This brief summarizes the results of an annual study on the development of the investment climate in Latvia from the viewpoint of key foreign investors – companies that have made the decision to invest in the country and have been operating here for a considerable time period. The study was initiated in 2015 and aims to assess investors’ evaluation of the government policy initiatives to improve the investment climate in Latvia. It also aims to provide an in-depth exploration of the main challenges for and concerns of the foreign investors, both by identifying problems and offering solutions. The study draws on a survey/ mini case studies of the key foreign investors in Latvia. Our findings suggest that in recent years, some progress has been achieved on a number of dimensions that are crucial for the competitiveness of the investment climate in Latvia, such as the political efforts by the government of Latvia to improve the investment climate, the overall attitude to foreign investors, and labour efficiency. At the same time, foreign investors see little, if any, improvement with regards to other key areas, such as the availability of labour, the quality of education, the court system, corruption and the shadow economy.
The study on the development of the investment climate in Latvia from the viewpoint of key foreign investors in Latvia was first launched in 2015 by the Foreign Investors’ Council in Latvia (FICIL) in cooperation with the Stockholm School of Economics in Riga (SSE Riga). This study aims to foster evidence-based policy decisions and promote a favourable investment climate in Latvia by:
- (i) Assessing how foreign investors evaluate the government’s efforts and current policy initiatives aimed towards improving the investment climate in Latvia, and
- (ii) Providing an in-depth exploration of the main challenges and concerns for the foreign investors, both by identifying problems and offering solutions.
The study draws on a survey/mini case studies of the key foreign investors in Latvia. The first 2015 wave of the survey covered 28 key foreign investors in Latvia. Our panel has gradually expanded over time, reaching 47 participating companies in 2019. From September to early November 2019, we interviewed 47 senior executives representing companies that are key investors in Latvia. Altogether, these companies (including their subsidiaries) contribute to 23% of Latvia’s total tax revenue from foreign investors, 9% of the total profit and employ 11% of the total workforce employed by foreign investors in Latvia, where by foreign investors we mean companies with above a 145 000 EUR turnover and 50% foreign capital (data form Lursoft, 2018).
All interviews were conducted by FICIL board members. The guidelines for the interviews consist of the following key parts:
- (i) Assessment of whether, according to foreign investors, the investment attractiveness of Latvia has improved during the past 12 months;
- (ii) Assessment of the work of Latvian policy-makers in improving the investment climate during 2019;
- (iii) Evaluation of progress in the major areas of concern identified by foreign investors in Latvia in 2015, including demography, access to labour, level of education and science, quality of business legislation, quality of the tax system, support from the government and communication with policy-makers, unethical or illegal behaviour on the part of entrepreneurs, unfair competition, uncertainty, the court system and the healthcare system in Latvia.
Furthermore, in the 2019 study we included questions related to some of the key issues discussed between foreign investors and policymakers during 2019, including the tax system, the stability of the financial sector and the quality of higher education and science in Latvia.
Investment Attractiveness of Latvia: Key Concerns of Foreign Investors in Latvia
The results of the 2019 study suggest that, even though the assessment of foreign investors with regards to the investment attractiveness of Latvia and the work of policy-makers to improve the investment climate in Latvia is still at the average level, it shows some positive tendencies. Namely, on a scale from 1 to 5, where ‘1’ means that there are no improvements at all, ‘3’ some positive improvements and ‘5’ significant improvements, the development of the investment climate in 2019 was evaluated as ‘2.6’ (‘2.5’ in 2018 and 2017). Furthermore, when asked to score the policy-makers’ efforts to improve the investment climate in Latvia, using a scale of 1-5, where ‘1’ and ‘2’ were fail and ‘5’ was excellent, investors responded with an average of ‘2.9’ in both the 2017 and 2018 studies, whereas in 2019, the score improved to ‘3.1’.
Foreign investors were also asked to evaluate whether there has been any progress within the key areas of concern as identified in 2015. The results of the most recent study suggest that the demographic situation, which in the long term reflects both the availability of labour and market size, is still among the key challenges for the foreign investors. Namely, on the scale from 1-5 (where an indicator value of 1 means that Latvia is not competitive and 5 means that Latvia is very competitive in this dimension), investors assessed the demographic situation of Latvia with only ‘1.5’ in 2019. Furthermore, as many as 35 (out of 47) foreign investors stated that they had not seen any progress in this area over the past 12 months. This lack of progress is, perhaps, not very surprising as demographic changes may take substantial time.
Another two key areas where investors would like to see more progress are the quality of education and science and the availability of labour. On a 5-point scale, the quality of education and science was evaluated with ‘2.7’ in 2019 (‘3.0’ in 2018, ‘3.1’ in 2017) and 30 out of the 47 investors interviewed have seen no progress in the development of education and science in Latvia over the past 12 months. The availability of labour was evaluated with ‘2.8’ in 2019 (‘2.7’ in 2018 and 2017); investors scored the availability of blue-collar labour with ‘2.4’ in 2019 (‘2.3’ in 2018, ‘2.5’ in 2017) and the availability of labour at management level with ‘3.1’ (‘3.0’ in 2018, ‘2.9’ in 2017). The majority, i.e. 39 of 47 investors have also seen no progress with regards to the access to labour during the past 12 months. In this context, however, it should be emphasised that the efficiency of labour is increasing in Latvia, according to foreign investors: in 2018, it was assessed with ‘2.9’, yet, in 2019, investors evaluated the efficiency of labour in Latvia with ‘3.4’ out of ‘5’.
The quality of health and social security as well as the quality of business legislation are yet another two indicators of the competitiveness of the investment climate in Latvia that have been evaluated around the average level of ‘3’. Further, 33 of 47 investors have seen no progress with regards to improvement of the healthcare system in Latvia over the past 12 months.
While the overall standard of living is evaluated rather positively at ‘3.8’ in 2019, there is still not much improvement in this indicator as compared to the previous three years. One encouraging result of the 2019 study is that according to foreign investors, the attitude towards foreign investors is gradually improving in Latvia: from ‘3.2’ and ‘3.1’ in 2016 and 2017 to ‘3.6’ in 2018 and reaching ‘3.7’ in 2019.
The foreign investors in Latvia who took part in the 2019 study also expressed an expert opinion with regards to whether there has been any progress during the previous 12 months in the other areas of concern. In this light, the perception of uncertainty should be highlighted. As many as 25 (out of 47 investors) have seen no progress in this area, 16 have seen partial progress and 6 stated that there has been progress in reducing uncertainty. The court system of Latvia is another area where many foreign investors have seen no progress, i.e. 22 said ‘no progress’, 23: ‘partial progress’ and only 1 that there has been progress in the development of the court system in Latvia.
Specific Issues: Tax System, Stability of the Financial System and Quality of Higher Education and Science
In the 2019 study, we also initiated an in-depth exploration related to three key issues of concern extensively discussed between foreign investors and Latvia’s government during the FICIL High Council 2019 spring meeting, and throughout the year 2019 in general. These are: (i) the tax system, (ii) the stability of the financial system, and (iii) the quality of higher education and science. Foreign investors were asked to comment on the current situation and progress over the past years, as well as to provide suggestions to the policymakers in order to improve the situation in the particular area.
(i) Tax system:
The most recent tax reform was implemented in 2018, and the newly elected government has announced that the next reform will take place in 2021. Therefore, this year we asked investors to evaluate the results of the previous tax reform in Latvia. We also asked investors to comment on whether the recent tax reform has brought any benefits to their company and the overall economy of Latvia. On average, foreign investors scored the results of the previous tax reform in Latvia with ‘3.1’, i.e. slightly above the average.
Overall, at least one part of the foreign investors who took part in the 2019 studies highlighted that the previous tax reform was a step ‘in the right direction’. In particular, the zero-rate on reinvested profit was highlighted by a large number of investors as a very positive improvement. In some cases, investors also praised the progressivity of labour tax rates. However, a number of foreign investors highlighted that the tax system has actually become more complex after the reform. Investors also expressed suggestions for further steps to improve the tax system in Latvia, and these are as follows:
Avoid uncertainty. Stability and predictability of the tax system is what the majority of the foreign investors wish to see. In essence, this means fewer changes to the tax system.
Simplify and explain. Investors highlight that paying taxes should be a “simple task” and easy to understand. According to the viewpoints of foreign investors, there is also the potential for improvement with regards to how the responsible organisations, such as the State Revenue Service, communicate changes in the tax system to the private sector.
(Continue) the shift from taxing labour to consumption. Some of the investors that took part in the 2019 studies see that the process has been initiated by the previous tax reform and recommend continuing in this direction.
(ii) Stability of the financial sector in Latvia.
On average, foreign investors evaluated the progress with regards to the effectiveness of combating economic and financial crime with 3.2, i.e. above average. We then asked foreign investors whether they have felt any negative effects on their companies with regards to the situations in the financial sector over the past 2 years. We received some positive opinions, yet the negative ones prevailed. Namely, foreign investors highlighted the reputation risks of Latvia that often impact upon the operation of their companies and create challenges when working with foreign banks.
(iii) Quality of university education and science in Latvia.
Here, foreign investors were asked to reflect upon whether they were aware of any activities that policymakers carried out during the past year to improve the situation. On a positive note, a number of investors mentioned the recent development of the University of Latvia and Riga Technical University’s campuses. Some investors also highlighted that the reform to change the governance model of higher education institutions, initiated by the Ministry of Education and Science, was a good step towards improving the quality of higher education and science in Latvia. However, we also received a number of negative opinions, such as “Nothing has been accomplished, just talking”.
When asked “What changes would you suggest to improve the quality of education and science in Latvia and why? How would this help the business environment, e.g. companies such as yours?”, foreign investors emphasised the following:
Higher education (and science) is too local, fragmented and outdated. In essence, investors pointed out that there are simply too many higher education institutions in Latvia, that they work with outdated methods and are afraid (with no good reason) to open up internationally – also by attracting top quality foreign staff.
Change the governance of higher education institutions in Latvia is another strong request from foreign investors in Latvia. Many investors believe that changes in the financing model should also follow.
Improved connection between education and science and the world of business was yet another important aspect which was highlighted during the 2019 interviews, and also strongly emphasised in the previous studies.
Further Investment Plans and Message to the Prime Minister
When asked whether they plan to increase their investments in Latvia, as many as 64% of the investors interviewed answered with ‘yes’ (in the 2018 study, 55% interviewed answered with ‘yes’), 25% said ‘no’ (35% in the 2018 study) and 11% answered that ‘it depends on the circumstances’ (10% in the 2018 study) or that they have not yet decided.
Finally, we invited foreign investors to send a message to the Prime Minister of Latvia: one paragraph on what should be done to improve the business climate in Latvia, from the viewpoint of a foreign investor. These messages closely parallel the other findings of the 2019 study, stressing a number of key concerns that foreign investors are still facing in Latvia: the situation with regards to demography, quality of education and science, availability of labour, challenges with corruption and the shadow economy as well as needs for improvements in the health care sector amongst others.
The findings of the 2019 study on the view of the key foreign investors of the investment climate in Latvia suggest that in recent years, some progress has been achieved on a number of dimensions, such as political effort to improve the investment climate, attitude towards foreign investors, and labour efficiency. At the same time, foreign investors see little, if any, improvement with regards to other key areas, such as the availability of labour, the quality of education, the court system, corruption and the shadow economy.
Our findings highlight the need to continue policy-makers’ efforts to improve the investment climate in Latvia and provide policymakers with better grounds for making informed policy decisions with respect to the entrepreneurship climate in Latvia. We also hope that our study will further facilitate constructive communication between foreign investors and the government of Latvia.
- Lursoft (2018). Official company statistics of Latvia, 2018.
- FICIL Sentiment Index (2019), https://www.sseriga.edu/centres/csb/sentiment-index
Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.
Vladimir Putin is once more the Russian President and a new government has been formed consisting of most of the same faces and mentality. Putin’s victory looks complete – yet there is a very real risk that it will be Pyrrhic. Even if the ‘managed’ political and economic system – rooted in a lack of competition and openness – that has been his defining project can remain stable, it will continue to sap the country’s vitality. In the election campaign, even Putin acknowledged the country’s lack of modern and competitive industries, as well as a business environment plagued by corruption, cronyism and excessive regulation. Yet, in calling for further modernisation of the economy, Putin has also called for more of the same policies, notably a central role for the Russian state in supporting new industries and technological leadership; a newly established State Corporation for Siberia and the Far East is a case in point.
However, this very model has so far achieved very limited results. Oil and gas still account for nearly 70% of total merchandise exports and around half of the federal budget. While relying on publicly funded and managed entities – such as Rusnano – to shepherd the economy into more diversified and more productive spaces, particularly in high-tech activities, has also yielded a relatively meagre harvest. Rusnano itself has already acknowledged the limited portfolio of innovative projects to fund.
In the arena that provides the most compelling metric of competitiveness – export markets – relatively few Russian firms compete in international markets and very few do in higher value added trade. Ricardo Hausmann (2007) has argued that the products that a country exports also reflect the proximity of products and their reliance on similar sets of inputs, such as physical assets and knowledge or skills. Near the start of Russia’s transition it has been calculated that Russia had comparative advantage in only 156 out of 1242 product lines when using a 4-digit SITC classification. Most were natural resources. In contrast, China had comparative advantage in 479 product lines. And as regards proximity, few of Russia’s export products were closely connected to other products, meaning that there was limited scope for enhancing exports. Yet, by 2010 our research shows that there has been an increased concentration on natural resource exports. The contraction of manufacturing has, further, been associated with a fall in the number of Russian product lines with comparative advantage to 103. In contrast, the number for China increased in 2010 to 513. So, despite Putin’s rhetoric, the Russian export basket has become even more concentrated since the mid-1990s. Moreover, the ability to shift into proximate products, as well as diversify into new ones, remains very restricted. This is due to several factors.
A common diagnosis is that failings in the business environment are to be blamed. This is not a new complaint. While the options for limiting these constraints may not be straightforward but the broad policy direction and options are well understood. The challenge is in enforcement. In this – as also with improving governance and further reducing the role of public ownership – improvement is only likely to start with serious political commitment. That is still lacking.
But modernising the economy depends on much more than a good business climate. Critically, it depends on what sorts of skills and knowledge are available to the economy. Yet, even here where many have believed that Russia is relatively favourably situated, on closer inspection, the situation turns out to be far more problematic. In fact, our evidence indicates deterioration in the quality of both skills and education over time, including limitations on the supply of high quality management. Evidence from surveys suggests that Russian firms face problems in finding workers with the appropriate skill profile. While this may be the situation for existing firms, it seems likely that potential entrants to new, diversified activities may, if anything, face even steeper constraints. To understand whether this is indeed the case, the leading – 270 – recruitment firms in Russia were surveyed using face-to-face interviews in 23 locations in Russia, including Moscow and St. Petersburg. This included a small experiment looking at skills availability for work in more innovative activities, such as web technology aimed at social networking and marketing. The aim was to see whether innovative activities faced more binding constraints when trying to hire.
The results of this survey are unequivocal. Not only are there widespread skill gaps for all types of skills, but it takes firms a much longer time to fill vacancies for skilled personnel. This is particularly true for relatively innovative activities. Recruiting managers or high level professionals in the major Russian cities on average takes 3-5 times longer for innovative activity. Even in Moscow, recruiting a manager or high level professional would take between 3-4 times longer; the gap was yet greater in the Urals, Siberia and the Far East.
Moreover, looking at the sorts of skills that are lacking for each type of potential recruit (e.g., a manager); recruiters also report an absence of basic or essential skills. For example, lack of problem solving and management skills were overwhelmingly the most commonly cited limitations for managers, with high level professionals most commonly lacking both problem solving and practical skills. Among the consequences, many firms decide to postpone launching new products and/or modernizing plant.
In short, our evidence shows not only widespread skill shortages but also major barriers on the availability of personnel for firms wishing to establish new or relatively innovative activity. At the same time, anecdotal evidence also suggests that among the thin layer of top talent – likely to be essential for high tech and other innovative activities – many prefer to emigrate. In contrast, Russia fails to attract talent from other countries, not least because of a restrictive migration regime.
The last decade has seen an emphasis on modernising and diversifying Russia. The results have been depressingly limited. Yet Putin and his government propose more of the same. In effect, they are continuing to take a huge gamble by relying on a mix of energy prices and publicly funded industrial policy to paper over the structural weaknesses of the economy. As this article has shown, what Russia currently produces and exports – and the underlying skills and knowledge – provide a very weak base for achieving the goals of modernisation.
- Denisova, I., and S.Commander, S.Commander and I. Denisova (2012), ‘Are skills a constraint on firms? New evidence from Russia’, EBRD and CEFIR/NES, mimeo
- Hausmann, R., and Klinger, B., (2007), “The Structure of the Product Space and the Evolution of Comparative Advantage”, CID Working Paper No. 146
- Volchkova, N., Output and Export Diversification: evidence from Russia, CEFIR Working Paper, 2011