By Heidi Brown

Capital Hospitality
February 6, 2006
Think of the Baltic countries, and images of Gorbachev’s tanks rolling through the Lithuanian capital of Vilnius in 1991 might come to mind. Or you might simply draw a blank. The tiny nations, which, along with Lithuania, include Estonia and Latvia, sit next to their much-larger neighbor Russia and attract little attention beyond their borders. Yet they have quietly and effectively created some very attractive incentives for foreign investors.

Even before the Baltic states were fully independent from their communist overlord, they were trying to reform their economies.

It was Lithuania’s implementation of price increases in early 1991 that brought Soviet troops across the borders of Estonia and Latvia and into the streets of Vilnius. The soldiers quelled protests, killing civilians in the process. The three counties became independent later that year and immediately set about making their economies more attractive. They knew it was a priceless opportunity; they were small and nimble and situated right in the heart of Europe–able to communicate with investors from Western and Central Europe and, eventually, Russia.

Today, according to a study, Estonia ranks No. 8 in the world in terms of the welcome it rolls out to foreign investors. Latvia ranks No. 22 and Lithuania No. 29. In accounting for the number of restrictions the countries place on foreign capital, the champion, Estonia, is in the 100th percentile, with the two others trailing slightly in the 92nd percentile. And the Baltics have clearly seen their reforms pay off: Estonia’s GDP is growing at a 7% clip, Latvia’s at 8% and Lithuania’s at a respectable 6%.

Last year, the U.S. State Department found that Estonia was the most competitive of all new European Union countries, and that one-third of its GDP was generated by companies owned at least in part by foreigners.

Estonia’s flat tax of 24% has made tax collection efficient and has earned its government a reputation for transparency and fairness. The country also doesn’t discriminate between foreign and domestic capital–it’s all treated the same. Such policies mean that, beyond the usual suspects, like McDonald’s (nyse: MCD – news – people ) and FedEx (nyse: FDX – news – people ), foreign investors include Bristol-Myers Squibb (nyse: BMY – news – people ), Eli Lilly (nyse: LLY – news – people ), 3M (nyse: MMM – news – people ) and Manpower (nyse: MAN – news – people ). The country’s 1.4 million residents are highly educated, but with an average per-capita monthly income of $600, Estonians earn a fraction of the incomes of their Scandinavian neighbors.

Although Latvia falls farther down Forbes’ list of most hospitable countries to foreign capital, it still ranks above far-wealthier nations, such as the Netherlands, France and Israel.

For Latvia, which was dominated alternately by Germany, Poland and Sweden for 700 years before being ruled by the Soviets, freedom has been especially sweet–and enriching: Its stock market was up 43% in 2005. With its German influence, Latvia’s picture-book capital, Riga, attracts tourists from around Europe, who come to enjoy the modest prices, continental service and surroundings that are just familiar enough to be comfortable. Investors come for the lax regulatory environment: The country has a score of 86 for regulation. Microsoft (nasdaq: MSFT – news – people ), Procter & Gamble (nyse: PG – news – people ) and General Electric (nyse: GE – news – people ) have noticed, and all have a presence in Latvia.

Of the three, Lithuania may have the furthest to go, but it still beats Belgium, the Czech Republic and Poland in terms of openness to foreign capital. And its citizens are reaping the benefits: Last year, the country’s unemployment rate stood at just 5%–compared with 8% for Belgium and 9% for the Czech Republic. Closest to Poland geographically, Lithuania at one time was part of an empire with its bigger neighbor that stretched to the Black Sea.

For this southernmost Baltic nation, privatization was not as easy as it was for Latvia or Estonia. In the 1990s, the Lithuanian government moved swiftly to take apart the collective farms that flourished during the Soviet era, and there were accusations of corruption and mafia participation in land reforms. Today, however, agriculture is fully privatized and is still a significant part of the economy. And U.S. companies have a strong presence here, too: Hertz, Hewlett-Packard (nyse: HPQ – news – people ), Merck (nyse: MRK – news – people ) and Pfizer (nyse: PFE – news – people ) are just some of the foreign firms in Lithuania, which–like its two Baltic neighbors–is known for its highly educated populace.

One measurement that the three Baltics share with pride is a median rating of 74 by Transparency International for their control of corruption. Compare that with Russia, which gets a depressing score of 21. It’s no secret that there is a direct connection between corruption and lack of foreign investment.