Trade Policy, Informality and Institutions

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Trade Policy, Informality and Institutions

• By Krassen Stanchev (stanchev_at_ime.bg, www.ime.bg
  )
• Institute for Market Economics

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Recent trade policy developments

• 28 FTA agreements concluded, under the umbrella
  of the Stability Pact (SP) the most lengthily
  process has been chosen. Three ways ahead,
  according SP, Economic Survey of Europe, 2005, No
  1, p.98 a) harmonize and simplify existing FTAs
  b) expand CEFTA (BG, Cro, Ro plus Macedonia in
  talks c) link FTAs in SEEFTA.
• However, as pointed out (WIIW, IBEU) a) little
  (or no) evidence that FTA changed anything, b)
  CEE exceeds SEE as trade partner, not to refer to
  EU c) CEFTA made little sense in terms of
  generating trade between Croatia, and is not
  expected to have any impact on the trade with
  Macedonia d) trade liberalization is more
  crucial for the regions security and prosperity
  than trade generation.
• As required by EU SAA, policies should target
  openness including free movement of goods,
  services, capital, people and improving
  accountability of procedures (e.g. public
  procurement) and, especially reducing entry and
  exit barriers.
• Measures The argument favouring radical versus
  gradual/partial trade liberalization is still
  going on, but regional informal trade but also
  formal will be hit by visas, imposed by EU
  accession.

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Merchandise SEE exports/imports for 1995-2003
period (USD billion, Source UNECE)
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Seven Recent Winners
Legend Production factors, Demand
characteristics, Industry, strategy, rivalry,
Clustering characteristics, Government
policies/regulations
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Seven Recent Winners cont.
Legend Production factors, Demand
characteristics, Industry, strategy, rivalry,
Clustering characteristics, Government
policies/regulations
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Five Expected Winners
Legend Production factors, Demand
characteristics, Industry, strategy, rivalry,
Clustering characteristics, Government
policies/regulations
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Some Expected Losers
Legend Production factors, Demand
characteristics, Industry, strategy, rivalry,
Clustering characteristics, Government
policies/regulations
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Top Determinants of FDI in SEE countries
(Jacobzone, 2005)
Quality of business Infrastructure
Source FDI Confidence Index, AT Kearney
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SEE FDI (UNCTAD, WIR 2004, in US million)
Efthymiadis, 2005
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Comparative FDI flows CEE, SEE, Black Sea
Efthymiadis, 2005
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Comparative FDI stock (Efthymiadis, 2005,
Source UNCTAD, World Investment Report 2004, in
US million)
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Findings (IME in the framework of IBEU)

• The informal economy is an omni-present and
  exogenous phenomenon that emerged from societal,
  political and economic change.
• The majority of the unreported activity takes
  place in the form of partial-informality.
• Tax burden appears as the most significant factor
  conducive to informality but the overall
  administrative burden appears to be much higher
  than its visible part such as taxation.
• Evasion of labour tax is the most widespread form
  of tax evasion.

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Findings (cont.)

• Informal activities are one of the strategies
  firms choose to reduce transaction costs, e.g.
  vertical integration emerges as a mean to reduce
  the cost of transacting.
• In an environment of overwhelming informality
  firms trade with known partners and do not
  recourse to official contract enforcement
  institutions.
• The incentives to engage in protective (rather
  than productive activity) must be attributed to
  both the seller and the buyer of labour. Thus,
  the motivation for informality must be ascribed
  to a much wider population than just the business
  community.

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Findings (cont.)

• Owners usually dominate company structures and
  impose informal intra-organizational labor
  relations, thus preventing the utilization of the
  competitive and formal market for specialized
  labor.
• In certain activities (non-specialized labor,
  mass commodities, etc.) staying informal and
  avoiding taxes is the dominant competitive
  strategy to reduce costs, and therefore selling
  price.
• Increased (state) control to ensure and increase
  compliance has been counter-productive. If
  successful, controls involve a risk (that is
  difficult to measure) to force self-reliance
  disappearing at high political and fiscal costs.

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Obstacles to investment (Efthymiadis, 2005)
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Institutional developments

• Tax and quasi-tax, including administrative,
  burdens are partially lowered and somewhat
  simplified (Romania, Bulgaria, Serbia and
  Montenegro).
• Measures related to taxes unification of
  national treatment, elimination of special
  exemptions and preferences is a problem, in some
  countries impossible or difficult, e.g. Serbia
  and Montenegro, Bosnia and Herzegovina.
• Measures related to quasi taxes basically
  delayed facilitation of entry and business
  registration, separation of inspections/controls
  from commencing activities, reduction of licences
  and permits, depersonalisation of thus reformed
  administrative process use of one stop shops
  and e-government.

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Improving Licensing Procedures (Jacobzone, 2005)
Note Source OECD (2004) Review of Regulatory
Governance in SEE Countries
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Time for Appeal and for Redress (Jacobzone, 2005)
Notes World Banks data. The estimates are
measured as the number of days from the moment
the plaintiff files the lawsuit in court, until
the moment of actual payment. This measure
includes both the days where actions take place
and waiting periods between actions. The
respondents make separate estimates of the
average duration until the completion of service
of process, the issuance of judgment (duration of
trial), and the moment of payment or repossession
(duration of enforcement). Lower figure is the
BiH average and the higher figure is RS average
(excluding outliers) as per the FIAS
Administrative and Regulatory Cost Survey in
2002. Estimate is an average commercial court
procedure. Sources OECD (2004) Review of
Regulatory Governance in SEE Countries and World
Bank (2003) Doing Business. Understanding
Regulation in 2004. Washington DC.
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Contract enforcement in comparison with Estonia
and OECD
Source Doing Business Survey, own calculations
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Quid pro quo

• EU is crowding out Balkan FTAs, CEFTA, and
  provisional SEEFTA
• EU substitutes in the minds of investors the
  availability of an appropriate business
  framework, resembles political stability, helps
  profit repatriation and certainly enlarges the
  market.
• Trade policy is a dependent variable in the
  policy mixes it makes little sense outside EU
  SAP and accession processes.
• Countries are very different, the overall and
  informal trade would suffer from accession
  related movement restrictions.