This chapter examines the extent of FDI and SME linkages in the Baltic states and the potential for the diffusion of knowledge, technology, and skills from foreign multinational enterprises to domestic small and medium-sized enterprises. It examines how core channels of FDI-SME diffusion play out in Baltic countries – namely value chain relationships; strategic partnerships; labour mobility; and competition and imitation effects – relative to peers in the OECD and the European Union, and across sectors.
Strengthening FDI and SME Linkages in the Baltic States
Abstract
For FDI-SME spillovers to take place, domestic SMEs must be exposed to the activities of foreign MNEs, either directly or indirectly. Such exposure can boost productivity spillovers through the transfer of knowledge, technology, and skills. This also enhances the innovation and scaling capabilities of domestic firms. This chapter examines primary channels for FDI-SME spillovers, including value chain linkages, strategic partnerships, labour mobility, and competition and imitation effects, in the Baltic states.
MNEs operating in the Baltic states provide valuable opportunities for local SMEs through local sourcing of intermediate inputs. These “backward linkages” are one of the most direct channels for FDI spillovers, as foreign MNEs often require higher-quality inputs, which incentivise domestic SMEs to adopt international standards. Meeting these standards enhances the operational capabilities of local firms, helping them remain competitive in both domestic and global markets. However, there are notable differences in the extent of domestic sourcing across the Baltic states. For instance, MNEs active in Latvia show a stronger reliance on domestic suppliers, with 71% of foreign affiliates’ intermediate inputs sourced locally, while MNEs in Estonia and Lithuania source less locally, at 56% and 57%, respectively. These differences reflect variations in economic structures, sectoral compositions, and policies across the region.
Despite these opportunities, spillovers through “forward linkages” to domestic SMEs from foreign MNEs remain limited. A significant portion of foreign affiliates' intermediate output in the Baltics is either exported or supplied to other foreign affiliates rather than being integrated into local SME production. For example, foreign affiliates in Estonia have the highest share of exports, at 43%, limiting the potential for spillovers through local value chains. Additionally, foreign affiliates in the Baltics are more likely to sell their output to other foreign firms than in peer economies, such as Finland or Italy, where foreign affiliate output is more widely distributed across domestic supply chains. This suggests that, while there are opportunities for SMEs to engage with foreign firms, the current structure of foreign-owned networks in the Baltic region presents barriers to the broader diffusion of knowledge, technology, and innovation to local SMEs. Strengthening linkages between foreign MNEs and domestic SMEs is crucial for fostering greater spillovers and enhancing the competitiveness of the Baltic economies.
Strategic partnerships between foreign MNEs and domestic SMEs play a crucial role in fostering technology transfer and innovation, particularly through joint R&D and collaborative innovation projects. The level of inter-firm collaboration varies significantly across the Baltic states: firms are more likely to form partnerships with domestic entities rather than foreign firms, which may limit opportunities for knowledge and technology spillovers. Technology licensing is more common in Estonia, with 18% of large firms, 9% of medium firms, and 7% of small firms acquiring or licensing intellectual property. This suggests a stronger domestic innovation ecosystem and greater potential for FDI-SME spillovers through this channel.
Labour mobility, particularly the movement of workers from foreign MNEs to domestic SMEs, is an important source of knowledge spillovers in the context of FDI. Job-to-job mobility, defined as the movement of individuals between jobs from one year to the next, is notably active in Lithuania (11%) and Estonia (10%), especially in science and technology-related jobs, while Latvia's rate is 6%. The higher mobility rates in Estonia and Lithuania may be linked to proactive talent attraction policies. Nevertheless, wage differentials between foreign and domestic firms may reduce labour mobility from MNEs to SMEs, limiting knowledge and productivity spillovers: In Lithuania, foreign firms offer wages twice as high as domestic firms, while in Latvia and Estonia, they provide 1.9 times and 1.5 times higher wages, respectively. The wage disparity is particularly pronounced in the service sectors across the three countries. This significant wage gap may discourage employees from moving from foreign MNEs to domestic firms, thereby reducing the potential for skill transfer and knowledge diffusion.
FDI-SME diffusion channels through competition and imitation effects play a role in productivity and innovation spillovers. When highly efficient foreign firms enter the market, they can incentivise domestic enterprises to improve efficiency and enhance innovation efforts. Estonian and Lithuanian firms engage relatively frequently in innovation cooperation with competitors, facilitating tacit learning and imitation effects. Around 30% of medium-sized firms in these countries engage in process innovation cooperation, a level comparable to leading EU innovation ecosystems. Collaboration within the same sector and with foreign competitors remains relatively weak across all three Baltic states, further reducing the scope for knowledge spillovers. Moreover, Baltic SMEs do not view competition as a significant barrier to innovation. Instead, they identify limited access to finance and skilled labour as more pressing constraints.
In the Baltic states, value chain linkages between MNEs and local firms, either as suppliers or customers, can play a vital role in fostering knowledge spillovers that enhance the productivity and competitiveness of domestic SMEs. Through these linkages, local suppliers can gain access to advanced technologies, technical training, and insights into global quality standards, while local customers benefit from improved product design, market knowledge, and technical expertise (OECD, 2023[1]). MNE affiliates produce significant indirect effects, which depend on the extent of their integration into domestic economies. Globally, on average, every USD of additional sales by foreign affiliates contributes an additional USD 0.62 to the domestic economies where they operate (Cadestin et al., 2019[2]). Nevertheless, the impact of these spillovers depends on the absorptive capacity of SMEs, the depth of collaboration with MNEs, and the presence of supportive government policies and industrial ecosystems. Strengthening these linkages in key sectors can help the Baltic economies move up the value chain, increase innovation, and better integrate into global markets.
This section explores value chain linkages in the Baltic states, with Box 3.1 illustrating the conceptual relationship between foreign firms’ sourcing practices, value added, and output. By examining the quality and depth of these buyer-supplier relationships, the analysis seeks to assess their spillover potential and benchmark them against supplier-buyer linkages in other OECD countries.
To understand value-chain linkages between foreign affiliates and local firms through the optic of data presented in this chapter, it is important to clarify how firm output, value-added and sourcing relate to each other. Firms’ output can be split into value added and sourcing of intermediate inputs (Figure 3.1). Foreign-owned and domestic firms can differ in their sourcing patterns in general and across sectors.
This section focuses on the extent to which foreign firms source intermediates directly from firms established domestically in each country (Estonia, Latvia, Lithuania), as opposed to sourcing of inputs from abroad through imports. In addition, the domestic sourcing structure is therefore further split into sourcing from other foreign affiliates established in the Baltic states, domestic MNEs (i.e. Baltic firms with establishments abroad) and domestic non-MNEs (i.e. Baltic firms with no establishments abroad).
The extent at which value added generated by foreign affiliates stays in the host Baltic economy or is repatriated to home economies is out of the scope of this chapter. This aspect is also of key interest in the context of the direct contributions that foreign firms have on the growth and development of the host economy. Part of foreign affiliates’ value added is used to pay salaries of their (mostly local) employees and therefore “stays” in the domestic economy. The remaining part, including earnings, may or may not leave the host economy. The latter is particularly important in the context of tax policy.
Source: Based on (Cadestin et al., 2019[2])
Foreign affiliates in the Baltics rely on local inputs, although to varying extents
Foreign multinational enterprises operating in a host economy can source intermediate inputs either from local suppliers or through imports. Choosing to source locally provides domestic SMEs with valuable opportunities by increasing demand for their products and services. Backward linkages through local sourcing are among the most direct channels for generating positive FDI spillovers. By demanding higher-quality inputs, MNEs incentivise SMEs to adopt and comply with international standards. (Liu, Douw and Sabha, 2020[3]). Moreover, the experience gained from meeting the high standards often required by foreign affiliates strengthens their operational capabilities, enabling sustained growth and competitiveness in domestic and global markets.
Foreign affiliates in the Baltic states rely significantly on domestic markets for intermediate inputs, though the extent varies across countries. Foreign affiliates in Latvia source 71% of their intermediate inputs domestically, closely aligning with the OECD average of 65% and reflecting a strong integration of local suppliers into foreign affiliates’ value chains. MNEs in Estonia and Lithuania source 56% and 57% of their inputs domestically, respectively, underscoring their reliance on imported inputs. This reliance may stem from differences in the strength of domestic supplier networks, sectoral composition, and trade or investment policies. While a weaker domestic supply base can limit local sourcing opportunities, the use of imported intermediate inputs has been shown to enhance total factor productivity and drive firm-level innovation. (Stone and Shepherd, 2011[4]). The Baltic region’s domestic sourcing rate, averaging 60%, is comparable to medium-sized economies such as Finland (66%), Denmark (65%), and Sweden (66%). It is slightly lower than Italy's 75% but surpasses the Netherlands' 54% (Figure 3.2, Panel A).
The divergence reflects different economic structures and supply chain dynamics. Latvia’s relatively lower share of international sourcing indicates a stronger reliance on domestic inputs, reflecting the country's economic composition, which is more focused on sectors like wood processing and food production, where local resources play a more significant role (OECD, 2024[5]). Lithuania and Estonia relying more on international sourcing could stem from their respective export bases. Lithuania's higher reliance on international sourcing is likely tied to its more diverse and export-oriented industrial base, which integrates into global value chains, particularly in sectors such as chemicals, electronics, and machinery (OECD, 2022[6]). Estonia's similar sourcing level may stem from its highly digitalised economy and a strong component of service orientation (OECD, 2024[7]). While lower domestic sourcing can indicate weaker local supplier networks, it can also reflect greater integration into global value chains, enabling firms to access more competitive, high-quality, or specialised inputs that enhance productivity and innovation.
Foreign affiliates in the Baltic states rely more on inputs from other foreign affiliates than the OECD average, highlighting a tendency for foreign companies to trade and collaborate closely with each other (Figure 3.2, Panel B). In Estonia, foreign affiliates source 36% of their inputs from other foreign affiliates, the highest share among the Baltic states (31% in Latvia and 27% in Lithuania).
Note: The OECD benchmark countries used in this report are: Denmark, Finland, Italy, the Netherlands and Sweden.
Source: OECD (2019[8]), Analytical Activity of Multinational Enterprises (AMNE) Database, www.oecd.org/sti/ind/analytical-AMNE-database.htm
Domestic MNEs play a relatively limited role in the supplier networks of foreign firms in the Baltic states compared to their counterparts in peer EU economies. In Latvia, foreign affiliates source 12% of their inputs from domestic MNEs, followed by 13% in Lithuania and 17% in Estonia, below the OECD average of 23%. In benchmark countries, foreign affiliates in Finland source 24% of their inputs from domestic MNEs, both Italy and Sweden match the OECD average at 23%, and the Netherlands follows at 20%. These comparisons highlight potential opportunities to strengthen integration of domestic MNEs into foreign-led supply chains in the Baltic region, to enhance economic integration and competitiveness (Figure 3.2, Panel B). Although domestic firms, including smaller ones, are already well integrated, there remains potential for further strengthening these linkages.
The participation of non-MNEs in the local supplier networks of foreign firms is particularly strong in Latvia (57%) and Lithuania (60%), surpassing both the OECD average of 53% and the participation rates of most peer EU economies. This highlights the capacity of smaller, domestically-owned firms in Latvia and Lithuania to integrate more effectively into the supply chains of foreign affiliates, seizing opportunities for collaboration, and potential knowledge and technology transfers. In Estonia, fewer than half of non-MNE firms (47%) participate in these networks, a share that falls below the OECD average. This may be partially due to the high foreign ownership among SMEs, which could influence their integration patterns. It can also suggest potential challenges in integrating local firms into the operations of foreign companies, highlighting differences in factors such as the structure of local economies, the availability of competitive domestic suppliers, or the strength of policies and programmes aimed at fostering linkages between foreign affiliates and local businesses.
While specific data distinguishing SMEs from non-SMEs are unavailable, the reported shares suggest that Baltic SMEs likely play a substantial role in the local sourcing activities of foreign affiliates, given that SMEs typically constitute a significant share of non-MNE businesses. Especially in the Baltic states, SMEs dominate the business landscape. In Latvia, they represent 99.8% of all economically active enterprises. In Estonia, micro-enterprises account for 94% of all businesses Similarly, in Lithuania, SMEs make up 99.6% of enterprises, with 84.6% classified as micro-enterprises (OECD, 2024[9]). Taking this into account, and given empirical evidence showing that SMEs are generally less likely to engage in international operations, while firms affiliated with international business groups tend to be larger on average (Cadestin et al., 2019[2]), it follows that SMEs are more likely to be classified as domestic non-MNEs.
The share of local sourcing of foreign firms from both foreign and domestic firms operating in the Baltic states has exhibited distinct patterns across the three countries and the four sectors analysed – low and medium technology manufacturing, high technology manufacturing, lower technology services, and higher technology services (Figure 3.3, Panels A and B). One example is Latvia, where the share of local sourcing in higher-technology services surged by nearly 20 percentage points between 2006 and 2020. This upward shift suggests a significant strengthening of domestic supplier networks and service providers in this sector. Such growth could be attributed to improvements in the capabilities of local firms, an expanding pool of skilled labour, or targeted policy initiatives aimed at fostering stronger linkages between foreign investors and domestic enterprises. The share of local sourcing in domestic firms has followed a downward trend in all three countries, although the drop was not as significant. However, the decline has been more gradual and less pronounced compared to that observed among foreign firms. This suggests that while domestic enterprises are increasingly integrating into regional and global supply chains, they continue to maintain relatively stronger ties with local suppliers.
International sourcing has been on the rise among both domestic and foreign firms operating in the Baltic states, driven by deeper integration into GVCs, which tends to weaken domestic linkages while significantly accelerating the growth of domestically produced value-added through efficiency improvements (OECD, 2023[1]). When it comes to sourcing intermediate inputs among the three Baltic countries, trade volumes in 2020 were relatively low compared to peer EU economies. Latvia imported the highest value of intermediate inputs from Lithuania, amounting to nearly USD 1.5 billion, which represents around 13.5% of its total intermediate imports. Lithuania, in turn, sourced close to USD 1 billion worth of inputs from Latvia, equivalent to just over 3% of its total. Estonia imported more intermediate inputs from Lithuania (USD 850 million, 5.1%) than from Latvia (USD 730 million, 4.4%). These figures indicate that intra-Baltic trade in intermediate goods remains modest, though economically meaningful, particularly between Latvia and Lithuania (OECD, 2023[10]). This relatively weak regional integration among the Baltic countries may reflect differences in industrial specialisation and market size, as well as logistical or regulatory barriers that hinder cross-border business linkages. Strengthening regional supply chains could enhance the competitiveness of Baltic firms by facilitating knowledge spillovers, technology transfers, and greater economies of scale.
Participation in GVCs is linked to increased firm-level productivity due to knowledge and technology spillovers from international production networks (Masso and Vahter, 2022[11]). In the Baltic region, the value added generated by both foreign and domestic firms has increased significantly from 2006 to 2020 across all three countries and across all four sectors analysed. This upward trend reflects broader economic development, industrial upgrading, and deeper integration into regional and global markets. Among the three countries, Estonia has experienced the most pronounced value-added growth in higher-technology services. This aligns with existing literature, which suggests that domestic firms establishing linkages with foreign-owned firms in high-tech sectors tend to benefit more in terms of productivity gains compared to those operating in low-tech industries (Masso and Vahter, 2022[11]). In Latvia and Lithuania, the most significant increases in value-added have been observed in higher-technology manufacturing and services, indicating a gradual move up the value chain. This suggests that firms in these countries are strengthening their capabilities and integrating into more advanced segments of GVCs. Factors such as increased foreign direct investment, industrial specialisation, and policy initiatives aimed at fostering innovation and competitiveness likely contribute to this shift (Box 3.2). Moreover, in the Baltics, a significant expansion in domestic supply chain integration can be observed, with the local sourcing of foreign affiliates operating in the region surging across all four sectors assessed (Figure 3.3, Panel C).
Interreg, part of the EU Cohesion Policy, supports cross-border cooperation to promote balanced economic, social, and territorial development across the EU and beyond. The Interreg Baltic Sea Region Programme spans nine countries: Denmark, Estonia, Finland, Germany, Latvia, Lithuania, Norway, Poland and Sweden.
The Interreg programme has provided long-standing support to SMEs in the Baltic Sea Region, playing a key role in enhancing their capacity, adaptability, and resilience while strengthening economic connectivity and regional cohesion.
Over the past two decades, Interreg projects have organised over 1 200 events to help SMEs develop business plans, secure venture capital, and enhance training and advisory services. These initiatives expanded networks by connecting incubators, chambers of commerce, and clusters, fostering cross-border partnerships and market access. SMEs also gained valuable innovation expertise and access to research facilities. The programme further strengthened regional innovation ecosystems and integrated SMEs into smart specialisation strategies. In addition to driving innovation, projects provided crisis support, business succession guidance, and mentorship, helping businesses avoid bankruptcy and preserve jobs.
The 2021-2027 programme includes several initiatives designed to enhance the absorptive capacity and scalability of SMEs. One example is the BSR Go-Abroad project, which seeks to create a roadmap to help micro-SMEs expand their offerings and access new markets across the Baltic Sea region, aiming to mitigate potential shocks from geopolitical tensions. The project provides micro-SMEs with the knowledge, tools, and networks required to implement effective internationalisation strategies and strengthen local value chains. It will pilot an internationalisation programme, producing a blueprint with tools and recommendations to foster local trade and cooperation among micro-SMEs.
The degree of sourcing intermediate inputs locally varies across the Baltic states, but a more granular analysis by sector demonstrates that both domestic and foreign firms source more intermediate inputs locally rather than through imports. This is more pronounced in services, rather than manufacturing. On average, foreign firms in the Baltic states have demonstrated a strong reliance on domestic suppliers for their service sector operations, though with notable differences across countries. In Estonia, domestic sourcing accounted for 63% of total procurement in services, while in Latvia it was higher at 75%, and in Lithuania, it stood at 66%. These figures indicate that foreign firms in Latvia maintain the strongest domestic linkages within the services sector, whereas Estonia shows a comparatively lower reliance on local suppliers (Figure 3.3, Panel A and B). Domestic firms exhibit even higher levels of local sourcing, with 77% in Estonia, 79% in Latvia, and 72% in Lithuania. This suggests that domestic companies, while also engaging in international sourcing, maintain stronger connections with local suppliers than their foreign-owned counterparts, especially in terms of services, which are often non-tradable and only available to be sourced locally. In the manufacturing sector, both foreign and domestic companies in the Baltic states rely less on local suppliers, with domestic sourcing shares remaining relatively low across all three countries. Among them, Latvia exhibits the highest levels of local sourcing, with domestic firms procuring 64% of their inputs from local suppliers, while foreign-owned companies source 57% of their inputs locally. The reliance on domestic sourcing is particularly low for intermediate inputs in high-technology manufacturing. This suggests that firms operating in high-tech industries are more dependent on imported components, likely due to the limited availability of specialised suppliers and the need for advanced technological capabilities. Addressing these gaps could be particularly beneficial for fostering spillovers in high-technology manufacturing.
Note: The classification of sectors into the different groups follows the classification outlined earlier in this report (see chapter 2).
Source: OECD (2019[8]), Analytical Activity of Multinational Enterprises (AMNE) Database, www.oecd.org/sti/ind/analytical-AMNE-database.htm
Note: The classification of sectors into the different groups follows the classification outlined earlier in this report (see chapter 2).
Source: OECD (2019[8]), Analytical Activity of Multinational Enterprises (AMNE) Database, www.oecd.org/sti/ind/analytical-AMNE-database.htm
Note: The classification of sectors into the different groups follows the classification outlined earlier in this report (see chapter 2).
Source: OECD (2019[8]), Analytical Activity of Multinational Enterprises (AMNE) Database, www.oecd.org/sti/ind/analytical-AMNE-database.htm
Foreign MNEs in the Baltics have a strong export orientation but selling to domestic SMEs remains limited
Foreign affiliates serve not only as buyers in host countries but also as suppliers, providing both intermediate inputs to other firms and final products to the market, creating forward linkages (OECD, 2019[12]). Through forward linkages, SMEs can strengthen their capacity to meet the higher quality standards demanded by foreign markets when exporting their products. The nature of GVC participation varies considerably between the services and manufacturing sectors, with services showing more pronounced forward linkages (Ignatenko, Raei and Mircheva, 2019[13]). MNEs in the industrial sectors usually offer training and upskilling on the use of their products, especially in machinery, thereby contributing to a diffusion of know-how and innovation (Jindra, 2006[14]). It is also applicable in the context of sustainability – MNEs are more likely to set industry standards and diffuse knowledge and promote environmental sustainability (Ocelík, Kolk and Ciulli, 2023[15]). The degree of these spillovers depends on the extent to which local SMEs incorporate the output of foreign firms into their production processes.
In the Baltic states, a larger share of foreign affiliates' intermediate output is either exported or supplied to other foreign affiliates within the local market, compared to peer economies. On average, 37% of the output of foreign affiliates operating in the Baltics is exported, compared to 27% in the OECD area. Out of the three Baltics states, foreign affiliates operating in Estonia export the highest share of their outputs (43%), compared to Latvia (28%) and Lithuania (39%) (Figure 3.6, Panel A). This suggests a lower potential for spillovers to domestic firms through forward linkages, as fewer foreign-produced inputs are integrated into local SME production. Foreign affiliates of MNEs are responsible for a significant share of domestic intermediate consumption and this share is higher than the OECD average of 22% (24% in Lithuania, 27% in Latvia and 33% in Estonia) (Figure 3.6, Panel B). This highlights the presence of a significant cluster of foreign MNEs in each of the Baltic countries, capitalising on demand from other foreign affiliates, particularly within the manufacturing sector. The data presented refers to 2019, the latest year available, and may not fully reflect more recent market dynamics.
In other comparable advanced economies with larger domestic markets, foreign affiliates sell a significantly smaller share of their output to other foreign affiliates. For example, in Finland, only 21% of foreign affiliate output is directed toward other foreign firms, while in Italy, this share is even lower at 19%. This indicates that in these economies, the output of foreign affiliates is more widely distributed across domestic supply chains rather than being concentrated within foreign-owned networks. As a result, local firms, including SMEs, benefit more from spillover effects, knowledge transfer, and increased access to high-quality inputs, fostering stronger domestic linkages and enhancing overall competitiveness.
There could be several reasons why foreign-owned firms often form closed clusters with limited spillovers to local SMEs. Much of the FDI is vertically oriented, focused on cost-efficient production for export, with key inputs imported and higher-value functions retained abroad. Knowledge transfer is uneven across the region. Limited SME absorptive capacity, such as meeting scale, quality, or innovation requirements, further constrains linkages. In addition, multinationals often prioritise global supply chains, protect intellectual property, and consolidate R&D outside the host economy, reducing local engagement. These factors could potentially explain why significant foreign investment does not always translate into broad technology or innovation spillovers for Baltic SMEs (Burinskas et al., 2021[16]).
Note: The OECD benchmark countries used in this report are: Denmark, Finland, Italy, the Netherlands and Sweden.
Source: OECD (2019[8]), Analytical Activity of Multinational Enterprises (AMNE) Database, www.oecd.org/sti/ind/analytical-AMNE-database.htm
Note: Foreign MNEs = foreign affiliates of multinational enterprises; domestic MNEs = domestically owned firms with foreign affiliates abroad; domestic non-MNEs = domestically owned firms with no operations abroad. The OECD benchmark countries used in this report are: Denmark, Finland, Italy, the Netherlands and Sweden.
Source: OECD (2019[8]), Analytical Activity of Multinational Enterprises (AMNE) Database, www.oecd.org/sti/ind/analytical-AMNE-database.htm
Foreign MNEs and domestic SMEs establish strategic partnerships to develop joint R&D and innovation projects, which can foster technology transfers, particularly in high-tech and knowledge-intensive industries (OECD, 2023[1]). Strategic partnerships can take various forms, including joint ventures, licensing agreements, research collaborations, and participation in global business networks such as trade associations and stakeholder alliances. Additionally, R&D and technology alliances play a crucial role in fostering innovation and knowledge exchange. These partnerships enhance market access, drive technological advancement, and strengthen SME integration into global value chains. This section examines the strengths of such collaborations and the opportunities they present for boosting competitiveness and fostering economic growth in the Baltic region.
Cooperation through strategic partnerships on R&D and innovation varies across the Baltic states
The degree of inter-firm collaboration in the Baltic states varies significantly, with Estonia leading the way, while Lithuania and Latvia are making strides to improve their innovation ecosystems. In Estonia, approximately 44% of innovative enterprises report cooperation through strategic partnerships with other enterprises, which is relatively high compared to 22% in Lithuania and 13% in Latvia. Peer countries such as Sweden, Norway and Finland showcase strong innovation ecosystem, aligning with Estonia. These are supported by effective policies and robust support structures which facilitate high levels of inter-firm collaboration (OECD, 2022[17]; OECD, 2024[18]). Similarly, 25% of Dutch enterprises report strategic partnerships, benefiting from a well-established industrial base and innovation infrastructure (WIPO, 2024[19]). Czechia, with 20% of enterprises participating in strategic partnerships, compares to Lithuania, while Poland, at 14%, faces similar challenges to Latvia, with low levels of collaboration prevalent especially among smaller firms.
Moreover, both SMEs and large firms in the Baltic states show varying levels of inter-firm cooperation. In Estonia, large firms are more likely to engage in cooperative activities compared to medium-sized and small firms. In contrast, Lithuania and Latvia exhibit lower cooperation levels across all firm sizes, with small firms facing the most significant challenges. This can be attributed to limited capacities in access, technology, skills, and market knowledge, which hinder their ability to innovate and form strategic partnerships. Furthermore, the policy environment, particularly contract enforcement, intellectual property protection, and incentives for collaborative R&D, also plays a crucial role in shaping inter-firm cooperation in the Baltic states.
Effective support structures such as business incubators, accelerators, and industry associations are essential for fostering collaborative efforts. Despite the constraints in technology and skills, Lithuania is making efforts to enhance its innovation ecosystem through initiatives like innovation hubs and clusters (see Chapter 5). Latvia is also working on improving its policy environment and support structures to encourage more inter-firm cooperation. Estonia by comparison, benefits from a more robust innovation ecosystem that supports inter-firm collaboration. However, according to the European Innovation Scoreboard, since 2018, relative to the EU, Estonia and Lithuania have experienced declines in the number of innovative SMEs collaborating with research institutions and other firms (almost 60 and 62 index points respectively), whereas Latvia has seen a 16 index points increase1 (European Commission, n.d.[20]).
Baltic firms demonstrate varying levels of cooperation across different sectors. In Estonia, cooperation is the most prominent in the energy sector, where 65.9% of firms engaged in innovative core activities, followed by the mining sector (62.5%) and the information and communication sector (61.3%). High cooperation in these sectors likely stems from the need for technological advancements and sustainable practices. The Estonian government set a goal to produce all energy consumed domestically using renewable energy sources by 2030 (IEA, 2024[21]). Such high cooperation could enhance knowledge and technology spillovers, potentially boosting domestic firm productivity within the energy sector. Latvia differs, with the technology- and skills-intensive sectors leading. The information and communication sector accounts for 24.2%, followed by financial and insurance activities (21.2%) and water and waste (20.1%). While lower overall percentages compared to Estonia indicate less extensive cooperation, possibly due to different economic structures and market dynamics. Latvia’s focus on information and communication highlights the growing importance of the digital transformation and technological upgrading (Investment and Development Agency of Latvia, 2024[22]). In Lithuania, the information and communication sector also leads, with 46.2% of firms engaged in innovative activities, followed by financial and insurance services (36.3%) and mining (27.8%). The relatively high cooperation in these sectors suggests a strong emphasis on developing new technologies and platforms, similar to Estonia. Cooperation in the energy sector is at 26%, impacted by ongoing efforts to transition towards more sustainable energy solutions. For example, over the past decade, Lithuania has significantly reduced the carbon intensity of its electricity and heat production, making its share of renewables in final energy consumption comparable to that of leading IEA countries (IEA, 2021[23]).
Enterprises that co-operated on business activities with other enterprises or organisations (% of enterprises)
Note: An enterprise is considered as innovative if during the reference period it successfully introduced a product or process innovation, had ongoing innovation activities, abandoned innovation activities, completed but yet introduced the innovation or was engaged in in-house R&D or R&D contracted out. Firms report co-operation in R&D, innovation activities, and other business activities. Small firms = 10 to 49 employees. Medium-sized firms = 50 to 249 employees. For all countries data was used from Community Innovation Survey 2020, however data for Estonia was taken from Community Innovation Survey 2018.
Source: Eurostat Community Innovation Survey (CIS) 2020, 2018 (Accessed 2 October 2024).
Enterprise collaboration in the Baltic states is common, with Estonia outperforming the EU27 average and Lithuania and Latvia close behind. Estonian innovative firms primarily partner with suppliers, enterprise group members, and clients. Lithuanian firms engage in R&D at a smaller scale, collaborating with suppliers, clients, consultants, and private enterprises. While Estonia and Lithuania’s small firms meet or exceed the EU27 average in R&D cooperation, Latvia is slightly below, particularly among small firms, while medium firms are more aligned. At the same time, the collaboration of Latvian SMEs with universities stands out, suggesting a niche group of highly knowledge-intensive businesses (Box 3.3).
Latvia is classified as an emerging innovator in Europe, with strengths in tertiary education and a relatively high rate of public–private co-publications. This reflects ongoing efforts to foster academia–industry collaboration, particularly in key sectors such as pharmaceuticals and technology.industries
These collaborations also extend to SMEs such as SAF Tehnika and HansMatrix., SAF Tehnika, a firm specialising in microwave data transmission and wireless network solutions, invests approximately 8% of its revenue into R&D. It has participated in collaborative projects, including the European CHARM industrial IoT initiative, which seeks to enhance resilience in harsh industrial environments. Additionally, it has worked with Riga Technical University to develop next-generation telecommunications solutions.
HansaMatrix, an electronics manufacturing services (EMS) company, also prioritises innovation through strategic collaborations and investments. In 2021, it partnered with Lightspace Technologies and the University of Latvia to develop a compact, high-brightness laser image projection system for volumetric 3D displays. The company has also invested in research instruments and test systems to strengthen its manufacturing capabilities.
The pharmaceutical sector also demonstrates strong academia–industry linkages. Grindeks, a major pharmaceutical company specialising in cardiovascular, central nervous system, and anti-cancer medications, actively engages in R&D through long-standing collaborations with universities. Notably, its partnership with Rīga Stradiņš University (RSU) in 2024 focuses on the development of innovative pharmaceutical products, drawing on RSU’s research expertise (RSU, Rīga Stradiņš University, 2024). Olpha, another leading biotech firm, focuses on producing finished dosage forms, active pharmaceutical ingredients, and chemical intermediates. With historical roots as a state-owned enterprise, it has transitioned into one of the region’s largest pharmaceutical manufacturers. It maintains close ties with academia, supporting pharmacy education through internships, research projects, and curriculum development.
However, private R&D investment remains limited at around 0.74% of GDP in 2021, with some firms facing challenges in retaining research talent (World Bank, 2025). The Latvian government has set a target to increase R&D spending to 1.5% of GDP by 2027 (Government of Latvia, 2020). Additionally, university-led initiatives, such as the UniLab incubator, support science-based start-ups and technology commercialisation. These developments illustrate the evolving nature of Latvia’s innovation ecosystem and the growing integration between industry and academia
% of innovative SMEs*, by kind of cooperation partner
Note: The enterprise is considered as innovative if during the reference period it successfully introduced a product or process innovation, had ongoing innovation activities, abandoned innovation activities, completed but yet introduced the innovation or was engaged in in-house R&D or R&D contracted out. Non-innovative enterprises had no innovation activity mentioned above during the reference period. EU-27 it's an average data, without counting the missing data.
Source: Eurostat Community Innovation Survey (CIS) 2020 (Accessed 2 October 2024).
Baltic firms, regardless of size, are more likely to cooperate with domestic entities than foreign ones, though they show stronger cooperation with foreign firms compared to the EU27 average, especially in Estonia. In Estonia, 72% of large firms, 48% of medium-sized firms, and 33% of small firms cooperate with domestic firms. For foreign cooperation, 61% of large firms, 32% of medium-sized firms, and 22% of small firms engage with foreign entities. Similarly, in Latvia and Lithuania, foreign cooperation rates are higher than the EU average. Estonian small firms, in particular, are over three times more likely to cooperate with foreign firms than the EU27 average. Cooperation with foreign firms can enhance productivity by facilitating knowledge and technology spillovers (OECD, 2023[1]).
Innovative enterprises that cooperated on R&D and other activities with domestic and foreign enterprises or organisations (% of innovative enterprises)
Note: An enterprise is considered as innovative if during the reference period it successfully introduced a product or process innovation, had ongoing innovation activities, abandoned innovation activities, completed but introduced the innovation or was engaged in in-house R&D or R&D contracted out. Non-innovative enterprises had no innovation activity mentioned above whatsoever during the reference period. Small firms = 10 to 49 employees. Medium-sized firms = 50 to 249 employees.
Source: Eurostat Community Innovation Survey (CIS) 2020 (Accessed 2 October 2024).
Technology licensing rates in the Baltics signal potential for FDI-SME spillovers
Technology licensing is more prevalent among Estonian firms than in their Lithuanian and Latvian counterparts. In 2020, approximately 18% of large firms, 9% of medium-sized firms, and 7% of small-sized firms in Estonia acquired or licensed intellectual property (IP) rights from private businesses (Figure 3.11). Estonian enterprises are actively acquiring and leveraging IP rights within the country, reflecting a strong emphasis on innovation and technology adoption, which allows Estonia to outperform peer EU economies. Additionally, it suggests that Estonian firms are proactive in enhancing their products and services domestically. Moreover, this signals a strong domestic innovation ecosystem and active participation in local IP transactions. The comparatively high diffusion of technology licensing agreements among private enterprises in Estonia indicates potential for FDI-SME spillovers to take place through this channel. The lower rates of technology licensing in Lithuania and Latvia suggest less opportunities for FDI-SME spillovers through this channel: 6% of large firms, 6% of medium firms, and 4% of small firms in Lithuania, and 9% of large firms, 3% of medium firms, and 3% of small firms in Latvia (Figure 3.11) engage in such practices,. However, Eurostat CIS data is not fully conclusive in this regard, as it does not distinguish between foreign owned and domestically owned IP issuing firms.
% of total firms in innovation core activities
Note: Small firms = 10 to 49 employees. Medium-sized firms = 50 to 249 employees. Large firms = more than 250 employees. Data for Estonia, Czechia, Poland, Finland, Latvia, Italy was used from Community Innovation Survey 2020, however data for Sweden and Lithuania was taken from Community Innovation Survey 2018.
Source: Eurostat Community Innovation Survey (CIS) 2020, 2018 (Accessed 2 October 2024).
Baltic small firms engage in technology licensing partnerships at different rates. In Latvia, 16% of small firms participate in such partnerships, aligning with the benchmark OECD average, while Estonia and Lithuania follow at 12% and 8%, respectively. Latvia’s relatively higher engagement suggests stronger integration into foreign innovation networks, not only among international firms but also among medium and large domestic enterprises, which enter such partnerships at 37% and 54%, exceeding the benchmark OECD average. This highlights the presence of a smaller yet highly innovative segment of firms in Latvia actively involved in R&D.
Among large firms across all three Baltic states, engagement in foreign technology licensing is relatively high, indicating stronger integration into global innovation networks and greater potential for technology spillovers (Figure 3.12). This suggests that larger firms are more actively leveraging external knowledge and technological advancements to enhance their competitiveness. However, the extent of such engagement is notably lower among medium and small firms, which may face barriers such as limited resources, weaker networks, or a lack of absorptive capacity to effectively adopt and use foreign technologies.
In the Baltic countries, the gap between foreign and domestic firms engaging in technology licensing partnerships is relatively narrow, indicating that both foreign and domestic firms actively engage in technology-driven innovation. The extensive use of foreign technologies by foreign firms operating in the Baltics, mainly in Estonia and Latvia (23% and 28% respectively), underscores a strong potential for technology spillovers. However, the extent of these positive effects may be constrained by the limited international exposure of domestic SMEs, which could hinder their ability to absorb and capitalise on these innovations.
Note: The OECD benchmark countries used in this report are Denmark, Finland, the Netherlands, Italy and Sweden.
Data for Denmark, Finland, the Netherlands and Sweden is available for 2020 and for Italy for 2019.
Source: Adapted from (OECD, 2022[24]). OECD based on World Bank Enterprise Surveys Enterprise Surveys Indicators Data - World Bank Group
Labour mobility, especially the movement of MNE workers to local SMEs, is a key channel for knowledge spillovers in the context of FDI (OECD, 2023[1]). Workers from foreign MNEs can transition to domestically owned enterprises through various channels, including temporary assignments, long-term employment contracts, or by launching start-ups, such as corporate spin-offs. Likewise, talent can move in the opposite direction, with employees from domestic firms joining MNEs, contributing to knowledge exchange and fostering wage spillovers. These mobility dynamics enhance skill transfer, innovation diffusion, and overall labour market competitiveness. This section examines the role of labour mobility in driving spillovers between foreign and domestic firms in the Baltic states.
Job-to-job mobility in science and technology has been on the rise, highlighting its role as the key FDI-SME spillover channel
Labour mobility in science and technology related jobs in Lithuania is the highest in Europe, followed closely by Estonia – where the share of workers moving between jobs has doubled in the last decade. According to Eurostat data on job-to-job mobility – defined as the movement of individuals between jobs from one year to the next, excluding transitions from unemployment or inactivity – in the science and technology sectors, approximately 11% of Lithuanian workers and 10% of Estonian workers transitioned between occupations during 2020, with a strong increase from 8% in Lithuania, and a doubling from the 5% in 2010 in Estonia (Figure 3.13). Lithuania and Estonia are among the top performing countries across the EU in terms of job-to-job mobility, surpassing both the OECD benchmark and the EU average of 7%. On the other hand, Latvia records a lower rate at 6% of workers, showing little change over the decade. High labour mobility in Lithuania and Estonia illustrates the strong potential for this to be one of the main channels for FDI-SME spillovers in these countries.
% of total employed human resources in science and technology
Note: Human resources in science and technology (HRST) describes individuals in science and technology occupations, such as professionals, technicians and associated professionals, as well as those in other occupations who successfully completed a tertiary-level education in science and technology. Job-to-job mobility excludes inflows into the labour market from a situation of unemployment or inactivity. The figure refers to HRST in total NACE (Statistical classification of economic activities in the European Community) Rev 2 activities.
Source: Eurostat, Job-to-job mobility of HRST by NACE Rev. 2 activity dataset (hrst_fl_mobsect2), 2022 (Accessed 3 October 2024).
The strong increase in overall job-to-job mobility from 2010 to 2020 in Estonia and Lithuania can partially be attributed to policies addressing labour shortages through active recruitment and attraction of workers from abroad. Estonia and Lithuania have introduced targeted measures to attract high-skilled foreign workers, including streamlined immigration procedures, relocation support, and fast-track visas. These policies help mitigate skills shortages in high-growth sectors where FDI may outcompete domestic firms (see Chapter 5). By easing access to foreign talent, both countries strengthen their innovation ecosystems and enhance the potential for FDI-SME spillovers (OECD, 2023[1]).
Low levels of labour mobility among highly skilled workers appear to be a long-standing trend in Latvia. While the local labour market is tightly characterised by low job-to-job mobility in certain types of highly skilled personnel, the conditions for mobility of foreign high-skilled workers have been evolving in recent years (see Chapter 5). For example, Latvia’s approach is aligned with the EU Blue Card scheme, providing a standardised path for high-skilled workers. This scheme provides a fast-track procedure for highly skilled non-EU citizens to live and work in Latvia for five years, offering benefits such as favourable family reunification rules (EU Immigration Portal, 2022[25]). Additionally, Latvia has simplified its immigration procedures, making it easier for high-skilled workers to obtain residency after living in the country for five years (EU LAW FIRM, 2021[26]).
The higher wage premia of foreign affiliates may limit labour mobility towards domestic firms in the Baltic states
Labour mobility can generate positive spillovers, such as upskilling and higher wages, but it may also contribute to skills shortages in domestic economies. Foreign firms, often more productive and technologically advanced, tend to offer higher wages, making it harder for domestic firms to attract and retain skilled workers (OECD, 2024[27]). On average, in 2021, personnel costs per employee – a proxy for wages – in Lithuania foreign firms were twice as high as in domestic firms, while in Latvia they were around 1.9 times higher than in domestic firms, and in Estonia, 1.5 times higher. Wage disparities between foreign and domestic firms in the Baltic countries are relatively stable and persistent, varying by sector. While foreign firms generally offer higher wages, the gap has not significantly increased over time (Eurostat, 2024[28]).
At the sectoral level, wage disparities between foreign and domestic firms in the Baltic states in 2021 were more prominent in service sectors. These include the arts, entertainment and recreation in Estonia, as well as information and communication, and professional, scientific and technical activities in Latvia and Lithuania, which are also sectors with the highest shares of cooperation in innovation and other activities amongst enterprises.
Although less significant, wage premia are substantial in the construction sector in Estonia and Latvia and in education and real estate sectors in Lithuania. The significant gap in wages may discourage workers from large foreign MNEs to move to smaller domestic firms operating in these sectors. Thus, this may not be a major source of productivity spillovers for the Baltic SMEs. The advanced technologies, management practices, and expertise introduced by foreign firms drive productivity growth and efficiency (OECD, 2022[29]; OECD, 2023[1]). If domestic firms achieve similar levels of productivity growth through other means, the wage differential may closely align with wage premia.
In the education sector in Estonia and the health sector in Latvia, domestic firms tend to pay higher wages than foreign firms. Education in Estonia is predominantly a public sector activity, and the Estonian government has been actively increasing teachers' salaries to make the profession more attractive and to address teacher shortages (OECD, 2024[7]). The Latvian government has implemented various initiatives to increase wages in the health sector, which primarily benefit domestic public health institutions, to address workforce shortages and improve the quality of healthcare services (OECD, 2024[5]).
In 2021, the wage difference between foreign and domestic firms was significantly smaller in all three Baltic states compared to peer economies. This may be attributed to the different types of industries and sectors in which foreign firms operate. If foreign firms are primarily concentrated in lower-wage sectors, or if domestic firms compete in high-wage sectors, these dynamics could explain the smaller wage premia observed in foreign firms. For example, foreign investments in the Baltic states are concentrated in sectors such as manufacturing, wholesale and retail trade, which have lower wage disparities in comparison to sectors like finance and information technology. On the contrary, domestic firms in the Baltic states are competitive in high-wage sectors like information and communication, professional services, and select manufacturing industries, helping to narrow the wage gap with foreign firms.
Source: Eurostat, Foreign controlled EU enterprises by NACE Rev.2 activity and country of control (from 2021 onwards) dataset, 2021, https://doi.org/10.2908/FATS_ACTIV (Accessed 3 October 2024).
Foreign firms lead in training, but Baltic SMEs drive workforce upskilling
Foreign affiliates help strengthen the domestic talent pool by providing employee training, improving job mobility, and enhancing workplace quality. Workers who transition to domestic firms or start their own businesses, transfer valuable expertise, fostering entrepreneurship and innovation. Additionally, foreign investors encourage local firms to upskill their workforce to remain competitive, mitigating brain drain to multinational employers. By driving skills development, foreign affiliates not only support local innovation but also enhance the region’s appeal for further foreign direct investment. This, however, needs to be supported by domestic governments collaborating with foreign affiliates and local suppliers to balance broad benefits for domestic firms with the specific needs of foreign investors (Jordaan, Douw and Qiang, 2020[30]).
In the Baltic states, foreign firms generally provide more employee training than domestic firms, with Lithuania being the exception. In Latvia, 65% of foreign firms offer training compared to 49% of domestic firms, while in Estonia, the figures stand at 60% and 40%, respectively. This suggests that foreign firms play a significant role in workforce development, likely due to their need for specialised skills and adherence to global corporate standards. Lithuania, however, presents a slight reversal of this trend, with 28% of domestic firms offering training, slightly surpassing the 26% of foreign firms. Both Estonia and Latvia perform above the OECD average in terms of training opportunities. Firm expenditure on staff training in Baltic firms exceeds most European peers. Firm expenditure on staff training in the Baltic states is notably higher than in most European peers, particularly among small firms. In Estonia, small firms contribute approximately 34% of total training expenditure, while in Lithuania, their share is even higher at 42%, both well above their European peers. Medium-sized firms in both countries allocate around 31% of total training spending. In contrast, large firms account for a comparatively smaller share of training expenditure - 35% in Estonia and 27% in Lithuania - figures that are lower than in most European economies. This suggests that, unlike in other countries where large firms dominate training investment, Baltic SMEs play a more prominent role in upskilling their workforce (Figure 3.15). Extensive training provisions within the SME sector can encourage the mobility of MNE workers to smaller local firms, enhancing the potential for knowledge spillovers through this diffusion channel.
Note: For Panel A data on Finland and Ireland refers to year 2020; on Austria, France, Germany, and Spain refers to year 2021; and on Estonia, Hungary, Portugal, and Romania refers to year 2023. For Panel B data on Romania, France, Austria, and Lithuania refer to year 2018. Panel B shows expenditures of enterprises by area of expenditure for innovation active enterprises in thousand euro.
Source: Panel A World Bank Enterprise Survey. Panel B Eurostat CIS survey 2020.
FDI-SME diffusion channels involve market mechanisms which are related to competition and imitation effects. Competition effects arise when highly efficient MNEs enter the market, thereby creating pressure for domestic companies to become more innovative and productive regardless of their operating sector or value chain segment (OECD, 2022[24]; OECD, 2023[1]). Imitation and tacit learning effects occur on a more local level when domestic enterprises imitate practices of foreign MNEs (OECD, 2024[27]). The introduction of new standards and practices by foreign firms can also enhance productivity and innovation spillovers at the local level (OECD, 2023[1]). This section examines how and the extent to which competition and imitation effects might influence FDI and SME sectors in the Baltics.
Baltic SMEs leverage collaboration with competitors to drive innovation and knowledge spillovers, but to a varying degree. Collaborating with competitors on innovation is common among SMEs in Estonia and Lithuania but less prevalent in Latvia. Cooperation with competitors on innovation has potential for economy-wide spillovers through imitation or tacit learning. Estonian and Lithuanian enterprises engage with competitors and other enterprises for both product and business process innovation.
Around 30% of medium-sized firms in Estonia and Lithuania collaborate with competitors in business process innovation, on par with EU economies like Finland, Sweden, and Norway. This collaborative behaviour aligns these countries with high-performing EU economies and suggests a significant openness to cooperation as a driver of innovation. However, product innovation collaborations are somewhat less common, especially among smaller firms, highlighting possible gaps in leveraging competitor cooperation for more complex or market-facing innovations. Smaller firms perform similarly well, with 17.5% and 14.5% of them cooperating in product innovation in Estonia and Lithuania respectively, above peer countries such as Italy, Czechia, Latvia, and Poland. While Estonian SMEs do engage in product innovation, with over 16% of medium-sized and over 9% of small-sized firms collaborating with competitors, their activity level is slightly below average compared to other countries. Similarly, Lithuanian SMEs show a comparable trend, with around 14% of medium-sized and over 9% of small-sized firms participating in inter-firm collaborations for product innovation.
Latvian enterprises engage less with competitors in product and business process innovation compared to peer economies Latvian medium-sized firms show low collaboration with competitors in both product and process innovation, with only 10.5% and 13.3% of firms engaging in cooperation respectively. Moreover, small firms lag in cooperation on both product and process innovation, with only 5.8% and 7.2% of firms participating, respectively. Latvia’s overall limited cooperation with competitors in product and business processes as well as in strategic partnerships can constrain productivity among domestic SMEs due to difficulties in benefiting from knowledge and technology spillovers (see section on strategic partnerships). Moreover, Latvia’s limited cooperation with competitions may indicate fewer opportunities for economy-wide spillovers to take place through imitation, tacit learning, or inter-firm partnerships.
% of innovative enterprises
Note: The enterprise is considered as innovative if during the reference period it introduced successfully a product or process innovation, had ongoing innovation activities, abandoned innovation activities, completed but yet introduced the innovation or was engaged in in-house R&D or R&D contracted out. Small firms = from 10 to 49 employees. Medium-sized = from 50 to 249 employees. Large = 250 employees or more. Micro firms with less than 10 employees are not included.
Source: Eurostat Community Innovation Survey (CIS) 2020 (Accessed 3 October 2024).
Same-sector collaboration on innovation with competitors2, particularly foreign firms, is relatively weak in the Baltic states. Baltic countries have relatively low same-sector cooperation and collaboration with foreign competitors. Approximately 4-5% of medium-sized and 4-5% of small-sized Baltic firms engage in R&D and innovation cooperation with same-sector competitors. This is lower in comparison to peer economies such as Denmark and the Netherlands. Among large firms, 14% in Estonia, 12% in Latvia, and 6% in Lithuania partake in same-sector inter-firm partnerships. Moreover, cooperation on innovation with foreign enterprises, within and outside the EU, is also moderate among Baltic SMEs and large firms compared to peers like Denmark, the Netherlands, and Finland
This could be partly attributed to the individual entrepreneurial cultures of each Baltic country’, which fosters risk aversion and a preference for independent operation (OECD, 2023[1]). Enterprises may often perceive the costs of collaboration, such as sharing intellectual property and making joint investments, as outweighing the benefits. This is particularly the case when immediate gains are not guaranteed (see section on strategic partnerships). However, data suggests some potential for FDI-SME spillovers. More frequent collaboration with foreign-owned competitors could enhance opportunities for imitation and tacit learning for local firms, especially within the same sector or value chain, contributing to product and process quality improvements and local enterprise productivity growth (OECD, 2023[1]; OECD, 2024[27]; OECD, 2022[24]).
Few firms in the Baltics view competition as a major barrier to innovation
Baltic SMEs cite lack of access to finance, high operating costs, and lack of qualified employees within enterprise as major barriers to innovation, with high competition seen as less a significant barrier. In Estonia, 12% of small firms, 12% of medium firms, and 13% of large firms consider high competition a significant barrier to innovation. In Latvia, the figures are 15%, 11%, and 7%, respectively. In Lithuania, the figures stand at 9%, 10%, and 8%. This is lower than the EU averages of 15%, 13%, and 11% respectively (Figure 3.17). Most firms perceive competition as only a moderately important barrier to innovation (Eurostat, 2020[31]). This may reflect differences in market focus, with many Baltic SMEs targeting niche or local markets where they face limited direct competition from foreign firms. It could also point to structural challenges. such as lower absorptive capacity or difficulties in meeting higher standards in areas like management practices, product quality, or delivery speed, that reduce competitive pressure and limit knowledge spillovers from foreign firms through imitation and competition effects (OECD, 2022[24]).
% of innovative enterprises rating the importance of high competition as a “high”, “medium”, “low” or “not important” barrier to innovation, by size class
Note: Small firms = from 10 to 49 employees. Medium-sized firms = from 50 to 249 employees. Large-sized firms = more than 250 employees. EU average of the following countries: Austria, Bulgaria, Croatia, Cyprus, Czechia, Denmark, Estonia, France, Hungary, Italy, Latvia, Lithuania, Luxembourg, Malta, Poland, Portugal, Romania, Slovak Republic, Spain, Sweden, Türkiye.
Source: Eurostat Community Innovation Survey (CIS) 2020 (Accessed 3 October 2024).
The entry of foreign firms into the domestic market may increase competition and gradually dominate less productive firms. The reallocation of resources towards more productive firms is crucial for improving economic and productivity growth, as it drives firms to innovate, introduce new products, and adopt new management practices (OECD, 2023[1]; OECD, 2024[27]). However, high business dynamism may also reflect challenges that hinder SME growth and competitiveness. For example, in highly competitive markets, the exit of firms may highlight not only the removal of inefficient incumbents but also the difficulties of newer enterprises to scale up and engage in knowledge-intensive activities (OECD, 2021[32]).
Business demography indicators such as rates of market entry and exit, churn rate and business survival, are key in evaluating competition and market conditions in the Baltic countries. OECD Product Market Regulation indicators show that the Baltic states maintain generally open and pro-competitive regulatory environments that support business activity and firm entry. Reforms in recent years have helped reduce barriers across service and network sectors, fostering a more dynamic business climate. As described in Chapter 2, Baltic countries exhibit fairly high business dynamism and a churn rate above the OECD average across the business economy. Estonian 1-year business survival rate was 81.4% in 2022, while Latvian and Lithuanian were 74.1% and 70.3% respectively, both below the EU average (81.2%) (Eurostat, 2024[33]). These findings may indicate a challenging environment for smaller firms to scale up. However, a moderate rate of firm entry and exit could also suggest that market dynamics allow unproductive firms to exit relatively easily and that entry barriers remain low, supporting business dynamism and thereby supporting healthy competition. In 2023, the share of high-growth enterprises3 in the Baltics exceeded the EU average of 10.5%, standing at 11.6% in Estonia, 11.3% in Latvia and 11.9% in Lithuania (European Commission, 2023[34]).This indicates that, despite scale-up challenges for smaller firms, the region maintains a strong core of dynamic, fast-growing businesses contributing to competitiveness and job creation.
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← 1. This indicator measures the share of SMEs that engaged in innovation cooperation during the three-year survey period (firms with at least one cooperation agreement on innovation with another enterprise or institution), expressed as a proportion of all SMEs. Results are indexed to the EU’s 2018 performance for this indicator.
← 2. Collaboration with competitors captures cooperation with any firms identified as competitors, whether domestic or foreign, and may include firms operating in different sectors that compete in overlapping technological or market areas. Same-sector collaboration with competitors is a narrower measure, referring specifically to cooperation among firms within the same industry, often distinguishing between domestic and foreign competitors.
← 3. High-growth enterprises are firms that employed at least 10 people at the start of a three-year period and achieved an average annual increase in employment exceeding 10% over that period.