An economy
in the dark

Bulgaria’s shadow economy is the largest in the European Union. A report by Friedrich Schneider, PhD, at the University of Linz in Austria, published last year, estimates that, of the €41bn that made up Bulgaria’s GDP in 2013, around €13bn was undeclared.

That means that 31.2 percent of economic activity in Bulgaria is performed behind closed doors, away from the government.

This is of course alarming for both Bulgarian interests and their European integration, but it calls into question the country’s cleanliness and economic prestige during a vital redevelopment period for the EU.

What is it?

At its most basic, the shadow economy—often called the informal, grey or even non-observed economy, though the terms tend to be interchangeable—refers to the section of a country’s GDP that is not declared to the government.

Teodor Sedlarski is the Vice Dean for Academic Affairs and International Relations at the University of Sofia. He sits behind his desk in a small, book-laden room on the fifth floor of the Department of Economics.

“You don’t get taxes from the shadow economy. This is the problem,” he says. “The most interesting question is how you fight that.”

Between Bulgaria’s national government and the European Commission, numerous methods for fighting the rise in the shadow economy have been implemented.

“Everybody was paying the minimum wage for all their people in all sectors, and then the other part of the salary was paid cash,” explains Sedlarski. “So even if you were in the normal economy, you were officially getting the minimum wage, but you were getting ten times more in cash.”

Yavor Alexiev from the Institute of Market Economists in Sofia also points out that there is a large gulf in income equality between the capital and the rest of the country.

“[This], coupled with the country-wide fixed rate of social security payments in different economic activities, force smaller companies from the countryside to quickly lose competitiveness,” he explains.

“In some cases, [they] engage in undeclared activities in order to remain active.”

Some analysts point out that economic activity that is not documented can still benefit Bulgaria, despite the impact on tax revenues.

“It’s very hard to estimate the overall impact, because from one point of view of course you can say that you have negative influence because of the lower tax collection,” says Todor Yalamov, economic analyst at the political think tank the Center for the Study of Democracy (CSD).

“But at the same time, non-observed economic activity might be contributing to economic growth in particular areas, or in particular groups, who have difficulties integrating through the formal labour market.”

“By having additional jobs in the shadow economy, they might actually be less dependant on the social security system, which means that while the government is lacking revenues, at the same time they’re saving on some social programs that otherwise would have been necessary.”

Professor of public policy at the University of Sheffield, Colin C. Williams, PhD, did an investigation into the motivations behind those participating in the informal economy in the European Union. According to his research (PDF), published in the Journal for Contemporary European Research, around half of those questioned felt “both parties benefited” from the undeclared work, and almost a quarter said they could not find work in the regular economy.

Notably, almost one in six said that undeclared work was “common practice in this region or sector so there is no real alternative”, while only one in eight argued taxes were too high.

Sedlarski notes that the liberal view of the shadow economy is far more accepting. “I know European economists that are liberal, and they ask, ‘what is the bad thing about having a shadow economy?’,” he says.

“It’s still producing income, and okay, the state doesn’t get anything from that, but it still gives money to people. It’s producing. You see this kind of thing in economic textbooks. The mafia is kind of structuring economic activity but in a different way. The state doesn’t interfere there, the mafia itself is the state that makes the rules and gives the income to people.”

While useful to provide economic context for the shadow economy’s prevalence, it is also a good example of the corruption in the country that influences this trend.

Tangible corruption

There is a tangible perception of corruption in Bulgarian politics among the public, and indeed throughout the rest of Europe. It is certainly not something that is unique to Bulgaria. A report by the European Commission in February, the first of its kind dealing with the topic of corruption in the EU, found that the true cost of corruption was €120bn per year.

Over a quarter of respondents said someone had “asked or expected someone from your company to pay a bribe” at least once. The EU average was 5 percent.

Bulgaria broadly performed better in the survey than other countries in Europe’s periphery, such as Portugal, Greece and Italy, but 84 percent of those surveyed considered corruption to be “widespread”.

“The fact that public opinion towards the government is low is highly related to the fact that corruption remains an unresolved issue, despite public rhetoric and ‘actions’ in the opposite direction,” says Filip Lipev, economic and political analyst at CEEMarketWatch.

“Corruption is well spread in our country. It is not only in public administration, it is in police, healthcare, education, and so on. So, one would say that we have a big problem with that.”

“I would say this is one of the main reasons why the state lags behind many EU countries in real GDP per capita, etcetera. If we tackle corruption problems more effectively, we would become much wealthier, that’s for sure.”

In the Commission’s survey, only one in ten Bulgarians agreed with the statement that “there are enough successful prosecutions in Bulgaria to deter people from corrupt practices”. This is the lowest figure in the Union. And in the Global Corruption Perception Index 2013, organised by Transparency International, Bulgaria ranked 77th with a “cleanliness” score of 41. This places them between Italy and Greece, and below the likes of Brazil, Romania and Cuba.

Slavi Binev is a nationalist politician who was elected to the European Parliament as a member of nationalist party Ataka. He currently represents the right-wing National Front for the Salvation of Bulgaria. He says that the public perception of corruption in Bulgaria is entirely accurate.

“Many of these people [in the Bulgarian government] did not have any business activity before that,” he says, “and when they leave their governmental posts, they walk out with economic empires, banks and become parts of the business elite.”

“The shadow economy could not exist without the umbrella from the government,” he adds. “It is part of the corruption in the country.”

Dutch MEP Sophie in ’t Veld, who represents the progressive left-leaning Democrats 66 in the Netherlands, says the Bulgarian government’s inaction makes it hard for their fellow EU member states to support them in the face of rising populism.

“I am a staunch defender of the accession of Bulgaria and Romania to the EU, to Schengen, and to everything else that we are part of,” she says, “but I also think that they are making it very difficult for their supporters, for their allies like me, to defend their position if they’re not more vigorous in fighting corruption and making their administrative systems work better.”

“People see Bulgaria and Romania like they shouldn’t be in the European Union. Which I think is usually unfair, and largely unfounded. But again, Bulgarian and Romanian governments make it very easy for others to criticise them.”

While corruption is widespread in eastern European states, Bulgaria’s membership of the European Union means this issue is placed under further scrutiny. Since joining in 2007, there has been some level of distrust among politicians in other member states who are opposed to expansion.

Anti-immigration parties, such as the Freedom Party in the Netherlands, Front National in France and the United Kingdom Independence Party (Ukip), have been vocal in their opposition to further expansion.

When borders opened to Romanian and Bulgarian citizens at the start of this year, Ukip used this to their advantage and were involved in a hostile media campaign warning of the dangers an influx in migrant workers would carry.

“The general sentiment among people is hesitant at best, and fear for job losses and social security tourism holds sway, which is, by the way, not or barely reflected in the figures on the European labour market presented by the Commission,” says Dutch MEP Judith Merkies, who represents the Labour Party of the Netherlands in the European Parliament.

“Bulgaria is facing considerable challenge to eradicate some of the most important problems that undermine their credibility as an EU partner.”

Curbing the trend

In 2007, the Bulgarian government implemented a flat tax rate of ten percent for corporations, a fourfold decrease from ten years earlier. This has encouraged many organisations to declare what they perhaps wouldn’t have before.

The personal income tax rate in Bulgaria is also a flat ten percent, which is by far the lowest level in the EU. In western and northern Europe, the rate for top earners can be as high as 57 percent (in Sweden).

“Of course it’s a problem for all the European countries,” says Ivailo Kalfin, who was Minister of Foreign Affairs of Bulgaria from 2005 to 2009, and is currently a Member of the European Parliament (MEP) for the Bulgarian Socialist Party.

“I wouldn’t say that Bulgaria is an extreme example,” he adds, “just the opposite, because we have quite low taxes, and with low taxes you have much better incentive to be in the legal economy, the light, and pay your taxes rather than go outside of it.”

“Despite rapidly falling employment levels and rising unemployment, personal income tax has in fact been the only tax to generate higher revenues in the most difficult years of 2009-10,” says Alexiev.

“In our view, this was due entirely to the introduction of a flat income tax rate from the start of 2008, which obviously led to reduction of the informal economy in labor contracts.”

Aleksandar Dimitrov, PhD, is chief political analyst at the Centre of Historical and Political Studies. He points out that the measures could have gone further to help deal with the problem.

“They promised that they would change it to multi-level tax, rising level tax with the income of the person,” he explains. “But we still have ten percent tax. They didn’t change it. I don’t know why.”

“I think the prime minister [independent politician Plamen Oresharski] believes in the flat tax. But the socialist party don’t believe in the flat tax. No actual dialogue about the strategic tax policy [between the two parties].”

The socialist party is the second party in Bulgaria and the leading part of the Coalition for Bulgaria. It currently serves as the opposition to the ruling Citizens for European Development of Bulgaria, a more conservative party.

A staggered minimum wage was also introduced as a solution for combatting the size of the shadow economy, as Sedlarski explains.

“One thing was to set minimum wages for different professional areas,” says Sedlarski. “And that actually helped. A lot of firms have to declare how many workers they have and they have to pay the social security for them at a certain minimum level.”

Minimum wage is now a flat 340 lev (around €174) per month, which equates to about 2.03 lev (€1.04) per hour. This is the lowest such figure in the European Union.

“People employing lawyers could not pay them the minimum wage, they’d pay them some five times that. You had a lot more people employed after this measure, on a wage that was bigger than the minimum.”

Sedlarski also talks about the Washington Consensus, a set of ten economic policy prescriptions applied to, among others, the former Soviet states in the early nineties. “We hosted a professor at Harvard recently, and he gave a lecture about how it was actually something very stupid, and that we should have had institutional reforms.”

“We have seen that we should have given more attention to institutions. Rules, laws… they were missing. The economy, after the changes, evolved as something illegal. From the beginning, everything was initially privatised by directors, as in all Soviet states. Everything was part legal, part illegal.”

Alexiev says his organisation, the Institute for Market Economists, took part in a project “focused on identifying and transferring best practices in the fight against the shadow economy from other countries within the European Union”.

Of the 20 proposals they put forward, some are common sense. Establishing a legal definition for “undeclared work”, for instance, as well as campaigns to increase the awareness of the impact of the grey market.

Some seem a little more challenging. One such suggestion is to create a registry of law-abiding companies which would then be afforded different administrative privileges, while another seeks to craft a set of hiring procedures for businesses to help them avoid accidentally contributing to the shadow economy.

For the most part, these measures appear to have worked. The shadow economy in Europe has been slowly and consistently shrinking over the past decade.

“If you compare 2003, pre-accession, and after accession in 2007, the levels of shadow economy are significantly lower,” says Todor Yalamov.

“In 2013 there was alarming indicators that the economy was not doing well, and a lot of people were engaged in shadow economy activities as a response to that, especially those that returned from other EU countries.”

“But the macro-trend is positive.”

“Bulgarian labor markets are not flexible enough, which makes many employers and employees reluctant to declare their labor relations in order to avoid long administrative procedures and additional costs,” Alexiev says.

“The continuing social and political turmoil in the country is a problem, since political appointments in key state institutions lower their capacity in the fight against the shadow economy.”

European impact

As part of their report into corruption, the European Union released a set of guidelines addressed to the Bulgarian government for how to manage and prevent corruption in the future.

Among these is to establish anti-corruption regulators, shielded from the government, as well as codes of ethics for members of the National Assembly.

“[The Center for the Study of Democracy is] also closely monitoring the levels of corruption in different EU institutions,” Yalamov says.

“The institutions that were experiencing positive trends after European Union accession are directly linked with the shadow economy, which means that particular areas like smuggling and the levels of tax collection significantly improved after the accession. So we’re experiencing a positive impact.”

But Slavi Binev is highly critical of the EU response.

“I believe that it is not good for the European Union to close its eyes and not to interfere to defend the Bulgarian citizens from the controlled dictatorship they are subjected to,” Binev says.

“I think that the non-interference of the EU shows its hypocrisy and its double standards. It turns out that Europe could interfere in North Africa, in Crimea and everywhere else in the world but when it comes to its own yard, it remains silent.”

“This undermines the EU institutions, and not people who want their freedom.”

Exactly how the European Union institutions can deal with the size of the shadow economy in Bulgaria, and the corruption that goes with it, is not clear. In this situation it seems that the national governments must take the initiative.

Yavor Alexiev concedes that Bulgaria’s economy is perhaps too small for their shadow economy to really impact on European statistics—the country’s output accounted for just 0.3 percent of EU-wide GDP in 2013, and per capita is one of the poorest economies in the 28.

“Most undeclared activities happen at small and medium-sized enterprises that operate on the local level, where competition from other countries is practically nonexistent,” he says.

Lipev, however, has a radical solution from Europe’s side.

“I strongly believe that what the [Commission] needs to do with Bulgaria to tackle this issue and put more serious pressure is simply to stop its EU funds to the country,” he says.

“This will have a serious negative impact on the country and will almost certainly lead to a social outcry, thus putting muchneeded strong pressure on politicians to act and take more effective measures.”

“Such kind of sanctions could do the work, in my opinion. Otherwise, the process could take years.” ▤

Design by Joe Sutherland
Photographs by Joe Sutherland and Paul Burgaud
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