This chapter provides an overview of key findings and policy considerations outlined in the country study to strengthen FDI and SME linkages in the Baltic states. Specifically, it presents the main challenges and opportunities for foreign direct investment (FDI) and small and medium-sized enterprises (SMEs) and examines how strengthening their linkages can help enhance productivity and innovation. Based on the assessment of Estonian, Latvian and Lithuanian regulatory and policy framework, the chapter also proposes recommendations for policy reform to strengthen the spillover potential of FDI and the productive capacities of Baltic SMEs.
Strengthening FDI and SME Linkages in the Baltic States
Abstract
In a context marked by rising geopolitical tensions, mounting environmental challenges, and an ongoing digital transition - further compounded by the disruptions caused by the COVID-19 crisis and Russia’s war of aggression against Ukraine - global production systems and value chains (GVCs) are undergoing a profound transformation. These evolutions reflect significant disparities in countries’ economic resources, policy responses, and the severity of disruptions across business activities and value chains.
In this shifting global landscape, innovation and productivity are critical to enhancing competitiveness, sustainability, and resilience across firms, regions and countries. Small and medium-sized enterprises (SMEs) and foreign direct investment (FDI) are key drivers of this transformation. SMEs, and especially micro enterprises dominate the Baltic economies, constituting 99% of all enterprises (Figure 1.1). SMEs also account for 76% of jobs and 72% of value added in 2025 (European Commission, 2025[1]). The business landscape skews toward very small firms, particularly in Lithuania and Latvia, although Estonia distinguishes itself with a dynamic start-up ecosystem.
Note: includes firms operating in the business economy, except financial and insurance activities
Source: OECD Structural business statistics by size class and economic activity (ISIC Rev. 4), https://data-explorer.oecd.org/
FDI stock has grown steadily in Estonia, Latvia, and Lithuania over the past two decades, underscoring the increasing importance of foreign investment in their economies. The share of FDI in GDP has risen markedly across all three countries, reaching 95.4% in Estonia, 63.4% in Latvia, and 49.2% in Lithuania in 2023 (Figure 1.2). This sustained growth reflects strong investor confidence and the region’s deeper integration into global investment flows. Foreign-owned enterprises are now firmly embedded in the Baltic economies, particularly in sectors such as services, manufacturing, and digital technologies.
Source: OECD International Direct Investment Statistics, http://www.oecd.org/investment/statistics.htm
Evolving patterns in global trade and investment present new opportunities for SME upgrading. Participation in GVCs enables SMEs to enhance productivity by capturing technology and knowledge spillovers, strengthening workforce and managerial skills, and improving innovation capacity. Recent analyses indicate that firms integrated into GVCs recovered more rapidly from the COVID-19 crisis, underscoring the contribution of GVC participation to economic resilience (Giglioli et al., 2021[2]) (Constantinescu et al., n.d.[3]).
SME internationalisation and GVC integration can occur directly, through trade, by supplying or sourcing from foreign companies, or indirectly, by establishing linkages with the foreign affiliates of multinational enterprises (MNEs). FDI and linkages between MNEs and SMEs hold strong potential for productivity and innovation spillovers, although their magnitude depends on the host country’s economic, geographic, and structural conditions.
Against this background, this report examines the enabling conditions, institutional frameworks, policy mixes, and main diffusion channels that shape the extent and effectiveness of FDI-SME spillovers in the Baltic countries. By analysing these dimensions, the report aims to identify the key factors that influence how foreign investment contributes to domestic innovation and productivity growth and propose recommendations for policy reform to strengthen the spillover potential of FDI and the productive capacities of Baltic SMEs.
A common thread in the Baltic states is that the capacity of domestic SMEs to absorb and capitalise on foreign investment – through skills, technology, and scale – is limited. Shortages of skilled labour, low R&D engagement, and modest digital adoption among many Baltic SMEs constrain their ability to meet MNE standards or learn from foreign best practices. This not only hampers direct spillovers but also means that even when linkage opportunities arise (e.g. a foreign firm looking for local suppliers), few local companies may be qualified to respond. Many support programmes focus on upgrading SME capabilities (skills training, innovation grants), yet these efforts need to be intensified and better aligned with the needs of FDI-intensive sectors.
SME upgrading is a pre-condition for effective linkages. Without stronger foundations – a skilled workforce, managerial know-how, innovation capacity, and access to growth capital – Baltic SMEs risk being on the margins of global value chains. Initiatives to enhance human capital (through education and vocational training reforms, management training, ICT skills) and to stimulate SME innovation (through R&D incentives, university-industry collaboration, digitalisation support) are critical complements to any FDI linkage policy. Boosting absorptive capacity across the region will increase the pool of local firms that can engage with and benefit from foreign investors. To ensure regional inclusion, governments should establish regional thematic working groups and supplier-readiness teams, which could be anchored in regional hubs, to deliver linkage programmes beyond the capitals, operate a shared pipeline with national agencies, and track regional KPIs.
The most prominent cross-cutting challenge is the need for better alignment between FDI-oriented policies and SME development policies. Estonia’s unified agency structure or Lithuania embedding FDI priorities into its innovation strategy offer positive examples– but there are also many instances of siloed approaches. Governance gaps manifest in overlapping mandates and a lack of formal coordination, which in turn weaken the effectiveness of support programmes. For instance, Latvia’s Special Economic Zones offered tax breaks to investors but attracted limited SME participation, partly because SME support agencies were not deeply involved in those zone programmes implementation.
In the Baltics, weakly institutionalised bridges between investment promotion, SME, and innovation actors dilute FDI impact. Stronger coordination, unified client services, and shared KPIs are needed to turn new investments into concrete SME linkages and spillovers. Governance fragmentation otherwise undermines sound tools: when IPAs, SME agencies, and innovation funds operate without synchronised goals or information-sharing, synergies, like matching an incoming investor with suppliers that received upgrade support, are missed. A whole-of-government framework would pair each major FDI project with parallel efforts to help local firms supply or partner with it. To embed this, the Baltics should bolster inter-ministerial coordination (e.g. joint committees, shared performance indicators), integrate services (e.g., unified client support for investors and domestic firms), and adopt cross-silo monitoring that tracks not only FDI volumes or SME growth, but also supplier uptake and knowledge transfer.
The policies across the Baltics currently have few targeted linkage programmes. Spillovers from FDI are not automatic as they often require proactive facilitation. There is a gap in the policy mix when it comes to supplier development initiatives, matchmaking schemes, or innovation partnership platforms that explicitly connect foreign investors with local SMEs. The absence of robust linkage programmes represents a missed opportunity: without them, FDI spillovers will be left to chance or limited to what individual firms may undertake. Establishing such programmes could significantly boost spillover outcomes relatively quickly. Designing these initiatives will require coordination and input from both sides: MNEs need to articulate what they require from suppliers or partners, and SMEs need support to reach those standards. Filling this policy gap would directly address several issues identified in the next chapters, from improving backward linkages to fostering strategic partnerships. At regional level, delivery can build on existing SEZs, industrial parks and hubs by pairing them with supplier matchmaking, mentoring and training, so that linkage programmes operate beyond capital areas and effectively connect local firms to incoming investors.
While the Baltics use tax incentives and grants to attract investors or support SMEs, these schemes rarely include conditions or features that promote local linkages. Addressing this gap is critical to better structure financial and regulatory incentives that encourage FDI–SME integration. Providing additional incentive premia for investors that establish local supplier networks or training programmes, or prioritising SMEs in grant competitions that have secured a foreign partner could help strengthen spillover channels, foster technology transfer, and enhance the long-term productivity benefits of FDI for the domestic enterprise sector. The relatively business-friendly regulatory regimes in the Baltics are a strength a strength policymakers can build on by introducing measures such as simplified procurement processes to give local SMEs access to MNE tenders, and streamlined certification procedures to help SMEs meet international standards.
At the regional level, FDI benefits are unevenly distributed, both within individual Baltic countries and across the three countries. Within countries, capital cities and a few major towns attract the bulk of foreign investment and host the most innovative SMEs, while smaller towns and rural areas lag. This can lead to widening disparities. Subnational capacity for FDI–SME initiatives is limited. Strengthening coordination between regional networks and the centre, through shared pipelines, joint planning and common KPIs, and extending linkage programmes beyond metropolitan areas (including via mobile delivery) would improve consistency and inclusiveness.
Across the Baltic states, there is an opportunity for pan-Baltic collaboration. The three economies, taken together, form a market of over 6 million people with complementary strengths – for example, Estonia’s digital sector, Latvia’s logistics hub, Lithuania’s manufacturing and life sciences base. A coordinated investment promotion strategy (branding the Baltics as a unified investment destination for certain industries) combined with integrated infrastructure (like joint industrial or innovation corridors) could attract larger projects than each country could alone. Additionally, cross-border clusters (for instance, linking related industries across Estonia-Latvia or Latvia-Lithuania borders) could enable SMEs in one Baltic country to supply foreign investors in another, spreading the spillover benefits.
FDI has driven productivity across the Baltics
Spillovers from FDI to domestic SMEs depend on a range of enabling conditions. These include the scale and degree of local embeddedness of foreign-owned affiliates in the host economy, as well as the productivity gap between foreign MNEs and domestic SMEs, given that MNEs typically have more robust innovation capacity, technologies, and managerial capacities. The extent to which spillovers materialise also depends on the absorptive capacity of local SMEs, particularly their ability to learn from and adapt to interactions with foreign firms. Overall, the attractiveness, embeddedness, performance, and spillover potential of FDI are shaped by a combination of economic, geographical, and structural factors that determine how effectively knowledge and technology diffuse within the host economy (OECD, 2023[4]).
The Baltic SME ecosystems are dynamic but fragmented. Strong entrepreneurship, digital readiness, and openness to innovation coexist with persistent gaps in skills, finance, and innovation linkages. While FDI has been a major driver of growth and productivity, its benefits have not fully reached domestic SMEs. Many foreign affiliates remain weakly integrated into local supply chains, limiting spillovers and collaboration opportunities. At the same time, SMEs often lack the capabilities, standards, and resources needed to partner with MNEs, while coordination between investment, SME, and innovation policies remains limited. As a result, FDI has boosted aggregate productivity but contributed less to productivity convergence and upgrading among local firms.
FDI has been a key driver of Baltic growth, but its gains are not fully diffused into the local SME base. FDI accounts for major shares of total investment in ICT, manufacturing, financial services, and real estate. All three countries have attracted robust FDI inflows that have fuelled growth, exports, and structural transformation. Since joining the EU in 2004, the Baltic states have achieved rapid convergence of incomes with those in Western Europe. GDP per capita more than doubled between 2013 and 2024. .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 scope to deepen FDI–SME linkages and boost productivity via technological upgrading, as spillovers are likelier in higher-value segments (OECD, 2023[4]). Despite solid fundamentals, structural headwinds, such as demographic decline, skills shortages, and low R&D investment, continue to constrain SME upgrading and knowledge diffusion. Since 2000, labour productivity in the Baltic states has converged rapidly toward the EU average, driven mostly by FDI. In the early 2000s, Estonia, Latvia, and Lithuania outpaced the EU, with double-digit gains in Latvia and Lithuania as rising FDI inflows catalysed structural reform, accelerated capital deepening, and transferred technology and managerial know-how. FDI also played a key role in integrating local firms into global value chains, amplifying productivity gains. However, productivity growth became more volatile after the 2008 financial crisis and again following the COVID-19 pandemic. Since 2020, Estonia has seen sharper declines in productivity, while Latvia and Lithuania have proved somewhat more resilient. Overall, the slowdown underscores emerging structural constraints that need to be addressed to sustain convergence of productivity levels towards the EU average.
Baltic SMEs are increasingly outward-oriented and digitally engaged, yet skills shortages, and low innovation capacity continue to constrain their ability to scale up
SMEs in Estonia, Latvia and Lithuania are increasingly outward-oriented, reflecting small home markets and deep EU integration. A growing number trade across borders, especially with Nordic and other EU partners, and are integrating into global value chains, including through knowledge-intensive services. Across the Baltics, most exporters are micro firms (Estonia 70%, Latvia 65%, Lithuania 60%), yet export value is concentrated in larger firms. Internationalisation remains uneven: many SMEs are held back by limited scale, thin managerial and financial resources, and cross-border regulatory and compliance costs, which constrain entry into more distant markets and higher-value segments.
The innovation ecosystem is dominated by small firms with low R&D productivity, indicating that many SMEs lack the technological capabilities to effectively absorb and apply the know-how that FDI could transfer. A persistent productivity divide exists between small domestic firms and larger or foreign-owned companies. Baltic SMEs, which make up over 99% of all firms and more than two-thirds of total employment, operate at roughly half the labour productivity of large firms, highlighting structural efficiency gaps. As a consequence, their contribution to value added remains modest, around 40% in Estonia, 42% in Latvia, and 45% in Lithuania, underscoring the limited scale and innovation capacity of smaller enterprises. This gap is most pronounced in knowledge-intensive industries, reflecting SMEs’ constrained access to advanced technology, skilled talent, and growth capital.
The Baltic entrepreneurial ecosystem is highly dynamic – new business birth rates are high – yet many SMEs struggle to scale up, as indicated by equally high firm churn and exit rates across the region. Across the Baltics, only about 0.9% of firms qualify as medium-sized in 2025 (0.7% in Estonia, 1.3% in Latvia and 0.8% in Lithuania), meaning that most enterprises remain micro or small throughout their lifecycle, underscoring persistent barriers to firm growth and scale-up.
SME product and process innovation is a prominent feature across the Baltics. Collaboration is especially visible in Estonia, supporting knowledge diffusion, and there is scope to expand SME-to-SME collaboration in Latvia and Lithuania. SMEs also account for a large share of total R&D, about 60% in Estonia, 55% in Lithuania, and 50% in Latvia, well above most EU countries. Yet overall business R&D intensity remains low, which limits firms’ capacity to absorb foreign technology.
Shortages of skilled labour have emerged as one of the most pressing structural challenges. Firms in every Baltic state report that the lack of qualified workers is the number one barrier to new investment and expansion. Shortfalls are most acute in STEM and ICT-related occupations, reflecting the talent demands for the digital and green transitions. Weak vocational training systems, scant adult up-skilling, and low incidence of on-the-job training (especially among SMEs) exacerbate this skills gap. As a result, many SMEs struggle to innovate, adopt new technologies, and meet the standards required to partner with frontier firms – a critical bottleneck for effective FDI–SME linkages.
These capability constraints translate directly into digital uptake: while the diffusion of digital technologies, including AI, is advancing in the Baltics, progress is uneven. Estonia leads on SME digital uptake, with a relatively small gap between Estonian SMEs and large firms, while Latvia and Lithuania have improved SME adoption of basic digital tools (e.g. cloud services) yet still lag EU averages in more advanced areas like AI and data analytics. Across all three countries, limited SME investment in digital skills and infrastructure, coupled with cost constraints, hinders smaller firms from integrating into high-value digital supply chains and benefiting from MNE technology transfers.
The financing environment for SMEs has improved since the COVID-19 crisis, but significant disparities persist across the Baltic states. The region still faces uneven access to finance, and investing firms turn to external funding less frequently than the EU average. Estonian SMEs rely less on bank credit, suggesting stronger internal funds or access to alternative finance. Lithuanian firms also depend largely on internal resources, with peer-to-peer lending and state support expanding. In Latvia, tighter bank lending and fewer alternatives leave SMEs more financially constrained. While interest rate spreads between small and large firms have narrowed between 2021 - 2022, most notably in Lithuania, where the gap fell from 0.29 to 0.1, borrowing costs remain higher for SMEs in Estonia and Latvia. Venture capital ecosystems are expanding in Estonia and Lithuania, aiding potential start-up scaling and innovation, but overall risk capital availability is still limited in scope. These financial constraints can limit SMEs’ capacity to invest in upgrading technology or capacity to meet the requirements of MNE partners.
FDI offers strong potential to boost SME productivity and innovation in the Baltics, but deeper spillovers depend on greater SME integration into MNE value chains. For FDI-SME spillovers to materialise, domestic SMEs must be exposed, directly or indirectly, to the activities of foreign MNEs. Such exposure fosters linkages that enable the transfer of knowledge, technology, and skills, enhancing SME productivity, innovation, and scale-up potential. To maximise these benefits, the Baltic states should attract higher-technology FDI and strengthen SMEs’ absorptive capacity through targeted support, facilitating deeper integration into GVCs. Key channels for FDI-SME spillovers include value chain linkages, strategic partnerships, labour mobility, and competition or imitation effects.
In the Baltic states, value-chain linkages are the main channel for FDI spillovers, but domestic sourcing by foreign MNEs is uneven, limiting diffusion in parts of the region. While MNEs do source locally, Latvia’s affiliates source a larger share of intermediate inputs domestically (about 71%, near the OECD average) than Estonia (56%) or Lithuania (57%). This greater domestic sourcing signals deeper integration with local supply chains in Latvia, while MNEs in Estonia and Lithuania rely more on imports. Meeting MNE quality and reliability standards can spur SME upgrading, as linked suppliers adopt international standards and build capabilities. Deepening these backward linkages can accelerate SME upgrading, as suppliers that meet MNE standards tend to adopt international practices and build capabilities (Figure 1.3).
Note: The OECD benchmark countries used in this report are: Denmark, Finland, Italy, the Netherlands and Sweden.
Source: OECD (2019[5]), Analytical Activity of Multinational Enterprises (AMNE) Database, www.oecd.org/sti/ind/analytical-AMNE-database.htm
Many Baltic SMEs are still weakly connected to global value chains, through backward linkages (domestic firms supplying MNEs) or forward linkages (MNEs selling inputs/technology to domestic firms). On the forward side, spillovers are limited: a large share of foreign-affiliate output is exported or sold to other foreign firms rather than to domestic SMEs; in Estonia, about 43% is exported, the highest in the region, constraining knowledge transfer. Foreign affiliates also trade more with foreign firms than in some peers (e.g., Finland, Italy), keeping MNE networks apart from local enterprise clusters. While this pattern reflects valuable GVC integration and efficiency gains, it leaves fewer opportunities for diffusion to domestic firms. Deepening local linkages via supplier development, standards alignment, and matchmaking - while safeguarding openness that underpins competitiveness - remains a key priority.
Collaborative FDI-SME partnerships in the Baltics remain limited, with most firms preferring domestic over foreign partners
Beyond value chain linkages, deeper forms of collaboration such as joint ventures, co-development projects, or licensing agreements can facilitate technology transfer from foreign investors to local SMEs. In the Baltics, however, firms tend to partner domestically more readily than they do with foreign companies, which may limit opportunities for cross-border knowledge exchange. The number of formal partnerships between MNEs and SMEs appears relatively low. One indicator is technology licensing: Estonia stands out with a higher share of firms acquiring or licensing foreign intellectual property (e.g. patents or know-how) – about 18% of large firms, 9% of medium firms, and 7% of small firms in Estonia have engaged in such licensing, placing it on par with countries like Poland and Sweden (Figure 1.4). This points to a somewhat stronger domestic innovation ecosystem and absorptive capacity in Estonia, with greater potential for FDI-related knowledge inflows via licensing, compared to Latvia and Lithuania, which both remain below the EU average.
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).
Overall, strategic alliances and collaborative innovation projects between foreign investors and Baltic SMEs remains limited. Baltic firms are more inclined to collaborate with local universities or domestic partners than with multinational corporations, leaving significant potential for spillovers - particularly in areas such as R&D collaboration and supply chain mentoring. Expanding these partnerships could substantially accelerate technology diffusion.
Wide wage gaps and mobility barriers limit the flow of talent from MNEs to local SMEs.
Employee mobility from foreign-invested firms to domestic firms is another important channel for skill and knowledge spillovers. The Baltics exhibit moderate levels of job-to-job mobility in science and technology, with some differences across countries. In Lithuania, about 11% of workers change jobs annually (job-to-job transition rate), job-to-job transition rate similar to Estonia’s 10%, both above the OECD benchmark and the EU average of 7%. By contrast, Latvia’s rate is lower at 6% (Figure 1.5).
% 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)
Large wage gaps still hinder talent moving from MNEs to local SMEs. Notably, a sizable share of this mobility occurs in science and technology occupations, meaning high-skilled workers trained or experienced in MNEs are potentially transferring to local companies in Lithuania and Estonia. Higher labour mobility in these two countries may be partly driven by proactive talent policies or vibrant tech sectors. However, a major hindrance to talent spillovers is the significant wage gap between foreign-affiliated firms and local SMEs. On average, foreign firms pay substantially higher wages – roughly double the local firm wage in Lithuania, about 1.9 times higher in Latvia, and 1.5 times in Estonia. The gap is especially large in services sectors. This salary differential can discourage employees from leaving jobs at MNEs to join or start ventures in the domestic SME sector, thereby limiting the transfer of skills and best practices to local firms. In addition, some regulatory constraints (e.g. work permit rules for foreign specialists) and limited cross-border labour mobility within the region constrain the full circulation of talent. Tackling these labour mobility barriers – by both narrowing the SME skills/wage gap and easing movement of skilled personnel – could enhance human capital spillovers from FDI.
In the Baltics, competition-driven spillovers are present but not maximised. Surveys indicate that Estonian and Lithuanian businesses engage in innovation cooperation with competitors relatively frequently – for instance, around 30% of medium-sized firms in Estonia and Lithuania collaborate on process innovation (often informally sharing knowledge), a rate on par with leading innovation-driven economies in the EU. This suggests a healthy degree of peer learning and knowledge sharing of best practices among firms in certain sectors. However, direct collaboration or benchmarking against foreign competitors remains weak across all three countries. In thinly capitalised segments the entry of highly efficient MNEs can also squeeze margins and deter investment or even displace weaker SMEs, especially those with limited innovation capacity or access to finance.
Baltic SMEs rarely form partnerships or learning networks with foreign-invested firms operating in the same industry, which limits their exposure to frontier innovations. Most Baltic SMEs do not perceive competitive pressure from FDI as a primary barrier – instead, they cite limited access to finance and skilled labour as more urgent constraints on innovation. This could imply that domestic markets are not yet intensely competitive, or that local firms feel they face bigger internal hurdles than external rivals. While foreign investment has introduced higher efficiency and new products to Baltic markets, the competition and demonstration effects on the broader SME sector have been moderate.
The institutional frameworks are streamlined but lack coordination
Strengthening FDI–SME linkages spans investment promotion, SME support, innovation, skills, and regional development. It requires coordinated governance - clear mandates, integrated services, accountable institutions, and outcome-based monitoring, to turn FDI projects into measurable spillovers.
The Baltic states have each established institutional structures to manage FDI attraction and SME development, with varying degrees of integration. Estonia operates a highly integrated model under the Ministry of Economic Affairs and Communications, with the Estonian Business and Innovation Agency combining investment promotion, export support and SME/innovation services; implementation priorities are to keep the investment function strategically focused, tighten links with skills and regional actors, and extend subnational delivery. Latvia follows a partially integrated set-up in which the Investment and Development Agency (LIAA) leads promotion and export support, while the development finance institution ALTUM provides instruments; clearer hand-offs with innovation and regional portfolios, stronger inter-agency co-ordination and a shared client pipeline are the main needs. Lithuania features close co-operation between Invest Lithuania and the Innovation Agency and comparatively well-developed SEZ governance; the emphasis is on clarifying mandates to reduce overlap, fully operationalising a one-stop shop for SMEs, and strengthening regional facilitation to better connect investors with local firms. (Figure 1.6).
Source: Based on EC/OECD Survey of Institutions and Policies enabling FDI-SME Linkages (2024).
Each Baltic country has a dedicated Investment Promotion Agency (IPA) that also contributes to SME support in practice. In Estonia, the Estonian Business and Innovation Agency (EBIA) serves a dual mandate as a large agency in charge of investment promotion, SME support, and innovation functions, also through its sub-branch the Estonian Investment Agency (EIA). Latvia’s Investment and Development Agency (LIAA) similarly acts as a one-stop shop for foreign investors, and houses units for export promotion and start-up support, thereby bridging investment and enterprise development functions. Invest Lithuania focuses on attracting and facilitating foreign investment (including through advisory services to incoming firms) and works closely with the new Lithuanian Innovation Agency; Invest Lithuania also supports regional development via incentives and managing Special Economic Zones (SEZs) to channel investment to various regions.
There are established formal mechanisms for inter-agency coordination (such as high-level councils, inter-ministerial working groups, or advisory boards) across the Baltics. Lithuania and Latvia use formal high-level coordination councils to align FDI–SME policy across ministries and agencies; in Latvia, the Coordination Council for Large and Strategically Significant Investment Projects is convened specifically to steer major investments and ensure joined-up delivery. Estonia anchors high-level coordination in national strategies, establishing a management board of relevant ministries and stakeholders to oversee implementation and cross-portfolio alignment. However, practical collaboration across institutions in the Baltics remains limited. In all three countries, some overlapping mandates and fragmented responsibilities persist, and in many cases, agencies rely on informal personal networks rather than systematic coordination processes. Vertical coordination – between national ministries/agencies and regional or municipal authorities – is also an area for improvement. Local governments play a role in SME support and occasionally in investment facilitation, especially via regional business parks or SEZs, but the linkage between national strategy and local implementation is not tightly structured.
The Baltic states have, in recent years, developed various national strategies that recognise the importance of linking FDI with domestic capability-building. These include national development plans, innovation strategies, export promotion strategies, and regional development programmes that often reference attracting higher-value FDI and strengthening SME competitiveness. However, these strategic documents can only achieve coherence if implemented through a whole-of-government approach. In practice, making cross-cutting strategies work has been challenging. Implementation tends to remain segmented by ministry. The overview of governance suggests that the Baltics could benefit from more formal joint planning and shared targets across their investment, SME, innovation and regional policies. In essence, the policy frameworks exist, but stronger coordination is needed to align them in practice.
The use of monitoring and evaluation tools to assess the effectiveness of FDI-SME policies remains limited across the Baltics. Many programmes and initiatives do not have rigorous ex-post evaluations or clearly defined performance indicators tied to FDI spillover outcomes. Where evaluations occur, they often focus narrowly on administrative outputs or compliance (e.g. how many firms received support, or reduction of red tape) rather than on actual impact (such as productivity gains or linkage formation). All three countries have introduced Regulatory Impact Analysis (RIA) requirements for new laws (Latvia and Lithuania mandate RIAs for primary legislation, for example), but implementation remains uneven in practice and often excludes secondary regulations or parliament-initiated measures. Stakeholder consultation in policy design is relatively strong, particularly in Estonia, which helps ensure that business perspectives (including those of foreign investors and SMEs) are heard. Going forward, building more robust M&E frameworks – with clear objectives, key performance indicators, and regular reviews – would improve accountability and allow Baltic governments to refine their FDI–SME linkage policies based on evidence.
Strengthen co-ordination mechanisms for FDI-SME policy. Limited thematic co-ordination in SME and investment policy highlights the need to expand the mandate of the centre of government to enhance policy coherence, reduce duplication, and ensure better alignment across ministries and implementing bodies. Strengthening co-ordination mechanisms is key to bridge policy gaps and foster cross-institutional collaboration.
Embed outcome-based monitoring and evaluation. Apply proportionate, results-focused M&E across all instruments using a concise set of indicators (e.g. local sourcing share, number of certified suppliers, MNE-SME co-R&D, regional reach) and conduct routine data tracking and periodic ex post evaluations.
Strengthen regulatory impact assessment (RIA) practice. Ensure consistent RIA for primary and subordinate regulations with proportionate thresholds, an SME test, and independent quality control; update guidance to reduce compliance burdens and align the regulatory stock and flow with strategic FDI-SME objectives.
Most policy initiatives in the Baltics focus on the growth and upgrading of SMEs
Approaches to FDI-SME linkages differ across the Baltics: Estonia is focused on governance (about 80% of initiatives), Latvia emphasises network-building (29% on collaborative platforms), and Lithuania concentrates on technical assistance (92% advisory, matchmaking, training). Despite these differences, all three countries place facilitation services at the core to broker partnerships between SMEs and foreign investors.
The Baltic countries have developed physical and virtual platforms intended to co-locate investors and local firms, or otherwise encourage collaboration. These include SEZs, industrial parks, innovation hubs, and clusters. Lithuania’s network of SEZs, for example, has attracted investors in sectors like biotechnology and fintech, yielding some positive spillovers to local firms and talent in those clusters. Estonia has fostered technology parks such as Ülemiste City in Tallinn and the Tartu Science Park, which act as dynamic hubs for digital and green-tech companies (both foreign and domestic). Latvia also offers SEZs and industrial parks with fiscal incentives to draw investors. However, in Latvia the engagement of local SMEs in these zones has been relatively weak, partly due to fragmented support structures that fail to actively link small firms with incoming investors. Across the region, while these collaboration platforms provide a foundation for FDI-SME interaction, they are not fully leveraged – more targeted programmes and coordination are needed to maximize their impact. For instance, simply having an SEZ or cluster is not enough; it should be paired with initiatives like local supplier matchmaking, innovation mentoring, or training centres that ensure SMEs around the platform can meet investors’ needs.
All three Baltic states have expanded their toolkit of services to connect investors with local businesses and to build SME capacities. These include investor one-stop-shop portals, supplier databases or matchmaking services, export promotion assistance, and SME training and consulting programmes. For example, Lithuania’s Innovation Agency works with Invest Lithuania to provide structured support to firms, offering diagnostics of SMEs’ capabilities and linking them with foreign market opportunities. Estonia’s strength in digital government is reflected in advanced e-platforms for business services and information; however, many of these are tailored to investor needs (such as fast e-registration and licensing) rather than specifically fostering local supplier integration. Latvia’s LIAA runs business incubators, consulting services, and some skills development initiatives for SMEs. A common issue is that these various services often operate in silos and lack strategic integration with each other. The supplier databases, for instance, might not be systematically used in investment promotion targeting, or training programs might not focus on skills that foreign firms demand.
Governments in Estonia, Latvia, and Lithuania provide a variety of financial instruments to encourage SME upgrading, innovation, and internationalisation – all of which can indirectly support better linkage with foreign investors. These instruments include R&D grants, innovation vouchers, equipment co-financing programs, export credits, and tax incentives (such as R&D tax allowances). Lithuania stands out for a comprehensive toolkit, offering innovation grants, tax incentives for technology adoption, and vouchers for SME training or consulting. Estonia’s public financing is more narrowly focused on specific priorities like green tech and digital innovation (for example, grants for climate-friendly technology development). Latvia makes use of its national development financial institution (ALTUM) to provide loan guarantees, export loans, and even wage subsidies for hiring in target sectors. Despite this array of financial support, few programmes are explicitly designed to link SMEs with foreign investors. The funds typically aim to upgrade firm capabilities in general, but they do not necessarily incentivise or require collaboration with MNEs. As a result, the current financial support, while central to enhancing SME absorptive capacity, may not fully realize its potential impact on FDI spillovers. Redirecting or improving some schemes to promote supplier development (e.g. grants contingent on partnering with an MNE, or subsidies for certification to meet MNE standards) could make this pillar more linkage-oriented.
The Baltic states have implemented various regulatory improvements to streamline business operations.
Estonia’s e-governance system allows for near-paperless business administration – opening a company, obtaining permits, and paying taxes are highly digitalised and user-friendly. Latvia and Lithuania have introduced special fast-track procedures (such as Latvia’s “Fast Track” initiative and Lithuania’s “Green Corridor” programme) to expedite permits and bureaucratic processes for large, strategic investment projects. Importantly, the Baltics have generally avoided creating distinct rules for SMEs, opting instead to keep regulations simple and uniform so that smaller firms are not burdened by compliance costs. This approach of minimising red tape for all businesses helps SMEs broadly, though it also means there are few regulatory advantages or set-asides specifically for FDI-SME linkages. One area of regulatory challenge is labour mobility and migration: firms report that bringing in skilled foreign workers or services can be difficult due to work permit rules and other barriers, which can constrain knowledge transfer from abroad. Overall, the regulatory climate in the Baltics is investor-friendly and ranks competitively on international indices, yet regulations have not been leveraged in a targeted way to incentivise FDI–SME interactions (for example, by requiring or encouraging foreign investors to source locally). There remains room to tailor certain policies – such as procurement rules or immigration for specialists – to be more responsive to the needs of SMEs and supportive of linkages.
Each country’s strategic planning documents set out priorities that indirectly affect FDI–SME ecosystems. Lithuania has made strides in integrating its FDI and innovation agendas: for instance, its Smart Specialisation Strategy is aligned with priority FDI sectors, and SME support measures are embedded in innovation and industrial policy plans. Estonia’s development strategy emphasises digitalisation and innovation across the board, applying a broad-based approach that benefits all firms (domestic and foreign) but without an explicit focus on linkages. Latvia’s overarching strategies (such as its National Development Plan) acknowledge FDI and SME growth, but implementation has been somewhat fragmented and subject to shifts with political cycles. FDI and SME policies tend to be formulated in parallel rather than jointly. For example, an investment promotion strategy might aim to attract high-tech manufacturing, while a separate SME strategy aims to boost innovation in local firms, yet the two may not cross-reference each other or coordinate actions. This limits the mutual reinforcement of policy efforts. Strengthening cross-ministerial coordination – for instance, by having joint task forces or combined action plans that explicitly connect FDI projects with SME capacity-building (in skills or supplier readiness) – would promote greater coherence. In all three countries, there is recognition that siloed strategies are a missed opportunity; more systematic integration of FDI-SME linkage objectives into national and regional plans is needed to ensure that foreign investment translates into inclusive, long-term development impacts.
Policy recommendations for the Baltic states:
To maximise the benefits of FDI for domestic firms, the Baltic States should enhance coordination between ministries, policymaking bodies, investment promotion agencies, and SME support institutions. Establishing more formal mechanisms for inter-agency co-ordination, such as shared strategic planning, co-designed programmes, and integrated client support systems, would help align investment promotion with SME upgrading goals and enhance the effectiveness of FDI–SME linkage policies.
Design and implement targeted supplier development programmes to strengthen linkages between foreign investors and local SMEs. Such programmes could focus on improving the capabilities of local firms to meet the quality, reliability, and compliance standards of MNEs, thereby fostering more durable commercial relationships.
Explore the development of cross-border investment corridors. By leveraging geographic proximity, shared EU membership, and complementary economic profiles, Estonia, Latvia, and Lithuania could jointly attract high-value FDI through integrated infrastructure planning, coordinated investment promotion, and harmonised regulatory frameworks. A pan-Baltic approach, such as joint industrial zones or innovation corridors, could enhance participation in global value chains, support green and digital investment, and foster inclusive regional development in border regions.
Promote FDI–SME linkage strategies that actively target regional disparities within countries by ensuring that less-developed areas and second-tier cities are included in policy design and implementation. To ensure more geographically balanced economic development, the Baltic States could consider strengthening the local reach of FDI–SME linkage policies by explicitly targeting less-developed areas and second-tier cities. This could involve extending investment facilitation and supplier development programmes beyond capital regions, tailoring support schemes to local firm capabilities, and improving regional access to advisory services, innovation funding, and training.
FDI is an important source of finance for advanced and emerging economies and can play an important role in supporting economic resilience and growth. Harnessing FDI for sustainable development, and particularly productivity and innovation, requires strong linkages with small and medium-sized enterprises (SMEs) in host countries. Foreign multinational enterprises (MNEs) do not just choose countries but locations in specific sub-national regions, and hence, FDI-SME linkages need to be considered and strengthened through place-based approaches.
SMEs contribute significantly to economic growth and social inclusion, and they can play a key role in building resilience and more sustainable growth. In the OECD area, SMEs account for almost all enterprises, about two-thirds of total employment and 50-60% of value added (OECD, 2021[6]). To achieve their full potential, SMEs need to increase productivity and scale up innovation capacity. They are often less productive and innovative than larger firms where size is often identified as a major barrier to higher performance. Yet, some SMEs can be more productive and innovative than large firms, signalling that size is no fatality. In digital-intensive sectors, for example, smaller firms can show higher productivity levels (OECD, 2019[7]). SMEs play a key role in shifting innovation models by adapting supply to different contexts or user needs and responding to new or niche demand (OECD, 2018[8]).
Changes in the global trading and investment environment offer new opportunities for SME upgrading. Participation in global value chains (GVCs) enables SMEs to enhance productivity by absorbing technology and knowledge spillovers, upgrading workforce and managerial skills and raising innovation capacity (OECD, 2018[8]). This can be achieved by linking their business activities with foreign affiliates of MNEs (and domestic owned companies) and/or by directly integrating in GVCs as exporters, i.e. by supplying companies located abroad.
In this context, beyond the contribution to capital investment and employment generation, FDI can play an important role for knowledge and technology spillovers in host economies, resulting in increased productivity of local firms, especially SMEs. While productivity and innovation capacity of SMEs are influenced by a variety of market, policy and other factors (OECD, 2019[7]; OECD, 2021[6]), this report focuses on the specific role of FDI and related policies in the Baltic countries This introductory chapter introduces the conceptual framework to assess FDI spillovers on domestic SMEs and outlines how this framework is implemented for the Baltics case (OECD, 2020[9]).
Spillovers from FDI on domestic SMEs depend on a set of main enabling factors:
Potential for FDI spillovers: FDI spillovers are possible as foreign firms are often more productive than domestic ones. Foreign MNEs are often larger than domestic firms, where size is found to be associated with higher productivity and a key determinant to overcome fixed costs for investment abroad (Helpman, Melitz and Yeaple, 2004[10]). Affiliates of foreign firms – through their links with parent companies – have typically greater access to technology, better managerial skills and more adequate resources for capital investment than domestic firms (Alfaro and Chen, 2012[11]). These capacity differences between foreign and domestic firms make it possible for SMEs to benefit from knowledge and technology transfers. The potential for FDI spillovers is further influenced by the volume of FDI inflows (i.e. the economy’s relative dependence on FDI) and a number of FDI characteristics that illustrate to what extent FDI is effectively embedded in the local economy. These characteristics include (a) the sector in which the investment occurs and the activities that the foreign company undertakes, (b) the main motivations behind the FDI decision (e.g. market-seeking, resource-seeking, asset-seeking, efficiency-seeking), (c) the type of FDI (e.g. greenfield versus mergers and acquisitions), (d) the country of origin of the foreign investor, including the geographical and cultural proximity to the receiving country and the degree of foreign ownership.
Absorptive capacities of domestic SMEs: Absorptive capacity refers to the ability of a firm to recognise valuable new knowledge and integrate it productively in its processes, i.e. to innovate (OECD, 2021[6]; 2019[7]). The stronger its absorptive and innovative capacity, the higher its chances to benefit from FDI. SME absorptive capacity depends on the firm’s prior capital endowment and level of productivity, i.e. its level of financial, human and knowledge-based capital and its efficiency in creating value from it. Beyond existing endowments of these resources, absorptive capacity also depends on SMEs’ ability to access strategic assets related to finance, skills and innovation as well as on the broader business environment. Not all SMEs are the same and their heterogeneity greatly contributes to explain their performance. SMEs vary in terms of age, size, business model, market orientation, sector and geographical area of operation. This means that different types of SMEs have different growth trajectories and therefore different chances to enter into knowledge sharing relationships with foreign multinational enterprises (MNEs) and to benefit from FDI spillovers.
Economic geography factors: This refers to geographical and cultural proximity factors, where the latter is defined by factors such as the differences between home and host countries in terms of language, culture, political systems, level of education, and level of industrial development (Johanson and Vahlne, 1977[12]). The localised nature of FDI means that geographical and cultural proximity between foreign and domestic firms affects the likelihood of knowledge spillovers, which often involve tacit knowledge, and whose strength decays with distance. Thus, productivity spillovers from FDI on local firms are often concentrated in the same region of the investment. Agglomeration effects, notably through the presence of local industrial clusters, have also been reported to affect FDI attraction and FDI spillovers. Clusters embed characteristics such as industrial specialisation (through specialised skilled workers and suppliers) and geographical proximity that make knowledge spillovers more likely to happen, including from MNE operations.
Other economic and structural characteristics of the host country: The degree to which FDI-SME spillovers materialise also depends on other economic and structural characteristics of the host country and its sub-national regions. These factors relate to the regional/national endowment as well as the macro-economic context, structure of the economy, sectoral drivers of growth, productivity and innovation as well as to the level of integration in the global economy, beyond FDI. These factors are often necessary conditions for FDI spillover potential, SME absorptive capacity and economic geography factors to turn into actual productivity gains for domestic SMEs.
While adequate enabling conditions are necessary, FDI spillovers only occur if domestic SMEs are exposed to MNE activities. Such exposure may occur through a set of diffusion channels:
Value chain linkages involve knowledge spillover from foreign MNEs to suppliers (upstream) and customers (downstream). Linkages help domestic companies extend their market for selling and raise the quality and competitiveness of their outputs. They can also generate knowledge spillovers when MNEs require better-quality inputs from local suppliers, particularly SMEs, and are therefore willing to share knowledge and technology with domestic companies to encourage their adoption of better practices.
Strategic partnerships involve knowledge and capacity transfer in formal collaborations, for example in the area of R&D or workforce/managerial skills upgrading. These partnerships can take many forms, including joint ventures, licensing agreements, research collaborations, globalised business networks (i.e. membership-based business organisations, trade associations, stakeholder networks), and R&D and technology alliances.
Labour mobility can be an important source of knowledge spillovers in the context of FDI, notably through the move of MNE workers to local SMEs – either through temporary arrangements such as detachments or long-term arrangements such as open-ended contracts – or through the creation of start-ups (i.e. corporate spin-offs) by (former) MNE workers. Firms established by MNE managers are often more productive than other local firms. Similarly, workers who moved from foreign-owned to domestic firms retain skills and competences, including management skills, acquired in the foreign firms and thus contribute more to the productivity of their firm than workers without foreign firm experience.
Competition effects occur with the entry of foreign firms, which heightens the level of competition on domestic companies and puts pressure on them to become more innovative and productive – not least to retain skilled workers. The new standards set by foreign firms – in terms of product design, quality control or speed of delivery – can stimulate technical change, the introduction of new products, and the adoption of new management practices in local companies, all of which are possible sources of productivity growth. This rising competitive pressure due to foreign firm entry and related productivity spillovers may also be associated with new incentives for workers to improve skills and SMEs to engage in skills upgrading.
Imitation effects occur when foreign firms can also become a source of emulation for local companies, for example by showing better management practices. Imitation, reverse engineering and tacit learning can therefore become a channel to strengthen enterprise productivity at the local level. Foreign firms may also participate in innovation clusters and collaborative innovation activities where cross-fertilisation of ideas can increase productivity, both of domestic and foreign firms.
The scope for productivity and innovation spillovers on domestic SMEs is ultimately determined by the interaction of enabling factors and diffusion channels. Public policies aiming to enhance these spillovers address these different aspects and cut across a range of policy domains, including investment policy and promotion, SME development, innovation and regional development.
Source: OECD (2023[4]), Policy Toolkit for Strengthening FDI and SME Linkages, https://doi.org/10.1787/688bde9a-en
References
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