Request to the OECD for support in undertaking a country study on strengthening FDI and SME Linkages in Estonia

II Strengthening cross-border FDI and SME linkages in the Baltic states Proposal for an EC/OECD study The objective of this note is 10 present the motivation and goals of a study exploring the potential of cross border foreign direct investment (FDI) and small and medium-sized enterprises (SMEs) ecosystems in the Baltic States. The study would be undertaken in the framework of an ongoing project jointly conducted by the OECD and the European Commission (EC) to oifer policy advice to national and subnational governments on how to boost the productivity and innovation of local economies through greater linkages between FDI and SME. As part of ths project, two in-depth country assessments of FDI-SME linkages in Portugal and the Slovak Republic were aiready conducted, and reviews of the Czech Republic and Poland are ongoing. Building on this experience and insights, the work aims to provide a new cross-border perspective on FDI-SME ecosystems. As a relatively integrated regional economy with a potential for further development, the Baltic region represents a case in point for cross-border analysis. The study would deliver analysis and policy recommendations for mproving the qual[ty and effectiveness of existing cross border FDI-SME policies and institutional arrangements, as well as for further developing integrated policy approaches across the Baltic region to improve the overail business climate, enhance the nvestment promotion framework and strengthen SMEs’ potential to innovate and scale up. Background and motivation The Baltic states i.e. Estonia, Latvia and Lithuania are small, open and well-integrated economies that — — display similarities in terms of their geography, history, size, demography and economic structure. Evidence points to strong macroeconomic bonds among the three countries, whose respective GDP growth trends appear to be more closely correlated among each other than with any other EU member state (Poissonnier, 20l7ij). Cross-border labour mobility flows among the three countries are high and so are mutual trade and investment linkages (BSR Finance Summit, 2022[2]; Poissonnier, 2017[1]). Despite existing specificities and asymmetries e.g., with Estonia typically being regarded as more exposed to — international developments and regional spillovers than its two neighbours these strong links and — correlations suggest the existence of a relatively integrated Baltic economy, i.e., a single cross-border region largely driven by common factors and economic linkages, with potential for further integration. Since 1991, the Baltic states experienced sustained growth and convergence with more advanced economies, with GDP per capita tripling over the past 30 years and the gap to OECD leveis narrowing continuously (OECD, 2O22[3J). There are stili significant structural transformations ongoing in the economy, with low-tech industries dominating manufacturing (EBRD, 2022[4]; OECD, 2021[5J). The ICT sector witnessed an impressive development over the last decades, especially in Estonia, where ts contribution to gross value added (GVA) raised by 50% since 2010 (EBRD, 2022[4]). The Baltic states have also developed some competitive edges in biotechnology, life science industry and the health economy (MITA, 2022[6]; LIIA, 2022j7]). The Baltic states are highly integrated into giobal value chains (GVCs). The three economies are strongly export-oriented, but knowledge-intensive exports of both goods and services remain modest and below the EU-27 average (EBRD, 2022[4J). Lithuania is an agricultural exporter (OECD, 2O22j). In Latvia, export production is concentrated in Iow-complexity products, and few exports go outside the EU (OECD, 2022[9]). Export performance in Estonia has held up well despite the pandemic and the fallout of Russia’s war of 21 aggression against Ukraine, thanks partially to the robustness of the ICT sector (OECD, 2022[3]). The Baltics themselves and the Northern parts of Europe remain the core-trading region for the Baltics. Significant foreign direct investment (FDI) inflows played a key role in boosting growth and economic convergence in the region in the past decades, but inward FDI slowed down since the financial crisis of the late 2000s. Over the last ten years, around 75% of FDI inflows have gone to service industries, mostly to firms operating in financial and insurance activities, wholesale and retail trade, real estate, professional services and logistics (EBRD, 2022[4]). Nordic and Central European economies (particularly Sweden, Finland and Germany) account for the majority of foreign firms operating in the Baltic states (EBRD, 2022j4j). Small and medium-sized enterprises (SMEs) dominate in the Baltic states, accounting for 78% of business sector value added in Estonia, 70% in Latvia and 66% in Lithuania in 2018 (against 53% in the EU)(OECD, 2023[lo]). Baltic SMEs are well represented in international trade, accounting for an above OECD average share of total imports and exports in aH the three countries (OECD, 2023[11]). However, differences arise when it comes to their level of GVCs integration, which is comparatively high in Estonia and Lithuania while remaining Iow by OECD standards in Latvia (OECD, 2023[11j). SME innovation potential is constrained - - across the Baltic region, particularly in Latvia, which is classified as an “emerging innovator” in the 2022 European lnnovation Scoreboard (EIS), exhibiting a widening performance gap relative to the EU (Hollanders, Es-Sadki and Khalilova, 2O22[12]). There is scope to boost business R&D expenditure and improve the attractiveness of the research system to talent from within and abroad in Lithuania (OECD, 2022[8]). In Estonia, skill shortages are among the main obstacles for SMEs to expand their knowledge-based activities, particularly in the fastest growing ICT sector (EC, 2022(13]). Access to finance (especially in Latvia and Lithuania) and the overali quality of infrastructure (transport, communication and energy) are key challenges for Baltic SMEs (OECD, 2022(14]; OECD, 2019(15]). These barriers and inefficiencies may hamper SME potential to further participate in and benefit from an open and integrated economy, ultimately restraining opportunities for scaling up the economic performance and adaptative capacity of the Baltic region. The Baltic states also show strengths, drawn from high digital intensity and business-friendly regulatory framework. Estonia is a frontrunner in digital governance and innovation, with stable and secure digital services for businesses, and has the highest number of native ICT “unicorns” per capita in the world (OECD, 2022j3j). Latvia benefits from the advanced digitaisation of public administration and business support services (EC, 2022(16]). Lithuanian firms lead on the use of key digital technologies such as enterprise resource planning (ERP), Customer Relationships Management and big data tools, as well as on the electronic sharing of supply-chain information, digital marketing and e-commerce solutions (EC, 2022(17]). The circular economy remains Iow in the three Baltics by EU standards, although the share of materials reused has been increasingly steadily in Latvia and Lithuania between 2013 and 2017 (EBRD, 2022(4]). The EC/OECD FDI-SME Linkages and ecosystems project The project “Fosterinq FDI-SME ecosystems to boost productivity and innovation” (hereinafter “FDI-SME project”) aims to provide EU national and regional policymakers with recommendations on how to maximise the positive impact of FDI on the productivity and innovation capacity of local SMEs. Launched in 2019, this joint European Commission-OECD project contributes to the OECD FDI Qualities Initiative, which examines how FDI supports sustainable development, and the OECD work on “Enhancinq SME participation in GVCs: Developinq the export capacity of SMEs and strengtheninQ FDI-SME ecosystems for greater sustainability and resilience”, which assesses enablers and barriers for SMEs to effectively tap into GVCs. As such it contributes to the programmes of work of the OECD lnvestment Committee and the OECD SMEs and Entrepreneurship Committee, benefiting from policy dialogue and reviews in these fora.  I The pilot phase of the FDI-SME project (2019-22) developed a diagnostic framework for national and regional governments to identify gaps in FDI-SME diffusion channels and policy options to enable greater FDI-SME spillovers (Po!icy Toolkit for Strengthening FDI and SME Linkages) (OECD, 2023[18]). It also identified 626 policies and institutions across EU countries involved in FDI-SME linkages. The diagnostic framework was used in two in-depth country assessments of Portugal (OECD, 2O22ig) and the Slovak Republic (OECD, 2022[zo]). These country assessments provide a comprehensive analysis of the enabling environment for inward FDI and SME performance and identified institutional and policy reforms to strengthen productivity spillovers. They involved a broad inter-agency consultation and national, subnational and international stakeholder policy dialogue and featured an analysis of selected subnational regions (Alentejo and Norte for Portugal, Bansk Bystrica and Kosice for the Slovak Republic). The second phase of the project (2023-24) is building on this pilot work to conduct two additional country assessments of the Czech Republic (OECD, forthcoming[21]) and Poland (OECD, forthcoming[22]). Furthermore, it aims provide a new cross-border perspective on domestic FDI-SME ecosystems by conducting a cross-country assessment. Adding to the pilot project and further developing its analytical framework, this new assessment exercise will explore potential cross-border linkages of local FDI-SME ecosystems and identify opportunities for regional value chains cutting across national borders. The Baltic states are a case in point for cross-border analysis, showing cultural differences and economic specificities, but also similar economic structures and policy visions (Poissonnier, 2Ol7[1j), an increasing economic cooperation, and trade and labour mobility exchanges that suggest a relatively integrated regional economy with a potential for further development. Main goals, activities and expected outcomes Differently from the single country” deep-dive study performed in Portugal, Slovak Republic, Poland, and Czechia, by looking at the Baltics as an integrated economic area, the study will assess their regional FDI-SME ecosystem from a cross-border perspective. To this purpose, it will provide a diagnostic of enabling conditions and diffusion channels of FDI-SME spillovers in the region, thus complementing the “single country” perspective of previous reviews with a “cross-border” analysis. The study will review the overall economic structure and specialisation of the Baltic states, as well as their degree of technological sophistication and integration into the giobal economy, considering the characteristic of each of the three countries but with a specific focus on production networks, clusters and regional value chains cutting across national borders and in specific sub-national regions. It will analyse the activities and characteristics of foreign multinational enterprises (MNEs) affiliates established in the region and assess their degree of Iocal embeddedness, particularly their potential for productivity and innovation spillovers to the host economies and to Baltic neighbours, in a regional perspective. The study will also assess the performance of Baltic SMEs, with a focus on their innovation and internationalisation capacity, and their ability to absorb spillovers from FDI, e.g. as suppliers, clients or partners offoreign MNEs. Finally, the study will identify the extent to which FDI-SME spillovers take place in the Baltic region through different diifusion channels, namely value chain linkages, business collaboration, labour mobility, and market mechanisms related to competition. The study will also provide an assessment of institutional and policy frameworks supporting FDI-SME ecosystems across the Baltics, referring to the specific framework in single countries but with a main focus on cross-border policy initiatives and collaboration. It will review existing cross-border institutional settings and governance arrangements as well as current coordination mechanisms across Estonia, Latvia and Lithuania’s public agencies and private sectors stakeholders in policy areas related to FDI-SME ecosystems support. It will also assess the regional regulatory framework and policy mix affecting FDI SME linkages and the potential for productivity spilovers, placing emphasis on inter-country policy initiatives that can foster the integration and boost the overali performance of the FDI-SME ecosystems across the three Baltic states. 41 Finally, the study will provide a set of policy recommendations to policy makers in the three Baltic states for improving the quality and effectiveness of existing cross-border FDI-SME policies and institutional arrangements, as weIl as for further developing integrated policy approaches across the Baltic region to improve the overail business climate, enhance the investment promotion framework and strengthen SMEs’ potential to innovate and scale up, in line with the specific regional goals and priorities. The assessment process of FDI-SME ecosystems in the Baltic states would include: O Setting up a cross-country taskforce, gathering representatives of relevant institutions from the three Baltics to serve as a platform to facilitate policy dialogue, ensure information sharing and coordinate inputs on the cross-country review. Participants wiIl include ministries, implementing agencies and subnational institutions responsible for investment promotion, SME development, innovation, and regional development. O Organising a fact-finding country mission to the three countries and bilateral meetings (virtual or on site) between the OECD Secretariat and local government departments and agencies, to gather relevant evidence and information. O Conducting desk-research and data collection, including literature reviews, update of online surveys, case studies and analysis of existing data and policy information on the Baltics’ investment and business environment. O Organising policy dialogue and a peer-review workshop involving different policy communities and business stakeholders from other EU and OECD countries to discuss findings and policy recommendations. The policy dialogue will also imply consultations and discussions with the OECD Committee for SMEs and Entrepreneurship, the OECD lnvestment Committee and the OECD Regional Development Policy Committee. O Organising a high-Ievel Iaunch event to present the main findings of the cross-country study, once published, with communication support and outreach and dissemination activities by the OECD Secretariat (e.g. social media). Timeline and budget The study will be conducted over 12 months. It will be entirely funded under the EC/OECD project. Contacts Marco Bianchini, Econornist, SME and Entrepreneurship Division, OECD, marco.bianchinioecd.orci Stratos Kamenis, PoIicy Analyst, Investment Division, OECD, stratos.kamenis(oecd.orc1 References Bank of Lithuania (2022), Review of the Bank Lending Survey Q2 2022, Financial Stability [24] Department of the Bank of Lithuania, https://www.lb.ltlen/reviews-and publications/cateqory.40/series. 1 96?categorv=&series=&ff= 1 & cf chl tk= 1 PHCo0KcQbrNZ OnqwQKtOnY5YwhC7A MpKW9p8IZXKw-1 676626455-0-gaNycGzNCPs. BSR Finance Summit (2022), The Integration of the BaItic Economies, [2] https :Ilwww. bsr2l 13. eu/the-inteQration-of-the-baltic-econom ies/. EBRD (2022), Diagnostic of Estonia, Latvia and Lithuania, European Bank for Reconstruction and [4]  I Development, London, https://www.ebrd.com/publications/country-diagnostics. EC (2022), 2022 SME Country Fact Sheet Latvia, European Commission, - [16] https://ec.europa.eu/docsroom/documents/50694 (accessed on 17 February 2023). EC (2022), 2022 SME Country Fact Sheet Estonia, European Commission, [13] https://ec.europa.eu/docsroom/documents/50685. EC (2022), 2022 SME Country Fact Sheet Lithuania, European Commission, [25] https://ec.europa.eu/docsroom/documents/50695. EC (2022), Digital Economy and Society Index 2022, European Commission, Brussels, [17] https://digital-strateqy.ec.europa.eu/en/policies/desi. Hollanders, H., N. Es-Sadki and A. Khalilova (2022), European Innovation Scoreboard 2022, [12] European Commission, Directorate-General for Research and Innovation, Publications Office of the European Union, 2022, https://data.europa.eu/doi/1 0.2777/309907. LIIA (2022), “Foreign Trade Statistics’, Investment and DevelopmentAgency ofLatvia (LIIA) [7] official website, https://www.Iiaa.gov.Iv/en/foreign-trade-statistics (accessed on 16 February 2021). MITA (2022), Agency for Science, Innovation and Technology (MITA) offlcial website, [6] https ://mita.Irv.Itlen/news/nano-solutions-for-macro-problems-5-things-to-know-about- Iithuanias-Iife-sciences-industrv (accessed on 16 February 2023). OECD (2023), OECD SME and Entrepreneurship Outlook 2023, OECD Publishing, Paris, [11] https://doi.org/1 0.1 787/342b8564-en. OECD (2023), OECD Structural and Demographic Business Statistics (SDBS) (ISIC Rev. 4). [10] OECD (2023), PoIicy Toolkit for Strengthening FDI and SME Linkages, OECD Publishing, Paris, [18] https://doi.orq/1 0.1 787/688bde9a-en. OECD (2022), Financing SMEs and Entrepreneurs 2022: An OECD Scoreboard, OECD [14] Publishing, Paris, https://doi.orq/10.1787/e9073a0f-en. OECD (2022), OECD Economic Sutveys: Estonia 2022, OECD Publishing, Paris, [3] https:I/doi.org/1 0.1787/21 ef46e4-en. OECD (2022), OECD Economic Sutveys: Latvia 2022, OECD Publishing, Paris, [9] https://doi.orq/1 0.1 787/cOl 13448-en. OECD (2022), OECD Economic Surveys: Lithuania 2022, OECD Publishing, Paris, [8] https://doi.org/1 0.1 787/0829329f-en. OECD (2022), Strengthening FDI and SME Linkages in Portugal, OECD Publishing, Paris, [19] https://doi.orq/1 0.1 787/d71 8823d-en. OECD (2022), Strengthening FDI and SME Linkages in the Slovak Republic, OECD Publishing, [20] Paris, htts://doi .org/1 0.1 787/972046f5-en. OECD (2021), “Improving effectiveness of Lithuania’s innovation policy”, OECD Science, [5] Technology and Industry PoIicy Papers, No. 123, OECD Publishing, Paris, https://doi.org/10.1 787/a8fec2ee-en. 61 OECD (2019), OECD SME and Entrepreneurship Outlook 2019, OECD Publishing, Paris, [15] https://doi.orq/1 0.1 787/34907e9c-en. OECD (forthcoming), PoIicy Toolkit for Strengthening FDI and SME Linkages, OECD Publishing, [23] Paris. OECD (forthcoming), Strengthening FDI and SME Linkages in Poland, OECD Publishing, Paris. [22] OECD (forthcoming), Strengthening FDI and .SME Linkages in the Czech Republic, OECD [21] Publishing, Paris. Poissonnier, A. (2017), The Baltics: Three Countries, One Economy?, Luxembourg: Publications [1] Office of the European Union, 2017, https://doi.orq/doi:1O.2765/763509 (accessed on 15 February 2023). RuLic OF EsT0NIA MINIsTRY OF EcoNoMIc AFFAIRs AND C0MMuNIcATI0Ns Catherine Wendt European Cornmission 19.01.2024 No 10-1/186-1 1. Avenue de Beaulieu 75775, Paris Lucia Cusmano Organisation for Economic Co-operation and Development (OECD) 2, Rue Andre Pascai 75775, Paris Ana Novik Organisation for Economic Co-operation and Development (OECD) 2, Rue Andre Pascai 75775, Paris Request to the OECD for support in undertaking a Country study on strengthening FDI and SME Linkages in Estonia Dear Ms Wendt, Ms Cusmano and Ms Novik, The Government of Estonia is committed to Creating a poiicy and institutional environment conducive to attraCting private investment, strengthening the performance of small and medium sized enterprises (SMEs), spurring innovation and inCreasing the overali Competitiveness of local economies. It is in light of this objective that 1 am requesting the technical support of the OECD in Carrying out a cross-country study on Strengthening FDI and SME linkages in the Baltics, including Estonia, with the financial support of the European Commission. We wouid like to emphasise our intention to fully take advantage of this opportunity to benchmark our efforts against the OECD standards and to mobilise ali relevant stakeholders as part of the process. The details concerning the impiementation of the country study will be defined by ali counterparts during a preparatory rneeting. Mr. Indrek Kaing, Head of Business Developrnent and Export Division at the Ministry ofEconomic Affairs and Communications will be the main contact point for ali matters reiated to the Country study during its impelementation. In anticipation of a fruitful coliaboration with the OECD and the European Commission in this endeavour, we look forward to undertaking the country study. Suur-Arneerika 1 / 10122 Tallinn / ESTONIA Phone: +372 625 6342 / Fax: +372 631 3660 / E-rnail: [email protected] / http://www.mkm.ee Please accept the assurances ofmy highest consideration. With best regards, Copy to: Organisation for economic co-operatioil and development, Marco Bianchini Organisation for economic co-operation and development, Martin Wermelingen Organisation for economic co-operation and development, Stratos Kamenis Anneli Arro [email protected] 2 (2)