Business, Direct Speech, Economic History, Latvia, Markets and Companies

As paradoxical as it may sound, local entrepreneurs, who have never seen quick and easy profits, might be the biggest winners on the verge of the great upcoming changes. The possible – however, imminent in my opinion – crisis will bring changes in the nation-wide business environment.

The employment level and welfare are directly linked with the number of creative entrepreneurs and proper business environment.

Unfortunately, I must say that Latvia is not a country well-suited for long-lasting and successful business. There are several reasons for this: tax policy, especially workforce (salary) taxes; lack of qualified employees and capital; low population purchasing power as well as low prestige of entrepreneurs in the society.

In addition to the aforementioned factors, it is also important how fast and effectively entrepreneurs can collaborate with the local authorities in a specific territory. Yes, I really mean local authorities here, because only monopolies and large businesses work with the central power. How this cooperation goes and what influences can be seen? In my report “Municipality as the main territorial unit for organizing business”, I will try to answer this and many other questions.

1. The role of municipalities in the business development in a specific administrative territory

What is needed for a municipality to welcome business in its territory?

1) Clear rules of the game (unchanging regulatory enactments).

2) Infrastructure required for organizing businesses under constant upgrading, that is, the municipality at its own costs builds all required communications and access roads of local significance.

3) Guaranteed safe business environment – presence of security, municipality police and primary medical aid.

4) Access to officials in the territory-in-question.

5) Listening to people living in the territorial base unit through municipality-organized regular meetings between locals and entrepreneurs.

Each and every of these points can be elaborated in nuances; therefore, let’s address the most important things.

When it comes to clear rules of the game, I mean bureaucracy. The quality of bureaucracy is the factor driving unified rules of the game and implementation control.

Therefore, municipality bureaucracy must be easily accessible, transparent, logic and without any risks of corruption.

Such bureaucracy is only possible in municipalities, and it can never be centralized. Entrepreneurs value that each individual issue can be tackled by a specific official or municipal employee. An entrepreneur should be able to inform about the operations of the company at any given moment, and the same goes for jobs created and problems encountered. The municipal officials, on the other hand, must be well placed to report on matters affecting the business environment: project approvals, planned infrastructure construction, procurements, PPP options, as well as safety and healthcare matters.

The municipality needs a proper budget for it to be able to work and become a partner of entrepreneurs. What taxes go into the municipality budget?

2. Tax distribution between the State and municipalities. Impact on the development of the territory-in-question

Municipalities receive a part of personal income tax (PIT) paid into the State budget by people with jobs. Overall this part of the tax shapes 25% of an employee’s PIT. Unfortunately, the amount of PIT flowing in the municipal budget does not depend on whether the company works in its territory. PIT contributions are made according to the declared place of residence; therefore, local governments of towns and rural municipalities are unconcerned about the fact that people with registered addresses in these territories travel for work elsewhere where salaries are higher. I believe that this is the main reason why local governments in the regional Latvia show no special interest in creating environment suitable for new jobs. Therefore, I suggest making changes and defining that PIT is received by the local government in the territory of which the company works and pays salaries to its employees.

Moreover, municipalities receive an immovable property tax and natural resource tax.

The latter is to be doubled and distributed in favor of the State budget. What does this mean for CEMEX, a cement-production company from Broceni which uses a natural resource – sand? The answer is quite clear – more expensive products and loss of market share to our neighbors.

The percentage distribution of the tax aggregate between the State and municipalities is of high importance.  In the EU Member States, municipalities on average receive 33% of all taxes, but in Latvia – 26%. Overall in Latvia 15 different taxes are levied and 12 of them fully flow into the State budget.

I have no idea why the main line of thinking, especially in the context of the administrative territorial reform, currently deals only with reduction of bureaucracy in municipalities, ignoring the over-sized State administration although it is State bureaucracy that consumes the most resources. Year after year, funds administered by the central authorities are lost in the black hole, making people pay ever-increasing taxes.

Furthermore, the operational principles of the Municipality Financial Cohesion Fund (established more than 20 years ago back in 1997) are now obsolete. The Treasury makes contributions to the Fund from the PIT revenue to be allocated to municipalities.

Essentially this means that the State pays into the MFCF money taken away from the same municipalities. As of now, there are 11 donor municipalities out of 119 in total. Such obsolete procedure hinders development of the recipient municipalities. I believe that it is time to think of other finance and tax instruments to develop municipalities which have been on the receiving end of funding for a long time. Here we can discuss Special or Free Economic Zones as well as special tax modes.

Bearing in mind the unavailability of commercial loans, taxes levied are the sole line of financial revenue for municipalities. It is good that the EU co-funding is used in Latvia to build new concert halls, stadiums, and pools. However, one must bear in mind that all these sites must be maintained but that requires funding. Therefore, local business must be systemic, and not short-term.

3. Centralization vs decentralization. Authoritarianism vs democracy in municipalities. Administrative territorial division examples from Denmark and Switzerland

My report surely would be incomplete if I would avoid the topic of ATR (administrative territorial reform). I see this reform as a decision between two incompatible State development models – Latvia as a decentralized and democratic country with municipalities where people make decisions about their own territory, including finances, business, military and possible migrant accommodation plans, or Latvia as a (authoritarian) centralized country where municipalities and accordingly their people will be just an appendix to the centralized authority, without real rights to have any impact on what happens in their territory.

What is the experience of European countries? I will take a closer look at two countries – Denmark and Switzerland (not an EU Member State) which are smaller than Latvia in terms of area. I picked these countries deliberately to show that the argument of J. Pūce, the Minister of Environmental Protection and Regional Development, that only large municipalities can be effective, is unjustified.

For example, Denmark consists of 5 regions. Regions are divided into 98 municipalities (commoner) which is rather close to our 119 municipalities.

Whereas Switzerland which is smaller than Latvia and whose area is mostly covered in mountains consists of 26 cantons. Cantons are divided into 137 districts which are divided into 2,324 municipalities.

Why so much? Because they live according to a historic principle – the local government must be in walking distance. In Switzerland, they still hold referendums where people gather in the central city square. That is the highest form of democracy! The Swiss federalism is defined as upward-facing system (complete decentralization) where cantons are sovereign, except as far as they are restricted by the federal constitution. It makes me sad to remember how condemning was the Ministry of Environmental Protection and Regional Development about legitime polling about ATR by several municipalities. Furthermore, Switzerland officially does not have a capital city (although actually it is Bern where most of the national authorities are located).

I will end with main factors required for municipalities to be able to promote business in their territories:

1. Honest tax distribution between the State and municipalities based on statutory functions and duties.

2. Municipality access to development-oriented commercial credits.

3. Replacement of 22-years-old MFCF with other instruments depriving the central power of any opportunities to manipulate with money due to municipalities.

4. Maximum power decentralization as a contrast to the centralization path of the current coalition.

5. Cooperation promotion between entrepreneurs living in the municipality’s territory, especially on matters associated with crop growing, processing and sale, construction, manufacturing and services.

 When it comes to local agriculture and animal husbandry, I wish to stress potential future risks. Let’s imagine for a moment that for whatever reasons it will no longer be cost-efficient to transport food from Poland, Holland, and other countries to local Latvian logistics centers. What will be our reserves? While we do have fuel reserves, we cannot say the same about our food. This is why centralized country is a great risk to Latvian people.

6. Local energy production using renewable resources available in the territory (woodchips, peat, sun, wind), thus reducing production costs.

Thank you for your attention!