1. 1 The Informal Economy and Corruption Ira Lieberman September 5, 2005

2. 2 Informal Sector and the Transition  Most Transitional Economies in the CIS and SEE have large informal sectors  Economies with large informal sectors also appear to have substantial corruption problems  Size of Informal Economy in Transition (%) Share of GDP Share of Employment Azerbaijan 60 31 Belarus 47 41 Kazakhstan 42 34 Serbia 34 35 Kyrgyz 39 29 Ukraine 31 41 (Source: Going Informal Benefits and Costs, Djankov, Lieberman, Mukherjee and Nenova)

3. 3 Informality Is Complex  Micro businesses that support the family– market traders, crafts, small farmers, retailers, etc.--- usually 100% informal  Small businesses– distribution, transport, light manufacturing may:  May understate number of employees  Not report cash sales  Under invoice sales  Not keep reliable books of account  Rent or lease premises and assets– little in the way of fixed assets Usually part formal and part informal eg. 50%/50%  Large businesses  Contract permanent employees– not pay social benefits  Under-report sales  Under invoice exports  Bribe officials not to pay import duties  Bribe officials not to pay taxes A small percentage informal, but meaningful to the economy

4. 4 Informality and Corruption  Problems with the Business Environment  Registration  Licensing  Inspections  Assymetric Impact on Small Business  Measured as the “Cost of Doing Business”= Bribes and Fees Paid + Time Absorption of Small Business Owner  Example: Ukraine different regions had different cost of doing business

5. 5 Informality and Corruption (continued)  Large Industrial Groups maintain ghost workers, e.g. Serbia  Receive full or partial salary, health and pension benefits  Show up for work infrequently or not at all  Workers employed in the informal economy  Cost to the economy: Groups receive subsidies to pay wages, do not pay taxes, do not pay utility bills, and accumulate substantial debt to the state and others

6. 6 Incentives to Reduce Informality and Corruption  Will not be reduced to zero, all economies have an informal sector –  Czechs18% of GDP, 12% employment  Hungary 24% GDP, 21% employment  Slovakia 18% GDP and 16% of employment  Can be reduced by simplifying rules governing registration and licensing and by limiting inspection– rule should be not to license at all if the business does not affect public safety  Establishing overall low tax levels eg. Hungary  Creating a unitary tax for small business  Providing access to finance for micro and small business– commercially provided microfinance  Reforming public administration= professional adequately paid bureuacracy