Thursday, September 30, 2010

Facing corruption in Estonia

There has been a certain amount of anguished debate in Estonia over the past few weeks over the way that Lithuania has been successfully attracting inward investment and Estonia has not. To a degree the comments from the Estonian establishment are well taken: Lithuania has been better at marketing and at providing incentives that the Estonian government -as a matter of principle- would not.

However, this is not the whole story, and the Estonian government needs to understand the consequences of several critical decisions that have been taken over the course of the past few years. In short, the country is in grave danger of losing its hard won reputation for open and fair dealing with international investors.

The fact is that 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.

Then there has been the long running saga of Estonian Energy. Again an American company, NRG, contracted to invest in the Estonian power sector after a period of negotiations that lasted over four years. Again, owing to internal political pressures, there were unilateral, material changes to contract terms and again the transaction ended in an acrimonious blizzard of litigation. The business urgently needs new capital, but as the planned IPO has been put off for another year, it could well be argued that many in the Estonian state have not taken their legal commitments seriously enough and that this is causing long term damage to the economy.

Now, yet another large scale international investment in Estonia appears to be receiving the same treatment: Tallinn Water. Up until now Tallinn Water had been considered a model for investment in local infrastructure. The terms of the privatisation were clear and, although the pro forma return on investment was relatively low, United Utilities 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.

In short, given the unfortunate track record of major investments into Estonia it is quite possible that Tallinn Water, like Estonian Railway and Eesti Energia is now facing political pressure which it is powerless to counter-act. The small and clannish nature of much of the Estonian political system can be very opaque to international investors, and more unfortunately still, the Estonian state seems to prefer it that way. A free economy requires a free and open dialogue, but at critical points the Estonians fail -apparently deliberately- to signal their intentions in a way that can be easily understood by investors. On occasion the supporters of free markets have entered into pacts with political figures that severely compromise Estonia as a genuinely fair and open investment market. In short, there have been a number of public allegations of corruption, not least by the investors in Estonian Rail, which prima facie may well be justified.

In the past Estonia has not taken action against well placed individuals who appear to have broken the law. The case of Victor Kaasik, a lawyer who was accused of defrauding his client and who has faced repeated allegations of ethics violations, is one of the more egregious examples. Despite multiple complaints to the Estonian bar association, so far, the case has not been publicly investigated and it seems that, so far, only the lightest of sanctions have been taken. This is widely thought to be because the lawyer enjoys significant political protection. If true, such "protection" should have no place in an open society.

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.

That is a very serious problem, and as the political campaign against Tallinn Water enters a new phase, Estonian politicians might recognise that in their bid to court short term popularity by reducing water tariffs they are damaging not only the long term viability of Tallinn Water but they are also destroying their own reputation and that of their country itself. Contracts, once agreed, must not be unilaterally altered to suit changing political whims.

As the rather futile debate over the relative merits of Lithuania versus Estonia as investment destinations continues, Estonian officials should not dismiss the idea that they actually have a genuine problem- and neither should Estonian voters.

3 comments:

Anonymous said...

well, those old privatisation decisions have been bad deals at best, more like idiotic sell out by young country.
Re: Tallinn Water
Monopolistic company with 50-60% profit margin? I would say regulators like Ofwat would try to reduce this to more logical level in other places like UK. In case of TW that's exactly what's going on. Water prices are too high and profit is too big for natural monopoly. And to get these prices under some control, similar measures will have to be taken i.e. prices have to be checked by official body.
Re. Railways: owners sold Est. railways back to state exactly and nicely before crash of russian transit, so they are not too sad probably.

Anonymous said...

Tallinn Water is targeted by the Estonian Government because the 2nd largest shareholder as City Of Tallinn and its Mayer Edger Savisaar is the leader of the largest opposition party in Parliment. In Estonia eveybody knwos it and the media sided the Government in return of ads contracts.Changing rules while in the game is disgrace, and changing laws while on the contract is almost crime.

invest said...

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