Vaidotas Šumskis, Chief Analyst at Finora Bank
Lithuania and Estonia have been competing in the IT sector for a long time. Over the past two years, Lithuania has become the fastest-growing economy in the Baltic region, avoiding the economic downturns that have affected Estonia and Latvia. Lithuanian IT companies and startups, which used to look up to Estonia as a model, are now catching up quickly.
Lithuania’s fintech sector and its fast-growing service export growth have been increasingly mentioned in Estonian media. Earlier this year, a Dealroom report highlighted that Lithuania’s startup ecosystem is the fastest growing in Central and Eastern Europe. In H2 of 2023, Lithuanian startups attracted more capital than those in Estonia, which used to lead in this area. Tallinn has long been the wealthiest region in the Baltics, but now Vilnius is taking over that position.
So, is Estonia’s star as a leader in IT exports and startups fading? Is Vilnius becoming the new tech capital of the Baltics?
Estonia Leads in Software Development Over Lithuania
Despite the overall economic downturn in Estonia, software development companies are thriving. In the first quarter of this year, their revenue grew by 18% even after adjusting for inflation. In contrast, the picture in the other Baltic countries is less optimistic. In Lithuania, inflation-adjusted revenues of software development companies barely changed, increasing by just 0.4%, while in Latvia, they decreased by 2%.
In other IT sectors, such as services, Lithuania and Latvia are experiencing growth, while Estonia lags behind. Adjusted for inflation, Lithuania’s web administration, data centers, and IT support services grew by an impressive 111% over the year. In Latvia, this sector grew by 3% annually. By comparison, real revenues for IT services businesses in Estonia decreased by 2% in the same period. Additionally, Estonia’s business administration and other back-office services sector has shrank by 29%, while in Lithuania, it grew by 72%.
Estonia is finding it increasingly difficult to match Lithuania’s growth. However, it’s important to note that software development and IT support services are separate business areas. While Lithuania and Latvia are expanding rapidly in IT services, Estonia remains the unquestioned leader in software development.
Why Estonia Remains Stronger than Lithuania in the IT Sector
Software development is a high-value sector with huge competition. Estonia’s steady growth in this field indicates that its software businesses are among the best in the world in terms of experience, capabilities, and efficiency.
Instead, IT support services are cost-sensitive, creating a risk that large international corporations may eventually relocate their support units to cheaper countries like India, as they previously did by establishing IT support service centers in the Baltics.
Market size also matters. In Estonia, software development is a crucial sector, contributing 10% to the country’s GDP, compared to only 4% in Lithuania. Meanwhile, IT support services contribute just 0.4% to Estonia’s GDP, whereas in Lithuania, they contribute 2%.
Lithuania’s larger population, international outlook, close connections with foreign investors and partners, and significant diaspora, especially in the USA, create beneficial conditions for IT sector growth. However, it will take time for Lithuania to catch up and match Estonia in terms of quality and value. This requires a more efficient education system and a mature IT ecosystem where businesses, the state, and educational institutions collaborate closely, supported by sufficient venture capital, experience, and networks provided by successful entrepreneurs.
Funding: The Major Challenge Ahead
Despite the competition, the Baltic countries are more like allies than competitors on a global scale. A stronger Baltic region can open more doors for new market players and attract more investment opportunities.
The main challenges for the IT sector come from a lack of funding, affecting Estonia, Lithuania, and Latvia. Working together could boost economic growth and digital progress in the Baltic region.
One significant obstacle is that IT companies, often small businesses, struggle to get the funding they need. Data from the European Commission, European Investment Bank (EIB), and OECD show this. Compared to other Central and Eastern European countries, small businesses in Lithuania and Estonia face higher loan rejection rates. Based on a 2023 EIB survey, 16% of Lithuanian companies applying for loans were rejected, while in Estonia, the rate was 13%, compared to 6% in other European countries.
However, there are positive trends. The banking market in the Baltics has become more dynamic and competitive recently. Increased competition will benefit many small businesses, and better access to funding will help grow the IT sector.