Estonia , on a November morning.

The Estonian capital of Tallinn is famous for its Old Town , which dates back to the Middle Ages. Two towers remain of what was once a larger gate system built in the 14th century. The towers with their red roofs are overgrown with green vines. In its history the city has been repeatedly invaded, ransacked and pillaged. Even today, the sharp sound of horses galloping over cobble stone pavement still seems to reverberate from the Old Town 's little alleys. But a 20-minute drive southwest will spirit you from the medieval ambiance of the Old Town to an icon of the 21st century, Internet telephony company Skype.

At 9: 00 in the morning, the modern offices of Skype in a Tallinn suburb are still dark, as the company's thirty-something employees quietly work under small desk lights. Not a single telephone is sitting on the desks.

Although eBay bought Skype for US$2.6 billion in 2005 and Skype meanwhile has 246 million customers worldwide, the globally known company decided to keep its R&D division in obscure Tallinn

“The Skype code was written by Estonians, and Estonians carry out quality control for all Skype products. All the technology is here,” says Skype spokesman Villu Arak with a hint of pride in his voice.

On Estonia 's journey toward success as a small country, Skype stands as the most prominent road sign: pooling national strength to develop knowledge-intensive industries.

The Tallinn headquarters are Skype's brain, and also the company's largest office worldwide. Here more than 300 Estonian engineers are quietly toiling, their noses to the grindstone, attempting to develop the next killer application.

When this reporter visited the company, Skype was just about to release a handset in Britain , Hong Kong and six other countries, in collaboration with 3, the Hutchison Whampoa-owned mobile phone operator. The new Skypephone allows customers to make free Skype-to-Skype phone calls wherever they go instead of from computers at home. The novel handset, which comes with a 2-megapixel camera, an MP3 music player, 3G multimedia capability and special Skype keys, was manufactured for 3 by Chinese handset maker Amoi Electronics. It is hard to believe that behind this much heralded Skypephone are unknown, quiet, young Estonians.

Small Country Comes Out on Top

In the game of globalization, late starter Estonia has unwittingly left the field behind, by playing the role of innovator.

After half a century of iron-fisted Soviet rule, the three small Baltic states of Estonia , Latvia and Lithuania embraced the free-market economy. Since regaining independence in 1991, the once lackluster former Soviet republics have emerged as Europe 's brightest stars.

In recognition of the three small countries' rapid economic rise, Europeans have dubbed them the “Baltic Tigers.”

The numbers speak for themselves – the Baltic Tigers have been the fastest growing countries in Europe in recent years. (Table 1)

Among the three, Estonia has carried out the most radical reforms and has made the fastest progress. With a population of just 1.3 million people, Estonia has fewer people than Taiwan 's Taichung County . However, Estonia last year grew at a faster pace than China , and its national income is about to catch up with Taiwan .

This year Estonia 's gross domestic product (GDP) at purchasing power parity (PPP) per capita stood at US$21,000 (Table 2) and was the highest among the Baltic states , according to International Monetary Fund (IMF) statistics. Last year Estonia ranked 26, hard on the heels of South Korea , in the Global Competitiveness Index by the World Economic Forum. In this year's report Estonia slipped to 27, but was still far ahead of China , and the new emerging economies of Eastern Europe and the Middle East .

Britain 's BBC has called Estonia an “Internet pioneer” and a leader of the Internet revolution. While Taipei prides itself on being a model “digital city,” Estonia this March became the first country in the world to use remote electronic voting via the Internet in parliamentary elections.

Estonia 's breathtaking economic growth has meanwhile begun to slow down, which is seen as a healthy development toward a “soft landing.” The Estonian central bank adjusts its forecast on economic growth next year from 8.4 percent to 7.3 percent, which is expected to appropriately cool down the overheated economy and rein in skyrocketing real estate prices.

From the Middle Ages Estonia had to endure a series of sometimes oppressive, alien regimes, being successively controlled by Denmark , Sweden , Germany and the Russian Empire. But since regaining independence, the country has come into its own.

But how did this minuscule state on the Baltic Sea manage to join the ranks of the advanced nations so quickly?

In the case of Estonia , being small is a strength and competitive advantage.

Estonia and its Baltic neighbors Latvia and Lithuania boast a combined population of less than 7 million people. This amounts to less than one third of Taiwan 's population, yet the Baltic Tigers' combined territory is five times bigger than Taiwan . Their combined GDP adds up to about US$102.2 billion, not even one third of that of Taiwan and less than 1 percent of the Eurozone GDP. On a global scale the Baltic Tiger economies are no more than a drop in the ocean.

But precisely because Estonia is small, the country is able to react quickly and to become a magnet for innovation in government, technology and business. Estonia has been quick on three fronts: The government is quick with policy reform, its enterprises are good at fast innovation, and its people adapt rapidly.

Small Country, Quick Reforms

“Speed is our biggest advantage,” says Marek M?gi, director of Enterprise Estonia , a state organization for promoting export and investment, in explaining what makes the Estonian economy tick.

The late Lennart Meri , Estonia 's first elected president after independence, was an author, playwright, and film director. During his nine years in office, he moved the people with inspirational speeches. Boosting people's morale, Meri led Estonia 's great turnaround from a Soviet republic to a Western-oriented free market economy. Meri once said that when it comes to reform, large countries resemble massive cruise liners that are slow and difficult to maneuver. Small countries, however, are like canoes, agile and easy to steer. This means that if they are on the wrong track, they can always turn around, making the risk of failure low.

And the Estonian boat has moved forward at high speed precisely because it did not fear failure.

In the 1990s the Estonian government carried out a string of financial reforms at lightning speed. It set the tone for economic policy by adopting a fixed exchange rate to reduce the inflationary pressure of the early post-independence years and a flat tax system to attract international investors.

When seven years ago Estonia scrapped taxes on corporate income and lowered individual income tax to 22 percent, money began to flood in from Scandinavia , a trend that still continues today. Three years ago, the three Baltic states joined the European Union. The elimination of customs and tariffs, quotas and other trade barriers at one stroke allowed the Baltic Tigers to jump on the bandwagon of the Scandinavian economic growth.

In the first year after EU entry, Estonia attracted the most foreign direct investment (FDI) per capita of all ten new EU member states, outdoing the Czech Republic , Slovakia and other Eastern European countries that are usually favored by Taiwanese investors.

Good Neighbor Scandinavia

Scandinavia contributed a lot to Estonia 's rapid economic rise.

Last year Finland and Sweden accounted for more than 65 percent of Estonia 's FDI of 118 billion euros.

Also hiding away in a Tallinn suburb is Europe's largest electronic manufacturing services ( EMS ) company Elcoteq, which last year posted revenue of 4.3 billion euros. Not surprisingly, the largest customers of Elcoteq's Tallinn plant are Finnish handset maker Nokia and Swedish telecommunications giant Ericsson.

Up to today, the Tallinn factory remains the largest manufacturing base of Elcoteq, which runs factories in eleven countries and does business in 16 countries around the globe. Highlighting Elcoteq's strong Scandinavian connection, the name cards of several Ericsson executives are scattered around the desk of Heikki M?ki, CEO of Elcoteq Tallinn.

“Incentives such as geographical proximity, cheap wages plus low taxes have helped Elcoteq Tallinn's rise,” accedes M?ki, a Finnish national, who moved his entire family to the Estonian capital. Due to his current job, Maki now visits China , India and Estonia more often than his native Finland .

A pro-business attitude and increasing economic integration with Scandinavia have allowed Estonia to quickly walk out from the shadows of the Soviet era and to steer its economy from the left to the right.

Finland , facing Estonia across the Baltic Sea, serves as a mirror image and model for Estonia , as well as its shortcut for learning how to globalize.

“If the Soviet Union taught us how not to get things done, Finland teaches us how to get things done,” says Enterprise Estonia director M?gi. Due to cultural affinities and closely related languages – Estonian and Finnish are both Finno-Ugric languages – Finland is something like a big brother for Estonia .

Against this backdrop Finland 's democratic politics, free economy, and emphasis on equality are bound to rub off on Estonia .

Small Country, Fast Innovation

Since they are small and young, Estonia 's industries are able to keep innovating.

When they gained formal independence in 1991 after the collapse of the Soviet Union , half of all Estonians did not have a telephone line. Sixteen years later mobile phone penetration in the former communist country has reached a staggering 123 percent. In Estonia people use their cell phones to pay parking fees and bus tickets, make bank transactions or pay taxes via the Internet. Within just 16 years almost 40,000 private enterprises, a sector that did not exist under Soviet rule, have sprung up.

The strongest innovative impulses come from information technology as well as biotechnology and biomedicine, both knowledge-intensive industries.

Visitors to the warm and elegant Tallinn offices of Docobo Ltd., the leading Estonian telemedicine firm, are in for some surprises. Docobo CEO Ardo Reinsalu demonstrates a hand-held electronic device that looks like a palmtop computer and allows patients to monitor their pulse, electrocardiogram, and blood pressure in the comfort of their home. Connected to a standard telephone line, the device transfers the readings to a central database. At the hospital doctors can access the patient records and directly respond to the patient.

In Britain , several thousand patients already use the 45-euros-per-month doc@HOME telehealth service, which was developed with funding from the Estonian government and the EU. Nine partners in four countries are involved in the project.

That tiny Estonia is able to export medical services is owed to the innovation of this small Estonian company.

“We are empty-handed. The only thing that we have is brains,” says Reinsalu, explaining why innovation is a small nation's competitive trump card.

Estonian national character - using brains rather than raw violence to reach a goal – is even reflected in folk tale. The servant Kaval Ants (Crafty Hans) does not wield a sword in battle, but rather relies on his sharp mind to outwit his master Old Nick, a giant farmer who is more stupid than malevolent. Kaval Ants eventually reaches heaven sitting on the giant's forehead. Like this quick-witted folktale character, the dwarfs of Estonian industry knew from the beginning how to borrow the strength of others to increase their own, innovating while conveniently standing on the strong shoulders of Scandinavian giants.

Docobo's telemedicine services are the innovative fruit of a multinational effort: A 100-person team at Docobo in Tallinn was in charge of developing the software, while a Swedish partner was tasked with quality control and medical ethics management, and a British partner was responsible for commercialization and hardware manufacturing. In cooperation with Estonia's Tartu University Hospital, Docobo has over the past few years expanded its clinical trials of the doc@HOME health monitoring service to Britain, Germany, Finland and Portugal.

“We can't do everything – R&D, marketing and manufacturing – that would be too expensive,” argues Reinsalu. He notes that as a small company Docobo needs to use external academic resources and target foreign markets.

The Estonian mobile solutions provider Regio Ltd. is another small enterprise that innovates quickly while standing on a giant's shoulder.

Jaan Jagom?gi, CEO of Regio, got into cartography at an early age, since his father was a geography professor. From age 18 he helped his father draw maps and legends. At 24 Jagom?gi took over his father's cartographic company and began to digitize maps, providing customers with geographical data and location-based services.

Meanwhile Regio counts people around the globe, from Saudi-Arabian sheiks to ordinary citizens in India , among its customers. Regio sells its location-based services, which provide location-specific information to mobile users on the go, to 117 countries worldwide. So far more than 100 million users have registered.

Yet Regio remains a small company with a staff of just 80 and annual revenue of just 44 million euros. Nonetheless, the Estonian government named Regio “Internationaliser 2006.”

In its newsletter Enterprise Estonia described Regio as a company that has conquered the eastern half of the globe.

“We are able to put together mapping and software talent. These are not the core competitive strengths of telecommunications giants,” Jagom?gi notes with pride. The industry giant that lent Regio a helping hand for its international breakthrough was Ericsson. Seven years ago when Ericsson began to develop mobile positioning services in Estonia the two companies joined hands. Presently, about one third of Regio's revenues still come from Ericsson.

Such swift innovation on the part of small companies is the combined result of historical coincidence and the wisdom of decision-makers.

“During the window of opportunity after independence, we introduced the most advanced Internet services and digitization equipment,” says Docobo CEO Reinsalu in contrasting Estonian telecommunications companies with their large British counterparts, which are heavily invested in fixed assets. Estonia , which had to build its modern economy from scratch, adopted the most cutting-edge technologies right from the very beginning.

“We are not superior at all, but we are special,” Jagom?gi notes with both modesty and confidence.

Catching up with the World

Skype spokesman Arak, who was a child during the Soviet era, believes that half a century of Soviet rule and backward isolation have led younger Estonians to embrace the rest of the world with a sense of urgency. “We can't wait to catch up with the world,” Arak says frankly. Despite having a certain complex about being a tiny nation, the Estonian mindset has changed quickly and people are eager to prove themselves to the world.

At the Radisson, a five-star hotel in the heart of Tallinn , the lobby's revolving door never comes to a halt, as a continuous stream of executives in suits comes and goes, briefcases in their hands.

Illustrating Estonian entrepreneurial spirit, American novelist Ernest Hemingway once wrote that in every port in the world at least one Estonian can be found.

Braving the bitter cold Baltic Sea breeze, scores of passenger liners and cruise ships keep calling at Tallinn Harbor . Backed by a strong wind of policy reform and industrial innovation and steered by a people that actively embraces change, the tiny boat of Estonia is sailing straight toward a brighter future.

Translated from the Chinese by Susanne Ganz