PUSHING THE ENVELOPE: ESTONIA TRIES TO SPUR INNOVATION

UNCLAS SECTION 01 OF 03 TALLINN 000754

SIPDIS

SIPDIS
SENSITIVE

DEPT FOR EUR/NB AND EEB/CBA

E.O. 12958: N/A
TAGS: ECON BEXP EN
SUBJECT: PUSHING THE ENVELOPE: ESTONIA TRIES TO SPUR INNOVATION

Ref: Tallinn 621


1. (U) SUMMARY: Estonia's relatively lean and dynamic economy
can still make progress in a number of areas towards spurring
greater innovation and productivity gains. Both will be
necessary to meet labor shortages and move the economy up the
value chain to a position where it can move out of competition
with lower-wage markets to be on par with EU-15 economies. The
GOE is trying to re-start a series of strategic efforts to meet
Lisbon Agenda goals by 2014, primarily by supporting more
research and development in ICT, bio- and nanotechnologies. Its
plans to do so, while detailed, are largely on paper so far.
Real change may ultimately come only in the areas where market
forces make it inevitable. Post will look for opportunities to
support this important goal. END SUMMARY.

Strong in some areas, stagnant in others...
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2. (U) Estonia is a well-know leader in the IT sector, and sits
at the forefront of e-commerce and e-government, with nationwide
wi-fi as well as Europe's highest level of internet usage and
the first-ever instance of online voting in a national election.
The country has gotten substantial mileage out of its role in
developing the internet telephony giant, Skype, and its pro-
business, free-market tax and investment policies. However,
with a tight labor market and rapidly rising wages (20 percent
growth in 2006),there is significant pressure on the economy to
increase productivity through innovation and new technologies.
(Note: Unemployment in Estonia was 4.2 percent as of Q3 2007,
and lower in the capital, as compared to the EU27 average of 8.2
percent for 2006. End Note) Prime Minister Andrus Ansip and
numerous business leaders have frequently cited potential gains
in productivity and innovation as ways to address the labor
shortage issue (reftel). Innovative new procedures, in
particular, would allow the economy to continue growing without
the politically unpalatable measure of importing large numbers
of workers from Russia or other non-EU countries, something that
all leaders of the country have said is not a viable option.
Estonia's December 23 accession to the EU's Schengen visa area
may alleviate some of this problem, by eliminating the need for
foreign workers to obtain a separate Estonian visa.
Additionally, politicians see innovation as key to shifting
Estonia's economic footing from a manufacturing and lower value-
added basis to one of higher-end services and information
technology. Estonia recognizes that with wage levels now at 65
percent of those in the older EU member states, it is no longer
competitive with China and India in electronics assembly,
textiles, and other manufacturing jobs even after accounting for
its geographic proximity to the EU market. (Note: The
International Labor Organization's 2006 Key Indicators in the
Labor Market ranked Estonian labor productivity ahead of Germany
and Switzerland, and at 67 percent of the U.S. level. End Note)

Among New EU Members: In the Middle of the Pack
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3. (U) Estonia's standing with respect to other EU Member
States on innovation performance was evaluated in the 2006
European Innovation Scoreboard (EIS). While Estonia ranked
relatively well against the nine other new Member States, it
fell into the 'Trailing' category overall, ranked below the
Czech Republic and Slovenia among other new members. Of the
five broad areas of innovation performance measured, Estonia did
best on "Innovation and Entrepreneurship," leading the EU in
expenditures per capita on Information and Communications
Technology (ICT). Estonia was ranked third best in the EU in
its support for Tertiary Education as one of the "Innovation
Drivers." Weak points were on "Applications" such as sales of
new-to-market products and high-tech exports, reflecting
comments we have heard locally that recent innovations in
Estonian business have been more "process" innovations in the
service sector than "product" innovations in manufacturing.


4. (U) Another major deficiency cited in the 2006 EIS was in
the area of intellectual property (IP). The number of Estonia's
new patents, trademarks and designs lagged far behind the older
EU states, but roughly in the middle among its peer group the
ten new members that joined in 2004. The Estonian Patent Office
announced July 9th that applications during the first half of the
year for the international registration of trademarks and
patents were both higher than for the same period in 2006.
Nevertheless, some GOE contacts speculate that the overall poor
showing in the IP category may reflect licensing agreements
which ultimately give the credit for research done by Estonian
subsidiaries to their foreign parent companies, instead of to
Estonia.

A Plan for Action, or just a Plan?

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5. (SBU) The Ministry of Economic Affairs and Communication
(MOE) coordinates the GOE's efforts to set thematic priorities
and create a supportive environment for innovation. In a
conversation with Econoff, MOE's Technology and Innovation
Policy Division chief, Marika Popp, explained the challenges
ahead, and the Ministry's strategy for addressing them. Over
the next six years, 2007-2013, Estonia will receive more than
EEK 53 billion (USD 4.5 billion) in EU structural funds. It
will be difficult to absorb these funds fully without more
expertise and capacity in the sciences and engineering, as well
as R&D. In order to use this money in ways that both improve
infrastructure and enhance the economy's competitiveness,
Estonia will need to attract outside scientists and specialists
in a range of fields and increase domestic spending on R&D. By
their own estimation, the GOE does not expect to meet the Lisbon
Agenda goal of 3 percent of GDP spent on R&D by 2010, but rather
by 2014. (Note: In 2005, the level was 0.94 percent of GDP,
which was double the 2001 level. Private sector investment in
R&D was another 0.42 percent of GDP and is growing quickly. End
Note.)


6. (SBU) MOE's Popp acknowledged that the government's first
national innovation strategy, "Knowledge Based Estonia 2002-
2006," lacked focus. The new plan is focused on the three key
areas of ICT, biotechnologies, and materials sciences; it also
aims to nearly double the 2004 number of workers in R&D by 2014.
While both MOE and the Ministry of Education and Research are
considering measures to attract the necessary workers and
specialists to Estonia, MOE's Popp admitted that "We have not
yet outlined [this program's] terms and conditions to such a
detailed extent." However, a working group comprising the
Ministries of Economy, Interior, Education and Foreign Affairs,
as well as representatives from labor and management, proposed
changes to the GOE which are expected to be passed into law soon
(by mid-2008). These changes would double the number of skilled
workers that could be admitted to the country, cut the wait time
by half for their visas, and ease restrictions on low-skilled
workers - perhaps even those from Russia and Ukraine.


7. (SBU) While the GOE's new innovation strategy, "Knowledge
Based Estonia 2007-2013" certainly seems focused on getting
results, and the GOE placed innovation in its new Coalition
Agreement priorities in April, some observers we spoke to have
their doubts. Marje Josing, Director of the Estonian Institute
of Economic Research, noted that the GOE has been urging the
private sector for years to move up the production value chain
and pursue innovations that would reduce dependency on labor and
increase productivity and competitiveness. The plans,
strategies and incentives are all well and good, but in the end
it is market forces and external pressures that are forcing
companies to make the hard adjustments, she noted. Two cases of
external pressure are the 1998 financial crisis in Russia and
the 2004 "double tariffs" which Russia imposed after Estonia
joined the EU, both of which forced Estonian firms to re-orient
themselves away from the Russian market and towards the EU and
other Western markets. Furthermore, the current convergence of
Estonian wages and production input costs with those of the EU
will likely be another market-driven incentive to force
companies to become more productive.

Venture Capital to the Rescue?
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8. (SBU) Dr. Erik Terk of the private think tank, the Estonian
Institute for Future Studies, feels the GOE needs to do a better
job of coordinating the efforts of its ministries, citing
Finland as a positive role model in this regard. Dr. Terk is on
the board of one such effort, the new Estonian Development Fund.
This fund, established by Parliament in 2006, capitalized by the
GOE with EEK 620 million ($53.7 million USD),and launched in
April 2007, was modelled on a Finnish example, "Sitra". The
Fund aims "... to stimulate and support positive changes in the
Estonian economy, contributing to modernization ... growth of
exports, and creation of new jobs requiring high qualification.
The Development Fund supports ... innovation, emergence of
innovative business ideas and the growth of entrepreneurship in
the whole society." While ICT and biotech are two of the stated
priorities of the Ministry of Economy, the head of MOE's lead
investment promotion agency, Enterprise Estonia, recently told
us that his priorities are bringing more tourism, manufacturing,
shipping and banking to the country (reftel). With Enterprise
Estonia apparently focused on older, mainline industries,
perhaps the new Estonian Development Fund or other private
sources will seek out and identify innovative firms and
individuals in the hi-tech economy.


9. (SBU) Comment: While there is no doubt that the Estonian

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business and investment climate fosters innovation and
entrepreneurship, the economy still faces serious challenges.
Gaps in the labor force may make it difficult - if not
impossible - for Estonia to absorb expected EU structural funds.
Without a real commitment by the GOE to provide more than just
plans on paper, Estonia will not be able to attract specialists
in the fields of ICT, bio- and nanotechnology where the GOE
wants to excel. That would be a shame because Estonia is
otherwise well-positioned to continue the remarkable
transformation of its economy seen in recent years. Post has
been active sending Estonian officials for IP training to the
U.S., but we will look for other areas where we can support
MOE's goals through exchange programs, training, and sharing of
expertise. End Comment.

DECKER