Thursday, May. 31, 2007 By ANDREW PURVIS/RIGA 
DECLINING ORDERS: An exception to the region-wide boom, the Polish shipbuilding city of Gdansk has struggled to stay competitive KATARINA STOLTZ / REUTERS
Locals in Riga, the Latvian capital, have a favorite trivia question: what was the biggest city in the 17th century Swedish empire? (Hint: it wasn't Stockholm.) For centuries, the stately medieval port on the shores of the eastern Baltic Sea served as the bustling gateway between Russia and the West. Then, following World War II, it withered after the Iron Curtain fell across Eastern Europe, cutting it off from the outside world. But Riga is now experiencing a renaissance. It may not have re-established the prominence it enjoyed 400 years ago, but as any of its trivia-wielding residents will tell you: it's getting there.
Today, the ancient city has emerged as one of a string of economic miracles on Europe's northern fringe. Trade volume in Riga has more than doubled over the past 10 years, and the average annual income has almost tripled to $6,200. Nearly 80% of Latvia's exports — from timber to textiles to farm machinery — now heads to markets in the West. Tourism is booming, too: last year, ferries, cruise ships and low-cost airlines disgorged 1.5 million visitors in Riga, up from 1.1 million the previous year. Visvaldis Lacis, an 83-year-old author and parliamentarian, recalls that under Soviet rule the kgb stopped every ship entering and leaving the harbor to check for spies and stowaways. Lacis now watches as a black and red Cypriot-flagged container ship slides by on its way to the sea. "This," he marvels, "is freedom."
Riga's revival is part of a broader expansion that has buoyed the Baltic Sea region, an area that comprises about 70 million people living in nine countries bordering the sea. Established players like Sweden and Finland are pairing up with emerging economies (and recent E.U. inductees) like Lithuania, Estonia and Latvia to transform a region once better known for herring, bad weather and cold war naval maneuvers into a global economic dynamo. "It's a hot spot for growth," says Peter Egardt, a Swede who heads the Business Advisory Council at the intergovernmental Council of Baltic Sea States.
When the leaders of the G-8 countries descend on the Baltic seaside resort of Heiligendamm in eastern Germany on June 6-8 for their annual summit, they will be visiting a part of the world where eight of nine countries are growing faster than the E.U. average; where several, including Latvia, which last year expanded 11.9%, are topping the European table; and where trade is expected to soar 50% by 2020. The port at Hamburg, just west of Heiligendamm, has seen a 40% increase in cargo shipped through the Baltic Sea in each of the past three years. As host of the summit, Germany has proposed a comprehensive agenda for world leaders ranging from more aid to Africa to persuading the U.S. to agree to a timetable for addressing climate change. But the meeting will also stress the importance of lowering existing barriers to investment and trade worldwide, with German Chancellor Angela Merkel stressing in the runup to the summit that "it is about mutuality, reciprocity." These are virtues that the freewheeling Baltic Sea countries pioneered in the 1200s and now embody once again.
Trading ships have plied the Baltic for more than 1,000 years. In the 13th century, the ports of Riga, Tallinn, Danzig (now Gdansk) and Hamburg, among others, belonged to the Hanseatic League, the world's first free-trade alliance, which dominated east-west commerce in Europe for the better part of 400 years. The cold war did not freeze trade altogether, but it introduced a bitter chill. Ships continued to sail the grey waters, carrying grain to Russia, and Lada automobiles to Africa and Latin America. But cities like Riga that had ties with Western Europe were compelled to turn inward, while ports such as Stockholm and Hamburg found themselves cut off from some of their oldest trading partners.
In Latvia, everything changed in 1994 when Russia withdrew the last of its military. Shortly afterward, the Latvian government began auctioning state-owned port facilities to American, Russian, Latvian and Norwegian companies. The port doubled in size as new container and passenger terminals sprang up. At its low ebb, in the early 1990s, only 1,000 ships entered the port each year; now more than 3,600 do so. Hermanis Cernovs, a naturalized Latvian born in Russia, has witnessed the transformation at first hand. When the Iron Curtain fell, he was commander of a Soviet nuclear submarine. Today, he organizes joint sea-rescue exercises with France, Sweden and the U.S. as the head of the Latvian coast guard. "The changes of the past decade were very, very fast," he says in English, the region's new lingua franca. "They were completely unexpected."
The new openness has had a visible effect in Riga. Jobs are plentiful and wages are rising fast: for construction workers, they jumped 50% last year. Prosperity is evident in everything from new Swedish hyper-markets, where parking spots are hard to come by, to the Italian cars rolling around the city's cobblestone streets. "If you want to do something, you have a future here," says Eri Esta, the 33-year-old chairman of a major stevedoring firm at the port. Esta, who graduated from a local business school in 2005, now earns a comfortable salary, takes vacations in Western Europe and the U.S., and often travels to Russia and central Asia to drum up business. Ten years ago, he says, this lifestyle would have been "unthinkable."
That pattern has repeated itself throughout Eastern Europe. As the Soviet Union melted away, newly unfettered countries were primed and hungry for economic growth. Back in 1994, for example, Estonia became one of the world's first regimes with a flat tax on corporate and personal income. These young democracies also benefited from advantages shared by the region as a whole, including enviable political stability, social cohesion and a sound regulatory environment. Equally key, they boasted high levels of education and innovation, giving rise to outfits like the Internet telephone company Skype, which was founded by a Dane and a Swede and was based on computer code written by Estonians. Established multinationals, meanwhile, such as Finland's Nokia and Sweden's Ikea, with their global customer networks, strengthened the region's links to the outside world. And never underestimate the dumb luck of geography: 90% of the world's trade is still transported by sea, and the Baltic is the major marine waterway of Eastern Europe. At a recent meeting of Baltic states, Swedish Foreign Minister Carl Bildt joked that the region possessed in its various countries all the components of an ideal economy — the Baltics' pro-growth policies, Finland's gift for innovation, Norway's energy resources and Sweden's wealth of executive talent.
That magic combination has attracted a flood of foreign money, including large sums from the U.S. and the U.K. But investment between the Baltic Sea nations has been crucial too, now comprising one quarter of the region's investment flows. And the financial superpower within the Baltic Sea is undoubtedly Sweden, accounting for 60% of that regional investment. Two years ago, for example, Sweden's fourth largest bank, Swedbank, completed a $2.6 billion takeover of the Hansabank Group, the Baltics' biggest bank, whose distinctive sea-green and orange Viking ship logo can be found from Tallinn to Vilnius. The marriage has worked out well so far. "We have been very, very happy about this interest from the Nordic countries. You can't overestimate their role," says Hansabank's ceo, Erkki Raasuke, a 36-year-old Estonian. The feeling is mutual: Hansabank generated 27% of Swedbank's $1.6 billion in profits last year.
Raasuke says his bank's experience with Swedbank is a good illustration of how Baltic Sea countries can work together. As a young banker in Tallinn, his first contact with the outside world after his country gained independence from Moscow in 1991 was with Finns and Swedes. They were ready to offer young bankers, new to capitalism, advice on how to organize such things as international payments. "Here were these tiny nations splitting off from the Soviet Union and we needed help," says Raasuke. Later, he adds, his bank needed equity following the Russian ruble crisis of 1998: "Who do you go to? You go to your best friends. The ones you've been talking to all along."
Raasuke predicts that the area's integration will only intensify. Many companies, including his own, already treat Estonia, Latvia and Lithuania as a single market. And close investment ties have already bred closer trade and cultural ties. A decade ago, there was just one flight a day between Tallinn and Stockholm. Now there are six. At Swedbank, half the staff is currently based in the Baltic states or Russia. Such connections have helped drive Sweden's own growth and bolstered its ability to compete on a global stage. When New York City-based nasdaq launched a bid to acquire Sweden's omx in late May, part of the attraction was that omx owns stock exchanges throughout the Baltics.
The news has not been uniformly good, however, and some Baltic cities have fallen behind. Gdansk in northern Poland was another Hanseatic League trading center that has recently emerged from communism. But like other parts of northern Poland and eastern Germany, it has failed to attract the levels of investment enjoyed by some Baltic cities. In the 1970s, Gdansk's famous shipyard employed 17,000 people and produced 30 ships a year. Today, as Japanese, South Korean and other shipbuilders have come to dominate, 3,000 Polish workers in Gdansk produce just a handful of ships, while Poland's share of the shipbuilding market has fallen from 4% to 1.6% since the early 1990s. "The shipyard industry used to be the jewel in the crown of the Polish economy under communism. Now it's a drag," says Andrzej Buczkowski, deputy head of the Gdansk shipyard. He blames political interference from Warsaw and the government's unwillingness to embrace tough reforms that might cost jobs. Local and national governments have also been slow to stimulate investment in the kind of technology-intensive industries that would help places like Gdansk to compete.
Elsewhere along the coast the story is much the same. The area around the city of Szczecin, on the border with Germany, recently placed last among Polish regions in a ranking of economic development, hobbled in large part by scant foreign investment. Poland has generally been slower than its eastern neighbors to embrace economic reforms, while red tape and a lack of bureaucratic transparency have also contributed to an unfriendly business environment.
Even among the successful Baltic economies, some storm clouds are brewing. High growth rates have triggered fears of overheating, especially in the new democracies. Latvia's President Vaira Vike-Freiberga recently complained that Swedish banks are too generous with their loans, tempting Latvian consumers to load up on debt, and driving up the prices of everything from cars to property. Latvia's year-on-year inflation rate hit 8.9% in April, triggering devaluation rumors. Latvian loans are denominated in euros, so devaluing the national currency, the lat, would hit debtors hard. "Like any good party it has to come to an end," says Anders Paalzow, head of the Stockholm School of Economics in Riga. "The question is how bad the hangover will be."
Russia's strategic goals within this region also remain an enigma and a worry. Its resurgent economy could help fuel growth in the area, but a recent trend toward economic protectionism is a potential threat. Several years ago, for example, Moscow tripled export taxes on goods traveling to Latvia in order to help its own ports, a measure that has pumped up St. Petersburg but slowed growth in rivals like Riga. And despite all the hype about free trade, the Baltic Sea region is still not capitalizing on its full potential: an economic study by the Swedish Board of Trade estimates that the elimination of existing investment and trade barriers in all Baltic Sea countries would add 1% — or about $30 billion — to the region's overall gdp. That said, there are few parts of the world that have embraced open markets more fully or to greater effect.
Back in Riga, the first long summer evenings are bringing residents out into the cobblestone streets. Many gather near the iconic Freedom Monument, erected in 1935 in honor of the young nation's earlier experience of independence, which lasted only from 1921 to 1940. Today, the locals flock here to listen to jazz, snack on sushi and parade around in the latest Zara jeans. Down the street, billboards advertising Swedish banks (and McDonald's) mingle with a backdrop of copper-green medieval spires. Visitors wanting to understand the city's deep commitment to free trade could explore its many history museums. Or they could take a look at something more current: the carefree faces around them on this early summer night.
With reporting by Beata Pasek/Warsaw
Source: Purvis, A. (2007) The Baltic Sea's Renaissance. The Times, published 31.05.2007.