Are there spots on the gloss of Estonia?

07.10.2010, 18:17

The following article was published in Eastern Approaches section of The Economist on October 2.

Few outsiders know the Baltic states better than James Oates, a Scottish investment banker and blogger. So Estonians and their friends should take note of his sharply worded remarks about the Estonian government's treatment of Tallinna Vesi, the foreign-owned company that runs water and sewerage in the Estonian capital. Estonia has long prided itself on an exemplary reputation in everything from anti-corruption indices to rankings of business-friendliness. That has stoked smugness (never far from the surface in Estonia) and perhaps even a degree of complacency.

But as Oates points out, Estonia's record on treating big foreign investors is a bit spotty

“... few of the major international investments in Estonia over the course of the past few years have gone smoothly. The American investment in Estonian Railways ended in acrimony and a more or less forced renationalisation. The American investors were caught between powerful Russian interests which limited their participation in the lucrative Russian freight market. However they also faced challenges from the Estonian political establishment that repeatedly kept trying to alter the terms of the contracts which the Americans had signed in good faith. In part this was perhaps because many Estonian politicians had developed grave doubts about the wisdom of Rail privatisation in the first place, but possibly it was also because they had fundamental misunderstandings about the nature and strategy of the business. The investment ended in a welter of arbitration and litigation, with the American investors more or less accusing the Estonian government of using force majeur against them. At that time, several allegations of corruption were also made against political and state figures in Estonia.
”Now Tallinn Water, which used to be seen as a model example of privatisation, is embroiled in a similar row

“The terms of the privatisation were clear and, although the pro forma return on investment was relatively low, United Utilities [the British owner] have made substantial investments in order to bring Tallinn Water up to international standards. Now, however, the company is facing political pressure to restructure and to reduce its prices well below the levels agreed under the formula set at privatisation. Furthermore, the company believes that specific legislation targeting Tallinn Water is being drafted- which it considers to be purely arbitrary. The company has repeatedly requested meetings with state officials and these have been repeatedly denied. The government appears to be dealing with Tallinn Water, as with other investors, on the basis of ultimatum and not negotiation. Putting pressure on investors by creating a kind of Kangaroo court of public opinion is dangerous populism.”
Oates blames the "small and clannish nature of much of the Estonian political system" which can be "opaque to international investors". He also takes a brisk swipe at the Faustian pacts that some free-market politicians have entered into. For legal reasons I won't repeat his central allegation here. He concludes

“The fundamental basis of a healthy free market economy and democratic politics is trust- and investors have found that they can not always trust the Estonian state not to break or unilaterally alter the contracts that they have entered into, or to properly investigate serious allegations of malpractice. Whether this is the result of corruption, bloody mindedness or just incompetence, it still amounts to the same thing: considerable damage to the country.”

To be fair to the government, voters are quite cross about Tallinna Vesi and what they see as its inordinate price rises. Politicians have to listen to their electorate. But they also have to explain reality. The original terms of the privatisation may have been too soft, and the regulatory oversight too lax. But breaking a bad deal is often even costlier than honouring it. Estonia may find that the price of an acrimonious public lawsuit with a high-profile investor is more than just lawyers fees and compensation payments

Link to the original article: http://www.economist.com/blogs/eastern-approaches