Saturday, June 15, 2013

SHEDDING LIGHT ON CROATIA’S SHADOW ECONOMY


Croatia’s economy must be better than the official numbers suggest.
Traveling around the United States in 2009 and 2010, you knew the economy was bad without looking at a single piece of data. No one was smiling, at least not among what’s become known as the 99 percent. Anyone you talked to, talked about how bad things were. The recession, just a few months old, was like a bad hangover that everyone shared.

In Croatia, the mood is quite different. Officially, the country’s been in recession almost continuously since early 2009 with GDP falling in almost every quarterly report. But walk down Bogovićeva, and street cafés are full of people chatting and gossiping under gas-fired heaters. Shops are closing, but new ones are opening, too, and the malls are crowded. Starbucks might have begged off, but Harvey Norman opened a huge store in Zagreb in 2011 and IKEA is desperately trying to navigate the bureaucracy and join the market.
Granted, on the edges you see distressing signs of the crisis. Seniors dig through garbage bins for plastic bottles and other valuables, and amputees beg at traffic lights. Small business owners tell me business is very depressed. Yet for all its real economic troubles, on the surface Zagreb is cheerful and vibrant. That’s one thing that makes it such a great place to live.

But where’s the recession?
A 2011 report from A.T. Kearney and VISA, “The Shadow Economy in Europe,” offers a clue. The report concluded that Croatia’s shadow economy—legal transactions that are either unreported or underreported—amounts to about 30 percent of GDP. That’s a huge proportion and is surpassed only by Bulgaria in the report. (Slovenia’s shadow economy was put at 16 percent of GDP, while other former Yugoslav countries were left out of the report.) For Croatia, this means essentially that for every three kuna in business known to the government, an additional kuna slips by unnoticed. It’s possible that if the shadow economy were counted, Croatia might not even be in recession.

VISA, the report’s sponsor, has a vested interest in inflating its estimate of the shadow economy, and the report concluded that electronic payment systems are a dandy way fight the shadow economy. Swiping a credit card leaves a paper trail that’s difficult to hide. (Something to think about next time you’re offered a discount for cash. The fee charged by credit card companies is marginal compared to the increased business the convenience of accepting cards can generate.)
But, a 2012 report from the World Bank offers a similar picture. The report, “In from the Shadow,” doesn’t include exact estimates of Croatia’s shadow economy, instead focusing on labor issues. (Workers in the shadow economy generally aren’t protected by labor laws, another reason next to tax evasion why some employers like staying off the radar.) However, charts included in the report show Croatia’s shadow economy at about 30 percent of GDP in 2000.

The shadow economy isn’t necessarily bad. Robert Neuwirth, author of “Stealth of Nations: The Global Rise of the Informal Economy,” argued that the shadow economy, which he calls System D after an obscure French term, plays a crucial role in economic development. Neuwirth estimated that globally System D accounts for about $10 trillion in economic activity annually and encompasses about 1.8 billion workers. If System D were a country, it would be the world’s second largest economy, after the United States.
Beyond its size, System D serves the mass of people generally too poor to participate in the formal economy. It can be an incubator for entrepreneurs who manage to grab the lower rungs of the ladder of success, going, for instance, from junk yard scavenger to junk dealer. And System D is essentially the purest form of economic activity. Neuwirth also noted that mainstream companies, such as household goods giant P&G, have long recognized the value of System D.

Like most people in North America and Europe, I’ve participated in the formal economy since before I left high school. As a taxpayer, I’ve dismissed the shadow economy as a marginal bunch of cheaters who won’t play by the rules. But Neuwirth has important points about the value and appeal of the shadow economy, particularly in the least developed countries.
However, Croatia isn’t a least developed country, and its shadow economy isn’t confined to people with few other options. In the service sector, some contractors, doctors, teachers, and others happily accept cash to avoid taxes and regulations. Transactions in the retail and manufacturing sectors are much harder to hide, but not impossible. I can’t imagine every pepper sold at Dolac or every coffee served at small cafés is reported to the taxman.

Assuming the World Bank and A.T. Kearney are right about the size of Croatia’s shadow economy, imagine if just half of that were captured, bringing it to the level of Slovenia’s shadow economy. Looking at taxes collected on income, corporate profit, goods and services in 2010, that would add almost 9 billion kuna to state revenues, much more than could be raised by taxing, say, TV shows. A good government could do a lot with that kind of money.
Unfortunately, that’s where it comes full circle. The government can’t bring in the shadow economy just by wishing it so. The World Bank report noted that countries with good governance and institutional credibility have smaller shadow economies. It seems, when people believe they’re getting a good deal from their government, they’re more willing to pay their fair share.

(Originally published in Croatian in 21. Stoljeve, on Dec. 14, 2012.)

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