Shadow economy in eastern Europe undermines growth, says World Bank

11.09.12 @ 09:29

  1. By Nikolaj Nielsen
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BRUSSELS - Doing business and working outside government regulation and tax systems in eastern Europe is so widespread that it risks undermining the region's long-term growth potential, says a World Bank report released on Monday (10 September).

  • Declared businesses in eastern Europe suffer tax revenue loss and unfair competition from informal firms, says the World Bank (Photo: EUobserver)

"The governments of the new member states in Eastern Europe simply cannot afford a large shadow economy, neither in the short run due to fiscal concerns, nor in the long run due to the shrinking labour force," said World Bank senior adviser, Katarina Mathernova.

The report looked primarily at Bulgaria, the Czech Republic, Estonia, Hungary, Lithuania, Latvia, Poland, Slovenia and Slovakia.

It found that the shadow economy made up 33 percent of Bulgaria’s GDP in 2007.

The report notes that the ongoing financial crisis has created a "renewed sense of urgency" to end the practice of untaxed and unregulated work.

The World Bank recommends a series of policy initiatives to ensure these governments provide a more attractive working alternative to the existing informal economy. A friendlier tax system coupled with a viable social and employment protection schemes is among its proposals.

In particular, the report notes that the sector most often involves low-paying and casual part-time jobs. State officials need to design "smarter social benefits that reward formal work" for those engaged in the shadow economy.

The World Bank recommends the states cultivate better practices to encourage unregulated businesses to declare their income and employ declared workers. It also says social norms need to change.

"Building trust in government is a key factor in convincing citizens paying taxes is useful," says the report.

Tax officials, it notes, should approach citizens on the "presumption of good citizenship" in order to build better relations.

Meanwhile, the shadow economy creates problems on three different levels, says Truman Packard, World Bank lead economist and co-author of the study.

Truman says that at the household level workers and families are unable to properly manage their income risks because they have no formal access to social security.

Businesses that operate outside regulation also lack access to credit protection of property rights while formal companies "are overburdened due to tax revenue losses and unfair competition from informal firms."

"At the societal level, a large informal sector erodes the financing of public goods and services, thereby inhibiting the government’s capacity to provide proper education and health care services and a well-functioning infrastructure," said Packard.

European Commission statistics estimate Bulgaria's shadow economy as accounting for 32 percent of GDP in 2012.

This is followed by Romania (29%), Lithuania (28.5%) and Estonia (28.2%). Austria is at the other end of the scale, with 7.6 percent of GDP coming from the black market.

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