1. State of the Region-Report 2004: Competitiveness and Cooperation in the Baltic Sea Region Christian H.M. Ketels, PhD Institute for Strategy and Competitiveness Harvard Business School and Institute of International Business Stockholm School of Economics This presentation draws on joint work with Professor Örjan Sölvell and has benefited strongly from ideas that Professor Michael E. Porter has developed. The State of the Region-Report has been financed by VINNOVA. VINNOVA and the BALTIC DEVELOPMENT FORUM are the lead institutions in the project that this Report is part of. The full Report is available at www.bdforum.orgwww.bdforum.org Additional information on competitiveness research can be found at the website of the Institute for Strategy and Competitiveness, www.isc.hbs.eduwww.isc.hbs.edu

2. 2 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK The Baltic Sea Region Entering a New Era Past Present Ties in the region far below historical precedents Enthusiasm about freedom and opportunity in the East Main goal is political: integrate and secure West providing help to East; East providing new markets and access to low-wage labor Ties in the region far below historical precedents Enthusiasm about freedom and opportunity in the East Main goal is political: integrate and secure West providing help to East; East providing new markets and access to low-wage labor Many trade and organizational ties across the region Realism about benefits raises demands on cooperation Main goal is economic: raise prosperity across the region West and East operating with same objectives from different points of departure Many trade and organizational ties across the region Realism about benefits raises demands on cooperation Main goal is economic: raise prosperity across the region West and East operating with same objectives from different points of departure

3. 3 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Towards A New Strategy for the Baltic Sea Region How strong is the economic performance of the Baltic Sea Region? What is the profile of the economy in the Region? What are the strengths and weaknesses of the business environments across the Region? What are the implications for a sound regional strategy?

4. 4 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Profile of the Region Nordic Countries Denmark, Finland, Norway, Sweden 24 Mio. People (41% of the region) GDP of € 793bn (74%) Denmark, Finland, Norway, Sweden 24 Mio. People (41% of the region) GDP of € 793bn (74%) Northern Germany Hamburg, Mecklenburg- Vorpommern, Schleswig- Holstein 6.3 Mio. People (11%) GDP of € 172bn (16%) Hamburg, Mecklenburg- Vorpommern, Schleswig- Holstein 6.3 Mio. People (11%) GDP of € 172bn (16%) Northwest Russia Northwestern Region 16 Mio. People (27%) GDP of € 46bn (4%) Northwestern Region 16 Mio. People (27%) GDP of € 46bn (4%) Baltic States Estonia, Latvia, Lithuania 7.4 Mio. People (12%) GDP of € 34bn (3%) Estonia, Latvia, Lithuania 7.4 Mio. People (12%) GDP of € 34bn (3%) Northern Poland Zachodnio-Pomorskie, Pomorskie, Warmins- ko-Mazurskie 5.4 Mio. People (9%) GDP of € 24bn (2.5%) Zachodnio-Pomorskie, Pomorskie, Warmins- ko-Mazurskie 5.4 Mio. People (9%) GDP of € 24bn (2.5%) Source: EU (2004) Western shoreEastern shore

5. 5 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Real GDP Development Over Time Baltic Sea Region Countries, 1993 - 2003 Source: Groningen Growth and Development Centre and The Conference Board (2004), EIU (2004), authors’ calculations Sorted by CAGR, 1993 – 2003: Real GDP, PPP-adjusted, 1993 = 100

6. 6 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Key Observations Profile of the Region Clear dominance of the Nordic countries in the overall Baltic Sea Region economy –Countries on the eastern shore still account for only 10% of the regional economy –In addition, Germany, Poland, and Russia all have their economic centers of gravity outside the Region Overall growth performance of economies in the Region suggests dominance of nation-specific over regional factors –Among western shore countries, Nordic countries did in general better than Germany but even among them differences emerge –Among the eastern shore countries, Poland and the Baltic countries followed different paths. Lithuania in particular stands out with its late bounce-back from the transition crisis

7. 7 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Measures of Competitiveness Productivity Innovative Capacity Competitiveness ProsperityProsperity Source: Michael E. Porter

8. 8 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Prosperity Selected European Regions and Countries Estonia Baltic Sea Region Iberian Peninsula Central Europe British Isles Norway Denmark Finland Poland (North) Russia (Northwest) Lithuania Latvia Sweden Germany (North) Real GDP per Capita 2003, PPP-adjusted, $-US (1999) Growth of Real GDP per Capita (PPP-adjusted), CAGR, 2000-2003 Source: Groningen Growth and Development Centre and The Conference Board (2004), authors’ calculations

9. 9 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Decomposing Prosperity IncomeIncome Labor Productivity Labor Utilization Domestic Purchasing Power Consumption taxes Local market competition Efficiency of local industries ProsperityProsperity Skills Capital stock TFP Working hours Unemployment Participation rate Population age profile

10. 10 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Key Findings Performance Drivers Labor utilization - employees per capita and hours worked per employee are highest of all peer regions –Gap to Iberian Peninsula and British Isles is, however, falling; it is slightly increasing versus Central Europe Labor productivity is on par with Central Europe and Iberian Peninsula, lagging the British Isles –Baltic Sea Region is currently improving its position versus peer regions Domestic purchasing power of income is lowest of all peer regions –Gap to Iberian Peninsula and British Isles is, however, falling; it is slightly increasing versus Central Europe Advantages Disadvantages

11. 11 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Economic Performance Decomposition by Baltic Sea Sub-region Nordic countries GermanyPoland Baltic countries Russia Labor Productivity ++ - - - - Employees per capita =0--++ Hours worked per Employee --+++ Domestic Purchasing Power --+++++++ Prosperity (% of Region) 154%150%53% 37% Note: +++ for >150% above Baltic Sea Region average, ++ for > 50%, + for > average, - for < average, - - for < 30%, - - - for < 50% Source: Groningen Growth and Development Centre and The Conference Board (2004), national statistics (2004), authors’ calculations

12. 12 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Note: Bubble size is relative to total U.S. patents filed in 2002; sub-national region shares by GDP share Source: USPTO (2004), author’s analysis. U.S.Patents filed per Capita, 2003 Growth of U.S. Patents Filed per Capita, CAGR, 1998 - 2003 Innovation Performance Patenting in the U.S. Estonia Central Europe British Isles Norway Denmark Finland Russia (Northwest) Lithuania Sweden Iberian Peninsula Baltic Sea Region Germany (North) Poland (North)

13. 13 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Innovation Performance Top Patenting Organizations ERICSSONSweden1246 NOKIAFinland809 NOVO NORDISK A/SDenmark553 VALMET CORP.Finland273 SANDVIK AKTIEBOLAGSweden236 AKTIEBOLAGET ASTRASweden202 BEIERSDORF AGGermany136 ASEA BROWN BOVERI ABSweden133 AB VOLVOSweden126 ERICSSON, INC.Sweden99 TETRA LAVALSweden96 DANFOSS A/SDenmark95 SIEMENS ELEMA ABSweden94 AKTIEBOLAGET ELECTROLUXSweden90 DRAGERWERK AGGermany83 PACESETTER ABSweden81 PHARMACIA & UPJOHN ABSweden75 KVAERNER PULPING AKTIEBOLAGSweden74 HALDOR TOPSOE A/SDenmark71 U.S. Patents, 1997-2001CompanyCountry Source: USPTO (2004), author’s analysis.

14. 14 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Other Economic Indicators World Export Market Share over Time Central Europe British Isles Iberian Peninsula Baltic Sea Region Source: WTO (2004), author’s analysis. World Export Market Share

15. 15 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Other Economic Indicators Relative Export Intensity Share of World Exports versus Share of World GDP, 2001 Source: WTO (2004), EIU (2004), author’s analysis.

16. 16 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Note: Bubble size is relative to FDI stock in 2001; subnational regions by their share of national GDP Source: UNCTAD (2004), author’s analysis. Inward FDI stock as % of GDP, Average 1999- 2001 Inward FDI Flows as % of Domestic Capital Formation, Average 1999-2001 Other Economic Indicators Inward FDI Position Estonia British Isles Norway Denmark Finland Poland (North) Russia (Northwest) Lithuania Latvia Sweden Baltic Sea Region Iberian Peninsula Germany (North) Central Europe

17. 17 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Other Economic Indicators Multinational Companies’ Home Base Business Week 1000 Fortune Global 500 British Isles77 Baltic Sea Region 30 Sweden15 Finland 5 Norway 5 Denmark 4 Northern Germany 1 Iberian Peninsula13 Central Europe11 British Isles77 Baltic Sea Region 30 Sweden15 Finland 5 Norway 5 Denmark 4 Northern Germany 1 Iberian Peninsula13 Central Europe11 British Isles36 Baltic Sea Region15 Sweden 6 Finland 4 Denmark 2 Norway 2 Northern Germany 1 Iberian Peninsula 7 Central Europe 7 British Isles36 Baltic Sea Region15 Sweden 6 Finland 4 Denmark 2 Norway 2 Northern Germany 1 Iberian Peninsula 7 Central Europe 7 Note: Business Week ranks by Market Value, Fortune by Revenues Source: Business Week (2004), Fortune (2004), author’s analysis.

18. 18 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK The Composition of Economies Local industries Do not compete across regions Tied to location Dominated by services More critical for prosperity than for income 68% of employment 57% of income 31% of employment 42% of income Cluster Compete across regions/countries Can locate anywhere Strong role of manufacturing Critical for income Source: Michael E. Porter, Economic Performance of Regions, Regional Science (2004), Cluster Mapping Project, Institute for Strategy and Competitiveness, Harvard Business School Natural-resource based industries 1% of income and __employment

19. 19 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK *Growth figures exclude Baltic States and Northwest Russia Source: WTO (2004), Institute for Strategy and Competitiveness, author’s analysis. World Market Share, 2000 Absolute Growth* of Exports, 1995 - 2000 Cluster Composition Baltic Sea Region Export Performance by Cluster Entertainment Transportation Food & Beverages Forest Products Health Care Multiple Business Materials & Metals Petroleum/Chemicals Power Semiconductors Telecommunication Textiles & Apparel Office Household Personal BSR overall: +2.1% (versus +5.3% world trade) BSR overall: 5.36%

20. 20 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Nordic Telecom Forest Products Health Care Oil/Chemicals Food Products Defense Power Household Metals Multiple Bus. Entertainment Office Semiconductor Transportation Textiles Personal Telecom Forest Products Health Care Oil/Chemicals Food Products Defense Power Household Metals Multiple Bus. Entertainment Office Semiconductor Transportation Textiles Personal Germany Semiconductor Transportation Office Personal Multiple Bus. Textiles Entertainment Power Health Care Household Metals Food Products Oil/Chemicals Forest Products Telecom Defense Semiconductor Transportation Office Personal Multiple Bus. Textiles Entertainment Power Health Care Household Metals Food Products Oil/Chemicals Forest Products Telecom Defense Russia Defense Oil/Chemicals Metals Multiple Bus. Forest Products Personal Food Products Power Textiles Transportation Entertainment Semiconductor Household Office Health Care Telecom Defense Oil/Chemicals Metals Multiple Bus. Forest Products Personal Food Products Power Textiles Transportation Entertainment Semiconductor Household Office Health Care Telecom Baltic Textiles Forest Products Household Food Products Entertainment Telecom Metals Personal Power Oil/Chemicals Office Transportation Health Care Semiconductor Multiple Bus. Defense Textiles Forest Products Household Food Products Entertainment Telecom Metals Personal Power Oil/Chemicals Office Transportation Health Care Semiconductor Multiple Bus. Defense Relative Cluster Specialization Baltic Sea Sub-Regions Poland Textiles Entertainment Personal Household Metals Transportation Power Defense Food Products Forest Products Multiple Bus. Office Semiconductor Oil/Chemicals Health Care Telecom Textiles Entertainment Personal Household Metals Transportation Power Defense Food Products Forest Products Multiple Bus. Office Semiconductor Oil/Chemicals Health Care Telecom Higher share Lower Share Source: WTO (2004), Institute for Strategy and Competitiveness, HBS (2004), author’s analysis.

21. 21 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Microeconomic Foundations of Development Quality of the MicroeconomicBusinessEnvironment MicroeconomicBusinessEnvironmentSophistication of Company Operations and StrategySophistication of Company Operations and Strategy Determinants of Productivity and Productivity Growth Macroeconomic, Political, Legal, and Social Context for Development A sound macroeconomic, political, legal, and social context creates the potential for competitiveness, but is not sufficient Competitiveness ultimately depends on improving the microeconomic capability of the economy and the sophistication of local companies and local competition Source: Michael E. Porter

22. 22 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Business Competitiveness Index Ranking of European Regions and Countries Baltic Sea Region British Isles Central Europe Iberian Peninsula TOTAL RANK 6 Finland 1 Sweden 3 Denmark 4 Germany 5 Norway22 Estonia28 Latvia29 Lithuania40 Poland46 Russian Federation 63 TOTAL RANK 6 Finland 1 Sweden 3 Denmark 4 Germany 5 Norway22 Estonia28 Latvia29 Lithuania40 Poland46 Russian Federation 63 TOTAL RANK 9 United Kingdom 6 Ireland21 TOTAL RANK 9 United Kingdom 6 Ireland21 TOTAL RANK 21 Germany 5 Austria17 Slovenia30 Czech Republic35 Hungary38 Slovak Republic42 Poland46 TOTAL RANK 21 Germany 5 Austria17 Slovenia30 Czech Republic35 Hungary38 Slovak Republic42 Poland46 TOTAL RANK 27 Spain25 Portugal36 TOTAL RANK 27 Spain25 Portugal36 Source: Global Competitiveness Report (2003), author’s analysis.

23. 23 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Context for Firm Strategy and Rivalry Related and Supporting Industries Factor (Input) Conditions Factor Demand Conditions Business Environments’ in the Baltic Sea Region Key Observations + +Strong physical infrastructure, especially for communication + +High skill base of the labor force + +Well developed science system + +Public servants apply laws with neutrality; low level of corruption – –Significant level of bureaucracy – –Emerging weaknesses in the education system + +Presence of a number of globally competing cluster + +Strong basis for the activation of existing clusters + +Companies competing globally on innovation and differentiation + +High formal openness of markets – –Low rivalry on many local markets – –High level of taxation, especially on labor, reduces incentives – –Presence of distortive subsidies, especially in Germany and Russia + +Demanding regulatory standards, especially on environmental issues – –Buyer sophistication, including government procurement, is only average Source: Global Competitiveness Report (2003), author’s analysis.

24. 24 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Lithuania Factor Conditions Spending on Human Resources Growth in Spending on Human Resources, CAGR 1995-2001 Baltic Sea Region Estonia Norway Denmark Finland Poland (North) Latvia Public expenditure on education as % of GDP, 2001 Central Europe Iberian Peninsula British Isles Germany (North) Sweden Source: EU Structural Indicators (2004), author’s calculation

25. 25 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Factor Conditions Average of Reading, Scientific, and Mathematical Literacy Average Educational Attainment, 2000 Source: OECD PISA-Study (2003), author’s calculation OECD average

26. 26 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Context for Strategy and Rivalry Market Pressure Baltic Sea Region Nordic Germany Baltic Poland Russia Effectiveness of Anti-Trust Policy10 Hidden Trade Barrier Liberalization11 Foreign Ownership of Companies12 Intensity of Local Competition18 Tariff Liberalization20 Administrative Burden for Start-Ups22 Extent of Locally Based Competitors23 Extent of Distortive Subsidies29 Effectiveness of Anti-Trust Policy10 Hidden Trade Barrier Liberalization11 Foreign Ownership of Companies12 Intensity of Local Competition18 Tariff Liberalization20 Administrative Burden for Start-Ups22 Extent of Locally Based Competitors23 Extent of Distortive Subsidies29 11 10 16 22 24 21 37 17 11 10 16 22 24 21 37 17 5 13 11 13 15 34 4 93 5 13 11 13 15 34 4 93 43 41 52 39 38 34 46 26 43 41 52 39 38 34 46 26 45 52 47 51 45 52 46 78 45 52 47 51 45 52 46 78 73 79 93 83 76 84 48 70 73 79 93 83 76 84 48 70 Nordic and Germany both formally open for competition but effective competitive pressure is significantly lower in Nordic countries High differences in competitive intensity among Baltic countries, Poland, and Russia Source: Global Competitiveness Report (2003), author’s analysis.

27. 27 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Context for Strategy and Rivalry Taxes on Production Direct Taxes and Social Security Contributions as % of GDP, 2002 Source: Eurostat (2004), author’s analysis. Social security contributions Direct taxes (labor, capital)

28. 28 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Context for Strategy and Rivalry Flexibility of Firing Less flexible More flexible Source: World Bank (2004), author’s analysis.

29. 29 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK EU-14 + Norway Overall Cluster Strength in Europe GCR Ranking 2 4 5 7 8 9 10 14 15 17 18 21 25 41 51 2 4 5 7 8 9 10 14 15 17 18 21 25 41 51 Finland Italy Germany Denmark Sweden United Kingdom France Austria Netherlands Spain Ireland Belgium Norway Portugal Greece Finland Italy Germany Denmark Sweden United Kingdom France Austria Netherlands Spain Ireland Belgium Norway Portugal Greece Accession Countries 31 32 33 34 40 44 45 53 68 31 32 33 34 40 44 45 53 68 Czech Republic Lithuania Latvia Poland Slovak Republic Estonia Slovenia Hungary Malta Czech Republic Lithuania Latvia Poland Slovak Republic Estonia Slovenia Hungary Malta Source: Global Competitiveness Report 2003/04, Institute for Strategy and Competitiveness (2004)

30. 30 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Innovation Capacity 1 5 10 20 15 25 30 35 40 Rank on Innovation Capacity Index, 2003 Source:Michael E. Porter/Scott Stern (2003), author’s calculations

31. 31 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK 30 Rank on Innovation Capacity Sub-indices, 2003 1 10 20 40 50 60 70 80 Innovation Capacity Sub-Index by Country or Sub-Region Source:Michael E. Porter/Scott Stern (2003), author’s calculations Proportion of Scientists and Engineers Index Innovation Policy Index Cluster Innovation Environment Index Innovation Linkages Index Operations and Strategy Index

32. 32 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Source: EU Innovation Scoreboard 2003, author’s calculation Annual Growth of Gross Domestic R&D Spending, average of three preceding years - 2001 Factor Conditions Total R&D Spending Gross Domestic R&D Expenditure as % of GDP, 2001 (or latest available) British Isles Nordic Baltic States Iberian Peninsula Germany (North) Central Europe Poland (North) Baltic Sea Region

33. 33 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Factor Conditions Share of R&D Spending by Business Source: EU Innovation Scoreboard 2003, author’s calculation Business Share of Total R&D Spending, 2001 (or latest available)

34. 34 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Influences on Competitiveness Multiple Geographic Levels Broad Economic Areas Groups of Neighboring Nations States, Provinces Cities, Metropolitan Areas Nations World Economy Source: Michael E. Porter

35. 35 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Regional Cooperation Levels Stage 3: Joint action Limited independence Includes joint positioning of the region abroad, including in international/ supranational bodies Stage 2: Coordinated action Medium level of independence Includes joint efforts to upgrade border procedures, improve infrastructure, develop clusters,.. Stage 1: Learning and benchmarking Leaves national autonomy fully intact Includes networks covering all areas of policy in an “open model of cooperation” Countries act in isolation Countries act as one

36. 36 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK HighLow Regional Cooperation Benefits and Costs of Regional Heterogeneity Degree of Heterogeneity Easy to develop a common identity Easy applicability of others’ experience Balanced distribution of benefits Regional cooperation is easier but provides fewer benefits Huge potential gains from regional benchmarking Huge potential gains from division of labor Regional cooperation is harder but provides higher benefits

37. 37 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK Situation Implications of the Report Key Implications Stage 3: Joint action Stage 2: Coordinated action Stage 1: Learning and benchmarking More ambition than reality Some activities currently under way Many activities currently under way Current patterns of heterogeneity suggest high benefits but also difficulties in achieving joint action High level of regional integration signals room for development of strategic action plan High remaining heterogeneity in the region signals ample room for further cooperation

38. 38 Copyright 2004 © Christian H. M. KetelsBaltic Sea Region Report – HH Conference 09-02-04 CK The Way Ahead BDF Meeting Hamburg 2004 Launch of the 1 st State of the Region- Report Set a structure for the regional debate Provide data to review performance, cluster composition, and business environment quality across the Region BDF Meeting Stockholm 2005 2 nd State of the Region-Report Provide data to discuss the positioning of the Baltic Sea Region Provide data to set regional action priorities Provide data on current regional efforts Ongoing discussions in the Region Validate the performance and business environment quality assessment Identify areas for further in-depth analysis Develop the foundations for an institutional capacity to act Moving to Action Launch meetings to define a regional strategy for action Launch institutional structure to coordinate decision making and implementation