Analytics, Latvia, Legislation, Round Table, Shadow economy

The RT was organised by the Baltic International Academy, The Baltic Course Internet Magazine (www.baltic-course.com) and Latvian Employers Confederation.

The reason to convene the new Round Table was, in fact, rather obvious and simple: in the conditions of the present economic crisis, the shadow economy issues have become of utmost importance dragging some of the transitional economies back to the initial development stage in 1990s.

The following authors submitted their reports for the round table: Vladimir Vaskevich, deputy head, Latvian National State Revenue Service, Eugene Etertis, LLD, assoc.prof., Denmark, Michael Bazilinsky, financial analytics, Canada and Olga Pavuk, Doctor of Economics. 

Around the problem’s importance

The Round Table’s moderator, Ms. Olga Pavuk, the Baltic Course Magazine’s editor-in-chief, summarized at the start of the RT’s discussion the main reasons behind addressing these important issues.

“There are several reasons why we address this theme to-day: the shadow economy issues have become a great problem even in most affluent countries of the world, e.g. Denmark, Germany and Sweden, as well as a serious threat to public management in the former Soviet block countries”.

It has been generally acknowledged by world experts, that about one third of the global GDP was within the “shadow turnover”. It seems that at the time of global economic crisis, the growth of shadow economy share is deemed to grow in most countries. This will inevitably lead to greater state budget deficits, along side some other negative factors, argued Mrs. Pavuk.

According to international experts, the Baltic States are among the most troublesome countries from the point of view of shadow transactions and corruption. Most serious are these problems in Latvia, which has already turned to the outside financial assistance and support to find way out of crisis.

Thus the main aim of the present round table, Mrs. Pavuk acknowledged, was to exchange expert opinions and reveal various “sides” of shadow economy to the wider readers’ audience, and as well as to suggest some recommendations in order to eradicate the negative trends.

Juris Pajders, Deputy Editor, Neatkarīga avīze (Latvian Daily), Dr. Geogr.

A famous Latvian expert in shadow economy issues, Mr. Juris Pajders, made the inaugural speech at the round-table. He started with a trivial notion, that the society’s wealth is connected to the goods and services produced in the country. However, he added, the public state budget depends on how the revenues are collected. 

“The crisis has led to the situation in Latvia when about one third of country’s enterprises are in danger of being closed, he continued, another third will most probably stop paying taxes (in order to sustain existence) and the rest will definitely turn to shadow practice”. This will lead consequently to the situation, he argued, when the level of unemployment in Latvia would soon reach 35 per cent, instead of present 9-10 per cent.

Mrs. Elina Egle, Latvian Employers Confederation, General Director.

According to Mrs. Egle, representing country employers’ community, “the country during last 10-15 years was trying to move from an almost non-existent management in economics to a market one; now it has been extensively drawn back”.

There are several levels at which the business activity are presently affected, argued the Confederation’s general director:

• The companies that experience temporary difficulties;
• Entrepreneurs that are under the threat of liquidation (about 50 thousand companies have acquired bank credits and cannot repay debts);
• Those that are ready to “optimize” their available resources, and
• The companies that still wish to find their ways to international markets.

There are certainly some reasons behind the fact that entrepreneurial community would like to “turn to shadows”. Thus, main company’s expenses are connected to human resources and work force; until recently, there were quite a few companies that wanted to fire their staff. The effect of the crisis has forced the companies since September 2008 to “optimize” available human resources.

That has led to increased unemployment: “however, argued Ms. Egle, one has to take the unemployment figures – which are reaching 100 thousand (for a country with 2,3 mln population, editor’s note) with certain reservations. Several of those that are actually registered as unemployed and receiving social benefits, do work illegally; therefore nobody knows exactly how many are there so-called truly unemployed people”.        

The shadow economy negatively affects mainly the following sectors: industrial sector, communications, and infrastructure, as well as food industry. However, looking at the situation from purely entrepreneurial stance one can’t see that regional and municipal service-networks are in the most difficult situation, mainly due, in a great extent, to the excessive sectors’ monopolization. It is exactly these activity spheres that should attract the attention of country’s anti-corruption agency, Mrs. Egle recommended.

During the discussion, Mrs. Egle pointed out that Latvia lacks the procedure of self-tax-declarations for physical/private persons (often called the 0-tax declaration); it is regarded a necessary tools to legalize entrepreneurs’ profits.

Ms. Olga Provarne, International Baltic Academy, docent; practicing auditor.

As a practicing auditor, Ms. Provarne underlined that during all previous years of development Latvian business was forced to use “shadow means” in order to avoid excessive taxation. Presently, she added, only the methods of money laundering are changing (not the problem itself), and the crisis made the situation even worse.

Ms. Ilze Jurcha, Department head, Public Authorities Control Department, National Anti-corruption Agency (KNAB).

Ms. Jurcha started with explanations as to why during the first two years of KNAB’s existence this activity sector was among the priority ones. She referred to the official research outcomes made for KNAB by the National Economy Institute, with Raite Karnite as its director. The latter had calculated, after assessing the statistical data, that due to “dirty money laundering” the country had been deprived of about 400 mln. lat each quarter! 

This is why, according to Ms. Jurcha’s opinion, “the 0-declaration” will always be useful and important. And she confirmed that “public officials and their relatives would always claim being rich due to unclear origin of their profits, which they used to buy property and summer-houses in, e.g. Cyprus, expensive cars, antiquity, etc.” Because, she continued, if there are no data on declared income, it would be impossible to find out where the money came from; therefore, it was quite often, argued Ms. Jurcha, that the margin between profits and expenses in declarations differed by hundred thousand lats.

At the same time, Ms. Jurcha calls the presently valid additional personal revenue declaration “criminal”, which somehow functions as a financial background for a person’s business activity. Besides, argues KNAB’s representative, it is impossible to plan development if a country lacks adequate information on corporate and personal liquidity transactions.

A good question: what is worse, a bribe or embezzlement?

A discussion of this burning for the country issue has touched upon a recent scandal in the national anti-corruption agency when one of the agency’s official was accused of severe embezzlement. Really, what could discard the society’s attitude to that agency more!

Ladislav Kubizhnjak, Rowan Legal, Czech Republic.

Mr. Kubizhnjak described the present situation in Czech Republic, where the bribery’s combat had acquired an unusually specific stance: businessmen reserve in advance about 2,5 percent of company’s profit  for bribes.

In this way, he argued, the society knows that “oiling the way through” costs the country about 1,5 bln euro; nobody is happy about it, but at least the attitude is fully honest.

Dr. Stanislav Buka, International Baltic Academy (IBA), Chairman of the Board.

In his remark, Dr. Buka underlined that International Baltic Academy had been fully exposed to the worsening economic situation in the country: it affected students’ fees and other payments, as well as students’ sabbatical leaves. “This is only one revelation of the crisis under which the economic issues inevitably takes a shadow form. However, it seems easier to turn a legal business into a “grey one”, though it is much more difficult to return it back”, concluded Mr. Buka. 

Some thoughts about Parex Bank’s problems

Ms. Jurcha used a vivid example to describe the situation in the bank; she heard it from Parex banka experts. They compared the national economy with a bathtub filled with clean water, in which a thin current of dirty water slowly entering from a nearby vessel (the latter signifies “dirty or shadow” economy).

The comparison seemed quite interesting, argued participants, though not really appropriate, so to say, not to the theme under discussion. Thus, Mr. J. Pajders maliciously remarked that dirty water did not spoil the clean water; it just disappeared in Parex banka’s accounts.   

In fact, the issue, argued Ms. Egle, has rotated around professionalism in the issues that state and the government bought out Parex banka assets; she reminded that public institutions and regional/local administration offices managed somehow to withdraw their deposits from a ruining bank. The round-table participants have generally agreed that the bank’s bailout issue has not been really transparent an it needed additional investigation, which could be a task, for example, for KNAB agency.  

Editor’s note: On 29th July 2009, the European Commission opened in-depth investigation into aid package for Latvian JSC Parex Banka.

Creditors’ “shadow behaviour”

The issue of creditors’ situation under the present critical conditions also attracted RT participants’ attention. Mr. M. Andrushenko explained his position towards the issue of creditors “shadow behaviour”. During last six months, he was involved in analysing corporate credits viability (through creditors’ financial accounts) and situations with paying back creditors’ debts. He acknowledged that some new trends in creditors’ behaviour had appeared recently, which was affected by the present economic-financial crisis.  

Mr. Michael Andrushenko, SIA Balt Risk, member of the Board.

First trend in creditors’ behaviour is connected with creditors’ inclinations to hide behind closed doors, with much less visual transparency about their activity. Presently, a major share of companies asking for credits generally does not reveal their financial position. More that that, the number of refusals to supply such information by corporate authorities has greatly increased in the last months, compared with the similar situation in previous years. Main reason behind this, according to Mr. Andrushenko, was that corporate units more often turn to, so-called, alternative accountancy in order to avoid excessive taxation.

Two outcomes follow out of the first trend: fewer revenues available to the state budget and, what is as important as the previous one, big reduction (sometimes, even seizure) of corporate credit lines due to the lack of adequate information for credit availability. “The ultimate value of the second outcome for Latvian corporate units, underlines the credit expert, lies in the fact that the general part of a company’s capital in almost any business sector derives from commercial credits”.      

Second trend is connected to the generally unspecified methods and structures –at least legally- of corporate relationships. “As soon as companies retreat from the officially recognised accounting system, the whole system of business-like- relationship in industry or manufacturing is turning apart. Hence, no official legal and para-legal liability instruments can be used in assessment. It could be envisaged that with the growth of shadow part in economic activity, alongside official ways of recovering debtors’ liability, the not-so-old mafia system of debt-recovery in 1990s would appear on the market again, warned Mr. Andrushenko.   

Mafia groups –“red mobs” – returning to the country

Mr. Valerij Zemljanov, Latvian Criminal Detectives and Security Federation, member of the Board, IBA docent.

Being at the same time the “Criminal Detective Club” president, Mr. Zemljanov warned about the return to the country of an old situation of mafia-type corporate “protection”. The apparent danger of such a situation lies in the fact that close ties are being already formed between public servants and mafia groups, in which state officials are becoming active participants of “shadow-mob-economy”, as well as being “partners” in criminal activities.

Mr. Zemljanov attracted RT participants’ attention to the following dangerous trends being presently formed in Latvian society:

• Growing mafia-criminal “protection services”;
• Process of reviving and modernising the not-so-old system of “mafia-protection” in which an ever active part is performed by the state prosecution offices;
• Further growth of “white color” management influence in real economy;
• Latent development in private detective services, when professional inspectors tend to turn to more lucrative “shadow economy” sectors’ employment.   

Arguing that private detective system has presently become an integral part of national internal security system, Mr. Zemljanov expressed his concern over the necessity to modernise security’s legal background in order to increase detectives’ operational potentials. For example, private detectives must have wider access to various information data, including country’s personal register system, criminal records’ statistics, etc. “If our work is hampered by the lack of such access, we are in danger of creating a corrupt liaison between public prosecution system and mafia groups”, concluded Mr. Zamljanov.

Mr. Edgars Poljanskis, Latvian Foreign Office, Third Secretary, IBA’s Master Studies.

Mr. E. Poljanskis presented to the round table his master’s work theses, which was devoted to the comparative analysis of shadow economies’ situation in Latvia and Uruguay. Master student argued that there were definitely certain common points in the issue’s development. Quite notable, he got several practical advices from numerous experts participating the round table.

Mrs. Ilze Ostrovska, International Baltic Academy (IBA), professor.

Mrs. Ilze Ostrovska, alongside other round-table participants, regards the main nation’s problem not in the “transformation” of gray-shadow economy into a “white-one”, but rather in those ties that orginised criminal groups have established with the government agencies. This is exactly the spheres, which should be under strict control by the national law enforcement bodies and the country’s anti-corruption agency.

IBA’s professor referred to the Italian government experience as an example of a positive approach to the controversial issue, the country where the share of shadow economy reached 15 per cent. This figure is regarded as “a critical, though publicly non-officially acceptable”, the figures which cannot be exceeded under any conditions. Moreover, the government is closely watching that stability of the “balance”.