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Markus Villig: Weak national defense scaring away investors in Estonia

Markus Villig.
Markus Villig. Source: Private collection

It is impossible to simply talk our way out of the security risk Estonia faces, and the country will need to invest in defense in order to attract investments and talent, Bolt co-founder Markus Villig writes.

Talking to investors or people applying for a job at Bolt, I'm often asked about the security situation in Estonia.

The Bank of Estonia presented its worse-than-expected economic forecast this week. While we cannot affect the broader European economic environment, we can shape how attractive Estonia is as a destination for the rest of the world. For investors to dare invest and foreign talents to come work here, it is important they perceive Estonia as a safe country.

For investors, a deteriorating security situation constitutes a risk, and that risk comes at a price. The latter hits every company, household and the state budget. We can dub it "Putin's tax" which creates no added value for the economy while we're all still saddled with it. It is the price we pay for not having sufficiently developed national defense.

How big is 'Putin's tax'?

This risk premium is easiest to calculate by comparing Estonia's bond rates to those of other similar countries following the start of the Ukraine war.

Let us take the example of Slovenia, which is similar to us both in terms of size and economic development. Estonia carried out a bond issue in the fall of 2022, hoping for a rate of return of 3 percent to match that of Slovenia's ten-year bonds' issue in September. But Estonia's ten-year bonds were given a rate of return of 4 percent.

Estonia's public debt is roughly €5 billion and private sector debt some €40 billion. "Putin's tax" making up 1 percent would amount to more than €450 million annually. This is €350 per every Estonian resident. To compare, Estonia's annual defense spending will be €1.3 billion in 2024.

There are multiple examples of how it is possible to develop an attractive investment and interest environment living next to an aggressive neighbor. South Korea, Singapore, Israel, Taiwan or Finland. All have higher-than-average defense spending.

The threat posed by Russia is similar for Finland and Estonia, while the former's rates are about a percentage point lower. Therefore, we can claim that by developing the Estonian Defense Forces to emulate Finland we can considerably reduce "Putin's tax."

Hiking defense spending would help

The Ministry of Defense says that critical shortcomings could be remedied with €1.6 billion. Instead of bearing this invisible burden, we might start by adding what "Putin's tax" is costing us to defense spending for the next three years. It would help manage security risks, which would boost the interest of investors and foreign talents in Estonia, which in turn favors economic development.

By postponing these investments, we're risking not only Estonia's security but also higher capital costs in the future. Because the continued worsening of the security situation would amount to a much bigger risk premium than 1 percentage point.

Of course, this needs to be done sensibly and in accordance with EU deficit rules. A few weeks ago, European Commission President Ursula van der Leyen proposed an exception to the 3 percent of GDP deficit rule for defense investments. We would be hard-pressed to justify not taking the opportunity.

Potential for local defense industry

Of course, investors' risk perception depends on other things than just defense investments. In the case of Israel and South Korea, innovation in the defense industry and the countries' general technological level also play a role. Investor interest in defense startups has been growing rapidly in recent years. According to the Financial Times, venture capital investments in the field came to $16 billion in 2019 but had doubled to $33 billion by last year.

Estonia is known for its digital state and successful tech companies and we have the same potential for developing next generation defense contractors. The government could seriously consider supporting defense technology firms and making the effort to attract talent from the rest of the world, including Ukraine.

It is impossible to simply talk our way out of the security risk Estonia faces, and the country will need to invest in defense both realistically and perceptibly in order to attract investments and talent.

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Editor: Marcus Turovski

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