The shadow or 'gray' economy reached 26.6% of gross domestic product (GDP), according to the results of the Stockholm School of Economics in Rīga's “Shadow Economy Index in the Baltic States” study, which has become an important annual measure and is now in its twelfth iteration.
In an interview with Latvian Radio, the report author Dr. Arnis Sauka said that the growth of the shadow economy in Latvia was actually smaller than expected in the contect of the Covid-19 pandemic. Sauka added that the shadow economy had grown even more substantially in neighboring Estonia and Lithuania.
In monetary terms, the total lost tax revenue from the shadow economy in Latvia exceeds EUR 2.7 billion
“On the one hand, it cannot be denied that the shadow economy in Latvia, as well as in the other Baltic countries, has been negatively affected by the Covid-19 pandemic. However, unfortunately, the data of our study show that policy makers, especially in Latvia, have not done well in reducing the shadow economy even in the years of economic growth, before the pandemic.
"This year, in addition to the Covid-19 pandemic, there has also been uncertainty, incl. economic uncertainty caused by the war Russia has started in Ukraine. In such very difficult circumstances, the reduction of the shadow economy in the coming years should not be forgotten, and new, more modern solutions should be found to reduce it. Because still great resources are wasted in the shadow economy that would be useful both for strengthening national defence and for health, education and science, social protection and other areas,” said Sauka in comments accompanying publication of the report.
Compared to 2020, the shadow economy in Estonia increased by 2.5% in 2021, reaching 19.0% of GDP. In Estonia, this is the highest figure of the shadow economy since 2012, when the shadow economy reached 19.2% of GDP.
Meanwhile in Lithuania, the size of the shadow economy increased by as much as 2.7% in 2021, reaching 23.1% of GDP. In Lithuania, this is the highest indicator of the size of the shadow economy since 2009.
Most likely due to the Covid-19 pandemic, the shadow economy in 2021 has increased in all three Baltic countries. Although the difference between the size of the shadow economy in Latvia and Lithuania is relatively smaller than in previous years, it is still highest in Latvia.
The results of the study show that the most important component of the shadow economy in Latvia, Estonia and Lithuania in 2021 was envelope wages, which account for 46.2% of the total shadow economy in Latvia, 42.7% in Estonia and 38.8% in Lithuania.
In 2021, undeclared income made up 30.0% of the shadow economy in Latvia, and undeclared employees accounted for 23.8%. In 2021, unreported employees, in Estonia and Lithuania, respectively, accounted for 30.0% and 23.5% of the total shadow economy, while undeclared income accounted for 27.2% and 37.7% of the total shadow economy.
According to the results of the study, in 2021 compared to 2020, the share of the average salary (%) that entrepreneurs hide from the state, or the envelope wages, increased in all three Baltic countries. In Latvia, however, this increase is relatively small, only by 0.3%, with envelope wages increasing to 23.8% in 2021. In Estonia, the amount of envelope wages in 2021 has increased by 3.8%, reaching 17.0%, but in Lithuania by 0.9%, increasing to 16.2%. As professor Sauka emphasises: “Thus, the amount of envelope wages is still significantly higher in Latvia, which largely explains the differences in the overall shadow economy between the Baltic states.”
The results of the study indicate that the overall level of bribery (as a percentage of the income unofficially paid by businesses as ‘grease money’) has increased in all Baltic countries in 2021, compared to 2020. The largest increase is observed in Lithuania, where this indicator has increased by 3.9%, reaching 12.3%. In Estonia, general bribery has increased by 0.6%, reaching 7.0% in 2021, and in Latvia - by 0.9%, rising up to 9.2%. The level of general bribery in Latvia has not been so high since 2014, in Lithuania since 2015, but in Estonia this is the highest indicator since this study has been made. The results of the study also show that in all the Baltic states in 2021, compared to 2020, the average % of the contract amount to ensure public procurement has increased. Namely, in Latvia there is an increase of 1.1%, reaching 8.0%, in Lithuania - by 2.1%, reaching 7.7%, but in Estonia - by 0.1%, with this component of the shadow economy increasing to 4%.
The highest levels of shadow economy in Latvia is observed in Rīga region, Kurzeme and Zemgale. In terms of sectors, the highest share of shadow economy in Latvia still comes from the construction sector.
The results of the study also show that although younger and smaller companies are proportionally more involved in shadow economy activities than larger and older companies, the overall contribution of the shadow economy is bigger for larger companies (with more than 50 employees and an annual turnover of more than EUR 500,000). This trend is directly related to the fact that the largest companies, although proportionately less involved in the shadow economy, still have a much higher financial turnover.
Evaluating the latest data on the shadow economy, professor Sauka said:
“Although the trends are generally negative, given the context, the growth of the shadow economy in Latvia, Estonia and Lithuania in 2021 could have been higher. The shadow economy is likely to continue to grow over the next 2-3 years, especially if adequate resources are not devoted to reducing it. In this regard, co-operation between various institutions with an aim to reduce the shadow economy should be further strengthened in Latvia, especially at the operational level. It would urge policy makers not only to concentrate resources on reducing the shadow economy in the most problematic areas, but also to take a comprehensive approach to reduce the shadow economy by introducing a number of interrelated measures. The shadow economy is a complex phenomenon that cannot be reduced by one, single measure. We should not forget about raising the government's reputation among entrepreneurs and the population, including the publicly fair trial of corruption and other economic crimes.”
The Stockholm School of Economics in Rīga carries out its ‘Shadow Economy Index for the Baltic Countries’ study once a year, surveying businesses in the Baltic states. The authors of the study are the head of the SSE Riga Centre for Sustainable Business, professor Dr Arnis Sauka and SSE Riga professor Dr Tālis Putniņš. In order to estimate the size of the shadow economy as a percentage of GDP, the index includes calculations of undeclared business income, unregistered/hidden employees, as well as undeclared envelope wages.
As recently reported by LSM, a revised strategy to tackle the shadow economy is being worked on by officials.
The English-language version of the Index is available to download and read HERE.