The industry of The Baltic States: heading the same direction

What Latvia and Estonia see as the future of industry and how they are preparing for it: interview with Minister of Entrepreneurship and Information Technology Rene Tammist and Minister of Economics Arvils Ašeradens.

Ministry of Economics is forecasting an increase in wages about 6% anually, which need to be matched with an increase in productivity, shifting from labour intensive production to high value added products.Arvils Ašeradens
What kind of challenges and possibilities await Latvian industry in the near future? What should be expected in our region’s industrial sector?
Arvils Ašeradens, Minister for Economics.

As one of the main challenges we face today and in the nearest future is labor availability and their practical and profesional skills. The lack of labour force in long term could really affect posibility to rise productivity of industry. This problem is topical for all Baltic region.

The number of students in general education will decrease in the long term both at primary and secondary level. The trend of reduction also applies to the number of secondary vocational education students. The structure of secondary education depends on the choice of elementary school graduates for further education. It needs to be made clear that the main problem in vocational education is still low attractiveness: about 3/5 of young people in Latvia choose to continue their studies in general education who enter in the labor market without a certain specialty and skills. Latvia has set a target to achieve at least 50% of the total number of pupils at vocational secondary level by 2020. In terms of the proportion of students in engineering, the goal is to reach 27% of the total number of graduates in 2020.

Regarding to the lack of labour force industry has begun to intensify its consideration of the use of various IoT solutions to improve production processes. The implementation of robots and various digital solutions in the long run will allow to replace the missing professionals. The Ministry of Economics of Latvia also sees potentional of the development of digitisation, AI, Industry 4.0 and regarding to this potentional we have several national initiatives and strategies for the more successful implementation.

Since the manufacturing industry is energy intensive, large costs for companies are earmarked for electricity costs. The energy efficiency is one more aspect to improve in our region to stabilize the development of the industry in national level.

From 2018 Latvia has been made significant changes in the national tax system also which is one more aspect which allows to develop industry. Latvia was already among the top five most competitive countries, and recent tax reforms helped it move to 2nd place in the International Tax Competitiveness Index. In its annual overview the World Bank has ranked Latvia 1st among the Baltic countries with relatively low total tax rates. In 2018 Latvia implemented a business tax reform package and now applies 0% tax to reinvested profit. Corporate income tax at a rate of 20 percent is paid in case of distributed profit.

VAT is charged on all transactions made in the course of business. Latvia has VAT standard rate of 21 percent and reduced rate of 12 percent. Moreover, from 1 January 2018 the new super reduced VAT rate of 5 percent is applied to a range of traditionally locally produced vegetables and fruit.

Personal income tax is charged at 20, 23 and 31.4 percent differential tax rate from January 2018 on employment and other income, except for income from capital and capital gains which are taxed with a flat tax rate of 20 percent.

There is micro-enterprise tax (MET) in Latvia which is unique in the world. MET is a single tax payment of 15 percent from turnover (up to 40 thousand EUR), it includes social contributions, personal income tax, corporate income tax and business risk fee.

How would you assess the competitive advantages and possibilities of your country’s industrial companies?

We have strong local and international companies in each of industries with their unique competitive advantages. If we have to take a more general position and to identify key success factors throughout all industries, I would say that the following characteristics would give the most accurate description:

  1. Perseverance
  2. Reliability
  3. Creativity
  4. Flexibility.

These characteristics have helped our industrial companies stand out not only in the Baltic Sea region, but globally. From winning efficiency awards within 6 months of signing a contract with Alibaba, to training Tom Cruise and Shaolin monks to fly. From supplying NASA, with the toughest of quality demands to cooperating with Daimler-Benz in finding new efficiency solutions. From supplying glass solutions in the Louvre museum in Paris, to constructing CLT buildings in Scandinavia.

Each industry, of course, has their additional benefits and advantages, but I would say that those four qualities are the main competitive advantages that have allowed those companies to fully embrace difficult challenges and turn them into possibilities.

As one of supportive instruments for industrial companies is the availability of EU Structural Funds. Regarding to financial instruments, the possibility to receive support for the project implementation are provided and application process is simple, also the necessary improvements are being made in order to ensure that this process for applicant is convenient as possible.

In recent years, the importance of the availability of financial support has increased in stimulating investment. Financial conditions are counted as a significant factor supporting investment, which is equivalent to technical factors such as technological development, availability of skilled labor, etc.

In particular, I would like to point out the development of innovations through grants, which is one of the main aspects why the Latvian industry can become attractive and competing abroad. Latvia’s innovation performance has slightly improved over the last years, but many challenges still remain.

What are the prospects of the production sector in Baltic countries?

In the medium and long-term manufacturing growth rate will remain relatively fast. At the same time, growth will be not so much related to the extensive increase of materialintensive production volumes, but rather with the usage of newest technological processes, digitisation (Industry 4.0 concept), process optimisation, etc. Due to the above-mentioned factors, faster development is expected in the high and medium technology sectors – chemistry, pharmacy, electronics, etc. Relatively fast growth rates are forecasted also in biggest manufacturing sector – wood-processing. Sectors which are more focusing on domestic market (for example, food industry, printing) will be mostly effected by the dynamics of domestic demand. Manufacture of other non-metallic mineral products will be closely related to construction tendencies.

As a result of multiple factors like demographics, EU single labour market and labour wages in other EU countries, in the medium term labour force will become more scarse therefore more valuable, especially among industry workers with vocational education. Ministry of Economics is forecasting an increase in wages about 6% anually, which need to be matched with an increase in productivity, shifting from labour intensive production to high value added products.

Some improvements can be expected in energy costs, and financial instruments for productivity increase and accessibility of venture capital. Upstream integration in value chains will contribute to sustainable growth in industry.

Nowadays, the 4th industry revolution, industrial robotics, digitization and the predominance of services for the industry are often discussed. The traditional concept of a sector is vanishing away, and more and more attention is being paid to cross-sectoral business. What are the prospects in this field?

Considering the EC and Europe-wide guidelines, Latvia also pays special attention to the integration of new technology solutions into Latvian manufacturing companies. Latvia intensifies its focus on updating digitization activities by providing manufacturing companies with the opportunity to work with smart technology developers, mainly companies of ICT industry, to collaborate on the implementation of new technologies and the improvement of existing ones awaring the latest available technology and data processing capabilities.

Applying new technologies and digital tools in manufacturing processes is important for our industries. The use of innovative and especially – digital technologies in manufacturing can make the easier transition to a more sustainable economy. We have all preconditions in Latvia to ensure systematic move to industry which is driven by digital tools.

We also have special programs which supports cross-sectoral partnership and collaboration via innovative project implementation (e.g. Competence Centre program). The aim is to increase the competitiveness of enterprises by facilitating research and industrial cooperation in new product and technology development projects.

What changes and tendencies are being observed in this sector?

During the crisis, as labour costs fell, the competitiveness of Latvian producers improved, which served as a basis for the export rise and, therefore, also for the development of tradable sectors. The structure of the national economy changed. In 2008, tradable sectors alone (agriculture, forestry, manufacturing and transport services) comprised only 26% of the total value added, while in 2010 their share reached 33%. In 2017, the share of these sectors has fallen slightly, constituting 29.5% of the total value added.

As Latvia has returned to economic growth after the crisis, the growth rates of the manufacturing have been considerably faster than the overall economic development. Manufacturing, in fact, has become one of the main driving forces of economic growth. The development of manufacturing is mainly facilitated by the improvement of the competitiveness of Latvian manufacturers and positive demand dynamics in the largest export markets.

In 2017, as the external environment improved, manufacturing experienced the largest growth in recent years. In 2017, a rise was recorded in all sub-sectors, especially in manufacture of basic metals and metal articles and food industry. Other sub-sectors, such as the production of transport vehicles, the production of electrical and optical equipment; as well as the production of non-metallic mineral products also greatly contributed to the overall industry’s growth.

What should one pay a special attention to while assessing and analysing the situation in your country’s industrial companies?

To analyze situation, it is very important to have clear and objective information for having real overview in the market. For overview it is important to collect such a data as technological readiness level of technological development, availability of workforce and infrastructure.

It is important to identify existing and potential export markets as well as potential future partners. In order to be able to develop the industry, it is necessary to look at the global trends and the overall demand.

It is important that our companies look attractive in the international arena. One of the ways we can do it, is to encourage companies to engage in research and development. By demonstrating the potential of creating new products and technologies, we have made the domestic market attractive to foreign investors, raising interest in the region as a whole.

Viewed separately, the internal market of each state is too small to focus on. Two thirds of goods produced in Estonia are sold in export markets and we expect this share to rise even higher.Rene Tammist
What kind of challenges and possibilities await Estonian industry in the near future? What should be expected in our region’s industrial sector?
Rene Tammist, Minister of Entrepreneurship and Information Technology.

We have many important changes waiting ahead in Estonian industry sector. The industry is moving towards more complex production and higher extent of automation not only in Estonia, but also in the whole region. As we see a great disparity of productivity between the companies in the manufacturing industry (Finland has productivity rate three times higher than Estonia and even more compared to Latvia and Lithuania) then there is a clear demand to minimize such gap in coming years. This also means that the structure of the manufacturing industry in Baltic states has to change significantly. In addition to that, we have a challenge to meet all the ever-tightening environmental requirements as well.

How would you assess the competitive advantages and possibilities of your country’s industrial companies?

First of all, Estonia’s manufacturing industry is extremely flexible. Generally, the companies aren’t very big, and doing business with them is fast and simple. The client’s expectations are also rather easily met. Estonia has a flexible labour market and the policies behind it allows to expand the workforce when needed.

In addition to that, we have very good connections to the Baltic Sea through various ports, making the logistics much cheaper and easier. Locating the industrial potential close to the sea gives the competitive advantage to move large structures by ship.

One of our greatest strengths is the ICT sector that supports the industry with digitalisation and implementing artificial intelligence as well. This means that in many fields the production is modern, automated and hence very efficient.

What are the prospects of the production sector in Baltic countries?

The development of Baltic states’ industry is closely tied to competitiveness in foreign markets. Viewed separately, the internal market of each state is too small to focus on. Two thirds of goods produced in Estonia are sold in export markets and we expect this share to rise even higher.

Another very important direction is the funding of scientific research and development of the industry. According to Eurostat, Estonia invested 29 euros per capita to industry’s R&D, while Latvia did 8 and Lithuania 13 euros. At the same time, Germany and Sweden invested over 700 euros and Finland about 500 euros per capita to R&D.

Nowadays, the 4th industry revolution, industrial robotics, digitization and the predominance of services for the industry are often discussed. The traditional concept of a sector is vanishing away, and more and more attention is being paid to cross-sectoral business. What are the prospects in this field?

The digitalisation and use of industrial robots and other intelligent machines provides wide opportunities to industries in the Baltic states. We are partnering with the private sector to make better use of the possibilities created there. The sale of the services tied to the product and production become more important and more profitable for the industry. The government of Estonia is supporting taking the risks and intervenes in case of market failure. We have different measures that address such problems, such as co-funding the product development and diagnostics for digitalising and automatizing the processes of a company. We also adjust the curriculums of colleges and universities according the need from the market. The enterpreneurs themselves are looking for opportunities to conduct in product development activities and to use new technologies as well. The interest in digitalisation has grown at great speed during last few years.

What changes and tendencies are being observed in this sector?

The business model is changing and the share of services is growing in manufacturing industry as well. From 2013 to 2017 the export of services in Estonian manufacturing industry has grown 50% while the overall export of goods had grown only 1%.

There is a shift towards more expensive end products. The average salary has risen 36% in Estonia during last five years. On one hand it means that it’s increasingly difficult to hold the competitive edge with cheaper products, but on another it gives a better chance to hire higher skilled specialists and professionals, either domestically or from abroad.

What should one pay a special attention to while assessing and analysing the situation in your country’s industrial companies?

The major focus must be on added value and export capabilities. We have very good preconditions to excel in both.

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