Transcript Poverty and the Underground Economy in Croatia 1990

Poverty and the Underground Economy in Croatia 1990-2000
Project leader Katarina Ott
Predrag Bejaković
Institute of Public Finance, Zagreb, Croatia
HR-10000 Zagreb, Katančićeva 5, P.O.Box 320,
Tel: +385 1 48 864 55, Fax: +385 1 48 19 365
e-mail: [email protected], www.ijf.hr
UNECE Seminar on Poverty, Geneva, 2-3 October 2003
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Some statements about poverty
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In general, the art of government consists in taking as much money as
possible from one class of citizens to give to the other. - VOLTAIRE
(1694-1778), the French writer and philosopher
And distribution was made to each as had need. - ACTS 4:35
A decent provision for the poor is the true test of civilization. - SAMUEL
JOHNSON (1709-1784), English lexicographer and writer
Almight God! Thou who holdest in thy hand the minds od men, deliver us
from fatal arts and science ... give us back ignorance, innocence and poverty
which alone can make us happy and are precious in thy sight (Discourse
on the Arts and Science, 1750:27) - ROUSSEAU, Jean Jacques
(1712-1778), French philosopher, social and political theorist
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Project and presentation contain
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Description of research into the underground economy (UE)
in Croatia in the 1990 to 2000 period.
The circumstances surrounding and the reasons for the origin
of the UE
Estimations of the dimensions of and changes in the UE at
the level of the whole of the economy and in terms of
certain industries.
The socio-cultural and institutional dimensions of the UE are
analysed, including the influence of formal and informal
norms, privatisation, poverty, self-employment and so on.
Influence on poverty
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What is the Underground Economy
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The Underground economy encompasses all activities
that are formally legal but ideologically are suspected;
hence there is official tendency to discriminate them
and give them an inferior status. It covers productive
activities that are quite legal in themselves but which are
concealed from public authorities to avoid taxes and
similar charges.
Activities in "hidden" economy consist of undeclared
legal production of goods and services, production of
illegal goods and services, and concealed income in
kind.
Tax evasion
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How to measure in
measurable?
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(1) a monetary approach;
(2) official statistics with arbitrary estimates;
(3) calculation and analysis of the structure of informal economy
(4) comparing the rates of activity in longer period or among different
countries (if rates of activity are decreasing, it can be due to withdrawing
from formal to informal sector);
(5) differences between income and consumption (if consumption is bigger
than income this part of income can be realised in informal economy)
(6) using the data from national accounts;
(7) better control of taxpayers and tax obligations;
(8) examining the opinions of experts for particular part of economy;
(9) method of causes where the reasons that stimulate for the participation in
the informal economy are analysed;
(10) electric consumption.
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Various evaluation methods give different results, but
according with the most applied methods (national accounting,
discrepancy between income and expenditures method, labour
force survey) in the Republic of Croatia the UE came on
average to about
25% of GDP in the 1990-1995 period, and in 1996-2000 to
an average of 10% of GDP.
With reservations because of
the uneven results obtained by these various methods and
uncertainty whether this is a matter of a genuine reduction of
the UE or of an improvement in statistics
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In 1996 the Institute of Public Finance did research into the UE in Croatia in
the 1990-1995 period. The whole project has been published or participated in:
• the journal Financijska praksa, 21 (1-2), 1997, (English Summery on
http://www.ijf.hr/eng/fp/97/1-2/index.htm)
• a summary in Bicanic and Ott (1997), The Unofficial Economy in Croatia:
Causes, Size and Consequences. Occasional paper, 1 (3), November. Available at
http://www.ijf.hr/.
• an international conference on the UE in transition, works from which were
also published in Financijska praksa, 21 (5-6), 1997 (English Summery on
http://www.ijf.hr/eng/fp/97/5-6/index.htm)
• the book of Edgar Feige and Katarina Ott, (1999) Underground Economies in
Transition: Unrecorded Activity, Tax Evasion, Corruption and Organized Crime.
Aldershot : Ashgate.
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Trends in the unofficial economy in Croatia could be influenced by
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structural conditions (impoverishment, increasing inequality, unemployment,
destitution of the public services), and
the institutional changes (privatisation, taxation policy, sanctioning).
Reasons for UE were
the inherited tradition
 the transition with its vigorous sector and institutional restructuring
 the great influence of the government in the economy, particularly through
paternalism and privatisation.
 the high tax burden
 unclear and non harmonised laws and regulations
 the lack of the independence and resources of the courts
 the lack of or insufficient organisation, efficacy, expertise and cooperation of
state bodies.
There is the obvious ambitions of the state to become large, expensive and
paternalistic, to invest in economy or to subsidise it, which encourages new
corrupt and illegal practices.
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A particular problem of the unofficial economy in Croatia
is its involvement in privatisation, due to:
 the quantity of the social capital included in
privatisation,
 the impossibility of measuring the unofficially economy
in privatisation,
 the attitude that privatisation auditing is a political rather
than economic, legal and moral question,
 the lack of transparency in regulations and the
concentration of power in the hands of the state
officials (lack of public accountability, appearance of
the state clientelism, etc.).
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Detailed measures of economic policy necessary for the
suppression of the UE were suggested, and particularly
stressed that in attempts to reduce the UE it was more
important to do away with the causes than to penalise the
consequences. Most important was to:
reduce taxes and customs duties (to the extent permitted by
the state budget)
reduce regulation (but selectively, without reducing, for
example, regulation of the labour market, which is positive)
reduce the role of the public sector and the presence of the
state in the economy while liberalising the economy
better estimate the size of the unofficial economy within
the overall economy and in individual sectors
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New phase of the Project
During 2001, the Institute of Public Finance went on with the previous research and
started a new chapter in investigation of the UE in Croatia
The whole project has been published or participated in:
 the journal Financijska praksa, 26 (1), 2002, (English Summery on
http://www.ijf.hr/eng/fp/02/1/index.htm)
 IJF Occational papers - available at http://www.ijf.hr.
 No. 15 Dollarisation and the Underground Economy: Accidental Partners?, Šošić &
Faulend,
 No. 14 Opportunism, Institutions and Moral Costs: the Socio-Cultural Dimension of
the Underground Economy in Croatia 1995-1999 / Štulhofer & Rimac
 No. 13 An Estimate of Tax Evasion in Croatia / Madžarević-Šujster,
 No. 12 The Underground Economy in Croatia / Katarina Ott
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An international conference Unofficial Activities in Transition Countries: Ten
Years of Experience, on line available on http://www.ijf.hr/eng/index.html
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Various approaches to the measurement of the
UE were applied:
the national accounts
monetary methods
labour force surveys
tax evasion
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It should be pointed out that comparisons of results obtained by different methods
are very risky.
The measurement of the UE via the national accounting discrepancy method always
gives relatively low results, unlike monetary methods, which always give relatively
high results
Figure 1. Share of the underground economy in GDP according to different methods
1) Share of tax evasion in GDP,
lower limit
40
2) Share of tax evasion in GDP,
upper limit
35
3) SNA method
30
25
4) Electricity consumption
method
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5) Monetary evaluation method
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10
6) Gutmann method
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7) Eurostat method (lower limit)
20
00
19
99
19
98
19
97
19
96
19
95
19
94
19
93
19
92
19
91
19
90
0
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Although the discrepancy in the national accounting method
has a number of drawbacks, this method does provide a general
picture, and it can be considered the lower border for the share of the
UE in GDP. It is a very good point of departure for
complementation with alternative methods of UE estimation.
The discrepancy in the national accounting method determined
that the UE in
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the period 1991-1995 came to an average of 25.4% of GDP,
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for the 1996-2000 period, the UE is estimated at an average
10.4%
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Some of the reasons and explanation
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Such results seem fairly logical. In the earlier
period in Croatia there was the war,
hyperinflation, the beginnings of the transitions
and reform, and in the second period
stabilisation and the strengthening of the ethical
and legal system.
Of course, one has to ask again how much this
is a real reduction in the UE, and how much a
better statistical coverage of the OE.
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Authors in Project have determined that in Croatia there is a negative correlation between
the UE and GDP. Source: Madzarevic-Sujster and Mikulic (2001).
Figure 2. Share of the underground economy in GDP (% of official
GDP)
40
10
36.88
35
30
5
0
29.4
28.15
25
25.45
20
15
-5
18.38
14.37
-10
16.31
-15
11.38
10
9.12
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1990
1991
1992
1993
1994
Grey economy, % of GDP - left axis
1995
1996
1997
1998
-20
6.81
-25
2000
8.41
1999
Real growth of GDP, % - right axis
Source: Madzarevic-Sujster and Mikulic (2001).
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Other methods
The results from monetary method are perhaps questionable, but are certainly
indicative. The authors endeavoured to link up literature about the UE and
dollarisation, suggesting this connection as a link that is missing, and which
could enhance the quality of research into both areas. Since the measurement
of underground dollarisation is in its infancy, this work is one of the pioneer
attempts that, one can hope, will stimulate new research into the phenomenon.
According to the Eurostat method adjusted to the needs of transitional
countries, employment data from official sources and labour force surveys are
compared. This method covers illegal activities such as prostitution, drug
dealing and so on. The difference of the officially recorded and the expected
rates of activity of the population is analysed.
In Croatia the main component of the UE is work on the black, or
unreported employment.
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Estimate of tax evasion
From 1994 to 2000 the lower border of tax evasion shows a declining trend, from 8.5 to 5.5% of
GDP, while the upper border up to 1998 was constant, and after that it fell from 11 to 7.5%.
Figure 3. Comparison of tax evasion and the share of the UE (% of GDP)
50
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45
11
40
10
The lower limit of tax evasion, right axis
Tax burden on the economy, left axis
Share of the underground economy, left axis
Upper limit of tax evasion, right axis
35
30
9
8
25
7
20
6
15
5
10
4
5
3
1994
1995
1996
1997
1998
1999
2000
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It is interesting that the upper estimate of tax evasion follows the tax
burden until 1998, the rise of the tax burden in 1998 led to the rise in tax
evasion, and in 1998-2000 the reduction of the costs of labour resulted in a
reduction of tax evasion.
Tax evasion is reducing, and we can be pleased with this. Nevertheless, 8.6
billion kuna (the lower limit) of missed revenue in 2000 is still a very large
amount. The missed revenue is greater than, for example, the deficit of
consolidated general government, which in 2000 came to 7.7 billion kuna.
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Estimates of the UE in individual industries
Agriculture - for the whole of the 1990-1999 period, an average lower limit of 6.8% and an
upper limit of 16.9%.
Industry is a branch with a relatively low though growing UE trend, from 2.3% in 1996 to 5.2%
in 1998. The growth or stagnation of the UE in industry, unlike the fall of the UE at the level of
the economy as a whole, can be explained by the lagging of the transition in this activity.
Trade. Although, depending on the definition, the results of estimates of the UE in trade vary a
good deal, the trends are nevertheless identical – a sudden growth in 1990-1993, a sudden fall in
1993-1994, a mild decline or stagnation from 1995 on.
Figure 4. The UE in agriculture, industry and trade (%)
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agriculture(upper
limit)
60
50
40
industry
30
20
commerce (upper
limit)
10
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Source: Mikulic and Madzarevic (2001).
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The trends, however, are essentially different: the UE is reducing in
trade, stagnating in agriculture, but rising in industry. The explanation
might be fairly simple – the speed of the transition per sector, the
development of a number of new, mainly small business units and the
number of employees, the relative weakening of the importance of
the big systems. In short, the transition was most rapid in trade,
slowest in industry – hence this kind of result.
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The socio-cultural and institutional dimensions dimension
of the UE
The causes and dynamics of the UE cannot be understood
outside the social and economic background of the area.
This means that the reduction of the UE is necessarily based on
the simultaneous action of social and cultural, legal and
economic measures.
In the theoretical assumption the dynamics of social
opportunism coincides with the dynamics of the UE, since the
rise in opportunism reduces moral costs. This, in turn, increases
the readiness to get round or break the standards and - if it goes
unpunished - sustains the expansion of opportunism.
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If we compare the results from 1995 and 1999, we will notice the
following:
•The level, in both diffusion and intensity, of opportunism has
decreased. The number of those who think that tax evasion and bribe
can never be justified has doubled.
•The age structure of opportunism has remained unchanged – the
youngest age group is still most apt to justify tax evasion and taking
bribes. This gives ground for concern suggesting that the
phenomenon might be long-lived.
•Distrust in institutions has increased, and is once again most
pronounced among the young.
•Economic traditionalism has ceased to be a relevant factor;
respondents are getting used to differences in wages and are, as it
seems, embracing the principle of individual responsibility.
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In a society there are both formal and informal institutions,
which are interwoven, that is the informal usually
complement the formal. In the transitional countries, the
formal institutions are incompletely articulated, not built
up, and some do not even exist. The weakness of formal
institutions contributes to the rise in the UE, crucial being
an analysis of the costs and benefits of accepting
(un)lawfulness.
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Privatization
Most activities of the UE in the first half of the 90s, such
as political clientelism, fictitious recapitalisation, failure
to report or appropriation of the profits of firms,
assets stripping, deliberate bankruptcies, corruption,
bribery, abuse of official positions and so on went on in
the second half of the 90s, with the new phenomena of
irregularity in the privatisation of the banking
sector and coupon privatisation. Because of the
absence of political will, the non-existence of an
effective and independent judiciary and the inefficient
public control, the UE was maintained in privatisation
during the whole of the decade.
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In analysing the poverty & unemployment, one could stress that in
Croatia:
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poverty is not the key generator of the UE,
the fact that the UE actually deepens inequality need not be equated
with the creation of poverty, and
a certain level of the UE in every developed society is related to the
poorest but this is not the segment of the UE towards which social
measures need to be directed.
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Basic facts about poverty in Croatia (I)
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Using an internationally comparable standard across transition economies
(4.30 US dollars a day per person at purchasing power parity) it was found
that the incidence of absolute poverty in Croatia is very low. This
international standard, however, may not reflect adequately specific
conditions of each society. For policy makers what matters is the extent of
poverty based on nationally relevant standards.
There is no national official poverty line in Croatia. The World Bank study
has estimated the level of total expenditures (including non-food items) of
households in Croatia at which families, after paying for essential non-food
expenditures, just attain minimal nutritional needs.
This level of expenditures represents therefore an absolute poverty line and
amounts to 41,500 HRK (5,500 Euro) per year (in 1998 prices) for a couple
with two children or 15,474 HRK (2,100 Euro) for an “equivalent adult”.
Only around 10 percent of the Croatian population falls below this nationally
specific poverty line.
Poverty Rate with International Line
4.0%
Poverty Rate with National Line
8.4%
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Basic facts about poverty in Croatia (II)
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The poverty gap is 1.8% of total consumption, and
that on average the consumption of a poor household
is 20.7% below the poverty line.
To bring all poor above the poverty line with perfect
targeting (i.e., each poor person is given a transfer
exactly equal to the poverty gap) would cost 1 percent
of GDP; and to give to all poor the amount equivalent
to the poverty line would require 4 percent of GDP.
Therefore, it would be affordable for Croatia to
completely eliminate absolute poverty.
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Basic facts about poverty in Croatia (III)
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Those Who Have the Misfortune to be Poor are
Seriously Deprived.
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Life of the poor differs in many respects from the nonpoor. The poor tend to live in overcrowded, poorly
maintained dwellings; their diet is limited to basic
staples (especially for the urban poor who can afford
little beyond basic staples such as bread, potatoes or
milk); and, they are poorly educated. Only few have
savings; they are often immobile, and their social
networks are very limited.
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The Poor Have Distinct Characteristics ….
The poverty profile is dominated by two groups:
 poorly educated individuals and the elderly.
 Almost ¾ of the poor live in families where the head has
primary education or less. They are likely to have bad prospects
for finding employment when they are not employed, or have
low earnings when they are employed. The risk of poverty is
particularly high when poor education is combined with
unemployment.
 Low pension benefits or no pension at all in old age is the
second cause of poverty: 40% of the poor live in households
with a retired. In 1998 as many as 25 percent of all retirees did
not receive pension benefits and about half of pension
beneficiaries received pensions that were below the poverty line.
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In Combination With Limited Opportunities
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Poverty in Croatia has already many features of a permanent
state: the poor are unlikely to escape poverty easily. This is due to
two basic reasons:
there are limited economic opportunities because growth so far
has not generated enough jobs. Many old jobs have been
destroyed and very few new jobs have been created. Growth has
benefited primarily those who kept their jobs. But for those
locked outside employment, the effect was close to nil, if not
negative. Furthermore, over-regulation of employment,
especially constraints on layoffs, are limiting opportunities for
small businesses and flexible working arrangements, both of
which could constitute a viable alternative to wage employment
for the poor; and
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… Make Them Likely to Be Stuck in Long term Poverty
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The poor are at a disadvantage to benefit even from this
limited set of opportunities. Once locked outside employment,
unemployed and economically inactive have limited possibilities
to break the circle of impoverishment. Over half of the
unemployed are long-term unemployed, so analysis of labor
market flows suggests that both unemployed and inactive are
unlikely to find a new job.
Most of working age individuals who are not employed have
either very low educational endowments (primary) or
narrowly formed skills (vocational schools graduates). Those
who are currently locked outside remunerative employment due
to their level of education are also likely to see their limited
opportunities perpetuated for their children.
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Almost crucial question in solving poverty is employment
(im)possibility. It is most important for employment to start to rise,
because then, all those who are in the UE not from their own will but
because it is the only way out will start to go over from the UE to the
OE.
With a rise in employment, the income of the population will
rise and this will have an effect on a reduction in the UE and
poverty.
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A propensity to evasion of pension contribution will be
crucially affected by an inadequate link between
contributions and pensions, an unjust system with many
(high) privileged pensions, without the payment of
contributions, and circumstances in which a contribution is
not a condition for being able to claim pension rights.
According to the Croatian Pension Fund in 2000 about 82%
of contributions were collected.
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The analysis of inefficacy of the judiciary warns of some apparent
problems and possible solutions:
it is important to encourage transparency in public tenders and
contracts clearly to determine authorities and responsibilities of
public servants and the opportunities they have for discretional
decision-making
the courts can have their load lightened by the encouragement of
arbitration of disputes.
the adoption of clear intelligible, unambiguous and lasting laws,
which will have an affect on the growth of the efficacy of the
judiciary, greater resistance towards unlawful behaviour, the
dissemination of the rule of law and democracy and, indirectly to a
reduction of the UE and unlawful forms of behaviour.
Unfortunately, key factors such as the transparency and quality of
public services are still not developing with adequate speed, and quite a
lot of time is still required for them to be improved.
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THE PROJECT CONTAINS MANY
RECOMMENDATIONS OF MEASURES NECESSARY
FOR THE REDUCTION OF THE UE
SHORT GENERAL RECOMMENDATIONS
GENERAL INSTITUTIONAL MEASURES
MEASURES IN THE PRIVATISATION PROCESS
MEASURES IN STATISTICS
REFORM OF THE TAX SYSTEM
ENCOURAGEMENT OF EMPLOYMENT
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THE JUDICIARY
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Better to obviate the causes than penalise the consequences.
Thank you for your attention
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