New index measures shadow economy in Baltic States
Published: 29 January 2012
The first Shadow Economy Index for the Baltic countries [1] was published in June 2011. The three aims of the survey were:[1] http://www.sseriga.edu/en/research/projects/shadow-economy-index/
In 2011 a survey conducted by the Stockholm School of Economics in Riga sought to measure the size of the shadow economy in the Baltic States as a percentage of GDP. Researchers drew up a ‘shadow economy index’ which identifies and measures indicators of informal economic activity such as under-reporting of profits, numbers of employees and salary levels. The intention is to monitor the size and role of the shadow economy in the three countries regularly using the new index.
Aims of the survey
The first Shadow Economy Index for the Baltic countries was published in June 2011. The three aims of the survey were:
to determine the size of shadow economies in Latvia, Lithuania and Estonia;
to explore the main factors that influence participation in the shadow economy;
to provide policy makers with information for making sound policy decisions about how to reduce informal economic activity.
The resulting ‘shadow economy index’ was drawn up in cooperation with the European Council for Small Business and Entrepreneurship (ECSB).
Methodology
The survey was based on 591 phone interviews conducted between March and April 2011 with company owners and managers selected by random sampling The questionnaire used by interviewers covered five topics:
external influences;
extent of shadow activities;
entrepreneurial orientation;
company and owner characteristics;
entrepreneurs’ attitudes.
In order to compare results, company owners and managers were asked to answer the same set of questions first about 2009 and then about 2010. The resulting shadow economy index measures the size of the shadow economy as a percentage of GDP. Evaluation consisted of three steps. Regression analysis was also used to identify the statistically significant determinants of companies’ involvement in the shadow economy.
In should be noted that sensitive questions about shadow economic activity are always subject to a certain downward bias in surveys since many respondents are naturally unwilling to acknowledge their involvement in it. However, Latvians are generally more willing to answer such questions and this, as noted in the report, can be linked to the relatively high tolerance of tax evasion in Latvian society.
Shadow economy size
The survey results show that the size of the shadow economy was considerably higher in Latvia in 2010 (38.1% as a percentage of GDP) than in Estonia (19.4%) and Lithuania (18.8%). Latvia’s shadow economy also appears to have increased by 1.5% since 2009, when it was 36.6%.
| 2009 | 2010 | 2010–2009 | |
|---|---|---|---|
| Latvia | 36.6% | 38.1% | 1.5% |
| Estonia | 20.2% | 19.4% | -0.8% |
| Lithuania | 17.7% | 18.8% | 0.8% |
Source: Shadow Economy Index
Extent of shadow activity
The survey suggests that the level of under-reporting of profits as a percentage of real profits in Latvia in 2010 was 33.7%, twice as high as that in Lithuania (16.6%) and three times higher than in Estonia (11.4%). Latvia also has the highest level of under-reporting of the number of employees as a percentage of the real number of employees (14.6% in 2010) when compared with Lithuania (7.9%) and Estonia (9.7%). Underreporting of salary levels as a percentage of real salaries in 2010 shows similar results as for underreported profits; at 35.5% in Latvia compared to 15.8% in Lithuania and 19.6% in Estonia. In 2010 the average level of bribery as a percentage of revenue spent on payments to ‘get things done’, reported by survey respondents, was 10.8% in Latvia (9.3% in Lithuania and 5.6% in Estonia).
Finally, owners and managers were asked to estimate the percentage of the contract value that firms typically offer as a bribe to secure a contract with the government. The results show that in 2010 companies in Latvia offered considerably larger bribes, an average of almost 10% of the contract value, whereas companies in Lithuania on average offered almost 6%, and companies in Estonia 2.2%.
Influential factors
The shadow economy varies by regions and is more extensive in Latvia’s capital, Riga, than in other regions (42% in 2010). Shadow activity also varies by sectors. The highest proportion of shadow activity is found in the construction sector (53.6% in 2010), services (41.7% in 2010) and retail (40.9% in 2010). The survey indicates that the level of shadow economy by company size is relatively higher in small and large companies than in medium-sized companies (11–50 employees) in Latvia. A total of 44.2% of respondents are very dissatisfied with the Latvian government’s tax policy and the amount of support it gives to entrepreneurs (36.2%). By comparison, in Estonia, only 5.2% of respondents are very dissatisfied with the government’s tax policy. Among the main reasons for tax evasion, respondents in Latvia cite high taxes, unwise use of public money by the government and an inflexible tax system. The regression coefficients indicate that more recently established firms are more likely to be engaged in shadow activity than older firms, in order to be competitive.
Commentary
The high level of dissatisfaction with the Latvian tax system and government could account for the large differences between the size of its shadow economy and those of the other two Baltic countries. The survey recommends that tax policy should be more stable, and that the government should provide a well-considered and transparent tax expenditure system. In the long-term, the main challenge is to increase trust in the government and state institutions.
Linda Romele, EPC Ltd.
Eurofound recommends citing this publication in the following way.
Eurofound (2012), New index measures shadow economy in Baltic States, article.
