther growth of 30% in 2011 and 16% in 2012 has continued to post new record levels. Th is has mostly been growth in export volumes, but unit export Introduction values also grew by 8-9% in 2010 and 2011, and by 3% in 2012. In contrast, most EU economies’ ex- A notable feature of the recovery from the recession port growth since the previous peak has been more in the Baltic states has been the strong performance modest1 and some countries (e.g. Denmark, UK, of exports. Th is is illustrated in Table 1, which Ireland and Luxembourg) have not yet recovered shows the developments of EU member state ex- their pre-recession export levels. ports from their pre-recession peak, and also from Th erefore, the Baltic states really do stand out – the low point experienced in 2009. and, arguably, this represents the real ‘success story’ While in nearly all EU countries, exports have of the Latvian economy. recovered from the low point of 2009, the Baltic Th is is even more the case because it is not states are the leaders, with export growth since the just a ‘bounce back’ from the recession. Table 2 low point of the recession between 86% and 93%. shows that the exceptional growth of Latvia’s ex- More signifi cant is the strength of export growth port volumes predates the recession. Th us, while from the pre-recession peak. Here, Latvia is the clear export growth accelerated after 2009, with export leader with exports in 2012 up by 51% as compared volume growing 67% and taking export volume with its pre-recession peak (which, for Latvia, and to a level more than 4 times greater than in 2000, for most countries, was reached in 2008). in 2008, export volume was already 2.75 times With 30% export growth between 2009 and the level in 2000, representing the third highest 2010, by the end of 2010 Latvia had surpassed its growth in the EU, after Lithuania and Slovakia, previous absolute record export level, and with fur- over 2000-2008.

Table 1: Export growth in EU27

10 0,0% Growth from peak Growth from 2009

80 ,0 %

60 ,0 %

40 ,0 %

20 ,0 %

0,0%

-20,0%

-40,0% Source: Eurostat

1 Other notable and interesting strong export performers include Greece, Bulgaria and Romania.

136 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Table 1: Development of export volumes EU27, 2000 =100 2004 2005 2006 2007 2008 2009 2010 2011 2012 Belgium 119.9 124.0 129.7 136.4 133.7 118.9 129.0 133.9 134.1 Bulgaria 149.2 166.5 183.6 198.0 213.0 183.2 220.9 266.4 268.4 Czech R 160.6 175.4 204.7 235.7 250.5 210.3 248.7 272.9 280.1 Denmark 110.7 117.2 122.4 126.8 128.4 114.2 118.0 121.4 120.5 Germany 120.5 127.6 139.8 148.9 148.3 121.6 140.1 149.3 150.7 Estonia 141.9 178.9 216.6 215.2 217.1 179.5 224.7 284.8 295.1 Ireland 109.9 110.1 106.3 109.6 105.2 104.7 106.0 107.5 106.9 Greece 102.5 115.1 127.8 129.8 129.3 116.9 121.5 155.3 178.4 Spain 113.4 114.6 120.2 125.8 125.9 112.0 125.0 135.6 136.5 France 99.8 99.5 100.8 100.8 99.6 84.7 93.1 95.5 96.2 Italy 103.1 104.2 110.1 115.7 111.6 90.6 100.3 104.8 105.8 Cyprus 188.3 284.0 244.1 228.5 228.1 222.9 242.5 282.3 295.9 Latvia 156.3 200.9 225.5 252.1 275.2 245.7 295.0 361.4 410.6 Lithuania 194.1 234.2 258.2 269.0 316.4 270.5 320.9 365.7 398.2 Luxembourg 156.7 183.5 216.3 198.5 213.0 203.7 187.1 186.3 179.2 Hungary 150.7 169.3 201.2 232.0 241.0 200.4 226.2 241.9 242.8 Malta 87.0 86.8 93.7 102.4 91.6 75.2 92.3 97.0 104.1 Netherlands 118.9 130.7 141.0 148.0 152.9 135.9 150.9 151.5 157.6 Austria 129.7 132.8 138.4 146.8 147.0 120.0 138.1 146.3 148.1 Poland 165.6 188.6 222.2 247.8 267.2 241.8 278.2 298.5 312.9 Portugal 107.7 116.2 127.1 133.8 132.6 112.6 121.3 137.0 149.1 Romania 156.9 172.3 188.6 215.0 232.0 213.9 254.8 282.0 278.4 Slovenia 132.5 150.0 173.4 198.7 203.9 171.9 193.3 207.8 207.6 Slovakia 159.6 172.6 221.5 280.7 312.3 270.9 322.4 360.7 400.1 Finland 106.9 106.5 118.0 118.6 119.0 87.9 93.9 95.1 95.1 Sweden 108.4 112.3 119.9 123.5 122.7 98.6 114.2 121.5 118.8 UK 90.4 95.5 103.4 91.6 89.5 75.0 83.7 89.7 85.1

Source: Eurostat

Developments in the theory and empirics of explanations for global international trade grow- international trade provide a basis for a deeper un- ing faster than GDP. Th e importance of GVCs is derstanding of the mechanics of international trade refl ected in the growth of interest in empirically and its growth, as compared with the classical com- distinguishing between a country’s total trade (ex- parative advantage approach, which explains only ports) and the share that generates domestic value the direction and commodity composition of trade. added. Th e challenge of mapping GVCs has been For example, detailed decomposition of trade into taken up by a number of international researchers, products and markets enables analysis of diversifi - and Box 1 in UNCTAD (2013) provides a sum- cation of products and markets, and of the relative mary of fi ve important initiatives, including the importance of new products and new markets in UNCTAD Eora data base, the OECD/WTO In- generating export growth, as compared to the inter Country Input Output model (ICIO) and the tensifi cation of export of existing products to exist- EU’s World Input Output Database (WIOD). ing markets. Th e GVC phenomenon also provides a link Another development has been the recognition between a country’s trade and the Foreign Direct and analysis of the role of ‘fragmentation’ in the Investment it attracts. international production process, whereby both Th is chapter aims to assess what light these production and services have been increasingly dis- approaches can shed on interpreting the develop- tributed over diff erent locations. Th is phenomenon ment of Latvia’s export performance. Th e fi rst sec- has come to be known as the development of global tion examines the evidence on diversifi cation and value chains (GVCs), and is regarded as one of the the extensive/intensive margin, the second section

STATE OF THE REGION REPORT 2013 137 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

examines the statistical evidence on Latvian par- Th is defi nitional picture is complicated by the ticipation in GVCs, and a third section reports on presence of a quality margin, i.e. higher quality can some recent export-oriented FDI case studies. increase exports at the intensive margin without sacrifi cing price or even at higher export prices. On the extensive margin, there is an issue of sustain- The diversiﬁ cation of exports: extensive ability of new export relationships. According to and intensive export margins Besedes and Prusa (2007), disaggregated export data show that most export relationships are very Considerable recent attention has been focused on short lived – they show that “for some countries export diversifi cation and on the role of extensive about 7 of 10 new export relationships fail within and intensive margins in the growth of exports for two years; by comparison, more successful export- diff erent groups of countries. Th e schematic de- ers experience failure at about half that rate” (p.1.) composition of export growth into extensive and How does Latvian evidence on the develop- intensive margins is illustrated in Figure 2. Th us, ment of markets and diversifi cation look? At the the ‘intensive margin’ is associated with higher or most aggregate level, we do not observe much ac- more intensive exports of existing export products tion. Figure 3 shows developments of the share of to existing export destinations. On the other hand, the top fi ve export groups in 2011 over a period the ‘extensive margin’ captures the emergence of new starting in 2006. export products and new export destinations. Th e It is apparent that, despite some loss of share for extensive margin can be further thought of in terms wood products, there is rather modest movement in of ‘product diversifi cation’, which is made up of the either the absolute shares or the relative positions sum of new products to new destinations and new of these top fi ve products2, especially since 20083. products to old destinations and ‘geographical diver- As a fi rst glance at a deeper analysis, it is of inter- sifi cation’ which consists of the sum of new products est to look at the development in the diversifi cation to new destinations and old products to new desti- of Latvian exports, as measured by the Herfi ndahl nations (see Amurgo-Pacheco and Pierola, (2008)). index of concentration4. Figure 4 illustrates this:

Figure 2: Decomposition of export growth into extensive and intensive margins

Intensive margin: higher volumes of existing products to existing markets Quality margin: improved quality of Export existing products growth

New products Extensive margin

New destinations

Exit of Survival/and markets products

Source: Adapted from Reis and Taglioni (2013) 2 These product groups correspond to the Roman numeral codes of the Combined Nomenclature: food products correspond to I-IV, chemicals are group VI, wood products correspond to IX and X, metals to XV and machinery to XVI. 3 Textiles, not shown in Figure 3, have declined from a share of about 8% in 2006 to just 4% in 2011. 4 The Herfi ndahl index is a standard measure of concentration and is defi ned here as the sum of the squared export shares of all commodity groups at the three digit level of the SITC (Standard International Trade Classifi cation). A high value of the index indicates a high degree of concentration, and lower values represent less concentration or, alternatively, more diversifi cation.

138 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Figure 3: Share of top ﬁ ve export categories: Latvia 2006-11

0,3

0,25

0,2 Food products Wood products 0,15 Metals Machinery 0,1 Chemical products

0,05

0 2006 2007 2008 2009 2010 2011 Source: CSB

Figure 4: The Herﬁ ndahl index of Latvian export concentration (SITC-3digit level)

0,06

0,05

0,04

0,03

0,02

0,01

0,00 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: Eurostat

Th e data show a quite dramatic diversifi cation destination country since EU accession. Th e main of Latvian exports from 2004 to 2008, with the things to note are: Herfi ndahl index of concentration falling from • the rapid emergence of Lithuania and Estonia more than 0.5 to less than 0.2. Since 2008, there as Latvia’s top export partners after EU acces- has been a fl attening out of the index. us,Th the sion in 2004; diversifi cation process as measured by the Herfi nd- • the decline of the German market; ahl index pre-dates the crisis and the recovery. Th e • the recent strong growth of both Russia and current level of concentration of Latvian exports is Poland as export destinations. less than CEE countries in general, and at about All of this refl ects diversifi cation away from the same level as that of Denmark. ‘old EU’, i.e. the EU 15, which in 2004 was the Export destinations off er another perspective. destination for 54% of Latvia’s exports, but today Figure 5 shows the development of export shares by receives about one third.

STATE OF THE REGION REPORT 2013 139 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Figure 5: Latvia’s main export destinations by export share%

20,0%

18,0%

16,0%

14,0%

12,0% LT EE 10,0% RU 8,0% DE PL 6,0%

4,0%

2,0%

Source: CSB

Figure 6: Herﬁ ndahl index by Latvian export destinations

0,09

0,08

0,07

0,06

0,05

0,04

0,03

0,02

0,01

0,00 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: CSB

Th e Herfi ndahl index for Latvia’s export des- 2 or 3 or 4 digit commodity classifi cation level. A tinations off ers an alternative perspective on diver- detailed and highly informative study of Latvia’s sifi cation, and the development of this indicator is export competitiveness in terms of diversifi cation shown in Figure 6. Here, no clear trend is discern- and at both the intensive and extensive margins ible and the intuition of this is not entirely clear, es- has recently been published by Benkovskis (2012). pecially in light of the rapid growth of new export Benkovskis employs data at the six-digit HS5 level destinations reported later in this section. Th ere is a limit to what can be concluded at the 5 Harmonised System. This is the commodity classiﬁ cation used in the United levels of aggregation considered so far, i.e. at the Nations Commodity Trade Statistics Database (Comtrade).

140 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Table 2: Development of export markets and products 1999-2010

1999 2003 2004 2005 2006 2007 2008 2009 2010 Markets 8,959 11,686 13,412 18,968 20,472 20,827 21,033 22,593 24,905 Products 2,638 2,854 3,065 3,377 3,490 3,416 3,462 3,562 3,610 Destinations 3.4 4.1 4.4 5.6 5.9 6.1 6.1 6.3 6.9 per product

Source: Benkovskis 2012 for the period between 1999 and 20106. Table 2 this eff ect (about 20%) is geographical, i.e. sale of shows the development over time of the number existing products to a new destination, while the of export markets, which is defi ned as the number share of new products was about 5%. At the same of countries where at least one Latvian product is time, the third component of the decomposition imported, and the number of exported products. has had a negative impact, i.e. the share of Latvia’s Th ese fi gures are very striking. Over the whole traditional markets in world trade has fallen, and period, both the number of markets and the num- this has contributed to a more than 15% reduc- ber of products increased strongly, especially after tion in Latvia’s share in world markets. Almost all EU accession, since when the number of markets of this eff ect is geographical: the share of Latvia’s has increased by 86% and the number of products traditional export destinations in the structure of per market has grown by 57% (from 4.4 to 6.9). world demand has declined. As Benkovskis points Th us, in terms of the classifi cation described in out, “important partners like Germany, Sweden Figure 2, Latvian export growth has certainly oc- and UK did not increase their imports as fast as curred at the extensive margin – Latvian exporters developing countries of Asia”. have been successful in bringing new products to Th e decomposition into intensive, extensive international markets, and in fi nding new markets and demand structure can also be done at the level in which to sell both traditional and new products of individual product groups. Th is analysis reveals However, although informative and sugges- that all of Latvia’s most important product groups tive, the ‘raw’ fi gures reported in Table 2 do not increased their share in world markets over 1999- by themselves permit a comparison of the relative 2010, with the market share of ‘vehicles and other importance of the intensive and extensive margins transport equipment’ improving by a factor of more in Latvian export performance. In order to make than ten, while the Latvian market share in ‘ma- such an assessment, Benkovskis has performed a chinery and mechanical appliances’ increased by a decomposition of changes in Latvia’s market share factor of more than fi ve, and for food products by in export markets7 into three components: the con- a factor of more than four. For these products the tribution of the intensive margin, the contribution Benkovskis decomposition shows that “both inten- of the extensive margin and the eff ect of shifts in sive and extensive margins [have been] important. demand. Latvia’s producers of machinery, vehicles and food Overall, the Benkovkis analysis concludes that were able to increase diversifi cation of their sales while the share of Latvia’s exports in world markets (mainly expanding the geographical dimension almost doubled between 1999 and 2010, which im- without losing product diversifi cation, although plies an almost doubled competitiveness, most of exporters of vehicles were also able to increase their this has been at the intensive margin, i.e. in the set of products by almost 15%) and at the same exports of traditional goods to traditional markets, time to enhance their presence at the traditional while growth at the extensive margin, i.e. growth in markets. A similar development, although not as market shares of new products or new markets, was rapid, was observed for base metals” (Benkovskis just under 25% over the period8, although most of (2012) p. 12).

6 This generates a database of 379,768 potential markets for Latvia’s export products On the other hand, for both wood products – that is 5,132 individual products times 74 importing destination countries. and chemical products Benkovskis concludes that 7 Benkovskis interprets the share of Latvian exports in the world market as an indicator of Latvian competitiveness. 8 The method of decomposition has something of a bias against extensive growth: year of appearance; if it survives further, it is reclassifi ed into the intensive margin. an export to a new market is classifi ed as belonging to the extensive margin in the fi rst However, this is fairly standard.

STATE OF THE REGION REPORT 2013 141 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

“[a] diff erent strategy was used by exporters. Th e trader in the world economy, Latvia is eff ectively a wood sector is the only important export sector ‘price-taker’ in many export markets. with almost unchanged diversifi cation over the In order to capture the non-price eff ect, Ben- last 12 years. Th e lack of geographical and product kovskis decomposes the relative export price index expansion was compensated by a more intensive into components that include a quality or taste presence of Latvia in traditional markets for wood component10. Th is component captures relative products. Th e same strategy was used by export- quality and taste, e.g. variety, and it turns out that ers of chemical products: changes in the extensive the gain in competitiveness generated by these fac- margin were small (albeit positive), while competitors outweighs the loss of price competitiveness. tiveness was improved by growing presence in tra- Th us, the combined competitiveness index (rela- ditional markets” (p.12). tive export prices adjusted for non-price factors) improved by nearly 10% between 1999 and 2010, and almost half of the improvement has occurred Price/non-price competitiveness since 2008. Th e product and geographical dimensions of Benkovskis off ers an interesting analysis of the role the changes in non-price competitiveness are in- of non-price factors in the evolution of Latvia’s teresting: all of Latvia’s top fi ve export products export competitiveness. Some commentators on except ‘vehicles’ have posted gains in non-price Latvia’s recent export performance have attributed competitiveness, with ‘prepared foodstuff s’ being the strong performance at least in part to the price the leader – showing a three-fold gain in non-price competitiveness achieved through the now famous competitiveness. Machinery, wood products and ‘internal devaluation’. Benkovskis argues that the chemicals have also achieved non-price competi- standard approaches, which are based on real ef- tiveness gains of 63%, 27% and 30%, respectively. fective exchange rate indicators, are fl awed because Geographically, the biggest non-price competi- these indicators contain elements that do not cor- tiveness gains have been observed in the Russian respond to, or appear directly in, export prices and market (by more than 100%) and Estonia, Lithu- as a consequence have overstated the loss of com- ania and Sweden (about 20%), whereas important petitiveness observed up to the crisis and also dur- markets where non-price factors have deteriorated ing the recovery afterwards. Using a ‘relative export are Poland (by 14%) and Germany (by 4%). Th e price index’ based on disaggregated trade data, he improvement in the Russian market is, of course, suggests that the maximum loss of price competi- linked to the improvement in the quality of food- tiveness for Latvian exports (observed in 2008) was stuff s, for which Russia is a major market. just 15% (as compared with the level observed in Th e Benkovskis results on non-price factors are 1999) and correspondingly the improvement in interesting because they point to a much bigger im- price competitiveness observed in 2009 and 2010 pact of quality (and taste) on the competitiveness of was also modest9. Benkovskis notes that the dif- Latvian products than suggested by conventional ferences between approaches can be accounted for indirect indicators of export quality, such as the by factors such as changes in VAT and excise taxes technical sophistication of Latvian exports. (which do not appear in export prices) and changes in profi t margins over the cycle and, perhaps most importantly, by “structural diff erences between Global value chains Latvia and its rivals, which are not captured by ag- gregated indices. A slower increase of disaggregated Although the so-called fragmentation of produc- relative export price might show that losses of price tion processes is not a new phenomenon, it is wide- competitiveness were much less pronounced in the ly believed that as a result of technological progress, main exporting sectors of Latvia” (p.18). Th is, of increased access to resources and markets, as well course, is consistent with the idea that as a small as trade policy reforms, world trade and production have in the last two decades become increasingly 9 This compares with, say, a 70% loss of competitiveness calculated on the basis of a unit labour cost-based real effective exchange rate and a subsequent recovery of around half of this. Consumer price-based real effective exchange rate variations are 10 This is based on an approach to measuring unobserved quality or taste developed slightly lower but larger than in the relative export price index. by Hummels and Klenow (2005).

142 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

structured through global value chains (GVCs) in Th e specialisation of countries in tasks or busi- which the geographical dispersion of individual nesses, rather than products, represents a challenge components in the chain is based on the compara- to the interpretation of traditional trade data both tive advantages of locations in tasks, rather than from a descriptive point of view and a normative in products or fi nal goods as such. A particularly one. Th us, the question arises of how much domes- important factor in these developments has been tic value added is contained in a country’s gross ex- the cost of doing business internationally. Th us, reports, and how much is in fact value added created search by Pham and Martin (2007) concludes that elsewhere, i.e. imported and then ‘re-exported’. Th e the cost of doing business has a “strong and signifi - fi rst item represents what is usually termed ‘domes- cant impact on the extensive margin”. tic value added’ (DVA) exports, and the second as Th e result is that, according to OECD (2012), ‘foreign value added’ (FVA) exports. Considerable “[t]oday, more than half of world manufactured recent eff ort has gone into measuring this decom- imports are intermediate goods (primary goods, position for diff erent sets of countries. Unfortu- parts and components, and semi-fi nished prod- nately, most of the publicly available databases do ucts), and more than 70% of world services imports not include Latvia. However, Rudolfs Bems from are intermediate services” (p.4). Or, according to the IMF is a leading researcher in this area and UNCTAD (2013), “GVCs account for some 80% he has made some estimates for the Baltic states, of global trade” which he has made available for this report. Figure Th e OECD “Mapping global value chains” 7 shows the development in DVA since the mid- (OECD 2012) defi nes a value chain as “the full 1990s: Latvia consistently has the highest DVA, at range of activities that fi rms and workers do to around 75%, with a dip to just below 70% during bring a product from its conception to its end use the fi rst years of EU accession. Estonia has had the and beyond. Typically, a value chain includes the lowest DVA, at around 60% or less, but increasing following activities: design, production, market- to nearly 70% by 2009. Th ese fi gures put Latvia ing, distribution and support to the fi nal consumer. at about the same level of DVA as Italy (73%) or Th ese activities can be performed within the same Switzerland (71%), below Russia (91%) or the US fi rm or divided among diff erent fi rms.” (p.7) More- (89%), but much higher than Netherlands (47%) over, these activities are increasingly spread across or Belgium (42%). 11 diff erent countries.

Figure 7: Domestic value added share in gross exports, Baltic states

0,9

0,8

0,7

0,6

0,5 Estonia Lithuania 0,4 Latvia

0,3

0,2

0,1

0 199519961997199819992000200120022003200420052006200720082009 Source: personal communication from Rudolfs Bems

11 See UNCTAD (2013), Figure 7.

STATE OF THE REGION REPORT 2013 143 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

Th ere is no particular normative signifi cance to from Latvia, including such very Latvian products these fi gures – thus, larger countries tend to have a as ‘griķi’ (buckwheat). higher DVA – and the welfare implications of value Here we off er four case studies of successful added trade require further analysis. export-oriented FDI. Th ese are not meant to be However, the value added trade is an input comprehensive or even representative, but should to the so-called ‘GVC participation rate’. Th is is be interpreted as illustrative examples of foreign defi ned as the sum of foreign value added (FVA) companies that have set up operations in Latvia and the value added supplied to other countries’ that are integrated in their global operations. exports as a share of gross exports. According to UNCTAD (2013), this indicator is useful because it measures “the extent to which a country’s ex- Bucher Schörling ports are integrated in international production networks and it is thus helpful in exploring the Th is represents an FDI in the vehicle components trade-investment nexus. Th is variable corrects sector in Latvia. Bucher Schörling Baltic Ltd is a the limitation of the previous indicators in which subsidiary of Bucher Group, a Swiss-based global countries at the beginning of the value chain (e.g. manufacturer of state-of-the-art machinery and exporters of raw materials) have a low foreign equipment used for a variety of purposes, such value added content of exports by defi nition. It as harvesting, producing and packaging healthy gives a more complete picture of the involvement foods, keeping cities clean and safe and hydraulic of countries in GVCs, both upstream and down- systems for high-performance machinery. With stream” (Box 2, p.5). approximately 7900 employees worldwide, Bucher OECD (2012) off ers some calculations of GVC Group generated over EUR1.6 billion in sales in participation rates for a selection of countries in 2010. 2008. For Latvia, this indicator took on a value of The Latvian-based company manufactures about 57% in 2008, which is less than for Lithua- components and spare parts for road sweepers and nia (just over 60%) or Estonia (also just over 60%). 100% of the output is exported. Th e fi nal prod- Th is is broadly consistent with the DVA evidence in uct is made in Switzerland and sold in countries Figure 7. Globally, countries with high GVC rates such as Russia, Germany, France, Italy, Spain and (over 70%) are Taiwan, Singapore and Malaysia. Ukraine. Spare parts produced in Latvia are sent In Europe, Luxembourg, with a GVC participa- directly to dealers in Russia, Germany, France, Ita- tion rate of nearly 80%, stands out, but otherwise ly, Spain, Ukraine, etc. Some of the inputs needed the highest participation rates are observed in the for production in Latvia are bought from Latvian Slovak republic, Norway, Hungary, Belgium, the suppliers, and others are imported from Germany, Czech Republic and Estonia (with rates between UK, Switzerland, Sweden, Italy, France, Austria, about 66% and just over 60%). Clearly, GVCs are Poland, etc. less prevalent in Europe than in Asia. Bucher Schörling Baltic Ltd. started operations in Latvia in 2004. In addition to manufacturing vehicle components, it manages Schörling’s Eastern Latvian case studies sourcing network. In 2011, Bucher Schörling Baltic invested EUR5 million—including co-fi nancing Latvian companies participate in international sup- from the EU Structural Funds—to open a second ply chains in a variety of ways. For example “Avoti factory in Ventspils, the port city in Western Lat- SWF” is a major Latvian furniture manufacturer, via. Th is brought the total number of employees in which now produces mainly for the global retail Latvia to over 100. sales network of IKEA. “Argos”, a leading UK re- Niklaus Huser, chairman of the board of Bu- tailer, outsources the production of plastic chairs to cher Schörling Baltic, has commented: “Availability Latvia, a switch from China, which is no longer re- of qualifi ed welders and mechanics is one of the garded as suffi ciently cheap. Food retailers “Tesco” most essential requirements for us, and we have in the UK and “Coop” in the Netherlands are in- made investments in training employees, especially creasingly importing a variety of food products as we expand our operations here. Our decision in

144 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

choosing Ventspils as our site was based on several industrial equipment and consumer appliances. considerations, including good overall entrepre- Th e company has almost 3,000 employees in 12 neurial conditions; outstanding support from the production facilities around the world, producing Free Port of Ventspils Authority and the local mu- over 2.5 million units each year. nicipality; a lower levels of salaries compared to the Its Latvian subsidiary, AKG Th ermotechnik Riga region; benefi ts from the free economic zone; Lettland, established its initial Latvian production a harbour with frequent ferry traffi c to and from facility in Jelgava in 2005 and focuses on the pro- Germany; and proximity to the Russian market.” duction of aluminium heat exchangers. With rev- Th e company is considering further expansion in enues of approximately EUR26 million in 2011, Latvia, given that the existing factory is operating the Latvian facility employs almost 200 people. at high levels of effi ciency. Jelgava has a developed metalworking sector and a long tradition in automobile manufacturing, as well as a low-cost industrial park with good infra- Brabantia: structure. 100% of AKG output is exported, with more than half of its sales being in Germany. In Th e Dutch company Brabantia is Europe’s leading 2012, the company received the ‘Made for Germa- supplier of innovative household products, with ex- ny’ prize, awarded by the German-Baltic Chamber ports to over 80 countries and a revenue of EUR93 of Commerce. million in 2010. “Th e factory in Latvia has the lowest produc- Th e company opened its fi rst production plant tion expenses of all AKG’s factories in Europe,” in Latvia in 2008, renovating a brownfi eld site, notes Dr. Gerhard Ritzmann. “Our low costs have and by 2011 it had moved its production of laun- enabled Jelgava to produce radiators even for buy- dry dryers and ironing boards to Latvia, employing ers in Asia, where local factories did not have the approximately 75 people. capacity to fulfi l all incoming orders.” AKG er-Th Th e company exports 100% of its output, motechnik Lettland plans to build a second factory mainly to the UK, Belgium and the Netherlands. in Jelgava by 2014 to double its current capacity. Some of the inputs needed for production are Th e plan is to invest EUR5 million for the second sourced in Latvia, while others are imported from factory, creating 150-200 new workplaces. Lithuania, Belgium, Italy, Finland, Poland, China, Slovakia, Sweden, and Germany A strong tradition in metalworking was a major Ferroplan factor in choosing Latvia as a location for a production facility. Other factors included Latvia’s Ferroplan is the leading Finnish manufacturer of membership of the EU, its Euro-pegged currency, conveyor solutions designed for handling piece and its business-friendly environment. Other posi- goods and bulk cargo, for a wide range of indus- tive factors include fast reaction to changes in de- tries and materials including environmental prod- mand by customers in the EU, lower inventory, a ucts, metal, logistics and storage, packing and talented workforce, low employee turnover and a wood. Th e company prides itself on innovation salary/productivity balance that is competitive with in design and production of conveyor systems, as Asian workers. well as effi cient, reliable and safe products. With Marcel van de Velde, Brabantia’s Production 60 employees in Finland and Latvia, the com- Director in Latvia, has also acknowledged the sup- pany had revenues of EUR7 million in 2011 and port and the professional assistance from LIAA, serves its global customers in a variety of indus- the Latvian Investment and Development Agency. trial sectors. Th e company opened its component manufacturing unit in Jelgava, SIA Ferroplan, in 2005, AKG Group specializing in welding, folding, plasma cutting and machining of diff erent kinds of metal prod- Th e AKG Group is a worldwide manufacturer of ucts with pallet dispensers, conveyors and conveyor coolers and heat exchangers for a broad range of components like rollers, metal frames and adjust-

STATE OF THE REGION REPORT 2013 145 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

able feet being important outputs. Most of SIA Fer- References roplan products are exported. In evaluating expansion opportunities in the Amurgo-Pacheco, A and Pierola, M.D. (2008) “Pat- Baltic states, Ferroplan selected Latvia as its invest- terns of Export Diversifi cation in Developing ment base because of its central location, the avail- Countries: Intensive and Extensive Margins” ability of a skilled workforce, and long-term cost World Bank Policy Research Working Paper 4473, advantage. In late 2011, the unit in Latvia initiated January 2008. a major development programme to enable the pro- Beltramello, A., K. De Backer and L. Moussiegt duction of more advanced products in Latvia. (2012), “Th e Export Performance of Coun- “We are very satisfi ed with the investment in- tries within Global Value Chains (GVCs)”, centives we received from the Latvian state and OECD Science, Technology and Indus- European Union.” says Mr. Pentti Patosalmi, man- try Working Papers, 2012/02. http://dx.doi. aging director of Ferroplan. “Together with our org/10.1787/5k9bh3gv6647-en investment here, our aim is to grow in Latvia and Beņkovskis, K. (2012) “Competitiveness of Latvia’s have 15-20 employees there in a few years’ time.” exporters” Bank of Latvia Working Paper 3/2012. Besedes, T. and Prusa, T.J. (2007) “Th e Role of Extensive and Intensive Margins and Export Concluding remarks Growth” NBER Working Paper No. 13628, No- vember 2007, Revised August 2010 Latvian export performance is an unequivocal suc- Hummels, D., and P. J. Klenow.(2005) “Th e Vari- cess story. However, the underlying causes are het- ety and Quality of a Nation’s Exports” American erogeneous. Th e case study evidence points to the Economic Review 95(3): 704–23. importance of export-oriented FDI in some of the OECD (2012) “Mapping global value chains” sectors that have experienced the strongest growth Working party of the Trade Committee, 4-5 of competitiveness, as measured by growth of mar- December 2012. ket share, e.g. ‘vehicles’ or ‘machinery and mechan- Pham, C. and Martin, W. (2007) “Extensive and In- ical appliances’. It is interesting that FDI has been tensive Margin Growth and Developing Coun- attracted to the historical locations of skills and try Exports” DECRG World Bank, Wednesday, that some of the investments have been supported March 14, 2007 by structural funds. Reis, J.G. and Taglioni, D. (2013) “Determinants Th e growth in the number of markets has been of export growth at the extensive and intensive impressive, though in some cases hard to under- margins: Evidence from product and fi rm level stand, e.g. in recent years Algeria has emerged as data for Pakistan” World Bank Policy Research a destination for as much as over 2% of Latvian Paper 6341, January 2013 exports – mainly steel and grains. UNCTAD (2013) Investment and Value Added Trade Th e importance of non-price competitiveness in the Global Economy: a preliminary analysis. is not something that has been extensively documented until recently. In terms of participation in global value chains, Latvia appears to be about average in a European context.

146 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

STATE OF THE REGION REPORT 2013 147 Final observations

148 STATE OF THE REGION REPORT 2013 Th e Baltic Sea Region likes to think about itself strongly export-driven, engaging in global value as the ‘Top of Europe’. It is, indeed, the ‘Top’; its chains at diff erent stages. Th e Nordics are more economic performance relative to other European FDI-driven, attracting knowledge-seeking invest- regions is once again strong, as it has been in many ment but otherwise engaging in international value previous years. But it is also ‘European’ in its ex- chains through activities located abroad but owned posure to the crisis that many of the economies of by companies located in the Nordics. Both models the continent fi nd themselves in; over the past year, are emerging according to the specifi c conditions this crisis has aff ecting the Baltic Sea Region much present in the diff erent parts of the Region – in more than before. part given by nature, in part by government policy. 2012 was a mixed year for the economies of While both can support high levels of prosperity, the Baltic Sea Region. Growth slowed down signif- they create diff erent types of challenges for eco- icantly, as the crisis in some other parts of Europe nomic policy. started to weigh fully on the economies in the Re- Th e underlying competitiveness of the Region gion. Th e outlook for 2013 is now fragile, and most remains strong, with no dramatic changes relative governments are preparing themselves for a pro- to previous years. Where there are changes, they longed period of slower growth. With investment are largely driven by short-term changes in eco- demand already subdued since last year, growth nomic conditions and sentiment. In Denmark, for dynamics will now depend strongly on trends in example, the perspectives of business leaders have domestic consumption. become more sceptical across the board, as some of Th e external shock has been felt relatively sym- the new government’s measures created public op- metrically across the Region. All countries are position. In Finland, the assessment has been much dependent on European market conditions, and more positive, despite the challenges facing Nokia country-specifi c factors have played less of a role. and a number of tax increases implemented in early With no quick recovery in sight for the European 2013. economy, the weak external demand is likely to Th e Baltic Sea Region continues to benefi t from limit Baltic Sea Region growth prospects for some an exceptionally strong network of projects and in- time. While the Region still benefi ts from much stitutions that span the Region. Th e EU Strategy more healthy domestic conditions than many other for the Baltic Sea Region has been a critical element parts of Europe, this unlikely to be able to drive in enhancing the co-ordination among the many much more than a stabilisation of growth rates at eff orts under way, and in orienting them towards a a modest level. clear set of objectives relevant for the Region. How- Apart from these cyclical factors, the Report ever, the recent review of the EU Strategy has also also highlights how the dynamics of globalisation made clear where progress is still limited. Truly are continuing to shape the Baltic Sea Region. Two new policy initiatives driven by the regional eff ort diff erent modes of internationalisation seem to be are few. Th e impact on policies that do not have a emerging: Germany, Poland, and the Baltics are direct focus on Baltic Sea Region collaboration re-

STATE OF THE REGION REPORT 2013 149 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

mains limited. Additionally, the engagement of the and Russia – all parts of the Region were out- private sector is still low; the argument for why Bal- performing their European peers. While the Re- tic Sea Region collaboration should be something gion suff ered more than others during the global companies in the Region should worry about has so downturn of 2008, it has proven more successful far not been made successfully. in regaining growth. For the Baltic countries, this Th e revised strategy and action plan recently happened through a roller-coaster of rapid growth, adopted provides a solid platform to address some deep recession, and robust recovery. For the Nordic of the weaknesses identifi ed. Th at said, it does not countries, active government policy in response to yet provide the solution to some of the key chal- the crisis played a large role. In Germany, a strong lenges that Region faces: industrial base and a fl exible response by govern- • The measurable objectives now identified ment and labour market partners were the under- should be derived from a systematic, regular pinnings its economic resilience in the face of the analysis of the Region and its strategic priori- global downturn. ties. Th e political nature of the action plan pro- In terms of competitiveness, many of the foun- cess might be one of the reasons for the limited dations for the relatively strong performance of the private sector involvement. following decade had already been laid in 2004. • Th e objectives and activities of the EU Strat- A central achievement of governments in the Re- egy for the Baltic Sea Region need to be in- gion was to stay the course, despite the diffi cult tegrated into the operational programmes of circumstances that they found themselves in after the broader set of relevant EU policies, in par- 2008. In the Nordic countries, the key choices had ticular the Structural Funds and the Horizon been made in the aftermath of their crisis in the 2020 activities. Th is is a critical pre-condition early 1990s. Th e famous Nordic welfare model had for increasing the reach of the strategy beyond been reformed, not abandoned. As well, the Nor- core regional eff orts, and for aligning activities dic countries made determined steps to embrace within national governments related to the dif- globalisation and leave the old model of relatively ferent EU policies. closed markets and repeated devaluations behind. • With the EU Strategy for the Baltic Sea Region In the Baltic countries and Poland, the process of established is a solid foundation, it is now pos- transformation followed by EU accession put them sible to more actively engage neighbours and on the path to robust catch-up growth. Th e small create a more systematic relation with related Baltic economies opened up the most, and ended institutions, like the CBSS, the Northern Di- up suff ering from the overheating that was fuelled mension, and a range of fora focusing on the by massive capital infl ows. Germany was fi nally Arctic. getting around to implementing some overdue re- • Most importantly, the Region needs an insti- forms. Although it was still criticized for its reliance tutional architecture that can mobilise the full on ‘traditional’ industrial strengths, its companies power of the existing structures for collabora- were rapidly restructuring to take advantage of glo- tion in the Region, and focus them on the is- balisation. Russia had still not fully recovered from sues most critical for its future competitiveness. its 1998 crisis, but was starting to benefi t from the Th is might not require new institutions, but it macroeconomic stabilisation policies that had been requires that existing co-ordination mecha- put into place in its wake. nisms be more visibly empowered. Maybe the most dramatic changes in the Baltic Sea Region over this past decade have occurred in With the future path highly uncertain, it is the way that the Region collaborates. In 2004, the useful to remember that over the last decade, too, Baltics and Poland had just become EU members, events have played out quickly and, sometimes, and the nature of the economic policy dialogue unexpectedly. Economically, the Baltic Sea Region was still dominated by the West providing help has gone through a full cycle. In 2004, the econo- to the East. Since then, collaboration has increas- mies of the region had just left the aftermath of ingly focused on integration as an instrument to the bursting IT/Telecom bubble behind. Growth upgrade the competitiveness of the entire region. was rapid and – with the exception of Germany Th e diff erences in the stage of economic develop-

150 STATE OF THE REGION REPORT 2013 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

ment across the region remain large, but integra- Th e Baltic Sea Region – the ‘Top of Europe’ as tion can provide mutual benefi ts. Th is year’s Re- it has been started to be called in this Report – has port looks at regional value chains as one element achieved much over the last decade. New challeng- of this process. A key test of this new relationship es are now ahead. First, the Region has to weather came during the recent crisis in Latvia, when the the diffi cult context of a Europe integration project government turned to international partners to get in crisis, economically as well as politically. Th e fi nancial support. Its neighbours in the Region, the Region clearly has a large stake in the outcome of Nordic countries, as well as Estonia, reacted most this crisis. What can it do to increase the odds of swiftly and provided backstop fi nancing. These a positive resolution? How can it prepare itself for funds were eventually not needed, but were a criti- whatever outcome materialises? cal sign of support at the time. Nordic banks had Second, the countries in the Region face new made signifi cant profi ts in the Baltics during the competitiveness challenges as they continue their period of fast growth. Despite much public discus- economic development process. What do the Nor- sion about their role, they stayed on and helped to dic countries and Germany need to do to retain provide these countries with a functioning banking their position near the top of global competitiveness system throughout the crisis. and prosperity rankings? How can the Baltics and Many of the existing networks and structures Poland reach the next stage of their development? for collaboration across the Baltic Sea Region had What is Russia’s position beyond an economy built been designed in the early 1990s, with a focus on on oil and gas? Crucially, how can regional collabo- enabling the peaceful reorientation of the former ration help countries in the Region to fi nd answers Communist countries towards the west. As the fo- to these questions? cus of collaboration shifted more towards competi- Th ird, the Region has to rethink its collabora- tiveness upgrading, the appropriateness of the ex- tion model. What steps are needed to increase the isting institutional framework was put to the test. reach of the EU Baltic Sea Region Strategy beyond Over the last few years, especially since the end of activities with a clear cross-border character? How 2007, when the European Council followed the in- can the non-EU members that are part of the Re- itiative of a number of Baltic Sea Region countries gion be more actively integrated into the model that and EU parliamentarians to request an EU Baltic has been created through the EU Baltic Sea Region Sea Region strategy, a new architecture has started process? Is it suffi cient to ‘repurpose’ existing insti- to emerge. Although formal institutions remain tutions, or does the Region need a modernisation largely untouched, the EU Baltic Sea Region strat- of structures to better engage other countries and egy process has led to a signifi cant alignment of reach out to new constituencies, especially in the activities within the context of an integrated action private sector? plan. Instead of changing institutions, the strategy has changed what these institutions do.

STATE OF THE REGION REPORT 2013 151 SECTION C Selected drivers of future competitiveness: transportation infrastructure and green growth

‘10 years of the State of the Region Report’

STATE OF THE REGION REPORT TM

[2006]

The Baltic Sea Region – STATE OF THE REGION REPORT 2004 Top of Europe in Global Competition An Assessment of Competitiveness in the Baltic Sea Region

Dr. Christian Ketels and Professor Örjan Sölvell

SECTION A THE CONTEXT FOR CROSS-NATIONAL COOPERATION IN THE BALTIC SEA REGION

TM TM TM STATE OF THE REGION REPORT STATE OFOF THETHE REGION REGION REPORT REPORTTM STATE OFOF THETHE REGION REGION REPORT REPORTTM

[2007]

2008 2009

The Baltic Sea Region as a Place to Do Business Sustaining growth at the Top of Europe Boosting the Top of Europe

STATE OF THE REGION REPORTTM STATE OF THE REGION REPORTTM STATE OF THE REGION REPORTTM

2010 2011 2012

The Top of Europe Bracing Itself for Difﬁ cult Times: The Top of Europe Recovering: The Top of Europe’s Quest for Resilience: Baltic Sea Region-Collaboration to Sustain Growth Regional Lessons from a Global Crisis A Competitive Region Facing a Fragile Global Economy

All State of the Region Reports and other BDF publications available at: www.bdforum.org’

152 STATE OF THE REGION REPORT 2013

About BDF Baltic Development Forum is an independent think-tank and networking organisation with members from large companies, major cities, institutional investors and business associations in the Baltic Sea Region. Baltic Development Forum works with a wide range of partners, including businesses, governments, regional organisations, research and media institutions.

Our network involves more than 7000 decision makers from all over the region and beyond. The mission of Baltic Development Forum is to promote the Baltic Sea Region as an integrated, prosperous and internationally competitive growth region.

Baltic Development Forum is chaired by Hans Skov Christensen, former CEO in Danish Industri. The Baltic Development Forum Honorary and Advisory Boards consist of high-level political dignitaries and prominent business executives representing the entire Baltic Sea Region.

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