BALTIC ENTREPRENEURSHIP: IMPLICATIONS FOR LABOUR MARKET AND BUSINESS INNOVATION

Dainora Grundey Kaunas Faculty of Humanities Vilnius University Muitines 8, LT-44280 Kaunas, Lithuania E-mail: dainora.grundey@vukhf.lt; mokslo.prodekanas@vukhf.lt BALTIC ENTREPRENEURSHIP: IMPLICATIONS FOR LABOUR MARKET AND BUSINESS INNOVATION Abstract The paper investigates the background of entrepreneurship in the three Baltic States (Estonia, Latvia and Lithuania) with some reference to other Central and Eastern countries, such Poland, Slovakia and Czech Republic. A wide discussion is led on the barriers to innovation and entrepreneurship in the Baltic States and Poland. A more detail perspective is given for innovation policies in Lithuania, identifying current innovation support programmes, initiated by the Government and other related institutions. Keywords: entrepreneurship, labour market, innovation, barriers to innovation and entrepreneurship, Baltic States, Poland. JEL classification: M13, J40, O32, O38, P2. The European Commission officially defines innovation as the renewal and enlargement of the range of products and services and the associated markets; the establishment of new methods of production, supply and distribution; the introduction of changes in management, work organization, and the working conditions and skills of the workforce (European Commission (COM 1995/688)). Introduction For most countries in Central and Eastern Europe, the transition process has been well underway for over fifteen years. In May 2004, ten of these countries joined the European Union, the Baltic States including. On the surface, these countries have developed a private sector that in terms of size and economic importance reflects the levels observed in advanced Western economies. However, a closer look shows that the composition of the private sector has been different. Whereas in transition countries most of the private sector emerged due to a shift of resources from state to private hands (through privatisation), in advanced western countries, the private sector emerged through the development of privately-owned enterprises (Pissarides, 2004; Aidis and Mickiewisz, 2004). Regardless of this difference, the development of a healthy small and medium-sized enterprise (SME) sector is of special importance in transition countries not only for their wealth and job generation possibilities, but also for their ability to foster innovation, entrepreneurship, experimentation and adaptation in the business environment. This paper aims at disclosing the entrepreneurship environment and trends in the Baltic States, with some reference to other Central and Eastern Countries (CEEC), such as Poland, Slovakia and Czech Republic. Entrepreneurship tendencies in the Baltic States will be viewed from the perspective of labour market and business innovation. A particular attention is drawn to the situational analysis of entrepreneurship environment in Lithuania, presenting potential obstacles and barriers to innovation as well as some governmental initiatives to

Baltic entrepreneurship: implications for labour market and business innovation 61 foster innovation and entrepreneurship in the country, especially among small and medium enterprises (SMEs). Review of Entrepreneurship Environment in the Baltic States As from mid nineties the tax rates on company income/profit in Latvia, Estonia and Lithuania various times has decreased. Amendments of Law on Companies Income/Profit in Latvia unlike to Estonia and Lithuania are not constitutive. The tax rate is the most visible element, but not the only which is determining the entrepreneurship. Tax base, adjustments, tax rebate and procedures have impact, too. In this chapter, we are looking at statistical data that display governments tax policies impact to business activities in Latvia, Estonia and Lithuania. Table 1. Economically active enterprises and business companies by main kind of activity in the Baltic States, 1998-2001 LATVIA ESTONIA LITHUANIA Year Services Industry and construction Agriculture, hunting, forestry and fishing TOTAL Services Industry and construction Agriculture, hunting, forestry and fishing TOTAL Services Industry and construction Agriculture, hunting, forestry and fishing TOTAL 1998 28311 6651 1168 36130 19467 6358 1492 27317 37311 9986 1320 48617 1999 29591 6904 1133 37628 24200 7285 1771 33256 46549 11908 1540 59997 2000 33192 7657 1143 41992 22711 6662 1379 30752 45272 11949 1583 58804 2001 31984 7604 1080 40668 24628 6777 1285 32690 49062 12993 1405 63460 Sources: compiled from Statistical Yearbook of Latvia, 2002; Central Statistical Bureau of Latvia, Riga, 2002; Statistical Yearbook of Lithuania, 2001, 2002; Department of Statistics, Vilnius, 2001, 2002; Statistical Yearbook of Estonia, 2002; Statistical Office of Estonia, Tallinn, 2002. An average number of economically active enterprises and business companies in Latvia during 1998 2001 were 39104 (Table 1). At the same time Estonia and Lithuania had 31003 and 57719 economically active enterprises and business companies accordingly (Table 1). As we can see from Table 1, in this time period greater total number of economically active enterprises and business companies as in Estonia is in Latvia by 26 per cent and in Lithuania by 86 per cent. If number of enterprises compare by kind of economic activity, then it s visible that in services in Latvia such enterprises are more than 35 per cent and in Lithuania more than 96 per cent as in Estonia. Industry s and construction s branches number of enterprises in Lithuania are more than 73 per cent but in Latvia only more than 6 per cent bigger as in Estonia. However, all three states have similar historical experience in agriculture, forestry, hunting and fishing branch, economic active number of enterprises in Latvia is the smallest during all viewed period. Average numbers of economic active enterprises in this kind of activity in Latvia are about 29 per cent and 31 per cent less as in Lithuania and Estonia. Rather high interest rate on credits testifies the state s support deficiency for Latvian enterprises. As it evidently in Table 2, in 2001 in Latvia is the biggest interest rate on credits in national currency comparing with Estonia and Lithuania, and it s more than 1.75 and 1.57 per cent points. Looking at other states in table, it is evident that in such state as Ireland there was economic boom, interest rate on credits is less than 5 per cent, the Netherlands and Spain about 5 per cent, and that favourable influences investment attract to entrepreneurship. In

62 Dainora Grundey Lithuania (9.6 per cent) and Estonia (9.42 per cent) interest rates on credit are lower than in Germany (10 per cent) and becomes closer to such states as Norway (8.87 per cent), Greece (8.59 per cent), Belgium (8.46 per cent) and Denmark s (8.2 per cent) level of interest rate. Table 2. Average annual interest rates on credits in national currencies in the Baltic States and selected EU countries, 1995-2001 (%) Ireland Holland Spain Finland Italy France Czech rep. Denmark Belgium Greece Estonia Lithuania Germany Latvia 1995 6.56 7.21 10.05 7.75 12.47 8.12 12.8 10.33 8.42 23.05 15.95 28.38 10.94 34.56 2000 4.77 4.79 5.18 5.61 6.26 6.7 7.16 8.08 7.98 12.32 7.62 12.1 9.63 11.87 2001 4.84 5 5.16 5.79 6.53 6.98 7.06 8.2 8.46 8.87 9.42 9.6 10.01 11.17 Source: Statistical Yearbook of Latvia, 2002; Central Statistical Bureau of Latvia, Riga, 2002. Rather high interest rate on credit unfavourably influences Latvian entrepreneurs attitude to state in a whole. Entrepreneurs do not see the state s support to entrepreneurship s development. In such way, it shows that there is not thought about long term investments. Enterprises investment in fixed assets indices by years as it confirms the state s support deficiency to entrepreneurship in Latvia. Table 3. Enterprises investments in fixed assets indices at current prices by year in the Baltic States, 1999-2001 (%) LATVIA ESTONIA LITHUANIA 1999 5.4-12.1-7.7 2000 4.9 38.7 3.9 2001 0.8 11.9 19.4 Sources: compiled from Statistical Yearbook of Latvia, 2002; Central Statistical Bureau of Latvia, Riga, 2002; Statistical Yearbook of Lithuania, 2001, 2002; Department of Statistics, Vilnius, 2001, 2002; Statistical Yearbook of Estonia, 2002; Statistical Office of Estonia, Tallinn, 2002. As it evidently in Table 3 Latvia s enterprises investment in fixed assets indices invariably decreases. On the contrary in Lithuania and Estonia after 1999 is noticed significant rise in amount of investment in fixed assets. The state s attitude to entrepreneurship, according to the authors, describes gross domestic product by kind of economic activity, too. From the production approach, gross domestic product is the sum of gross value added of various institutional sectors or various industries plus taxes and less subsidies on products. Gross value added was obtained by subtracting intermediate consumption from the value of the output of goods and services. Intermediate consumption comprises the value of purchased goods and services used up in production. In Table 4 are summarized data of particular European Union candidate states GDP by kind of economic activity in 2001 as per cent of gross value added. Comparing with Estonia, in Latvia Industry and construction part in GDP is more than 3.7 per cent point less, and comparing with Lithuania more than 9.6 per cent point less. Agriculture, hunting, forestry and fishing in Estonia are more than 1.1 per cent points higher, but in Lithuania even more than 2.3 per cent points.

Baltic entrepreneurship: implications for labour market and business innovation 63 Table 4. GDP by kind of activity in the Baltic States and selected CEEC, 2001 (as per cent to gross value added) Latvia Estonia Slovakia Poland Lithuania Slovenia Czech rep. Agriculture, hunting, forestry and fishing 4.7 5.8 4.1 3.4 7.0 3.1 4.1 Industry and construction 24.9 28.6 29.0 32.9 34.5 36.8 40.0 Services 70.4 65.6 66.9 63.7 58.5 60.1 55.9 Source: Statistical Yearbook of Latvia, 2002; Central Statistical Bureau of Latvia, Riga, 2002. Comparing with Estonia and Lithuania, in Latvia Services part in GDP is bigger more than (evidently) 4.8 and 11.9 per cent. Services part in GDP in Latvia is the biggest among viewed states in Table 4, and Agriculture, hunting, forestry and fishing in GDP is rather high, too. In addition, Industry and construction part in GDP is the smallest among viewed states, which testifies that state does not promote employers investments in fixed assets. As a result are delayed those industries development, in which production is necessary to invest big fixed assets and which could cause bigger value added and rise GDP in a whole. Table 5. Employed population in private enterprises in the Baltic States, 1998-2001 (%) LATVIA ESTONIA LITHUANIA 1998 57.2 68.9 68.1 1999 58.9 68.9 69.0 2000 59.6 71.2 69.4 2001 60.9 71.3 70.1 Sources: compiled from Statistical Yearbook of Latvia, 2002; Central Statistical Bureau of Latvia, Riga, 2002; Statistical Yearbook of Lithuania, 2002; Department of Statistics, Vilnius, 2002; Statistical Yearbook of Estonia, 2002; Statistical Office of Estonia, Tallinn, 2002. Is possible to see in Table 5 that Latvian entrepreneurship s environment, comparing to Estonia and Lithuania, is more imperfect. In all three Baltic States the share of employed population in private enterprises rises without interruption. Nevertheless in Latvia that indicator in time period 1998-2001 is smaller than in Estonia and Lithuania for about 10 per cent. Barriers to Innovation for Enterprises in the EU From a firm perspective, innovation leads to new products, processes and services which allow a firm to reduce its production costs, access new markets or market segments (either by being able to offer new products and services or through new distribution or marketing channels and systems), or develop new ways of doing things. Beyond the direct impact on the innovating firm, innovative activities of individual firms contribute to increased productivity, growth of existing firms, firm start-ups and employment. In addition to its effects on economic performance and competitiveness, business innovation/ innovative companies may provide society with new socially beneficial products, processes and services, inventions that may contribute to the solution of important social, cultural or environmental problems (Koch et al., 2003, p.5). Furthermore, innovative companies augment the general competence base in their field, and trigger learning processes which may

64 Dainora Grundey benefit, or spill over into, other areas or sectors. In a recent article, Sena highlights the fact that innovations have multiple spill-over effects in an economy: individual firms innovations facilitate the dissemination of knowledge throughout an economy, leading to an increase in the total stock of knowledge available to an economy. This, in turn, results in greater entrepreneurial activity and increased competition between firms, which induces firms to use innovations to maintain a competitive advantage and a steady flow of profits (Sena, 2004, p.f313). Innovation is viewed as the key to growth and competitiveness in modern capitalist economies (Sena, 2004). The Lisbon agreement launched by the European Council in March 2000 made the enhancement of innovation a cornerstone in its strategy to meet the target of becoming the most competitive and dynamic knowledge-based economy by the end of the decade (European Commission, 2003, p.4). Innovation is important not only for the individual firm but also for society at large (through its multiple spill-over effects), and for the role it plays in strengthening national economies. Investments in innovation have an impact on national economic growth and longterm competitiveness. These investments include everything from improvements in education systems (improving skill-levels) and broadened information and communication technology (ICT) infrastructure (encouraging access to and the spread of knowledge), to strengthened cooperation between science and industry (increasing applicability of research and the possibility to commercialize results) and ameliorated policymaking and governance structures (managing priorities and holding everything together). It is essential to develop an understanding of the various actors that are engaged what drives each one of them and how they can strengthen each other through constructive interactions. Thus, just as important as it is to understand that innovation is comprised of many elements, it is imperative to grasp the concept that no one of these elements holds the key to increased innovation leading to greater productivity and competitiveness. Given the importance of innovation for competitiveness, and the systemic nature of innovation and the need for governments to have a holistic view, coordination and priority-setting become essential. Innovation Barriers Whereas small companies are in most need of capital in order to innovate and grow, it is the large companies who have an easier time accessing capital: FDI is primarily geared towards large multinationals; commercial banks are more likely to extend favorable credit terms to well-established, larger companies; venture capital is generally only available in later/growth stages rather than early/ seed stages of investment. Smaller companies are left looking for alternative sources of expansion. One alternative that many countries are now considering as a method of strengthening/supporting smaller companies and catalyzing innovation nationwide is the development of clusters. Clusters, and particularly innovative clusters, can serve as an instrument for strengthening the innovative capacity and the competitiveness of SMEs: By increasing SMEs access to technology, capital, product markets, among other things, strategic alliances and other partnerships, as well as networks and clusters enable SMEs to combine their generally inherent fl exibility and ability to adapt quickly with the advantages of scale and scope generally only available to large corporations. (OECD, 2002a, p.21.)

Baltic entrepreneurship: implications for labour market and business innovation 65 Unfortunately, fostering innovation in the EU enterprises is not an easy task, as multiple surveys demonstrate that obstacles and barriers do exist in this process (Table 6). According to Eurostat (2004), the barriers to innovation for enterprises could be grouped into: economic factors (business risk, extensive taxes and shortage of financial sources), internal factors (organizational culture, lack of qualified human resources, lack of information on technology and markets), other factors (such as insufficient flexibility of regulations or standards and lack of customer responsiveness to new goods or services). Table 6. Barriers to Innovation for Enterprises in the EU without Innovation Activity (by sector and size class, 1998-2000, %) Economic factors Excessive perceived risks Innovation costs too high Lack of appropriate source of finance Internal factors Organizational rigidities within the enterprise Lack of qualified personnel Lack of information on technology Lack of information on markets Other factors Insufficient flexibility of regulations or standards Lack of customer responsiveness to new goods or services Source: Eurostat, 2004. Enterprises without innovation activities (absolute Industry Proportion of enterprises without innovation activities indicating specified hampering factors (%) figures) All Small Medium Large Enterprises without innovation activities (absolute Services Proportion of enterprises without innovation activities indicating specified hampering factors (%) figures) All Small Medium Large 22406 15 16 11 9 12936 12 12 13 7 30241 20 21 15 13 17390 16 16 16 9 20008 13 14 10 7 12493 12 12 10 7 8103 5 6 5 5 5717 5 5 4 5 17858 12 12 10 5 9305 9 9 9 3 7863 5 6 3 1 4682 4 5 4 2 7491 5 5 3 1 3923 4 5 4 2 10504 7 7 5 3 9894 9 10 6 5 12294 8 9 6 8 8126 8 8 5 3 Surveys in the EU industry and service sectors confirm that innovation costs pose the biggest problem for all companies small, medium and large but exceptionally for small enterprises (21% in industry and 16% in services). SME survey data in Estonia, Latvia, Lithuania and Poland confirms this, listing the primary constraint to innovation as being high costs/availability of financial means (Jürgenson et al., 2003; Central Statistical Bureau of Latvia, 2003; Aidis, 2003). When broken down by enterprise size class, it becomes apparent that the smaller the enterprise, the more it has problems with financial means; whereas the larger the enterprise, the more other barriers

66 Dainora Grundey (e.g. skills of employees, finding a market for products/services, etc.) have a higher relative importance (Jürgenson et al., 2003). Entrepreneurship and Enterprise Development Barriers in Poland Identification of barriers to enterprise development is extremely important, as they have a negative influence on the economy. Responses of business people, provided in questionnaires, can also be a useful source of information on the existing institutional barriers, which hinder enterprise development. A certain limitation of the methodology for applying questionnaires in this context is a natural tendency present among all social groups, including business people to seek the reason for own problems more in external than internal factors. Thus, it is natural that the entrepreneurs would less frequently declare that the problems of their firms are tied to poor competitive skills or not matching the product to market requirements. They are more willing to see the barriers in such issues as excessive taxes. Despite that, a careful analysis of areas, which the business people point out as particularly disturbing for their activity, can be a source of valuable recommendations for economic policy, oriented on the support and promotion of entrepreneurship. Questionnaire research conducted by the Polish Confederation of Private Employers (PKPP) in 2003 (comprising two thirds of the member-organisations of the Federation) shows that the most significant problems, reported by small and medium-sized enterprises, are the level of taxes and costs of labour. The second significant problem for business activity is the inflexible labour law and burdensome administrative procedures. The level of interest rates and foreign exchange rates are less problematic in 2003, compared to 2002, as PKPP stated. However, the entrepreneurs more frequently complain about bad infrastructure and activities of the banks. According to the questionnaires, the largest portion 20% of time dedicated to running the business is spent by small and medium-sized entrepreneurs in various offices. This is twice more than the time dedicated to analyzing changes in the environment, and three times more than time spent in sector meetings and scientific conferences. The formalities tied to the various public and legal charges are also a serious hindrance, as well as the time needed to fulfill them especially in the case of small firms, which still use the traditional form of making payments and complying with administrative duties, i.e. visits at the various offices. Entrepreneurs criticize both the improper procedures and bad service. The entrepreneurs are also very skeptical about the effectiveness of the judicial system. In view of the research conducted by the PKPP, the following three barriers are named as most important: instability of legal regulations, the amounts of taxes and other legal charges, and complicated legal regulations. The next two frequently named factors are bureaucracy and high labour costs (the evaluation of both categories exceeded 5 points). Some time ago, research used to show that the main barrier limiting development of firms was lack of capital. Currently this factor is still reported as important, but much less so than obstacles of administrative and bureaucratic nature. In the 2004 research conducted by the Polish Ministry of Economy and Labour, entrepreneurs most frequently reported small volume of turnover as the barrier to their activity. They also listed competition with large enterprises. The higher importance of the latter factor can be due to the fact that small-sized firms are more sensitive to bad economic situation. They can feel more competitive pressure from the larger ones, which fared better

Baltic entrepreneurship: implications for labour market and business innovation 67 during the period of bad economic situation. Certain entrepreneurs named also inflation level as the most important problem faced by their firm a factor not mentioned in the previous questionnaire. Figure 1. The most important obstacles for Polish entrepreneurs (2003) Inflation level Adequate qualifications of labour costs Hard to say Premises' conditions Labour costs Bureaucracy Competition with other small enterprises Other problems Competition with other big enterprises Complicated legal regulations Low turnover High taxes 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% Source: the Polish Ministry of Economy and Labour, 2004, p.180. Regardless of the size of business, the level of taxes and charges is listed as the main problem in business activity. The second most frequently listed problem is different in the various types of enterprises. In the case of the smallest enterprises, the problem is small turnover volume; small ones complain of complicated legal regulations; while medium-sized ones have problems with competition from their larger rivals. It can be stated that the improvement in the situation of firms in the past year led to improvement in terms of receivables. The business people complain less frequently of payment bottlenecks (5 th largest problem in the research of PKPP, 1 st during the previous edition). In sum, most entrepreneurs stated that the main problem for their activity are their relations with public administration bodies (sum of responses for: level of taxes and charges, complicated regulations and bureaucracy 53% of respondents in the research of Polish Ministry of Economy, Labour and Social Policy. Regardless of the opinion on the perspectives for development of their business, entrepreneurs list the following reasons influencing the development of small enterprises: change of the economic situation of the country (55% of responses) and change in sales opportunities (12%). The statements on administrative barriers and excessive formality of procedures result primarily from the fact, that entrepreneurs do not perceive these issues as having direct influence on their activity; and the time they spend to comply with all requirements could be used for acquiring new customers and for the operations of the company. However, quite often these barriers can be cited as another justification for the internal problems of the business. Entrepreneurs would less frequently declare that the problems of their firms are tied to the small scope of business, poor competitive skills or not matching the product to market requirements. They admit very rarely to losing in competition with other entities (this is cited

68 Dainora Grundey more frequently by small entrepreneurs GW Infor). In this context, accession to the EU was also sometimes named as a barrier. Difficult access to capital is one of the most serious development barriers, especially for small and medium-sized enterprises. Quite often, banks perceive investments of the SMEs sector as risky and difficult to service, taking into account the relatively high cost of customer verification and monitoring compared to the generated profits. Entrepreneurs give up the idea of contracting credits both due to the burdensome banking procedures, and due to the excessively high level of debt and lack of appropriate collateral (PKPP). In many questionnaires, issues tied to labour relations are cited as the area, which still poses many problems for entrepreneurs. Business people propose that rules should be differentiated, depending on the size of businesses. Requirements regarding employment of workers similar for small firms and for large, stable ones results in the large scope of the gray zone of the economy, claim entrepreneurs. Entrepreneurs decided that from the reforms of the labour law, introduced so far, the largest influence on their business was exerted by changes in the rules regarding remuneration for the illness, for overtime work and for holidays; as well as changes regarding termination of labour contracts and amounts of severance payments, as regulations concerning limitations of the reasons to dissolve work relations. Desired changes, that would have a positive influence on business, include liberalization of rules on weekly work time norms, labour safety and hygiene regulations, and the rules, which limit the possibility for laying employers off (PKPP). National Bank of Poland (NBP) has initiated a long-term survey (2002-2004) on benefits and costs of Poland s accession to the Euro zone, the results of which are reflected in the annual reports, summarized in Table 7. The development barriers factors were calculated on the basis of proportion of enterprises, which reported the existence of a given type of problem to the total number of enterprises participating in the questionnaire (including those firms, which did not provide any answers on development barriers). The surveyed business companies in Poland comprised a solid 43% of all SME businesses in Poland, which is sufficient to make generalizations. Table 7. Barriers to Enterprise Development in Poland, 2002-2004 Changes of taxes, bad regulations Accession to the EU Fluctuations in foreign exchange rates Low demand Collection of receivables, payment hold-ups Price increases Sharp competition Bad financial situation of buyers Uncertainty regarding political situation Problems with obtaining credit Lack of liquidity 1Q of 2002 - - 17.4 22.2 16.7 5.3 8.5 19.5-3.7 9.2 2Q of 2002 - - 17.9 25.3 20.1 4.2 13.2 21.7-4.9 6.7 3Q of 2002 - - 16.4 22.6 16.8 4.0 10.7 15.1-5.5 8.0 4Q of 2002 - - 13.9 19.9 17.6 2.7 8.5 16.6-7.2 7.5 1Q of 2003 - - 14.3 19.7 17.1-6.4 16.5-9.0 7.5 2Q of 2003 2.0-15.5 20.4 17.4 5.3 8.2 17.1-9.2 9.5 3Q of 2003 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a 4Q of 2003 10.9 3.7 13.5 15.6 14.5 3.6 8.3 9.8-8 6.3 1Q of 2004 11.2 7 14.4 13.3 13.3 5.8 8.4 6.6-6.3 5.3 2Q of 2004 17.2 14.2 13.8 9.8 9.8 8.3 8.1 6.3 6.1 5.2 4.8 Source: National Bank of Poland, 2004, p. 182.

Baltic entrepreneurship: implications for labour market and business innovation 69 From the above-presented reports on business obstacles in Poland, a different picture of impediments to enterprise development in Poland is perceived (Table 7). Major three problems in 2002-2004 are identified as follows: PROBLEM 1: low demand (this issue was mentioned by Polish entrepreneurs in 2002-2003 as being a major impediment to business development, though towards 2 nd quarter of 2004 this issue lost its importance by approximately 15 percent), which is direct result of low income. PROBLEM 2: bad financial situation of buyers (this issue was rated as the second important barrier for Polish entrepreneurs, though since 4 th quarter of 2003 it decreased sharply by nearly 20 percent). PROBLEM 3: collection of receivables, payment hold-ups (apparently this is still a solid obstacle for Polish companies, which remains constant in the period of 2002-1 st quarter of 2004, though 2 nd quarter of 2004 looked more promising, as this problem was treated as being of less obstruction by 9.8 percent of respondents. One of the greatest issues, which is quite constant in 2002-2004 surveys, is the fluctuation in foreign exchange rates, even though the situation improved by overall 4 percent in 2002-2004. The Polish zloty is not tagged to the Euro, therefore, a permanent fluctuation of the exchange rate between Polish zloty and the Euro causes business uncertainties to some degree. Developing Clusters in Latvia and Lithuania In mid-2001, the Latvian Information Systems (IS) cluster was set up, with the aim of ensuring that by 2010, Latvia would become the leading exporter of software, integration services, and outsourced services in Eastern Europe. Today, there are 20 enterprises and organisations in the cluster, including Latvia s leading software companies, communication service companies and data centres, a testing company, universities, a vocational training centre, and web design, marketing and PR companies. Although the IS/IT sector in Latvia began consolidating before, the formation of the cluster was facilitated by the project Support to Industrial Cluster Restructuring (2000-2001) which provided consultative support to the process of cluster formation, recommending cooperation areas and assuming the role of coordinator or network broker, as well as helping to define goals, strategies and joint values (collaboration, quality, competence and innovation) for the cluster. Recent evaluations of cluster members performance has shown that, on average, the companies increased profits rapidly. Growth in turnover and profits was proportionally much higher than overall economic growth in Latvia (during 2001). The focus achieved through the clustering process has lead to success: individual company revenues and exports have increased, and productivity/utilization has increased from 50-60% to 75%. Now, the cluster is preparing to expand beyond national borders, establishing a Baltic IS/IT cluster, aiming to compete with the U.S. and India. Recently, the Baltic IS cluster participated in the international exhibition COMDEX Scandinavia (in Gothenburg, Sweden, January 2004). In Lithuania, the Sunrise Valley Cluster was formed in May 2003 to contribute to the growth of the knowledge economy and increased competitiveness of Lithuania. Initial financial support of 200.000 has been provided by Phare. Its objectives are to provide modern conditions for quality education and research, linked to professional activities and business environment; generate employment opportunities for highly qualified university graduates, scientists and other specialists; provide favourable conditions for commercialization of research; act as a link between science and technology parks and

70 Dainora Grundey business incubator systems in Vilnius; and provide a basis for local and foreign investment for research projects. Founding members include the University of Vilnius, Vilnius Technical University, Bite, EKSPLA and Alna. The Knowledge Economy Forum and Vilnius City Municipality are the public organisations who are supporting this effort. To date, the facilities and international networks have been established; future efforts will be concentrated on strengthening the brand in order to encourage a physical concentration of high-tech business establishment (primarily in laser photonics, IT, medicine and biotech). Sunrise Valley is also trying to find ways to collaborate with other Baltic and Nordic countries, both to experiment with others concepts and to find ways to increase the level of collaboration (beyond sales/trade). Innovation system in Lithuania Lithuania has been very successful in maintaining a focus on the private sector in its development of initiatives and innovation policy measures. Strong mentors (primarily from the private sector) have initiated activities and inspired reforms to increase science-industry collaboration and clustering, build entrepreneurship skills, and strengthen international linkages and technology exchanges. Yet institutional leadership and concrete innovation strategies are still lacking (Schwaag-Serger and Wise-Hansson, 2004). In Lithuania, the Ministry of Economy and the Ministry of Education and Science have the main roles for establishing innovation policy (Figure 2). A recently-established Science and Technology Commission (October 2002) play the role of advisor to the government submitting proposals on the creation and implementation of policies, creating strategies for the development of applied sciences, technology and innovations, and stimulating interaction between science, industry and business. There are two main policy documents on innovation: the Long-term Development Strategy of the State (November 2002) and the Innovation in Business Programme. The first document mainly focuses on finalizing the transition to a market economy addressing restructuring of state-owned enterprises, reforms in the legal and regulatory environment, and priorities for economic growth. The second document focuses on creating an innovationfriendly environment for innovation development and implementation in SMEs. Some of the main priorities include: creating the necessary cluster infrastructure, stimulating cluster formation, and fostering cooperation between science and industry. Organisations such as the Lithuanian Innovation Centre play a key role in identifying and administering projects to fulfill these goals. Innovation policy in Lithuania is still quite new, and there are a number of issue areas remaining, including the creation of an effective financing system designed for innovative start-ups and the establishment of taxation incentives oriented to help innovation development and encourage research. Key actors supporting innovations: Technology parks (Science and Technology Park, Vilnius); Industrial R&D, Technology transfer & consulting structures (Lithuanian Innovation Centre, Kaunas university of technology innovation centre); Innovation & risk capital financing organizations (Baltic Small Capital Fund, INVEGA (CSC Investments and Business Guarantees), Baltic-American Enterprise Fund, Baltic Small and Medium Size Enterprise Fund); Networks & associations (6 business centres, 7 business incubators and 6 technology parks). The most innovative sectors in Lithuania (by proportion of firms implementing innovations ) are chemical product manufacturers (88%); food and drink (68%); furniture manufacturers (62%); machines and tools manufacturers (60%); construction materials (59%); light industry (47%) (Lithuanian Ministry of Economy, 2005).

Baltic entrepreneurship: implications for labour market and business innovation 71 The most innovative sectors (in terms of number of new and improved commercial products) are food and drinks, light industry and machines and tools manufacturers. The construction industry of Lithuania is lagging behind other sectors of the economy in terms of implementation of innovations; the use of both Lithuanian and EU support for S&T development (1998); and investment in S&T development (2000). The competitive strategy of the vast majority of Lithuanian companies is based on its relatively low labour and energy costs. This has an impact on innovation (2001). There has been a lack of investment by building construction firms in the development of products/processes that reduce heating costs (1998). Figure 2. Innovation policy making and delivering structures in Lithuania Source: Lithuanian Ministry of Economy, 2005. Table 8. Selected Innovation Indicators for the Baltic States, 2004 (%) Indicators EU-25 EU-15 The Baltic States Estonia Lithuania Latvia S & E graduates 11.5 12.5 6.6 14.6 8.1 Working population with 21.2 21.8 30.4 23.2 18.2 the 3 rd level education Public R&D expenditure 0.67 0.69 0.55 0.54 0.25 Business R&D 1.27 1.30 0.22 0.14 0.17 expenditure EPO hi-tech patents 26.0 30.9 2.6 1.3 0.5 EPO patents 133.6 158.5 8.9 2.6 6.0

72 Dainora Grundey SMEs innovating in house 31.7 32.1 36.9 21.5 15.9 SMEs innovating 7.1 6.9 11.3 12.3 4.0 cooperation Innovation expenditure 2.15 2.17 1.43 1.74 2.56 ICT expenditures/ GDP 6.3 6.2 11.5 8.2 10.1 Source: compiled from European Innovation Scoreboard (2005). Country Pages: EU25 + Candidate countries, p.29. One of the significant facts for the country s innovativeness is the public and private expenditures on the education (Table 8). It is important to note that the expenditure on education as a percentage of GDP has been reduced during the transition. Public expenditures on R&D in Estonia were 55% in 2004 as opposed to 79% in 2002 of GDP, similarly in Lithuania: reduced to 54% (2004) from 79% 2002) and Latvia: reduced from 43% (2002) to 25% in 2004. The business expenditures where much lower than public expenditures and amounted from 28% (2002) to 22% (2004) in Estonia, from 16% (2002) to 14% (2004) in Lithuania and from 20% (2002) to 17% (2004) in Latvia (2002) 1. Table 9. Major Government Funded Programmes and Initiatives in Favour of Innovation in Lithuania Programme Objectives of Funding available Responsible National Quality Programme (ended in 2001), some measures such as National Quality award still valid SME development programme Export development strategy action plan programme Increasing industry competitiveness through implementation of Total Quality management incentives and standards. Initiate and finance business development projects, promote favourable environment for SME development. To reduce deficit of foreign trade and serices balance, promote economic development of Lithuania, create new services and jobs, etc. Partial coverage of certification expenditures of enterprises, main part of funds directed towards implementation of International Quality Standards, training, etc. SME promotion fund: support of business incubators, business centres, technology parks, technical support to SMEs, Information and Training services for SME, Business development research support (interest rate subsidising and start-up support). Financing systematic measures for export promotion, such as creating more favourable infrastructure and supporting export related actions, such as participation in international exhibitions, industrial events, etc. Government body Ministry of Economy, Council of Quality Ministry of Economy, Lithuanian Development Agency for SME Ministry of Economy, Chamber of Commerce, Industrial Confederation and other professional associations also involved. 1 European Innovation Scoreboard 2004 & European Innovation Scoreboard 2002. Technical Paper No. 2, Candidate Countries, DG Enterprises.

Baltic entrepreneurship: implications for labour market and business innovation 73 Innovation in business programme Foreign direct investment promotion programme Increase international competitiveness of Lithuanian business, while promoting application of new scientific knowledge, technology developments and organizational incentives in business. To promote FDI in Lithuania. Part coverage of costs of innovative projects in enterprises, development of innovation support infrastructure. Promoting activities favouring investment conditions in Lithuania and creating investment infrastructure, (information services, international exchange of researchers and students, etc.). Ministry of Economy, Business Development Council, other bodies are involved in performing related tasks Ministry of Science and Education, Lithuanian Innovation Centre. Ministry of Economy, Ministry pf Foreign Affairs, Ministry of Science and Education, Lithuanian Development Agency. Source: compiled and structured after Innovation trends, 2004, p. 20. Estonia (30.4%) and Lithuania (23.2%) have the highest share of economically active population with the third level of education among CEEC. The Baltic States lag behind the EU-15 in all indicators except SME s innovation cooperation, working population with third level of education. Governmental Support to SMEs in Lithuania gets the shape in the following measures and programmes (Table 9): Tax credits and tax concessions granted according to the procedure prescribed by laws; Financial support provided by the Small and Medium-Size Business Promotion Fund; Financial support offered by the Government and local authorities in accordance with the small and medium-size business development programs; Support offered by guarantee institutions and/or insurance companies set up under the Law on the National Debt and other institutions which promote business development; Skills improvement services offered on favourable terms under business development and employment programs; The practice of accelerated depreciation applied to small and medium-size business, etc. Obstacles to Doing Business in Lithuania Data collected jointly by the EBRD and World Bank in 1999 and 2002 rating obstacles to doing business in 26 transition countries highlights a number of key problems as perceived by business owners: financial issues, infrastructure, tax issues, regulation, judicial issues, crime and corruption. The two survey results are presented in Table 10, for a relatively coherent group of eight new EU member states and three likely future members. Table 10. Average rating of obstacles to doing business in 1999 and 2002: New EU member states plus three likely future members Financial Infrastructure Tax issues Regulation Judicial Crime Corruption Countries 99 02 99 02 99 02 99 02 99 02 99 02 99 02 Bulgaria 2.9 2.9 2.3 1.2 3.0 2.4 2.2 1.7 2.3 2.0 2.7 2.1 3.1 2.2 Croatia 3.1 2.5 1.9 0.9 3.3 2.2 1.4 1.7 2.5 2.4 2.1 1.5 2.8 2.0 Czech republic 2.4 2.5 2.5 1.0 3.3 2.4 1.8 1.7 2.2 1.7 1.9 1.7 2.2 1.6 Estonia 2.4 2.1 1.6 1.4 2.7 2.0 1.1 1.8 1.8 1.7 1.6 1.7 1.7 1.6 Hungary 3.0 2.4 1.6 0.9 3.1 2.4 2.4 1.6 2.0 1.3 2.1 1.3 2.5 1.6 Latvia 2.6 2.0 2.1 1.7 3.2 3.0 1.8 2.1 2.4 2.0 2.1 1.8 2.6 2.2 Lithuania 2.5 1.9 1.8 1.6 3.3 2.8 1.6 1.7 2.3 2.3 2.2 1.9 2.3 2.1

74 Dainora Grundey Poland 3.0 3.0 1.7 0.7 3.2 2.9 2.3 2.0 2.4 1.9 2.5 1.9 2.7 1.9 Romania 3.0 2.7 2.5 1.6 3.3 3.0 1.4 2.0 2.3 2.5 2.0 1.9 2.2 2.7 Slovak republic 3.3 2.6 1.9 1.0 2.9 2.3 1.9 1.9 2.2 2.2 2.5 1.8 2.8 2.1 Slovenia 2.9 2.1 1.8 0.7 2.9 1.7 2.2 1.4 2.4 1.6 1.8 1.1 2.2 1.3 Mean 2.8 2.4 2.0 1.2 3.1 2.5 1.8 2.3 2.3 2.0 2.1 1.7 2.5 1.9 Lithuania s indices mean 0.3 0.5 0.2-0.4-0.2-0.3 0.2 0.1 0.0-0.3-0.1-0.2 0.2-0.2 Source: after Pissarides, 2004. Central and Eastern European (CEE) countries show visible improvements achieved in most areas, especially for infrastructure. However, regulation remains an exception, with very little progress on average, in some cases like Latvia, Lithuania, Estonia, Croatia, and Romania, the index has significantly deteriorated. For the Lithuanian case, business owners seem to be more greatly affected by financial barriers than most other transition countries. Tax issues also score high as business barriers for the Lithuanian business owners, however this is consistent with the results for other transition economies. In fact, the Lithuanian scores are slightly below the mean in this respect. While on average the business owners in CEE find taxes the most difficult area, the opposite is true for infrastructure. One may also note that corruption is a dimension where the standard deviation across this group of countries remains particularly high in both 1999 and 2002. On corruption, Lithuania improved its relative scores between 1999 and 2002 (from 2.3 to 2.1, while the CEEC mean is from 2.5 to 1.9), going down from marginally above the cross-country average to being marginally below in the latter year. Individual scholars have also researched the phenomenon of impediments to doing business in Lithuania. The attention could be drawn to the study performed by Aidis and Mickiewicz (2004). They formulated the questionnaire instrument related to perception of barriers in two parts. In the first part, the respondents were asked to assess the importance of nineteen business barriers, each separately. In the second part, the task was to identify the three most important barriers. The problem with the separate assessment of barriers is that it is based on 5 point Likert scale and the respondent is unable to differentiate between the most serious barriers, which are all given the highest scores. In this respect, the second question (enumerating the three most important barriers) has an advantage and this is the one we used for the subsequent analysis. For all of the barriers included in the questionnaire, Figure 3 below illustrates the frequency of responses identifying a given barrier as one of the three most important ones. Our estimation strategy was to include dummy variables for seven barriers, which were most frequently identified. It turned out that only those related to taxes and corruption were significant. In addition, there is multicollinearity between the tax dimensions, which makes the coefficients sensitive to small changes in specification and data, i.e. not robust and problematic to rely on. There is no single straightforward solution to this problem. Our response was to restrict ourselves to the two of the most important business barriers, namely taxes too high (63 percent) and corruption at the national level (17 percent) and exclude frequent changes to tax policies and ambiguity of taxes. However, interpreting the results, one should bear in mind that the retained tax indicator should not be narrowly related to the level of taxes, but interpreted as a proxy for a broader cluster of problems with tax system. The results of six specifications are reported below. Our dependent variable relates to expected growth categorised into four ranks, as described above, where the highest rank is the expected positive growth of both employment and turnover. In the first specification, Aidis and Mickiewicz (2004) used the dependent variable with four categories and include indicators for human capital, exporting, location, employment size categories, sectoral controls and perceptions of barriers, as described above. In the second specification, they

Baltic entrepreneurship: implications for labour market and business innovation 75 dropped insignificant factors. In the specification two, the authors used three categories of expected growth (instead of four) as dependent variable and in specification three they compreseds the dimensions further, by using expected employment growth as a binary variable, to see if the results are robust to the modification. Finally, specifications four to six, replicates the three previous ones with size measure given by turnover, instead of employment. Figure 3. Percentage of entrepreneurs in Lithuania identifying a given dimension as one of the three most important business barriers Source: Aidis & Mickiewicz, 2004, p. 14. Conclusions and recommendations for Lithuanian Innovation Policy (based on SWOT) The major national objectives for innovation at the current stage of development of NIS is the development of a favourable innovation support infrastructure and an internationally competitive R&D base in the priority areas (biotechnologies, laser technologies, mechatronics, IT and nanotechnologies), the improvement of the quality of human resources for R&D and Innovation (through increasing number of high quality study programmes at the graduate and doctoral level, development of innovative skills among science and technology graduates and scientists) and facilitation of R&D and business cooperation which should result in high value added technological, product and process innovations. However, the Lithuanian industry structure is still relatively unbefitting for rapid productivity growth and high value added manufacturing. According to the grouping of industries, by using criteria on industrial organisation and input use, Lithuania is dominated by: marketing-driven (32 percent),

76 Dainora Grundey capital-intensive (28.2 percent) and labour-intensive industries (20.9 percent), with a low share of mainstream industries (13.0 percent) and a moderate share of technology-driven industries (5.9 percent). Among the skill requirements, low skilled and medium skilled white-collar industries are predominant. Although few sectors such as biotechnologies, laser technologies, machinery and equipment show potential for growth, they are not significant in the general industrial structure. Table 11a. SWOT analysis for Lithuanian innovation policy formation: strengths & weaknesses STRENGTHS 1. Convenient geographical situation in the Baltics (ice-free port in Klaipeda, railways, motorways, airports); transit route to East West and North South; good transport infrastructure. 2. Good climatic conditions, suitable for agriculture, forestry, and for developing leisure and tourism sectors. 3. Reasonably stable economic environment. 4. Established trade links with Scandinavian and European countries as well as former countries of the Soviet Union. 5. Accession to the EU provides a large European market. 6. Access to a skilled and cost-effective labour force (in comparison to other EU countries). 7. Skilled IT, electronics and nuclear engineers. 8. Research-minded culture. 9. Relatively well-developed network of scientific and professional training institutions. 10. Established universities and colleges with good track records. 11. Track record in leading edge scientific disciplines (technology, laser technology, some medicine areas, etc.). 12. Numbers of scientific and technical graduates undertaking post-graduate research. 13. A framework of business support organizations, including incubators. 14. Some globally aware institutions have generated viable spin-out companies. 15. Disposition by school-leavers to undertake tertiary education. WEAKNESSES 1. Relatively new in developing private sector businesses, particularly on growth sectors, thus lack of critical mass and role model. 2. Low productivity level, especially in industry and agriculture sectors, probably due to poor investment, poor training, and risk-reward incentives. 3. Lack of mechanism for technology transfer. 4. Lack of coherent and well-delivered innovation and technology strategy and associated support. 5. Shortage of expertise required to deliver free market oriented innovation and enterprise development support to SMEs. 6. Lack of availability of capital and other SME support infrastructure. 7. Underdeveloped partnership culture and business networks. 8. Increasing gap in development between regions. 9. R&D institutes focus on basic (rather than applied) research. 10. Scientists lack business know-how and commercialization skills, and focus on basic (rather than applied) research. 11. lack of a patenting culture (intellectual property protection). 12. University system/curriculum does not encourage entrepreneurialism. 13. Manufacturing imbalance historical manufacturing specialization for large export market (Soviet) and lack of current domestic demand plus historical manufacturing specialization across Soviet bloc has resulted in gaps in supply