Economic Policy Review

Transcription

1 Institute for Market Economics, Bulgaria 1 Economic Policy Review February 2009 IME In the issue: Stimulating employment during a crisis how it should not be done Could we be free? The Idea of Effective Bankruptcy Is the voluntary refusal of profit a crime?!? The Ministry of Defense will fight the dragon?! IME Survey: BULGARIAN GOVERNMENTS EXTRA EXPENDITURES IME AWARD: "Golden Key" New Book: "How To Do It: Lessons from Successful Liberal Reforms in CEE" Support IME Stimulating employment during a crisis how it should not be done Adriana Mladenova One of the anti-crisis measures in the government plan (The Stanishev s plan) foresees that the government would provide additional 120 levs to the salary of employees in companies which introduce reduced business hours for a period of 3 months, in order to protect the employment of their staff. This week the information came out that the ranking of the companies which would receive these bonuses would depend on the reduction of their sales and profits. The greater the reduction and when it is not resulting from seasonal cycles, the greater is the chance that the companies would be included into the scheme. Every sensible person could not avoid it but ask the question why do you assist companies which are at most disadvantageous position and hence have the smallest chance of survival? Is not this program stimulating the lack of management sense and the making of wrong management decisions? Since the market logic is just the opposite on the market are winning the entrepreneurs, who have forecasted successfully the market trends and satisfy the needs of the consumers in the most effective way. Something more, the so called anti-crisis measure, placed under the heading care about the people, represents actually straight waste of money of the taxpayers. The rhetoric in presenting the idea however, is extremely populist: During temporary difficulties of Bulgarian employers we are ready to react by investing 27 million levs in order to stimulate them to keep their workers and staff at work. According to the presented calculations this would protect the employment of 16 thousand workers. Firstly, that represents about 0.5% of the employed in Bulgaria and would not have a real effect on the labor market in the country. Secondly, there is no way in which to view these 27 million levs as a long term investment, if they are given to companies in difficult financial conditions. Exactly those companies are at the greatest risk to fail and as a result the effect on employment from temporary bonuses would be zero and the benefit from spending the funds negative. In a recent publication Are all the sacred cows dead? Implications of the financial crisis for macro and financial policy analyst from the World Bank reached the conclusion, that under the conditions of a crisis the assistance from the Government for the private companies must be extremely limited and saving must be reserved for the most stable companies after they are identified (on a market principle). Otherwise the stimuli are biased even more a moral risk is

2 Institute for Market Economics, Bulgaria 2 created in the economy, while the money of the taxpayers are not spend effectively. This is about to happen in Bulgaria. It would be the best if the Government would listen to the voice of business It would be much more useful, if the government would temporarily revoke the increase in the minimal social security threshold for the branch this is the comment of Stefko Kolev, Chairman of the Branch Union of the knitwear industry in Bulgaria (Dnevnik). Instead of giving money for reduced work hours, without clear benefits from this policy to the economy on the long run, let the Government think about reducing the regulations and increasing the flexibility of the labor market. This could take place without costing money to the taxpayers, something even more when the (quasi)taxes are reduced for everyone and thus it gives a direct stimuli to the working people and the business, but based on the market logic from this measure would win only the most enterprising and successful companies. Could we be free? Svetla Kostadinova Exactly 15 years ago Heritage - the American Foundation, together with Wall Street Journal began to measure the level of economic freedom around the World. The authors formulated 10 factors which have greatest effect on the level of freedom within an economy freedom of business, commerce, investments, labor, monetary freedom, freedom from the Government, fiscal freedom and freedom from corruption. The highest degree of economic freedom represents the absolute right of ownership, entirely implemented freedom of labor movement, capitals and goods. The people are free to work, produce, consume and invest in any way they want and this freedom is maintained, warranted and not limited by the State. At the first glance these rules are not complex. The fact that the countries which increase their economic freedom over the years achieve higher economic growth, lower level of unemployment, higher incomes and good living environment and doing business, must be showing that the system is working. In other words, if a Government wants better results, then the way to achieve them is proven and more than clear. Bulgaria is given as an example this time good In this year issue Bulgaria is mentioned as one of the countries around the World, which has reduced the direct taxation to unprecedented low levels (10% personal and corporate tax). The question is whether the Bulgarian rulers are farsighted people who believe in the stimuli or are part of something global, which is happening around the World. During 1981 and 1986 Ronald Reagan reduced the highest profit tax in the US from 70% to 28%. The result was an unseen increase in the level of foreign investment and growth. At the end of the 80 s of the 20th century, Hon Kong was the first country to introduce true flat tax. In combination with opening the country to free trade, these were the reasons that the country was ranked first in the ranking for economic freedom for more than 15 years. Estonia introduced flat tax during Mart Laar then sincerely believed that the idea would work and the long term effect would be fast economic growth. That is what happened. For the period between 1980 and 2007 Norway reduced the highest tax rate on the personal income with 35 percentage points, Italy - with 29, Mexico - with 27, while France - with 12. During the same period there were reductions in the corporate profit tax rates Ireland with 32.5 percentage points, Austria with 30, Sweden with 12, Denmark with 15, while Portugal - with During 2008 China joined the group which was reducing the corporate profit tax and it is now 25% compared to the previous 33%. This reform together with the policy of favorable conditions for foreign investments, the privatization and expansion of the private initiative in the country lead to unseen levels of economic growth.

3 Institute for Market Economics, Bulgaria 3 Germany also carried out a tax reform, although very modest during 2007 the corporate profit tax was reduced with 9 percentage points. The most impressive however are the tax reforms in Eastern Europe. From 24 countries with flat tax almost half are from this part of the World. We are talking about Lithuania (27%), Latvia (25%), Estonia (21%), Slovakia (19%), Romania (16%), Czech Republic (15%), Monte Negro (15%), Albania (10%), Bulgaria (10%), Macedonia (10%) and Georgia (12%). The results were not late all countries mentioned above increased their economic growth, attracted foreign investments and have a real chance for fast growth of the standard of living. This which the Index does not include is the social security payments. If they are added and the overall tax burden is calculated, than Bulgaria certainly would be among the tax non-free countries. They are so high that they have become the main factor stimulating the concealment of the real incomes. A study by the World Bank shows that social security payments which are higher than 15% of the salary lead to higher costs of labor in the economy, encourage non declaration of income and discourage working in general. That is the reason why the social security payments must be reduced. Our government showed that it could reduce certain taxes and have to continue with the social security payments if it wants to increase the income of all working people. Why is it important that all taxes are low? When the taxes are low the people and the business decide what to do with their incomes not the State; The corporate taxes have the most negative effect on growth, followed by personal income taxes and than the taxes on consumption, according to a 2008 OECD study; A 2006 study of the American Entrepreneurship Institute showed the tax burden on the profit is born at the end by the workers in the form of lower wages. The 72 countries included in the study indicated that the salaries in industry are negatively related to the high profit tax rates; The reduction of the personal income tax leads to longer working hours by the workers and in general more people on the labor market hence, lower unemployment; The high taxes change the stimuli of the people and the companies they select a different country, hide incomes, decide not to work. The economic freedom in Bulgaria In the 2009 Index the Bulgarian economy gets a total score for freedom of 64.6 out of 100, which puts it into 56 place out of 183 countries, i.e. we are in the group of moderately free nations. The reasons that we are in that group are the introduction of the currency board, the opening of the economy for trade, which allows our business to use the common market, taking the company registration out of the courts, which makes it easier for the entrepreneurs and the reduction of direct taxes. Overall this is not enough. In Bulgaria still: The Government distributes more than 40% of the GDP, Gives subsidies to the agricultural producers, which is biasing the prices, The bureaucracy is large and is burdening the business with expenses, The changes in the legal framework are many and often with not clear result, Corruption is high, while The legal system is not working and impedes local and foreign investments. These are part of the reforms which must take place in our country as soon as possible. The Index of economic freedom may have faults (like every index), but this which is irrefutable is that it shows that higher freedom means more prosperity. For that reason every Bulgarian Government (or candidates for such) must use it as a matrix for their government program. It is a fact that freedom works! This article is based on the report on Economic Freedom 2009, which local partner in Bulgaria is the Institute for market Economics.

4 Institute for Market Economics, Bulgaria 4 The Idea of Effective Bankruptcy Metodi V. Metodiev When we live during times when the failures of companies and collapse of businesses could be a more frequent event than 1-2 years ago, it is important to start thinking about what are the actions when a given business eventually fails. We are talking about mechanisms how to bankrupt 1 an insolvent company and how to protect its creditors and shareholders. The procedure of insolvency is a coordinated mechanism, which aim is the maximum satisfaction of the creditors and the shareholders of the company. On a World scale the practice identifies three basic types of procedures of insolvency (bankruptcy): Proclaiming that a dept is overdue a process of compulsory collection by the creditor of an asset, given to him as a collateral on a loan, when the debtor does not carry out his obligations. We have to note that this approach does not protect creditors which have not taken collateral for their claims. This is a widely used procedure which in many countries does not involve the courts and which is overall quite flexible. For example in Singapore and Australia the creditors get about 90 cents for every dollar dept; Liquidation procedure this procedure requires intervention by the court and overall is quite slow. In Bulgaria the procedure of liquidation may precede the procedure of insolvency; Procedure of reorganizing the company this procedure is widely used in many of the OECD countries. According to the Bulgarian legislation there is a possibility to prepare a plan for recovery of the company and undertake a procedure of reform 2 and reorganization. The main objectives when building an effective insolvency procedure are: To maximize the total value of the company (on monetary terms), which must be distributed between creditors and shareholders; To protect the absolute right of making claims and the order of repayments to creditors and shareholders; To get through the process as fast as possible and with the possibly smallest costs. If we review carefully the Doing Business index of the World Bank we will see that one of the composite indices measures the effectiveness of the insolvency procedures. In the annual ranking for 2009 at the first place is Japan, followed by Singapore and Norway. The time necessary to conclude the insolvency procedure in the OECD countries is on the average approximately 1.7 years, while in Bulgaria it is 3.3 years. It is interesting to note the measurement of the total recovered value of the company before the beginning of the procedure. For the OECD the average value is approximately 68.6 cents from a dollar, while for Bulgaria it is barely 32.1 cents from a dollar, in other words the difference is a bit over two times. 1 The closest to the term bankrupt used in the Anglo- Saxon legislation is the term insolvency used in Bulgarian law. Bankruptcy in the Bulgaria legal system is part of the criminal law, which is the legal norm regulating the public norms, which regulate the public relations resulting from criminal acts. 2 Art. 261 from the Commerce Bill states: Company for which a procedure of insolvency has been initiated could be reorganized only if the recovery plan foresees continuation of the activity..

5 Institute for Market Economics, Bulgaria 5 Table: Doing Business insolvency procedure Economies Duration (in years) Price (per cent of the business value) Recovered value (cents from a dollar) OECD 1,7 8,4 68,6 East Asia and Pacific 2,7 23,2 28,4 East Europe and Central Asia 3,1 13,4 28,3 Latin America and the Caribbean 3,3 15,9 26,8 Sub Sahara Africa 3,4 20,2 16,9 Middle East and North Africa 3,5 14,1 29,9 South Asia 5.0 6,5 19,9 Bulgaria 3,3 9 32,1 Source: Doing business 2009 In Bulgaria the insolvency procedure is regulated by the Bill on Commerce. The declaration of insolvency is preceded by initial proceedings for declaration of insolvency and preparation of a recovery plan for the company. Unfortunately the bureaucratic obstacles and the sluggish procedure cost enormously for the company, which by itself leads to low level of real satisfaction of the creditors and the shareholders. It is necessary to optimize the insolvency process and the highest importance should be given to the effectiveness of the legal system and respect to the contractual relations. This is extremely important, because every entrepreneur must find it easy to start up his business, but it should also be possible to exit the business with the lowest costs * The article has borrowed ideas from studies of Simeon Djankov. He is a doctor of economics from the University of Michigan, vice president of sector Finance with the World Bank and one of the originators of the study Doing Business. Is the voluntary refusal of profit a crime?!? Petar Ganev We all know that the economic activity is directed towards making profit. This is the main motive which makes people to invest funds and time, to take risks and to be entrepreneurs. Some succeed in their pursuit of profit, others fail. This however does not give a clear answer whether or not it is mandatory that the entrepreneurs must aim towards profit. What would happen if there is an entrepreneur, who would like to provide a given service and announces publicly that he does not aim for profit. Would this be a crime? It is apparent that the answer to this question is positive, at least in Bulgaria. Just a few days ago the Commission for Protection of Competition (CPC) ruled the following: since every economic activity is directed toward gaining profit, the voluntary refusal of such over prolonged period of time is apparently aiming to liquidate a competitor or competitors, which is a form of disloyal attraction of customers. Aha, apparently the refusal of profit is pure crime in Bulgaria. Even according to me things should be sorted out completely in order to avoid mistakes in the future. We could make all businessmen sign a special declaration when they start a business, where they would declare their desire (and duty to the economy) to aim for profit. Thus it would be easier to make them responsible if they begin to make stupid things. Actually the above statement by the CPC comes as an argument to justify a sanction for providing free of charge internet. The commission does not compromise with such type of transgressions and in this case takes the following position The legislation clearly shows that maintaining prices which do not cover the costs for production

6 Institute for Market Economics, Bulgaria 6 and sale represents unscrupulous commercial behavior. This applies even stronger for providing goods and services. In other words, we could forget about any aggressive attempt to attract customers. May be we should forbid also promotions as such?! The truth is that to realize any profit in the first place are necessary customers. If there is no one to buy the good or to use the service it is unlikely to get any profit. Thus, there is nothing wrong in making everything possible to attract a maximal number of customers. Exactly for that reason we have the big paradox. According to the CPC attracting customers is a crime, particularly if they are customers to competitive company. Avery attempt to conscientiously attract these customers, by offering a lower price or better quality service is stigmatized by the Commission. This hurts the business (sanctions) as well as the consumers (fewer opportunities). In this specific case the voluntary refusal of profit does not aim at an altruistic behavior, but exactly at attracting more customers. Most likely the company has made their plan well, that by this will attract sufficient number of customers in order to make larger profits in the future. From this will profit the company and the customers, who are free to make their choice and not to change their supplier. The success of the company in gaining new customers is documented even by CPC we have determined without any doubt that the company was providing free internet as a result of that over a continuous period of time the customers have increased significantly. This success however is punished. The company has not refused the profit but was aiming at greater one and exactly because of that was punished. The Ministry of Defense will fight the dragon?! Zornitza Manolova On Monday the Minister of Defense expressed his dissatisfaction with the bad planning of the expenditures for defense and defense policy of Bulgaria. It became clear from his statement that during recent years are signed contracts for over 1 billion levs for unneeded equipment, which does not give any new military capabilities of the Bulgarian armed forced. The main expenditures are for transport and training planes, helicopters and multipurpose fighter aircrafts. Keeping in mind that Bulgaria is not under a real threat of a war or conventional military conflict, the enormous expenditures for equipment and the maintenance of a large army could not be justified and are irrational. They only show that the money of the taxpayers are not used effectively and do not lead to real benefits to society or the army. The lack of transparency and the speculations about corruption underline the suspicions for ineffective and unjustified use of the funds from the budget. Practically, for the contemporary army are required well trained soldiers and modern technology. These characteristics refer mainly to the high quality of execution of the defense policy. Bulgaria bets on the quantity on both points. This is indicated by the data about the percentage of the defense costs to GDP and the ratio of the armed forces to the population of the country. Defense expenses and military strength in some countries State Military expenses Armed forces/ Year (% of GDP) population ( ) Luxemburg 0,9 1, Canada 1,1 2,

7 Institute for Market Economics, Bulgaria 7 Lithuania 1,14 3, Spain 1,2 3, Hungary 1,2 3, Germany 1,3 3, Denmark 1,3 4, Belgium 1,3 3, Czech Republic 1,46 5, Holland 1,65 3, Slovenia 1,8 1, Estonia 1,8 4, Italy 1,8 3, Slovakia 1,85 4, Latvia 1,9 2, Poland 1,95 4, Romania 2,05 4, Bulgaria 2,1 4, Portugal 2,3 4, Great Britain 2,5 3, France 2,6 4, Source: The Ministries of Defense of the various countries, Center for Strategic and International Studies 2006, Jaffa Center of Strategic Studies For 2008 the military expenses of Bulgaria represent 2.1% of the GDP, which is placing us at the bottom of the table of the best European and World practices. Since we are members of the largest defense organization - NATO (during 2009 are providing 77 million levs to cover for our obligations) the necessity of very large expenses for defense is arguable. The same applies to the number of the armed forces, where Bulgaria is among the leader with a ratio number of soldiers to the population. Yes, the Bulgarian armed forces need modernization, but that does not mean, that are required amorous funds from the State budget. A sufficiently effective and economic instrument for financing the armed forces could be the privatization of the military estates. The Ministry of Defense manages and maintains a large number of real estate, which practically are not used. Naturally, we have in mind privatization of the estates through open tenders and complete transparency of the deals. Reducing the unnecessary large number of the armed forces would also free part of the estate for military purposes. Radical, but not unfounded decision is the total privatization of the military estates and than the armed forces could rent the necessary bases. As a result initially there would be significant revenues; the expenditure for maintenance would be reduced significantly while the armed forces would use optimally the resources. The funds could be used for total modernization and improvement of the war capabilities of the country.

8 Institute for Market Economics, Bulgaria 8 BULGARIAN GOVERNMENTS EXTRA EXPENDITURES IME survey shows: Bulgarian government likes to spend our wealth, especially when elections approach. The positive results from the followed fiscal policy lead to unprecedented income to the national treasury that significantly exceeds the plan. Exactly this unexpected extra income lies at the base of the state s extra spending. In recent years the Bulgarian government always finds a way to spend more than what has been put in the national budget. For the period the total sum of the additionally approved budget credits totals a bit more than 6.5 billion leva. Broken down yearly, on average the sum is a bit more than 2% of the GDP. Almost 900 million leva of them have been approved by the so called Reserve for unforeseen and urgent expenditures. These funds are spent on structural reforms, on prevention and elimination of disasters aftermaths, as well as for fiscal stability. A larger fraction of the 6.5 billion leva, around 4.6 billion, have been suggested by the finance minister and approved by the Council of Minister. Information on the expenditures is rather skimpy and it is almost impossible to notice any results. Thus, the expenditures can be hardly defended. The rest of the extra expenditures of around 1 billion leva have been suggested by the Council of Ministers and approved by the Bulgarian Parliament for 2007 only. Last year for the first time the finance minister suggested the Council of Ministers to be able to approve additional budget credits totaling no more than 1.5 percent from the planned income from the consolidated fiscal program for the year, and that required the vote of the Parliament. The procedure improved the transparency of the expenditures, but generally there are still no detailed reports. It is an impossible task to trace all of the extra expenditures. Nevertheless, several facts attract attention: The extra government spending is larger in years just before elections; During the budget preparation the Bulgarian financiers are either incapable of doing the calculations correctly, or unwilling; A large part of the extra funds have been provided to the Ministry of Defense at least 151 million leva from the reserve for structural funds, and 246 million leva from the extra income in the national budget; The larger part of the extra income in the national budget has been assigned to the Ministry of Health (335 million leva) and the Ministry for Regional Development and Public Works (280 million leva)

9 Institute for Market Economics, Bulgaria 9 The Council of Ministers has been extremely generous to itself it received 154 million leva from the funds approved by the Council of Ministers itself and suggested by the finance minister, which is even more than what the Ministry of Interior received (150 million leva); More than 1 billion leva from the extra money have been assigned to the municipalities without any clarity on how they have been approved and what they have been spent on. An enormous part of the extra funds for the prevention and elimination of disasters aftermaths have been given to the municipalities. A small fraction of them have been assigned to the Ministry for Emergency Situations, causing serious doubts about the actual responsibilities of the ministry and about the need for its existence. Analyzing the government s extra expenditures we can give the following recommendations: The budgeting in Bulgaria should be based on the logic that it is not necessary to keep a large budget surpluses; The economic processes should be taken into account realistically and objectively during the formulation of the national budget; The spending of the extra funds should be totally transparent and it should be decided by the Parliament; The finance minister should no longer be able to suggest the Council of Ministers the approval of additional funds (currently up to 1.5% from the consolidated fiscal program); The spending of extra funds should follow clear policy and random expenditures in the end of the year should be avoided; Pre-election expenditures should stop; The spending of the extra funds should be tightly controlled thorough reports, especially on the funds given to the municipalities; The surplus should be dedicated solely to financing of the transitional period toward privatization of the pension- and health-systems that need the resource; The surpluses are generated mainly by the net taxpayers and it is normal that they receive it back either through tax return, or simply through the reduction of the tax burden in the following years. The entire survey is available here! (pdf) in english IME AWARD Non-governmental organization, which has most actively exercised its access to information right For the sixth successive year Access to Information Programme (AIP) held the annual Right to Know Day Awards Ceremony in Bulgaria. More than 100 people attended the 2008 Right to Know Awards Ceremony that AIP held in the National Press Club at the Bulgarian News Agency on September 28 at noon.

10 Institute for Market Economics, Bulgaria 10 Executive Director of IME, Ms. Svetla Kostadinova, and the Chairman of the Management Board. Mr. Krassen Stanchev The Institute for Market Economy (IME) was acknowledged with the "Golden Key" for their persistent search of documents necessary for conducting various research works, analyses and recommendations by using the procedures of the Access to Public Information Act. The IME received the 2008 Golden Key award for also publishing all the documents received under the procedures of the APIA on its web-page. New Book: "How To Do It: Lessons from Successful Liberal Reforms in CEE" The book is available here! (pdf) Two decades ago, the people in the CE/CA region lived under communist regimes. Their countries were bankrupt and famished. Their citizens had to deal with empty store shelves, they were denied the right to a passport, and a formidable communist secret service spied on their private lives (Mungiu-Pippidi 2007). Twenty years later, a short time by a historical perspective, the people in many of these countries had succeeded in establishing democracies and free-market economies. A complete ideological, political, economic, and social system had just dissolved and a large part of the world, with some 400 million inhabitants, was to choose a new form in every regard, even including what shapes their countries should divide up into. This was one of the greatest revolutions the world has ever seen, and it was a liberal revolution in the classic, European sense. The initiative was seized by liberal revolutionaries, who hoped for a "normal society" and a "return to Europe". These radical reformers demanded the opposite of the petrified, state-dominated system. Communist dictatorships had to give way to democracy, pluralism, and individual freedom, replacing vertical state commands with horizontal market signals, and public ownership with private property (Aslund 2003).

11 Institute for Market Economics, Bulgaria 11 Support IME! If you are in favour of the free market and economic freedom, you can participate in IME fundraising campaign by making on-line donation via epay! Institute of Market Economics, Bulgaria ( Krassen Stanchev, Svetla Kostadinova, Adriana Mladenova, Veliko Dimitrov, Metodi V. Metodiev, Peter Ganev, Zornitsa Manolova, Velin Peev If you want to subscribe to IME Bulletin via please click here. For comments and recommendations: Contacts: Phone/Fax: ( ) ,