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Skilled labour and GreenTech — what’s behind Estonia’s record FDI numbers: report

Estonia's economic transformation is in full swing, fuelled by a surge in foreign direct investment (FDI). Green energy, high-tech manufacturing, and a skilled workforce are driving this growth and shaping Estonia's future.

Estonia, known for the best tax system in the OECD and a digital-first entrepreneurial infrastructure, constantly pushes for further advancements. The country’s government aims to attract tech-savvy individuals and businesses to drive innovation and economic growth further, with experts involved on all fronts.

Recently, a report titled “Estonian Economy: Situation and Outlook”, prepared by the Estonian Competitiveness Expert Group for the Estonian Parliament (Riigikogu), highlights major achievements in Foreign Direct Investments (FDI) inflows and potential areas of improvement. What are the main findings?

A deep dive into Estonia’s economic transformation

Foreign direct investment is crucial to the Estonian economy. In 2021, foreign investors accounted for 35% of the revenue generated by businesses with 20 or more employees (excluding finance and insurance), 25% of employment, 34% of value added, and 47% of exports.

The significance of FDI is even more pronounced in the manufacturing industry, where it contributes 45% of revenue, 37% of employment, 41% of value added, and 55% of exports. Within manufacturing, foreign-owned enterprises have the highest share in the electronics industry (91% of revenue), followed by the paper industry (81%) and electrical equipment manufacturing (71%).

The sheer numbers are also going up. While there was a decline in FDI inflows in 2021 and 2022, the year 2023 marked a significant turnaround, with FDI reaching record levels. This surge was primarily driven by the profits of foreign-owned enterprises operating in Estonia, half of which were reinvested back into the Estonian economy. All in all, in 2023, Estonia received a record-high FDI inflow of €3B. Half of this amount came from the profits of existing foreign-owned enterprises. New FDI driven by Invest Estonia efforts, amounted to €336M.

Businesses are also benefiting from these trends. Although the efficiency gap between domestic and foreign-owned enterprises has narrowed over the past decade, foreign-owned firms generally exhibit higher profitability and productivity levels than the average Estonian company. For instance, in 2021, labour productivity in foreign-owned enterprises averaged €52,800 per employee, while in Estonian-owned enterprises it was €36,100.

As explained by experts from the University of Tartu, this impact is evident in the transfer of knowledge and technology from parent companies to subsidiaries, the diffusion of knowledge to local businesses within the supply chain, and the achievement of stronger economies of scale. Estonia is now part of many value chains, producing high-tech electronics, medical devices and precise parts.

 Renderings of the upcoming Neo Performance Materials magnet plant in Narva, a €100M investment in the Ida-Virumaa region

FDI records and stronger competition

Estonia has been successful in attracting FDI due to its stable economic environment, liberal approach to foreign investments, favourable tax policies, and access to a skilled workforce. However, the motivations of foreign investors have evolved. Until the 2008 economic crisis, their primary motives for entering the Estonian market were to leverage cost advantages (low labour costs and inexpensive inputs) and gain access to resources (timber, raw milk, oil shale, etc.). Additionally, subsidiaries established in Estonia served as a bridge for expanding into the Latvian and Lithuanian markets.

With the Estonian economy maturing and its educational sector producing excellent results, considerations change. Following the 2008 crisis, the availability of skilled labour gained prominence and has since become a key factor. The presence of modern infrastructure and e-solutions, particularly the ease of digital interaction with the government, is also highly valued, show polls.

The best showcase of this progress is the closing gap in productivity between Estonian and Finnish firms. In 2008, Estonian labour costs were at 23.9% and productivity at 23.4% of Finland’s level. By 2022, these figures had changed to 38.7% and 43.1% respectively, showing that Estonia has managed to offset labour cost increases with productivity gains relative to Finland. While Estonia advances in relation to the Nordics, Baltic neighbours are catching up — the gap with Latvia and Lithuania has been shrinking.

Where does it all result? A clear trend has emerged, indicating a growing interest among potential foreign investors in green energy, raw materials for the green economy, and recyclable materials in the circular economy (e.g., oil shale ash). There is also an increased focus on seeking access to strategically important technologies, writes the report. Indeed, some of Estonia’s largest investments include large-scale GreenTech plants, battery makers, hydrogen innovators, wind and solar parks.

And there’s even more room to grow — besides green energy, there’s big potential for Estonia in development of the defence industry, novel food, and biochemistry, concludes the report.

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