The Blooming of the Baltics

As EU members, they'll bring fresh entrepreneurial vigor

It's just eight o'clock on a sunny spring evening. But the dance floor is already heaving at the vast Lido Mills, just two or three kilometers down the Daugava riverfront from central Riga. Built from wood in a rural Latvian style, the three-floor complex of self-service restaurants and bars can seat 1,500. And it's usually packed. Locals and tourists alike find it hard to resist the allure of low-priced smoked fish, blinis, and beer served in a friendly, and, to be frank, kitschy atmosphere.

Lido Mills is the biggest of an eight-restaurant chain that local entrepreneur Gunars Kirsons has built up since Latvia won its independence from the former Soviet Union in 1991. Kirsons' cheap-and-cheerful formula -- a beer costs 70 cents -- has earned him millions and turned him into one of Latvia's most popular businesspeople. Successful at home, Kirsons is expanding abroad, with a self-service chain in Moscow. "He's the ultimate success story," says Modris Leshiskis, who owns a souvenir shop and eats regularly at Lido Mills with his girlfriend, Irina Sturainis.

Latvia and its Baltic neighbors -- Estonia to the north and Lithuania to the south -- are full of similar achievers. The three countries' combined population may be tiny, at just 7.3 million, and much of their economic growth is driven by investment from Swedish and Finnish companies attracted by their low wages and taxes. Swedish clothing manufacturer Snickers and Finnish packaging firm Pakenso are just two of the many Nordic firms that have bought into Estonia.

(The Finnish and Estonian economies are now so closely intertwined that Tallinn is effectively an integral part of Greater Helsinki.) But the Baltic states also have more than their fair share of home-grown entrepreneurs. Indrek Kask, CEO of Asper Biotech, founded an Estonian genotyping research and services company that has become a world leader in its field. Ignas Staskevicius, general director of the VP Market retail chain in Vilnius, is the brains behind one of the most successful marketing schemes in the Baltic region: People who turned out to vote in Lithuania's referendum on European Union membership the weekend of May 10-11 were rewarded with coupons to buy heavily discounted snack foods at his stores. The referendum passed, his shops were filled to bursting, and sales rocketed 35%.

Thanks to such entrepreneurial vigor, the Baltics are already the fastest-growing and most economically dynamic of the EU's 10 future members. Together, they clocked an average growth rate of 6.1% in 2002. Growth will dip to 5.4% this year. But compare that with the euro zone, which will be hard-pressed to expand by 1%. "We're optimistic for the future," says Estonian Prime Minister Juhan Parts. When they join the EU next year, the Baltics, which not long ago were oppressed members of the Soviet Empire, will add a heavy dose of free-market ideology to the union.

To be sure, growth rates in Estonia, Latvia, and Lithuania look good partially because they are starting from a much lower base than Germany, France, and the other mature economies that make up the existing EU. They also get a boost from bargain-hunting Scandinavian tourists and Russian companies that ship their exports via Baltic ports. But since they threw off the Soviet yoke, the three tiny countries have embraced change with a relish that puts Old Europe to shame. Almost all of their industry has been privatized. Most markets have been deregulated. Capital controls have been abolished. Their economies have been opened up to foreign competition. Estonia even introduced a flat income tax and abolished tax on reinvested corporate earnings, a move that sparked an investment boom. "We moved almost overnight from the Communist past to the free-market future," says Siim Raie, director general of the Estonian Chamber of Commerce & Industry. "Maybe that explains our energy."

It hasn't all been smooth sailing. The Baltic states plunged deep into recession in 1998 -- after the Russian financial crisis broke and the purchasing power of their big neighbor to the east evaporated almost overnight. Poor infrastructure is holding back development, especially outside the big cities. Some manufacturers, particularly in the food sector, have been hit hard by foreign competition. Wages have been creeping up, eroding one of the region's key competitive advantages. "Imported pork [from the EU] is cheaper than mine," says Vaidotas Cekuolis, who runs a small meat- processing plant not far from Vilnius.

Most companies are responding well to competition from abroad, however. Rigas Piena Kombinats, Latvia's largest milk processor, has invested heavily in modern machinery. It has also brought in Finnish milk company Valio to help it develop new products. Other companies have cut costs, redesigned their products, and honed their marketing skills. Labor productivity in the Baltics has risen more than 5% a year over the past five years. Some have become ace exporters. Latvian lingerie and textile manufacturer Lauma sells half its $30 million output to the EU.

If there's one thing that has helped the Baltic states transform their economies, it is their commitment to sound government finances and strong currencies. The three countries have their budget deficits well under control, something that France and Germany seem incapable of doing. The budget shortfall in each country is no higher than 3% of gross domestic product. Estonia's deficit will be just 0.3% of GDP this year, and its entire government debt is only 5.1% of GDP. Germany's deficit is above 3% and its national debt is more than 50% of GDP. The Lithuanian and Estonian currencies are tied to the euro, and all three countries will meet the criteria to adopt the euro by mid-2006 if they keep up their current pace. Most tariffs between the EU and the Baltic countries have already been swept away, and more than 70% of their exports already head west. When they become members, trade is expected to increase further.

EU membership has some drawbacks. Baltic businesspeople fear it could bring more bureaucracy, slower decision-making, and attempts by the high-tax countries of core Europe to push through rules requiring all EU members to synchronize their tax rates. If that happens, the Baltic states would probably be forced to increase their corporate taxes. Competition from EU companies, already sharp, would intensify. That's why Parts says it is vital for Estonians, Latvians, and Lithuanians to redouble their efforts to add more value to their products and develop a more advanced, knowledge-based economy by investing heavily in higher education and improving links between universities and business. Given the eagerness with which most Baltic citizens adopted the Internet, that may not prove too difficult. More than 90% of bank transfers are now made online, three times the portion in France or Germany. Express trains between Tallinn and Estonia's second city of Tartu now provide Internet access. Old Europe will certainly learn a thing or two from its neighbors to the East.

By David Fairlamb in Riga

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