Tuesday, August 25, 2009
Sunday, August 23, 2009
Taxation is theft. We tolerate it because the thief, government, uses at least some of the loot rationally and sometimes we (civil society) get a piece of it back when using a public service such as education, the police and, in a number of countries, basic health care. When the system starts to break this implied promise, or otherwise grossly disappoint or appear to deceive us, society takes spontaneous action to keep more of the wealth it creates under its own direct and, generally, radically de-centralized control.
This is not meant as some kind of libertarian economic tirade, but a forecast that in Latvia, we will very likely see a resurgence of the grey economy -- the kind where most economic activity works as it should, but as much of it as possible takes place outside the tax system.
It is important to understand that the grey economy is nothing but the everyday, legal economy with a strongly diminished or completely absent incentive to make payoffs (taxes) to the state. It is not the black economy, where many activities are malum in se (evil per se) such as knowingly selling guns to criminals, trading in goods stolen or obtained by fraud, selling the fruits of forced labor and the like. Many would include the trade in state-prohibited intoxicants in black market activities, but that is another issue.
Latvia has a history of grey market activity going back to the 1990s and beyond. It stems from Soviet times when most of the population rightly regarded the state as a totalitarian monster(the Gulags, the KGB) and/or a pathologically lying buffoon (Brezhnev, Communist ideology, promises of socialist prosperity) and did everything in their power to deny to the state or expropriate back from it the fruits of their labor. To put it concisely -- stealing from the state was a virtue. It was the only relatively safe form of resistance.
The grey market continued to evolve during the 1990s, in the general chaos of legislation and system transition. Those who had “stolen” from the state under the Communists often saw little reason or incentive to stop. Only as Latvia reformed and rationalized its tax system, as the state bureaucracy became marginally less byzantine, as accession to the European Union approached and was achieved, did the grey economy recede. With lower tax rates and an apparent “return on taxation”(schools were built, roads fixed, hospitals upgraded), there was less to gain from trying to beat the system, plus there were considerable internal costs in doing so. A bookkeeper keeping two sets of books will ask to be rewarded (on or off the books) appropriately. Concealment and evasion strategies must be formulated in addition to the management time needed to run the core business.
By the middle or the end of the 1990s, the superprofitable business of plundering Soviet-era assets for a song and selling them in foreign markets was also drawing to a close. While making 300 % profit on selling the metal from an abandoned Soviet factory (with most of the labor bartered for vodka) was an incentive to keep such transactions off the books, there was less incentive when earning 25 % from a foundry that did most of its work buying legitimate scrap and selling to export customers that did not want to look like they were buying from bandits and insisted the business at least look like it was paying taxes.
What I see happening is that the massive state budget cuts, hitting at core public services such as education, health care, public safety and pensions, will trigger another boom for the grey economy. If anyone has not caught on to this destruction of “return on taxation”, they will catch on when the government raises a whole slew of taxes (the new tax on residences, higher income and VAT taxes -- in short, whatever was dreamed up this week and may be shuffled around next week). It is time to dust off the grey market experiences of 10 years ago.
The government is very aware of what its own actions are inciting in society -- otherwise it would not be urging the State Revenue Service/VID (or what is left of it after planned massive staff cuts), regulatory bodies and the police to crack down on tax evaders and “illegal” business. Instead of becoming more service-oriented and business friendly, the VID will, if government directives are carried out, revert to its worst inquisitorial auditor/punisher face. File your quarterly papers a day late (even if the taxes they refer to were transferred on time) -- fine ‘em, fine ‘em. Misspell your company name, forget a digit of the registration number, whatever -- off with your head! Now that makes deceiving these fuckers an honest sport again!
Aside from reverting to a state of low intensity civil-war-by-deception with the tax-collecting, regulatory and repressive organs of the state, some businesses (I like to think) have other incentives for paying wages by envelope rather than paying them after tax. Business owners see that off-the-books wages have tangible social benefits, while paying the state social tax has the opposite result. Beggars still huddle on downtown streets, hospitals are closed (for whatever reason), teacher’ s salaries are cut to barely above minimum wage, no matter how much taxes and social fees are paid. When paying envelope wages, the employer knows that the money is being spent by Jānis for his sick mother, by Ieva for her child’s education, by Sergey to modestly renovate his apartment. In other words, the enterprise becomes a kind of private welfare space, spending the money denied the state in more visibly and tangibly beneficial ways. This is not to say that all envelope wages are paid with this kind of consciousness, probably in many cases, this arrangement is part of haphazard and often exploitative labor relations. But then again, back when taxes were paid, weren’t they paid to have labor law enforcers do their job?
In a very rough and often uneven way, a functioning grey economy can at least partly replace the missing “return on taxation” from the Latvian government, which has, during the blind and foolish administrations of the “fat years”, painted itself into a fiscal corner in several dimensions. Officially, the IMF and other lenders are telling it to get its act together, save billions in the next couple of years, cost what it may socially, while society and the real economy are saying -- we won’t pay! (but we will pay some of those deserving it). In effect, the collapsing public services are replaced, in an unevenly distributed way, by the funding diverted to the grey economy.
The grey economy is no replacement for a functioning modern moderate welfare state (as Latvia has tried to pass itself off as being), nor is it a rational step in consciously moving toward a night-watchman state or minarchy (which Latvia seems to be stumbling toward, whether it knows it or not). It is an improvised solution based, not on a reform of the system of governance, but is a symptom of chronically bungled and incompetent governance.
The next developments in Latvia’s economy are going to be pretty rough. European countries with labor markets accessible to Latvian citizens will recover ahead of Latvia. There will be another wave of labor emigration, numbering in the tens of thousands, in the period 2010-2013. Like their predecessors to Ireland and Great Britain in the late 1990s and the first decade of the 2000s, these Latvian economic immigrants are unlikely to ever return permanently to Latvia. Their presence, however, will generate additional repatriated funds, which will be of some limited benefit to Latvia. The Latvian economy, however, will be deprived of much of its best, brightest, most skilled and entrepreneurial labor, increasing the demographic burden on those remaining beyond the mere numbers of those emigrating. Not only warm bodies, but productivity will emigrate, and with that, there will be less value generated by the domestic Latvian economy to reallocate to pensioners and already depleted public services. As for basing an economic recovery on exports, it will be pretty hard when many of the best export producers will have “exported” themselves.
So where will those remaining behind go? Not abroad, obviously. It is a bit exaggerated to think that there will be a day when the last Latvian shuts off the lights at Riga Airport. But in terms of economic and demographic tipping points, there may well be a point at which a sufficient number of “the best and the brightest” have departed, effectively switching off the lights at the end of any tunnels.
So where will the remaining ones go? I think they are already moving into the virtual, tentative, experimental, not-as-disfunctional-as-the-official-economy space that is the burgeoning, resurrected grey economy. And I do not blame them at all.
Friday, August 21, 2009
I don't know if Dombrovskis was referring to this blog (who knows? the man reads English) or, more likely, to a prominent Latvian political scientist's article which seems to have borrowed the title Failed State Latvija? from here.
In any case, I have always argued that Latvia was, if anything, a kind of failed state lite, with no Somalia-style dramas at street level (stoned competing militias driving around in technicals, shooting cattle for amusement, no public services whatsoever, etc.). The lights are on, public transportation runs, there is radio, TV, and if the shit going down is serious, the police will probably show up.
The reason I call Latvia a failing state or failed state lite is because the administrations prior to Dombrovskis allowed state finances and bureaucracy to bloat and private lending to run wild beyond a number of tipping points, so that most of what has happened in terms of budget cuts, international beggar-bowling, etc., was inevitable and unstoppable. Valdis Dombrovskis, the smart MEP with a cool, calm style, was the man chosen to be the fall guy for the economically lethal bungling of the administration of Aigars Kalvitis and, to some extent, Ivars Godmanis (who stayed around long enough to "save" Parex Bank and figure out that, indeed, the train of the state was runway and it was time to let someone else take the controls).
I don't know what Dombrovskis sees as a failed state. He seems to lean toward the definition that talks of a collapse of the monopoly on legitimate force. This isn't happening here, yet, but a lot else is, such as the de-facto collapse of public services and the widespread total mistrust of political power. It is, of course, a dramatic case of state failure when the population takes up arms against the police and military, but is it less a failure when folks simply ignore the alleged legitimacy of the state by ignoring it, evading taxes, dispensing rough justice and proclaiming (as in many parts of the countryside) that they see no evidence of state power or service.
It may not get widely publicized or reported, but there are probably communities kilometers down the pitted dirt road from the nearest policeman and his Soviet-clunker jeep, where drunks (and most of the population sometimes qualifies as such) who overstep certain boundaries are simply taken for a remedial walk in the woods, where what little business there is takes place as untaxed barter of goods (often alcohol) and services, and where the local school, admittedly a luxury with many teachers and staff for few pupils, will be closed with no way for children to reach the next district school, and where the district hospital will be closed as well. It is an interesting question as to whether there people abandoned the state, or the state failed them.
I can still walk about Riga safely, I can buy all necessities and (if I wanted to) a wide range of luxuries (flatscreen TVs are getting cheap, so are slightly used SUVs), but I am not at all sure that there will be anyone teaching my child at his underfunded school. I am resigned to having to pay full cost for any acceptable level of private health care (some is covered by insurance from work) and I assume that I will not be paid any reliable pension by the Latvian state. In other words, given the choice of another system of governance where these things worked, I would personally rank Latvia as failed and go there instead if and when that becomes a viable option.
In a broader sense, the scenario for Latvia is probably an L -shaped or even a drooping L scenario of stagnation for much of the next decade. One contributing factor will be that a large number of skilled and qualified workers will leave -- for all practical purposes, permanently --once EU labor markets revive. Recent TV spots about Latvians in Ireland indicate that those who have moved there --especially those making the psychologically and socially wise step (for all involved) of bring their families along -- are very unlikely to return. Even unemployed Latvians (laid off from construction work) say they are far better off and have better prospects in Ireland than they would ever have in Latvia.
Another contributing factor is that hasty cuts will collapse public services such as education and health care, leading to a decline in the skills of the younger generation and hastened mortality among the old. What impact this will have, I leave to other bloggers such as Edward Hugh, to comment on.
So I will respectfully disagree with Valdis Dombrovskis and say again -- Latvia is a kind of failed state and will continue to fail for the foreseeble future.
Tuesday, August 11, 2009
Unfortunately, this is unwarranted optimism. The problem is not the presence or lack of stimulus (although mechanical and largely chaotic budget cuts of over LVL 1 billion are a considerable "anti-stimulus"), but one of trust in the Latvian government as an institution. This, I believe, has completely and irrevocably failed. The past governments have allowed the country to spin into a recession and crisis that is far more severe than had some preventive measures been taken over the past two or three years. The present government has irreparably broken the compulsory social contract by effectively shutting down health care and education and cutting pensions (by 70 % for working pensioners). It has raised and plans to additionally raise taxes as the tax base contracts, thereby stimulating only the gray economy.
Don't get me wrong -- there is a lot of waste in the way Latvia is governed and in the way medical and educational services are delivered, but to chop them off and toss this into the "care"of society with little warning is not a solution. The right thing to do would have been to carefully analyze (by independent third parties) the gross inefficiencies of Latvia's government and public services and to start a gradual downscaling (privatizing hospitals, but setting up a credible private/cooperative health insurance network, cutting taxes and allowing broader use of private pensions, setting up private/cooperative schools with tax reductions and deductions). I suppose it would take some 10 years to move Latvia toward a night-watchman state with minimal taxes and a core of police, judiciary and defense services. Instead, the government has announced no plan, it has broken implied social promises and it has demoralized the able, working parts of the population ensuring that, as soon as the rest of the EU starts to recover, tens of thousands of Latvians will emigrate. This will ensure the stagnation of the economy as labor skills and entrepreneurial talent go elsewhere.
I am afraid that L is where we are going.
I suggest you click through to the YouTube site to get the best viewing experience.
Monday, August 10, 2009
This compares to an 18 % drop in GDP in the first quarter. In seasonally-adjusted terms, the second quarter drop was 18.2 %. Hardest hit were the restaurant and hotel business down 35 %, and retailing, down 28 %. Manufacturing's contribution to GDP was down 19 %.
Prime Minister Valdis Dombrovskis believes the economy is hitting bottom. Perhaps. But the figures that suggest a year-on-year drop of at least 20 % also mean tax revenues will shrink proportionately (at least), putting more pressure on the state budget, which faces cuts of an additional LVL 500 million for 2010. There has been some optimistic speculation of a reduction in the need to cut to LVL 260 million due to expected higher tax revenues (resulting from VAT and other tax increases). However, I think tax revenues will plummet due to GDP stagnating and citizens and enterprises moving to the grey market to avoid paying higher taxes for drastically shrinking government services.
The critical moment in terms of GDP is not what happens in Latvia, but whether there will be GDP upturns sufficient to generate new demand for labor in other EU countries. If that happens, expect a wave of emigration from Latvia as tens of thousands seek jobs and better governance in Britain, Germany, Ireland, Sweden, wherever... This will further shrink the tax base and extend the stagnation of the Latvian economy -- a situation in large part caused by the mindless budgetary and credit expansion of earlier years.
Somewhat better news is that inflation dropped to 2.5 % in July. But it is a statistic of mixed blessings. Are prices lagging after falling purchasing power, which in turn, is affected by lower revenues and wage cuts in both the private and public secor, which in turn lowers revenues for retailers again, which...? You get the point?
Deflation also increases the relative weight of euro-based loan repayments in family budgets, especially as wages fall as well. Devaluation would only aggravate the problem at this stage of the game.