Estonia Is Writing Its Own Playbook To Build A Defense Industry

From a control tower overlooking a muddy field in central Estonia, Maido Ruusmann and a pair of local investors watched as a meter-long spy drone was launched into the air using a giant elastic band. It climbed to a height of a kilometer and traced circles in the sky, sending data and images back to about a dozen people huddled around monitors on the ground below.

Ruusmann, a member of parliament from the southern part of the country, organized the demonstration less for national security reasons than for local economic ones. Like many rural areas, his hometown of Tõrva has seen its population decline over the years. Ruusmann was hoping that if the investors were to reach a deal with Skyassist, the Ukrainian defense company that manufactures the drone, they would set up a production facility in his region.

"We need to be salesmen for our town. All local governments have to compete for people and investment," he said later by phone. "The defense and drone industry is the industry of the future."

Estonia's relationship with its eastern neighbor and former occupier is tense. Russia took years to remove its troops after Estonia regained its independence in 1991. And as Russian President Vladimir Putin has become more aggressive about reclaiming his country's former territories, Estonia has been vocal about the threat posed by Moscow.

Since 2022, the year Russia launched its full-scale invasion of Ukraine, Estonia has hiked taxes, cut public spending and increased borrowing to triple its defense budget from €776 million ($897 million) to €2.4 billion in 2026. Military spending next year will translate to over 5% of the nation's gross domestic product, the highest in Europe. Though widely seen as necessary, that spending — most of which has gone towards foreign weapon systems such as US-made HIMARS rocket launchers — is also a burden. It comes in the wake of a multi-year recession, and as Estonia struggles with the euro area's highest rate of inflation.

Estonia's Defense Ministry is now focused on keeping more of that money in the country by channeling it into a domestic defense sector. Leveraging Estonia's status as a globally competitive startup hub, Tallinn announced in January that it would set aside €100 million to launch one of Europe's first funds explicitly focused on weapons.

That has supercharged a growing ecosystem of local defense startups, many of which were founded by Ukrainians or use that country's battlefields to test out their products. With governments across the EU beefing up their defense budgets — Germany alone has committed to spending more than €500 billion on defense between 2026 and 2029 — the hope is that Estonian companies will eventually draw international investment.

Tõrva is a bucolic lakeside town of 2,600 people that comes alive during the summer, when tourists arrive to enjoy its saunas and annual Fire Festival. While those months are crucial for the region's economy, average incomes remain among the lowest in the country. The biggest industries have long been agriculture and timber, and the largest employer is a woodworking factory.

The question of how to reinvigorate Tõrva's economy was on Ruusmann's mind last July when he was approached at the Fire Festival by a Skyassist representative. The dronemaker's Kyiv plant had recently been hit in a Russian air strike, but even before that, the company was looking to expand its manufacturing footprint in Europe.

"Unfortunately, there are no completely safe places in Ukraine today," said Skyassist's chief executive officer Igor Krynychko, who had only a few days earlier touted his product in neighboring Latvia.

At the time, Ruusmann, Tõrva's former mayor, was working with officials from neighboring towns to find tenants for a proposed €10 million industrial park that they hoped would become an economic hub for the region. Ruusmann, who has made several trips to Ukraine, most recently to deliver generators as part of a political delegation, had been wondering whether defense companies might be a good option.

"It was an interesting coincidence, because it's exactly what we had been talking about," he said.

Defense is a relatively new industry in Estonia, as the private sector wasn't allowed to manufacture weapons domestically until 2018. "If you went to a bank five years ago to talk about making lethal weapons, they would send you away immediately," said Jens Haug, who is on the management team for Nitrotol, an Estonian maker of explosives. That changed after a lobbying push.

"They are much more accommodating now," Haug noted.

The sector has grown quickly — there are around 200 companies in the defense industry association, including dronemaker Threod and unmanned vehicles builder Milrem — and sales by Estonian defense companies rose from €245 million in 2022 to €500 million in 2024. The amount of defense-linked government spending going into the Estonian economy is also increasing. In 2023, it was €395 million; in 2024, it was €489 million.

Estonia's size and newness to the sector, however, pose challenges. European governments typically purchase weapons from US manufacturers or their own domestic defense giants. While larger nations can keep tax revenues within their borders through deals with homegrown companies, Estonia is simply too small a market to adopt that model.

"The defense industry here needs to be international by its nature," said Nele Loorents, a research fellow at the International Center for Defence and Security in Tallinn.

Estonia is also treading carefully when it comes to partnerships with foreign defense giants. Military procurement cycles can last for years, with bad decisions having expensive and long-lasting consequences. Estonian officials learned that the hard way in the 1990s, when its first major weapons purchase from a state-owned Israeli company delivered dated artillery and guns that didn't work. (Some issues were eventually resolved, and the deal was later viewed more positively.)

Tallinn recently declined an offer from the German defense group Rheinmetall to build a new ammunition plant in the country on the grounds that, according to the Defense Ministry, the terms weren't favorable enough. Rheinmetall did not respond to a request for comment, but similar projects are moving ahead in Lithuania and Latvia.

One advantage Estonia does have is that its defense officials can be nimble when needed. As Russia's war in Ukraine escalated, it quickly became clear that Europe lacked production capacity for artillery shells. Estonia, which wasn't making any shells at the time, took this as a mandate. The government is now finalizing a deal with an artillery ammo manufacturer.

"From a national security standpoint, if you have production capacity in the country, you can use that for your own needs in a crisis situation," said Indrek Sirp, special advisor for defense industry development at the Ministry of Defense.

For the last two years, Sirp has been busy scouting sites that could host industrial parks for arms manufacturers. In April, the government selected two locations: one in Ermistu, in southwestern Estonia; the other in Põhja-Kiviõli, in the northeast of the country. Tallinn plans to spend about €50 million on infrastructure before missiles and explosives companies move in, and he anticipates they will need to put in another €200 to €300 million. In November, citing market interest, Sirp said the government would look into creating two additional industrial parks.

Despite broad public support for bulking up Estonia's defenses, however, some of these efforts have run into red tape and community resistance. In Ermistu, three local nonprofits and dozens of individuals filed a lawsuit to halt development on the industrial park, accusing the government of ignoring environmental and noise considerations. That worries some in the defense sector, who say that legal and bureaucratic obstacles to arms production could slow things down at a critical moment.

"We haven't moved fast enough," said Kalev Stoicescu, chair of the Estonian parliament's national defense committee. "What we initially wanted to do in four-to-eight years, we now need to do in one-to-three years because we don't know how the international security situation will develop."

For Ukrainian arms manufacturers accustomed to working at the speed of war, adapting to their new context may also be an adjustment.

"​​The main challenge is the excessive bureaucracy of the European market," said Krynychko, Skyassist's CEO. "Sometimes we see that some of the requirements of European licensing systems do not quite correspond to the requirements of real combat."

Source: Bloomberg Europe