VZCZCXYZ0000
RR RUEHWEB

DE RUEHTL #0989/01 3071229
ZNR UUUUU ZZH
R 031229Z NOV 06
FM AMEMBASSY TALLINN
TO RUEHC/SECSTATE WASHDC 9206
INFO RUEHHE/AMEMBASSY HELSINKI 5107
RUEHRA/AMEMBASSY RIGA 2805
RUEHVL/AMEMBASSY VILNIUS 6570
RUCPDOC/DEPT OF COMMERCE WASHDC

UNCLAS TALLINN 000989 
 
SIPDIS 
 
SIPDIS 
 
DOC for ITA-Leah Markowitz 
STATE for EB/CBA 
 
E.O. 12958: N/A 
TAGS: EINV ECON EN
SUBJECT: ESTONIA: INVESTMENT TRENDS & CHALLENGES 
 
¶1. (U) SUMMARY.  The Estonian economy is strong, and a 
favorable and open destination for foreign investment. 
Nevertheless, a labor crunch, infrastructure strain, and 
some uncertainties in the business climate pose possible 
future threats to growth.  Ideas for attracting future FDI 
include positioning the country for a greater role as a 
transit hub between the EU, Russia and China and increasing 
the focus on tourism, services, higher value-added 
industries, and exports, rather than the import of 
components and raw materials for processing here.  However, 
the GOE does not appear to have a concerted, long-term plan 
to realize these goals.  End summary. 
 
STRONG ECONOMY, WITH SOME WARNING SIGNS 
 
¶2.  (U) Foreign direct investment (FDI) into Estonia 
has remained steady at roughly EUR 500 million (USD 635 
million) per year for the past ten years.  The share of FDI 
comprised of reinvested profits has been growing steadily; 
it is currently almost equal to the level of new investment 
capital.  The overwhelming majority of FDI (79%) continues 
to flow into Tallinn.  The financial sector (47%), real 
estate (14%) and manufacturing (13%) make up the three 
largest activities into which FDI is flowing. 
 
¶3.  (U) Real GDP growth in 2005 was a strong 10.5% and 
accelerated further in the first quarter of 2006.  There 
are some factors, however, which could 
erode the positive investment climate in Estonia if 
not addressed quickly by the GOE.  One complaint frequently 
echoed by the hotel industry, manufacturing firms, and even 
IT companies is the shortage of labor.  U.S. companies 
currently invested in consistently complain they would be 
hard pressed to expand operations here due to the tight 
labor market and associated rising wages and employee 
turnover.  Furthermore, they find it difficult to find 
enough qualified Estonians with technical and engineering 
skills; not only is the Estonian educational system not 
producing enough of the right kind of graduates, but some 
are using their degrees to work abroad.  According to a 
recent labor market study by the Estonian Central Bank, an 
estimated 17,000 Estonians have moved abroad since EU 
accession.  Primary destinations are Finland, the UK, 
Ireland, and Sweden.  Another roughly 15,000 left to work 
in Finland during 2002-03 before Estonia joined the EU. 
(Comment:  With a full-time workforce of just over 500,000, 
the departure of even 30,000 workers over four years - many 
of whom are semi- or highly skilled - has clearly been 
felt.  It is not clear how many of these may have 
ultimately returned to Estonia.  End comment.) 
 
¶4.  (U) The GOE was initially reluctant to acknowledge a 
labor shortage, in part because for many years unemployment 
was the primary labor concern.  (Note:  Unemployment did 
not fall below 10% until 2004, and still remains higher 
than the national average for non-Estonian youth and the 
largely Russian-speaking northeast.  End note.)  As 
recently as last year, the Minister of Economic Affairs and 
Communication, Edgar Savisaar, said "I don't see a labor 
shortage in Estonia.  Some companies have complained they 
cannot find workers and I just say they are not advertising 
in the right places..."  While the problem is acknowledged 
today, there is still a reluctance to increase levels of 
immigration by foreign workers to Estonian given Estonia's 
unpleasant history with migrant workers during the Soviet 
period. 
 
TAXES, INFRASTRUCTURE AND OTHER ISSUES 
-------------------------------------- 
 
¶5.  (U) Uncertainty in regards to future investment in 
Estonia does not only stem from the tight labor market.  A 
lack of clarity on the future of the tax code, and the 
GOE's perceived lack of responsiveness to firms creates 
some uncertainty in the business climate as well.  To come 
into compliance with conditions of EU accession, the GOE is 
obligated to raise its rate of taxation on corporate 
profits reinvested domestically above the current rate of 
zero by 2009.  While the GOE is actively considering 
alternatives, it is still not clear when or how high they 
would raise this tax rate. 
 
¶6. (U) Estonia has made great strides in upgrading its 
Soviet-era infrastructure to meet the needs of a modern 
economy, in some cases leap-frogging over several 
generations of technology to implement state-of-the art 
practices, as they have done in the banking sector. 
Tallinn continues to experience a real estate boom, and 
major road, rail, bridge, and port development projects are 
underway.  The private port at Sillamae opened in October 
2005, and the U.S. Trade Development Agency is paying for a 
feasibility study for upgrades to the Port of Tallinn. 
 
¶7.  (U) Two key projects, however, are moving forward more 
slowly.  Business leaders, Enterprise Estonia and the 
Ministry of Economy identify an expansion to four lanes of 
the highway connecting Tallinn and Tartu, and a modernized 
railway bridge at Narva on the Russian border as important 
for future growth.  However, the road expansion could take 
10-20 years due to regulatory and technical issues, and the 
bridge must be negotiated with counterparts on the Russian 
side. 
 
¶8.  (U) Andrus Viirg, Director of Foreign Investments and 
Trade Promotion for Enterprise Estonia acknowledged what we 
have heard from the AmCham: that the GOE has been somewhat 
less "attentive" in recent years to the needs of businesses 
already operating in Estonia than it was in the late 1990s. 
This is in part due to an administrative re-organization to 
bring the formerly separate boards of tourism, business 
development, export promotion, FDI, and technology under 
one umbrella at Enterprise Estonia.  A second reason is 
that the GOE's attention is absorbed in the process of 
using EEK 5.8 billion (USD $476 million) in EU Structural 
Funds during 2004-06 according to the National Development 
Plan.  To date, 30% of these funds have been implemented. 
(Note: EU funds may also have a crowding-out effect on 
private capital that would otherwise compete for 
development projects.  End note.) 
 
ATTRACTING THE NEXT WAVE OF FDI 
------------------------------- 
 
¶9. (U) All of the parties we spoke to are focused on new 
strategies for attracting additional FDI to Estonia now 
that the initial wave of privatizations is over and the 
economy is maturing.  One of the most common ideas we have 
heard was to capitalize on Estonia's position as a 
geographic crossroads.  The country is an attractive, 
stable platform from which investors can operate in Russia, 
without the risks of being physically located there. 
Further, it is a potential logistics hub and transit point 
for rail and shipping between East and West, specifically 
for Chinese manufacturers shipping goods to the EU.  A 
large delegation led by the head of the Chinese 
Parliament's advisory body visited Estonia in late October 
to explore just such opportunities.  According to press 
reports, they discussed economic ties (including oil shale 
processing with Chinese cooperation for energy and chemical 
industry use), opportunities for transit, and cultural 
cooperation.  (Comment: While the recent Chinese delegation 
is an interesting development, the idea of Estonia 
capitalizing on its proximity to other large markets, 
namely Russia, has been around for some time.  It is not 
clear, however, that the GOE has any coordinated, long-term 
strategy for advancing this idea to bring in FDI.  End 
comment.) 
 
¶10.  (U) Estonians are certainly active in building 
business ties abroad, especially to the east.  People we 
spoke to within the GOE and in the private sector echo what 
the manager of Balti Spoon (a U.S. company and the world's 
largest manufacturer of wood veneer for use by Ikea and 
others) said at a recent symposium on doing business with 
Russia: "Estonians and Russians are quite similar in their 
business culture due to the shared Soviet background, so 
they easily find a common language.  When it comes down to 
people-to-people relationships, the political fog 
disappears..."  However, this advantage may not last.  A 
director of the majority U.S. owned Estonian Railway noted 
that this level of Russia fluency - a key advantage for 
Estonians in attracting investment away from their 
Scandinavian competitors - applies only to Estonians 25 
years and older.  "The younger generation does not have the 
same skills with Russian language and culture as people of 
my generation." he said. 
 
¶11. (U) A second approach to attracting the next wave of 
FDI to Estonia focuses not on geography, but on transition 
within the economy.  The president of the American Chamber 
of Commerce in Tallinn has frequently advised the GOE to 
increase focus on tourism, services, higher value-added 
industries, and exports, rather than the import of 
components and raw materials for processing here. 
(Comment: This approach might address the shortage of semi- 
and unskilled labor, but would require a long-term approach 
to re-tooling the economy.  It is not clear that 
development of such a long term approach is likely within 
the GOE, which has been characterized by frequent changes 
of leadership over the past 15 years.  End Comment) 
 
WOS