Tuesday, October 28, 2003

Eastern Europe's Informal Economy

There is definitely more than a hint of 'positive thinking' in the air. Whether this is unduly biased towards spin remains to be seen. Today two East European economists - Matthew Olex-Szczytowski and Jacek Rostowskitry - try to put a positive tint on the EU accession countries. They have a point. The situation is probably better than many imagine. At the same time it is important to differentiate. We can identify a number of 'groups' in the pack: Poland, Hungary, Czech Republic - Latvia, Estonia, Lithuania - Bulgaria, Rumania - the Ukraine, Russia. Of course there are others I have not mentioned, who do not fall easily into any identifable group. But if you look along the list, from left to right, the feeling you have is one of from bad to worse. All these countries suffer from major structural demographic breaks which make it difficult for them to sustain mid-term economic growth. Obviously those to the left of the list can benefit from migration from those more to the right. Thus there situation might be considered marginally better. Also short-term they seem likely to attract more FDI as the part of the manufacturing sector which can migrates from the Mediterranean fringe (Spain, Greece, Portugal).

But then look at the downside. The element which our two economists identify as a plus: the informal economy (incidentally how do they know it is significantly bigger in the East? We simply have no figures on Spain, Greece and Portugal. According to figures Marcello sent me from the Argentinian government, nearly half a million Latin Americans entered Spain on temporary visas in 2002 alone - this is based on information they extracted from the Spanish government - and few left.). Now the one thing I can tell you from my own research is: work in the informal sector is not high-wage, in fact quite the contrary. And employment in the informal sector is growing in an attempt to remain competitive by keeping salaries and costs down. And today, once you're hooked on this, it's hard to get off. In fact Spain in the 1990's grew rapidly in part because the PSOE economics minister Carlos Solchaga offered a favourable amnesty for firms to 'regularise'. This lead to a spurt of growth which was in fact an incorporation of already existing economic activity into the formal economy (incidentally he was last seen heading for Argentina just before the crash, in an attempt to do the same down there). That is, it was 'statistical growth' - although of course the Exchequer benefited enormously. In the last three years this situation has deteriorated markedly. Faced with a combination of pressure from competition from global outsourcing and from internal inflation in Spain, Spanish manufacturing has increasingly responded by 'informalising', particularly in the hard-pressed textile sector. One example, there are an estimated 10,000 undocumented Chinese workers in Barcelona dormitory towns Mataro and Santa Coloma. How do I know? Because I have a Chinese friend who is an interpreter, and every week the Policia Nacional contact her from the courts to go and interpret for an undocumented Chinese person who has had a brush-in with the law. Usually these are petty offences, domestic arguments, drunk in the streert etc etc, they are never pursued as problems about the lack of the legal right to be in Spain. What I am trying to say is that if the situation in Eastern Europe is as bad as these economists say (and my Bulgarian research suggests it is, although I have no quantitative data), I doubt this is going to change easily - simple cost economics says no - and the pension schemes are never going to be able to operate effectively. So watch out!

There is an unspoken compact underlying the expansion of the European Union. At least, that is what many in the eight central European accession countries believe. They have gone through wrenching reforms at a speed largely determined by the EU and are having to import the acquis communautaire - the EU's body of law, widely seen as an impediment to growth - en bloc. Now as they join and their "riskiness" falls they expect a massive flow of foreign direct investment in compensation.

Perhaps the most serious flaw in the data is the massive under-reporting of gross domestic product, largely because of failure to account for shadow economic activity. Since communist times this has been of a different order of magnitude in central Europe than in the old EU, and is widespread in the fast-growing new entrepreneurial sectors. The phenomenon has been accentuated in recent years by the growth in regulations and social charges. Friedrich Schneider, an economist at Linz University, has estimated that the shadow economy in the eight in 2000-01 averaged 28 per cent of official GDP, up from 23 per cent in the early 1990s. The percentages ranged from "only" 18 per cent in the Czech Republic and Slovakia to 40 per cent in Latvia. It follows that the region today generates well over €100bn ($116bn) in unrecorded output - a shadow Czech Republic plus Slovakia.

Labour markets are also healthier than the headlines imply. Prof Schneider found that the proportion of the working age population involved in shadow output ranged from 13 per cent in the Czech Republic to 33 per cent in Estonia. As with the GDP figures, these estimates are confirmed by local studies. In Poland, a survey last year for the Private Employers' Confederation put the proportion of workers in the shadow economy at 19 per cent.

These doctrines of doom reflect (and infect) mass opinion. In a recent Polish survey, 68 per cent of respondents thought life had become much worse since communism fell. Yet official real consumer expenditure per capita has risen by 55 per cent in the past 10 years (the EU managed 26 per cent).

In the Czech Republic, where irrational pessimism is dubbed blba nalada or "bad mood", about 30 per cent feel they are now poor. However, in recent years fewer than 5 per cent of Czech households have been below the official poverty line. By standard measures such as the Gini coefficient, the Czech Republic, Hungary, Poland and Slovakia, with coefficients in the 20s, are much more "equal" than, say, Italy or the UK, with coefficients of about 35.
Source: Financial Times

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