The Baltic Sea's Renaissance

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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.

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