The Baltic economies have experienced strong economic performance and rapid productivity convergence toward the EU average over the past two decades. This trajectory has been supported by deep integration into international markets and a business environment that has attracted sustained inflows of FDI, which has been central to the growth and structural transformation of the region.
All three countries have attracted robust FDI inflows that have fuelled growth, exports, and structural transformation. Services dominate the economy (77% of value added in Estonia, 79% in Latvia, and 72% in Lithuania), while higher-tech services are growing to 24%, 19%, and 15%, respectively. High-tech manufacturing remains modest (9% in Estonia, 6% in Latvia, 12% in Lithuania), highlighting the scope to deepen FDI-SME linkages and boost productivity via technological upgrading, as spillovers are more likely in higher-value segments.
Despite the success of FDI in boosting growth, its gains have not been fully diffused or embedded into the local SME base. Many foreign-owned affiliates remain weakly integrated into local supply chains, limiting spillovers and collaboration opportunities, while domestic SMEs often lack the necessary capabilities to partner with multinational enterprises (MNEs).
The enterprise landscape is heavily dominated by micro firms, while medium-sized enterprises remain markedly underrepresented, accounting for less than 1% of all firms across the three countries. This pronounced “missing middle” hampers firms’ ability to scale and weakens the absorptive capacity required to meet the technological, managerial, and quality standards demanded by MNEs.
The shortage of skilled labour, particularly in STEM and ICT fields, which firms in the three countries consistently cite as the number one constraint on expansion and new investment. This human capital gap is compounded by the fact that overall business R&D intensity remains low, which hinders firms' ability to adopt foreign technology. Consequently, a persistent productivity divide is evident, with SMEs generally operating at only about half the labour productivity of large or foreign-owned firms.
While SMEs in the Baltics drive innovation across the region, their uptake of advanced digital tools like AI and data analytics remains limited. This hinders their ability to successfully integrate into high-value global supply chains. Financial constraints, particularly the uneven availability of venture capital, further impede investment in the capability upgrades required to become competitive MNE partners.
Beyond firm-level barriers, institutional fragmentation also weakens SME–MNE linkage formation. FDI and SME policies are overseen by multiple ministries and agencies, leading to coordination gaps that underscore the need for stronger alignment between investment promotion efforts and SME development priorities. While the Baltic countries have each established solid institutional structures to manage FDI attraction and SME development, with varying degrees of integration, there is still a pressing need for stronger coordination and clearer alignment between policies designed to attract FDI and those aimed at developing SMEs. Currently, Investment Promotion Agencies (IPAs), SME support institutions, and innovation funds tend to operate in siloed environments without synchronised goals or effective information-sharing. This fragmentation results in missed opportunities to systematically match an incoming foreign investor with local suppliers who have recently received capability upgrading support.
Finally, investment is heavily concentrated in capital cities, where the most innovative SMEs are also located, leaving smaller municipalities and rural regions comparatively underserved. This risks widening regional disparities in income, productivity, and innovation capacity.
While current constraints limit the immediate absorption of foreign investment spillovers, they also reveal significant opportunities to deepen FDI-SME linkages. The Baltic states already exhibit strong integration into GVCs. In 2020, foreign value added accounted for 37% of Estonia’s exports, 31% in Lithuania, and 24% in Latvia, surpassing the OECD average of 26%. Forward integration - domestic value added embodied in other countries’ exports - stood at 23% in Lithuania, 23% in Latvia, and 20% in Estonia, broadly aligned with EU peers. The prevalence of stronger backward than forward integration partly reflects the characteristics of small, open economies and their industrial structure; nevertheless, it may also point to scope - conditional on sectoral composition and firm capabilities - for domestic firms to deepen their participation in higher value-added segments of global production networks
To effectively address current limitations and optimise the impact of FDI, policy efforts should focus on enhancing the mechanisms through which foreign knowledge and technology diffuse across the Baltic economies. Currently, the core channels for know-how transfer face constraints: value chain linkages are still strengthening, as MNEs' domestic sourcing varies and a substantial share of their output is exported rather than absorbed by local SMEs, thus limiting local knowledge transfer. Furthermore, strategic collaboration remains modest, with MNEs often preferring to partner with local universities or domestic counterparts instead of SMEs. Finally, talent mobility is hindered by significant wage gaps, where foreign firms typically pay substantially higher wages, which, combined with specific regulatory settings, impedes the desired flow of high-skilled talent and best practices from MNEs into the domestic SME sector. Therefore, targeted initiatives are warranted to address these barriers and facilitate the circulation of high-skilled individuals and technology.
To translate these insights into action and maximise the benefits of FDI for local firms, the report proposes several key policy recommendations.
Policymakers should focus on implementing targeted linkage programmes, which involve designing and executing robust, proactive supplier development and matchmaking schemes to systematically build lasting commercial and innovation-based relationships between MNEs and local SMEs. This effort must be supported by strengthened whole-of-government coordination, ensuring formal mechanisms (like joint committees and shared KPIs) are in place to align investment promotion, SME upgrading, and innovation goals across all relevant agencies.
There is an opportunity to leverage Pan-Baltic collaboration by exploring coordinated investment promotion and cross-border investment corridors to capitalise on complementary economic strengths to attract larger, spillover-rich projects and disseminate benefits regionally.
The success of these reforms must be monitored through the adoption of outcome-based monitoring, utilising tools that track measurable impacts such as the share of local sourcing, the incidence of MNE-SME collaborative R&D, and the rate of local supplier uptake, shifting the focus from purely administrative outputs to tangible results. These strategic steps will not only bolster the competitiveness and resilience of each national economy but also firmly establish the Baltics as a unified, innovative, and highly attractive destination on the global stage, ensuring sustained and shared prosperity for all local firms and communities.