Author: Admin

Paradise Leaked: An Analysis of Offshore Data Leaks

Posted on January 31, 2022 | Policy Brief

20220131 Paradise Leaked Image 01

In recent years, there have been several high-profile leaks of documents related to the offshore financial industry, such as the Pandora Papers released last year. Some of the data contained in the leaked documents have now been made public. In this brief, we discuss the advantages and pitfalls of using these data for economic analysis. We show that despite some caveats, there are patterns in these data that can shed light on a secretive industry. For instance, the number of offshore entities linked to a country increases significantly when that country experiences a change in political leadership. By contrast, financial sanctions on a given country result in a reduction in the number of established offshore entities. In the immediate aftermath of the financial crisis, many countries signed bilateral treaties with tax havens in order to promote transparency. Our analysis of the leaked data shows that the overwhelming majority of offshore entities are not governed by these treaties.

“… that I may see and tell of things invisible to mortal sight.”

John Milton, Paradise Lost

Offshore Tax Haven Leaks

Zucman (2013) estimates that household wealth held in offshore tax havens is equivalent to 10% of world GDP. While there are many legitimate reasons for wealthy individuals to use offshore financial services, the secrecy surrounding offshore holdings has also enabled tax evasion and money laundering. The international community has launched several initiatives trying to increase the transparency of offshore wealth holdings. Over the past decade, several large collections of documents from offshore financial service providers have been leaked to the media: Pandora Papers (2021), Paradise Papers (2017/2018), Bahamas Leaks (2016), Panama Papers (2016), and Offshore Leaks (2013). Investigative journalists have used information from the leaks to expose many instances of secretive financial dealings linked to political leaders. Examples from FREE network countries include: the connections between a close ally of Belarussian President Alexander Lukashenko and a gold mining venture in Zimbabwe, the offshore business holdings of past and present Ukrainian presidents and their respective allies, and the wealth of Russian President Vladimir Putin’s close associates and childhood friends (see, for instance, Cosic 2021, Mylovanov and Mylovanova 2016).

The International Consortium of Investigative Journalists (ICIJ) has made public information on more than 800,000 offshore entities that are part of the offshore data leaks (see ICIJ Offshore Leaks database). The data contain information on the names of companies or people who set up offshore entities, their country of origin, the offshore jurisdiction, and the dates of incorporation and deactivation for offshore entities.

What Can We Learn from the Data?

Despite the wealth of information that this database contains, there has been relatively little academic research using the offshore leaks data. Two notable exceptions are Alstadsæter, Johannesen and Zucman (2019), and Londoño-Vélez and Ávila-Mahecha (2021), who link information from the Panama Papers to administrative records from Scandinavia and Columbia, respectively. They find that tax evasion is concentrated among the richest households. Guriev, Melnikov and Zhuravskaya (2021) use the revelation of the Panama Papers to study its effect on perceptions of corruption.

There are several challenges to using the offshore leaks data for systematic data analyses. First, there are both legitimate and illegal uses of offshore financial services, and without further information, it is not possible to distinguish between them. Second, as this information is obtained through leaks at specific offshore services providers, the data are unlikely to be representative of overall offshore financial activity. Third, there is no information on financial transactions, and we do not know the amounts of money involved in the offshore entities. Finally, more sophisticated offshore structures may make it impossible to deduce the ultimate owner of each entity and its country of origin. Especially for the second and third reasons, economists have tended to focus on balance of payments statistics and cross-border bank deposit data when estimating flows to offshore accounts. For example, Andersen, Johannesen, Lassen and Paltseva (2017) show how the oil wealth of countries with weak institutions is diverted into secret offshore accounts. Becker (2019) investigates recent trends in Russian capital flows and shows that a significant share of Russian money flows to Western European banks. See also Nyreröd and Spagnolo (2018, 2021) for discussions of the role of European banks in recent money laundering scandals.

With these caveats in mind, Figure 1 shows the correlation between the number of offshore entities in the data (on the y-axis) and the offshore wealth holdings of each country’s households (on the x-axis) as estimated by Alstadsæter, Johannesen and Zucman (2018). While the chart shows a positive correlation of 0.56 between these two measures, it also illustrates that the number of leaked entities may be a poor proxy for the stock of offshore wealth. Countries with a significant fraction of offshore wealth in European tax havens are underrepresented in the leaks (e.g., France, Germany, and Italy) while the UK, Russia, and Latvia account for a disproportionate share of leaked offshore entities.

Figure 1. Number of offshore entities and estimated offshore wealth

Source: ICIJ Offshore Leaks database, Alstadsæter, Johannesen and Zucman (2018) and authors’ calculations.

Timing of Offshore Entity Creation

While the number of overall leaked entities per country might not be a perfect measure of the amount of offshore wealth, we find that there are systematic patterns in the timing of the creation of offshore entities. In particular, more offshore entities are created when individuals face political uncertainty in their own countries and fewer offshore entities are created by individuals from countries under financial sanctions.

Elections and Change of Leadership

Figure 2 shows the average number of newly incorporated offshore entities linked to a given country (on the y-axis), depending on that country’s political situation. Panel A shows no clear pattern of offshore entities being created by companies or individuals around the time of elections. Elections are often predictable and frequently result in the reelection of the incumbent government. In contrast, Panel B shows a clear increase in the number of offshore entities linked to a country around the time when that country experiences a change in the de facto political leader. Around four months before there is a change in political leadership, the average number of entities created per country per month almost doubles. Offshore entity creation falls back to normal levels typically around half a year following the transition of power. This pattern suggests that wealth leaves countries at times of political uncertainty and is consistent with the findings of Andersen, Johannesen, Lassen and Paltseva (2017) and Earle, Shpak, Shirikov and Gehlbach (2021).

Figure 2. Offshore entity creation and national political situation

Panel a. Elections

Panel b. Change of political power

Source: ICIJ Offshore Leaks database, The Rulers, Elections, and Irregular Governance (REIGN) Dataset and authors’ calculations. A change of power is defined as a change in the de-facto political leader (e.g., due to the incumbent losing an election or the collapse of a coalition government).

International Sanctions

Figure 3 shows the impact of sanctions from the United Nations, European Union, and the United States on the average number of offshore entities linked to a given country (on the y-axis). Panel A shows that when a country is subject to financial sanctions, the number of linked offshore entities created falls to around 10 per year from an average of 25 before the introduction of sanctions. The impact of sanctions can already be seen in the year before the start of the sanctions, which could reflect measurement and reporting errors or anticipation of the sanctions. In contrast, Panel B shows that trade sanctions that are not accompanied by financial sanctions have no significant impact on offshore activities. These charts suggest that financial sanctions may have some impact on how much capital can be moved from countries under sanctions to offshore accounts.

Figure 3. Offshore entity creation and international sanctions

Panel a. Financial sanctions

Panel b. Trade (without financial) sanctions

Source: ICIJ Offshore Leaks database, Global Sanctions Data Base and authors’ calculations.

Promoting Transparency

After the Financial Crisis in 2009, G20 countries compelled offshore tax havens to sign bilateral treaties to allow for the exchange of banking information under the threat of economic sanctions. More than 300 treaties were signed by tax havens that year. The effectiveness of this policy has been debated. For instance, Johannesen and Zucman (2014) show that the treaties lead to a relocation of bank deposits from compliant to less compliant offshore tax havens.

The G20 crackdown required each tax haven to sign at least 12 bilateral treaties. Relative to a comprehensive multilateral agreement, this policy had two limitations. Firstly, it leaves room for the diversion of funds identified by Johannesen and Zucman (2014). Secondly, tax havens were able to choose freely among potential partner countries – regardless of the underlying financial flows. Figure 4 shows that only a small fraction of the entities in the offshore leak database have a country of origin that signed a treaty with the tax haven in which they were incorporated. In addition, the small share of entities that will be subject to treaties suggests that havens did not always sign treaties with the most important counterparts. While the leaked entities may not be representative of offshore finance as a whole, this picture appears inconsistent with the OECD’s claim that “the era of bank secrecy is over” (OECD 2011)

Figure 4. Entity creation by treaty status

Source: ICIJ Offshore Leaks database, treaty events from Johannesen and Zucman (2014) and authors’ calculations.

Conclusion

A series of leaks over the past decade have exposed over 40 million documents related to the secretive offshore financial industry. Information related to over 800,000 offshore financial entities has been made public by the ICIJ. While a few high-profile cases received significant media coverage and gave rise to further investigations, the vast majority of references to networks of individuals, trusts, and shell corporations are difficult to decipher. This brief argues that, collectively, these leaked documents can be informative. They can be used to analyze the reasons for moving money offshore (such as domestic political uncertainty) as well as the constraints individuals face when doing so (such as international sanctions or bilateral treaties on bank secrecy).

In an effort to further increase transparency, 102 jurisdictions committed to a new standard for the automatic exchange of certain financial account information between tax authorities from 2019. Until such reforms are successful, leaks by whistleblowers are likely to remain a valuable source of information on the offshore financial industry.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

What does the Gas Crisis Reveal About European Energy Security?

Posted on January 24, 2022 | Policy Brief

20220124 Gas Crisis European Energy Image 01

The recent record-high gas prices have triggered legitimate concerns regarding the EU’s energy security, especially with dependence on natural gas from Russia. This brief discusses the historical and current risks associated with Russian gas imports. We argue that decreasing the reliance on Russian gas may not be feasible in the short-to-mid-run, especially with the EU’s goals of green transition and the electrification of the economy. To ensure the security of natural gas supply from Russia, the EU has to adopt the (long-proclaimed) coordinated energy policy strategy.

In the last six months, Europe has been hit by a natural gas crisis with a severe surge in prices. Politicians, industry representatives, and end-energy users voiced their discontent after a more than seven-fold price increase between May and December 2021 (see Figure 1). Even if gas prices somewhat stabilized this month (partly due to unusually warm weather), today, gas is four times as expensive as it was a year ago. This has already translated into an increase in electricity prices, and as a result, is also likely to have dramatic consequences for the cost and price of manufacturing goods.

Figure 1. Evolution of EU gas prices since Oct 2020.

Source:  https://tradingeconomics.com/commodity/eu-natural-gas.

These ever-high gas prices have triggered legitimate concerns regarding the security of gas supply to Europe, specifically, driven by the dependency on Russian gas imports. Around 90% of EU natural gas is imported from outside the EU, and Russia is the largest supplier. In 2020, Russia provided nearly 44% of all EU gas imports, more than twice the second-largest supplier, Norway (19.9%, see Eurostat). The concern about Russian gas dependency was exacerbated by the new underwater gas route project connecting Russia and the EU – Nord Stream 2. The opponents to this new route argued that it will not only increase the EU’s gas dependency but also Russia’s political influence in the EU and its bargaining power against Ukraine (see, e.g., FT). Former President of the European Council Donald Tusk stated that “from the perspective of EU interests, Nord Stream 2 is a bad project.”.

However, neither dependency nor controversial gas route projects are a new phenomenon, and the EU has implemented some measures to tackle these issues in the past. This brief looks at the current security of Russian gas supply through the lens of these historical developments. We provide a snapshot of the risks associated with Russian gas imports faced by the EU a decade ago. We then discuss whether different factors affecting the EU gas supply security have changed since (and to which extent it may have contributed to the current situation) and if decreasing dependence on Russian gas is feasible and cost-effective. We conclude by addressing the policy implications.

Security of Russian Gas Supply to the EU, an Old Problem Difficult to Tackle

Russia has been the main gas provider to the EU for a few decades, and for a while, this dependency has triggered concerns about gas supply security (see, e.g., Stern, 2002 or Lewis, New York Times, 1982). However, the problem with the security of Russian gas supplies was extending beyond the dependency on Russian gas per se. It was driven by a range of risk factors such as insufficient diversification of gas suppliers, low fungibility of natural gas supplies with a prevalence of pipeline gas delivery, or use of gas exports/transit as means to solve geopolitical problems.

This last point became especially prominent in the mid-to-late-2000s, during the “gas wars” between Russia and the gas transit countries Ukraine and Belarus. These wars led to shortages and even a complete halt of Russian gas delivery to some EU countries, showing how weak the security of the Russian gas supply to the EU was at that time.

Reacting to these “gas wars”, the EU attempted to tackle the issue with a revival of the “common energy policy” based on the “solidarity” and “speaking in one voice” principles. The EU wanted to adopt a “coherent approach in the energy relations with third countries and an internal coordination so that the EU and its Member States act together” (see, e.g., EC, 2011). However, this idea turned out to be challenging to implement, primarily because of one crucial contributor to the problem with the security of Russian gas supply – the sizable disbalance in Russian gas supply risk among the individual EU Member States.

Indeed, EU Member States had a different share of natural gas in their total energy consumption, highly uneven diversification of gas suppliers, and varying exposure to Russian gas. Several Eastern-European EU states (such as Bulgaria, Estonia, or Czech Republic) were importing their gas almost entirely from Russia; other EU Member States (such as Germany, Italy, or Belgium) had a diversified gas import portfolio; and a few EU states (e.g., Spain or Portugal) were not consuming any Russian gas at all. Russian natural gas was delivered via several routes (see Figure 2), and member states were using different transit routes and facing different transit-associated risks. These differences naturally led to misalignment of energy policy preferences across EU states, creating policy tensions and making it difficult to implement a common energy policy with “speaking in one voice” (see more on this issue in Le Coq and Paltseva, 2009 and 2012).

Figure 2. Gas pipeline in Europe.

Source: S&G Platt. https://www.spglobal.com/platts/en/market-insights/blogs/natural-gas/010720-so-close-nord-stream-2-gas-link-completion-trips-at-last-hurdle

The introduction of Nord Stream 1 in 2011 is an excellent example of the problem’s complexity. This new gas transit route from Russia increased the reliability of Russian gas supply for EU countries connected to this route (like Germany or France), as they were able to better diversify the transit of their imports from Russia and be less exposed to transit risks. The “Nord Stream” countries (i.e., countries connected to this route) were then willing to push politically and economically for this new project. Le Coq and Paltseva (2012) show, however, that countries unconnected to this new route while simultaneously sharing existing, “older” routes with “Nord Stream” countries would experience a decrease in their gas supply security. The reason for this is that the “directly connected” countries would now be less interested in exerting “common” political pressure to secure gas supplies along the “old” routes.

This is not to say that the EU did not learn from the above lessons. While the “speaking in one voice” energy policy initiative was not entirely successful, the EU has implemented a range of actions to cope with the risks of the security of gas supply from Russia. The next section explains how the situation is has changed since, outlining both the progress made by the EU and the newly arising risk factors.

Security of Russian Gas Supply to the EU, a Current Problem Partially Addressed

Since the end of the 2000s, the EU implemented a few changes that have positively affected the security of gas supply from Russia.

First, the EU put a significant effort into developing the internal gas market, altering both the physical infrastructure and the gas market organization. The EU updated and extended the internal gas network and introduced the wide-scale possibility of utilizing reverse flow, effectively allowing gas pipelines to be bi- rather than uni-directional. These actions improved the gas interconnections between the EU states (and other countries), thereby making potential disruptions along a particular gas transit route less damaging and diminishing the asymmetry of exposure to route-specific gas transit risks among the EU members. Ukraine’s gas import situation is a good illustration of the effect of reverse flow. Ukraine does not directly import Russian gas since 2016, mainly from Slovakia (64%), Hungary (26%), and Poland (10%) (see https://www.enerdata.net/publications/daily-energy-news/ukraine-launches-virtual-gas-reverse-flow-slovakia.html). The transformation of the gas market organization brought about the implementation of a natural gas hub in Europe and change in the mechanism of gas price formation. It is now possible to buy and sell natural gas via long-term contracts and on the spot market. With the gas market becoming more liquid, it became easier to prevent the gas supply disruption threat.

Second, Europe has made certain progress in diversifying its gas exports. According to Komlev (2021), the concentration of EU gas imports from outside of the EU (excluding Norway), as measured by the Herfindahl-Hirschman index, has decreased by around 25% between 2016 and 2020. While the imports are still highly concentrated, with the HHI equal to 3120 in 2020, this is a significant achievement. A large part of this diversification effort is the dramatic increase in the share of liquified natural gas (i.e., LNG) in its gas imports – in 2020, a fair quarter of the EU gas imports came in the form of LNG. An expanded capacity for LNG liquefaction and better fungibility of LNG would facilitate backup opportunities in the case of Russian gas supply risks and improve the diversification of the EU gas imports, thereby increasing the security of natural gas supply.

However, the above developments also have certain disadvantages, which became especially prominent during the ongoing gas crisis. For example, the fungibility of LNG has a reverse side: LNG supplies respond to variations in gas market prices across the world. This change has intensified the competition on the demand side – Europe and Asia might now compete for the same LNG. This is likely to make a secure supply of LNG – e.g., as a backup in the case of a gas supply default or as a diversification device – a costly option.

In turn, new mechanisms of gas price formation in Europe included decoupling the oil and gas prices and changing the format of long-term gas contracts. The percentage of oil-linked contracts in gas imports to the EU dropped from 47% in 2016 to 26% in 2020. In particular, 87% of Gazprom’s long-term contracts in 2020 were linked to spot and forward gas prices and only around 13% to oil prices (Komlev, 2021). This gas-on-gas linking may have contributed to the current gas crisis: Indeed, it undermined the economic incentives of Gazprom to supply more gas to the EU spot market in the current high-price market. Shipping more gas would lower spot prices and prices of hub-linked longer-term contracts for Gazprom. In that sense, the ongoing decline in Russian gas supplies to the EU may reflect not (only) geopolitical considerations but economic optimization.

Similarly, this new mechanism also finds reflection in the ongoing situation with the EU gas storage. The current EU storage capacity is 117 bcm, or almost 20% of its yearly consumption, and thus, can in principle be effective in managing the short-term volume and price shocks. However, the current gas crisis has shown that this option might be far from sufficient in the case of a gas shortage (see, e.g., Zachmann et al., 2021).  One of the reasons for this insufficiency can be Gazprom controlling a sizable share of this storage capacity (see https://www.europarl.europa.eu/doceo/document/E-9-2021-004781_EN.html). For example, Gazprom owns (directly and indirectly) almost one-third of all gas storage in Germany, Austria, and the Netherlands.  Combining this storage market position with a long-term gas contract structure may also lead to strategic behavior for economic (on top of potential political) purposes.

Last but not least, the EU gas market is likely to be characterized by increased demand due to the green transition agenda (see Olofsgård and Strömberg, 2022). Being the least carbon-intensive fossil fuel, natural gas has an important role in facilitating green transition and increasing the electrification of the economy. For example, Le Coq et al. (2018) argues that gas capacity should be around 3 to 4 times the current capacity by 2050 for full electrification of transport and heating in France, Germany, or the Netherlands. In such circumstances, the EU is not likely to have the luxury to diminish reliance on Russian gas.

Conclusions and Policy Implications

Keeping the above discussion in mind, should the EU try to diminish its dependence on Russian gas to improve its energy security? This may be true in theory, but in practice, this might be too costly, at least in the short-to-medium run.

The current situation on the EU gas market suggests that simply cutting gas imports from Russia is likely to lead to high prices both in the energy sector and, later, in other sectors of the economy due to spillovers. Substituting gas imports from Russia with gas from other sources, such as LNG, is likely to be very costly and not necessarily very reliable. Alternative measures, e.g., improving interconnections between the EU Member States or controlling transit issues via the use of reverse flow technology, are effective but have limited impact. Simply cutting down gas demand is not a viable strategy. Indeed, with the EU pushing for a green transition and the electrification of the economy, the EU’s gas imports may have to increase. Russian gas may play an important role in this process.

As a result, we believe that the solution to keep the security issue of Russian gas supply at bay lies in the area of common energy policy. It is essential that the EU implements and effectively manages a coordinated approach in dealing with Russian gas supplies. The EU is the largest buyer of Russian gas, and given Russian dependency on hydrocarbon exports, such a synchronized approach would give the EU the possibility to exploit its “large buyer” power. While the asymmetry in exposure to Russian gas supply risks among the EU Member States is still sizable, the improvements in the functioning of the internal gas market and gas transportation within the EU make their preferences more aligned, and a common policy vector more feasible. Furthermore, recent EU initiatives on creating “strategic gas reserves” by making the Member States share their gas storage with one another would further facilitate such coordination. Implementing the “speaking in one voice” gas import policy will allow the EU to fully utilize its bargaining power vis-à-vis Gazprom and spread the benefits of new gas routes from Russia – such as Nord Stream 2 – across its Member States.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Environmental Policy in Eastern Europe | SITE Development Day 2021

Posted on January 10, 2022 | Policy Brief

20210517 Carbon Tax Regressivity FREE Network Image 06

The need for urgent climate action and energy transformation away from fossil fuels is widely acknowledged. Yet, current country plans for emission reductions do not reach the requirements to contain global warming under 2°C. What is worse, there is even reasonable doubt about the commitment to said plans given recent history and existing future investment plans into fossil fuel extraction and infrastructure development.  This policy brief shortly summarizes the presentations and discussions at the SITE Development Day Conference, held on December 8, 2021, focusing on climate change policies and the challenge of a green energy transition in Eastern Europe.

Climate Policy in Russia

The first section of the conference was devoted to environmental policy in Russia. As Russia is one of the largest exporters of fossil fuel in the world, its policies carry particular importance in the context of global warming.

The head of climate and green energy at the Center for Strategic Research in Moscow, Irina Pominova, gave an account of Russia’s current situation and trends. Similar to all former Soviet Union countries, as seen in Figure 1, Russia had a sharp decrease in greenhouse gas emissions (hereinafter referred to as GHG emissions) during the early 90s due to the dramatic drop in production following the collapse of the Soviet Union. Since then, the level has stabilized, and today Russia contributes to about 5% of the total GHG emissions globally. The primary source of GHG emissions in Russia comes from the energy sector, mainly natural gas but also oil and coal. The abundance of fossil fuels has also hampered investments in renewable resources, constituting only about 3% of the energy balance, compared to the global average of 10%

Figure 1. Annual greenhouse gas emissions per capita

Note: Greenhouse gas emissions are expressed in metric tons of CO2 equivalents. Source: Emissions Database for Global Atmospheric Research (EDGAR).

Pominova noted that it is a massive challenge for the country to reach global energy transformation targets since the energy sector accounts for over 20% of national GDP and 28% of the federal budget. Yet, on a positive note, the number of enacted climate policies has accelerated since Russia signed the Paris Agreement in 2019. One notable example is the federal law on the limitation of GHG emissions. This law will be enforced from the end of 2021 and will impose reporting requirements for the country’s largest emitters. The country’s current national climate target for 2030 is to decrease GHG emissions by 30% compared to the 1990 level. As shown in Figure 1, this would imply roughly a 10 percent reduction from today’s levels given the substantial drop in emissions in the 1990’s.

Natalya Volchkova, Policy Director at CEFIR in Moscow, discussed energy intensity and the vital role it fills in Russia’s environmental transition. Energy intensity measures an economy’s energy efficiency and is defined as units of energy per unit of GDP produced. Volchkova emphasized that to facilitate growth in an environmentally sustainable way it is key to invest in technology that improves energy efficiency. Several regulatory policy tools are in place to promote such improvements like bottom-line energy efficiency requirements, sectoral regulation, and bans on energy-inefficient technologies. Yet, more is needed, and a system for codification and certification of the most environmentally friendly technologies is among further reforms under consideration.

As a Senior Program Manager at SIDA, Jan Johansson provided insights on this issue from an international perspective. Johansson gave an overview of SIDA’s cooperation with Russia in supporting and promoting environmental and climate policies in the country. The main financial vehicle of Swedish support to Russia with respect to environmental policy has been a multilateral trust fund established in 2002 under the European Union (EU) Northern Dimension Environmental Partnership (NDEP). One of the primary objectives of the cooperation has been to improve the environment in the Baltic and Barents Seas Region of the Northern Dimension Area. Over 30 NDEP projects in Russia and Belarus have been approved for financing so far. Seventeen of those have been completed, and the vast majority have focused on improving the wastewater treatment sector.

Johansson also shed light on the differences that can exist between governments in their approach to environmental policy. For example, in the area of solid waste management, Russia prefers large-scale solutions such as landfills and ample sorting facilities. In Sweden and Western Europe, governments have a more holistic view founded on spreading awareness in the population, recycling, corporate responsibility, and sorting at the source.

Environmental Transition in Eastern Europe

In the second part of the conference environmental policies and energy transformation in several other countries in the region were discussed.

Norberto Pignatti, Associate Professor and Centre Director at ISET Policy Institute, talked about the potential for a sustainable energy sector and current environmental challenges in Georgia. The country is endowed with an abundance of rivers and sun exposure, making it a well-suited environment for establishing the production of renewable energy such as wind, solar, and hydro. As much as 95 % of domestic energy production comes from renewable sources. Yet, domestic energy production only accounts for 21% of the country’s total consumption, and 58% of imported energy comes from natural gas and 33% from coal. Furthermore, the capacity of renewable energy sources has declined over the last ten years, and particularly so for biofuel due to the mismanagement of forests. A notable obstacle Georgia faces in its environmental transition is attracting investors. Low transparency and inclusiveness from the government in discussions about environmental policy, along with inaccurate information from the media, has led to a low public willingness to pay for such projects. Apart from measures to overcome the challenges mentioned, the government is currently working on a plan to impose emission targets on specific sectors, invest in energy efficiency and infrastructure, and support the development of the renewable energy sector.

Like Georgia, Poland is a country where energy consumption is heavily reliant on imports and where coal, oil, and gas stand for most of the energy supply. On top of that, Poland faces significant challenges with air quality and smog and a carbon-intensive energy sector. On the positive end, Poland established a government-industry collaboration in September 2021, that recognizes offshore wind as the primary strategic direction of the energy transition in Poland. Pawel Wróbel, Founder and Managing Director of BalticWind.EU, explained that the impact of the partnership will be huge in terms of not only energy security but also job creation and smog mitigation. The plan implies the installation of 5.9 GW of offshore wind capacity by 2030 and 11GW by 2040. Wróbel also talked about the EU’s European Green Deal and its instrumental role in accelerating the energy transition in Poland. By combining EU-wide instruments with tailor-made approaches for each of the member states, the Deal targets a 55% reduction in GHG emissions by 2030 through decarbonization, energy efficiency, and expanding renewable energy generation. Michal Myck, Director of CenEA, highlighted the role of social acceptance in accelerating the much-needed energy transition in Poland. In particular, to build political support, there is a crucial need for designing carbon taxes in a way that ensures the protection of vulnerable households from high energy prices.

Adapting to the European Green Deal will also create challenges for countries outside of the EU, especially if a European Carbon Border Adjustment Mechanisms (CBAM) is put in place in 2026 as suggested. Two participants touched on this topic in the context of Belarus and Ukraine respectively. Yauheniya Shershunovic, researcher at BEROC, talked about her research on the economic implications of CBAM in Belarus. It is estimated that the introduction of CBAM can be equivalent to an additional import duty on Belarusian goods equal to 3.4-3.8% for inorganic chemicals and fertilizers, 6.7-13.7% for metals, and 6.5-6.6% for mineral products. Maxim Fedoseenko, Head of Strategic Projects at KSE, shared similar estimations for Ukraine, suggesting that the implementation of CBAM will lead to an annual loss of €396 million for Ukrainian businesses and a decrease in national GDP of 0.08% per year.

An example of Swedish support to strengthen environmental policies in Eastern Europe was presented by Bernardas Padegimas, Team Leader at the Environmental Policy and Strategy Team at the Stockholm Environment Institute. The BiH ESAP 2030+ project is supporting Bosnia and Herzegovina in preparing their environmental strategy. This task is made more challenging by the country’s unique political structure with two to some extent politically autonomous entities (and a district jointly administered by the two), and elites from the three different major ethnic groups having guaranteed a share of power. The project therefore aims to include a broad range of stakeholders in the process, organized into seven different working groups with 659 members on topics ranging from waste management to air quality, climate change and energy. The project also builds capacity in targeted government authorities, raises public awareness of environmental problems, and goes beyond just environmental objectives: mainstreaming gender equality, social equity and poverty reduction. The project is 80 percent finished and will produce a strategy and action plan for the different levels of governance in the country’s political system.  There is also a hope that this process can serve as a model for consensus building around important but at times contentious policy issues more generally in the country.

Public Opinion and Energy Security

Finally, Elena Paltseva, Associate Professor at SITE, and Chloé le Coq, Professor at the University of Paris II Panthéon-Asses (CRED), shared two joint studies relating to the green transition in Europe.

Recent research shows that individual behavioral change has a vital role to play in the fight against climate change, both directly and indirectly through changes in societal attitudes and policies motivated by role models. A precondition for this to happen is a broad public recognition of anthropogenic climate change and its consequences for the environment. The first presentation by Paltseva and Le Coq focused on public perceptions about climate change in Europe (see this FREE policy brief for a detailed account). Using survey data the study explores variation in climate risk perceptions between Western Europe, the non-EU part of Eastern Europe, and Eastern European countries that are EU members. The results show that those living in non-EU Eastern European countries are on average less concerned about climate change. The regional difference can partly be explained by low salience and informativeness of environmental issues in the public discourse in these countries. To support this explanation, they study the impact of extreme weather events on opinions on climate change with the rationale that people who are more aware of climate change risks are less likely to adjust their opinion after experiencing an extreme weather event. They find that the effect of extreme weather events is higher in countries with less independent media and fewer climate-related legislative efforts, suggesting that the political salience of the environment and the credibility of public messages affects individuals’ perceptions of climate change risks.

The second presentation concerned energy security in the EU, and the impact of the environmental transition. It was argued that natural gas will play an important role in Europe’s green transition for two reasons. First, since the transition implies a higher reliance on intermittent renewable energy sources, there will be an increased need for use of gas-fired power plants to strengthen the supply reliability. Second, the electrification of the economy along with the phasing out of coal, oil, and nuclear generation plants will increase the energy demand. Today, about 20% of EU’s electricity comes from natural gas and 90% of that gas comes from outside EU, with 43% coming from Russia. To emphasize what issues can arise when the EU relies heavily on external suppliers, the presentation discussed a Risky External Energy Supply Index (Le Coq and Paltseva, 2009) that considers the short-term impact of energy supply disruptions. This index assesses not only the importance of the energy type used by a country but also access to different energy suppliers (risk diversification). The index illustrates that natural gas is riskier than oil or coal since natural gas importers in the EU depend to a greater extent on a single or few suppliers. Another crucial component of the security of gas supplies arises from the fact that 77% of EU’s net gas imports arrive through pipelines, which creates an additional risk of transit. Here, the introduction of new gas transit routes (from already existing suppliers) may increase diversification and decrease risks to the countries having direct access to the new route. At the same time, countries that share other pipelines with countries that now have direct access may lose bargaining power vis-à-vis the gas supplier in question, as demand through those pipelines could fall. Le Coq illustrated this point applying the Transit Risk Index developed in Le Coq and Paltseva (2012) to the introduction of the North Stream 1 pipeline. She concluded that the green transition and associated increase in demand for natural gas is likely to be associated with higher reliance on large gas producers, such as Russia, and resulting in energy security risks and imbalance in the EU. One way to counteract this effect is to exercise EU’s buyer power vis-a-vis Russia within the EU common energy policy. While long discussed, this policy has not been fully implemented so far.

Concluding Remarks

This year’s SITE Development Day conference gave us an opportunity to highlight yet another key issue, not only for Eastern Europe, but for the whole world: global warming and energy transformation. Experts from across the region, and policymakers and scholars based in Sweden, offered their perspectives on the challenges that lie ahead, but also highlighted initiatives and investments hopefully leading the way towards a brighter future.

List of Participants

  • Chloé Le Coq, Professor of Economics at the University of Paris II Panthéon-Assas (CRED). Paris, France. Research Fellow at SITE.
  • Maxim Fedoseenko, Head of Strategic Projects at KSE Institute. Kyiv, Ukraine.
  • Jan Johansson, Senior Program Manager, SIDA. Stockholm, Sweden.
  • Michal Myck, Director of CenEA. Szczecin, Poland.
  • Bernardas Padegimas, Team Leader: Environmental Policy and Strategy, Stockholm Environmental Institute. Stockholm, Sweden.
  • Elena Paltseva, Associate Professor, SITE/SSE/NES. Stockholm, Sweden
  • Norberto Pignatti, Associate Professor of Policy at ISET-PI, and Head of the Energy and Environmental Policy Institute at ISET-PI. Tbisili, Georgia.
  • Irina Pominova, Head of Climatwe and Green Energy at the Center for Strategic Research. Moscow, Russia.
  • Yauheniya Shershunovic, Researcher at BEROC, Minsk, Belarus. PhD Candidate at the Center for Development Research (ZEF). Uni Bonn.
  • Natalya Volchkova, Policy Director at CEFIR, Assistant Professor at the New Economic School (NES). Moscow, Russia.
  • Pawel Wróbel, Founder and Managing Director of BalticWind.EU. Poland.
  • Julius Andersson, Researcher at SITE. Stockholm, Sweden.
  • Anders Olofsgård, Associate Professor and Deputy Director at SITE. Stockholm, Sweden.

Global Gender Gap in Unpaid Care: Why Domestic Work Still Remains a Woman’s Burden

FROGEE PROJECT, Policy Brief

Woman standing with several children inside a circular tunnel, symbolizing the Gender gap in unpaid care and family responsibilities.

The gender gap in unpaid care work remains a central driver of gender inequality worldwide. Across both developed and developing countries, women perform more than two-thirds of unpaid domestic work, including childcare, eldercare, and household tasks. This unequal distribution of unpaid care work contributes to significant economic inefficiencies and reinforces gender disparities in labor market outcomes, earnings, and intra-household bargaining power. As a result, unpaid care work is increasingly recognized as a key factor underlying the gender pay gap and broader inequalities in the care economy.

In this policy brief, the authors review the existing literature on the economic and sociological determinants of the unpaid care work gender gap. The brief also evaluates policy responses based on the framework to recognize, reduce, and redistribute unpaid care work, highlighting their potential to improve gender equality and support more efficient labor market participation.

Country Reports

Armenia country report (EN) Armenian language version (AM)
Belarus country report (EN) Belarussian language version (BY)
Georgia country report (EN) Georgian language version (GE)
Latvia country report (EN) Latvian language version (LV)
Poland country report (EN) Polish language version (PL)
Russia country report (EN) Russian language version (RU)
Ukraine country report (EN) Ukrainian language version (UA)

Gender Gap in Unpaid Care: Why Domestic Work Still Remains a Woman’s Burden?

The realities of unpaid care and domestic work have received much attention lately in policy and academic circles, especially in light of the COVID-19 pandemic (Van Houtven et al., 2020; Craig and Churchill, 2020; Duragova, 2020). Recent surveys and reports confirm that while the unpaid household work burden increased for both genders, women around the world ended up shouldering the lion’s share of various household chores and care duties during the pandemic (UN Women, 2020). For many countries, prolonged lockdowns have put a sudden spotlight on the “hidden” side of people’s economic lives, not typically reflected in the national accounts data. Unsurprisingly, among the main issues connected with unpaid care work is the highly gendered division of labor in the “household sector” and its consequences for the emotional and economic well-being of families. In this policy brief, the author explores the current state and the evolution of gender inequalities in unpaid domestic care work worldwide, and discusses the academic literature which addresses the reasons and the consequences behind them. The author also discusses potential policy interventions which could promote greater work-life balance and help advance both social and family-level welfare.

Gender Gaps in Unpaid Care Work

The term unpaid care and domestic work appears under many terminological guises, including “unpaid care work” “unpaid household work”, “unpaid domestic care work” and others. These terms essentially refer to the same phenomenon – unpaid care activities carried out in the household. They include cooking, cleaning, washing, water and fuel collection, shopping, maintenance, household management, taking care of children and the elderly, and others (Addati et al., 2018). For the purposes of this brief I will use the terms interchangeably, relying mainly on “unpaid care”, “domestic work”, or “unpaid domestic care” to describe these activities. While the value of unpaid care work is not included in the national income accounts, it can be tracked by time-use surveys carried out by national statistical offices in many countries. According to the most recent surveys, (Charmes, 2019) more than three quarters (76.4%) of unpaid domestic care work worldwide is done by women, while 23.6% is done by men. In developed countries, the women’s share is somewhat lower (65%), while in developing and emerging economies, women perform 80.2% of unpaid care. Thus, according to the data, even in developed countries women perform around two thirds of the unpaid domestic care work. Currently, no country in the world seems to have achieved gender parity with regard to the unpaid care distribution in households (U.N. Women., 2019).

Is There Evidence of Convergence in Domestic Care Responsibilities?

Given that the first time use surveys in many countries have been conducted only relatively recently, it may be premature to make claims about changes in the distribution of domestic work and a potential closing of the gender gap. However, evidence from countries with a longer history of time use data, in particular the United States, suggests that the way mothers and fathers allocate their time between paid and unpaid work has changed dramatically between 1965 and 2011. In particular, as can be seen from the Figure 1 (from Parker and Wang, 2013), in 2011 women spent 2.6 times (13 more hours per week) more on paid work, while men spend 5 hours less than in 1965. The time spent on childcare increased for both men and women. At the same time, domestic work hours decreased significantly for women, while somewhat increasing for men.

Figure 1. Moms and Dads, the US 1965-2011: Roles Converge, but Gaps Remain

20211221 Gender Inequalities in Unpaid Work Figure 01 | Bar chart titled "Moms and Dads, the US 1965–2011: Roles Converge, but Gaps Remain" showing average weekly hours spent on paid work, housework, and childcare by mothers and fathers in 1965 and 2011, highlighting the Gender Gap in Unpaid Care.

Note: Based on adults aged 18-64 with own child(ren) under the age of 18 living in the household. Source: Parker and Wang (2013).

Overall, analysis of time use survey data over a 40-year span shows a degree of convergence in unpaid care work between men and women (Kan et al., 2011; Altintas and Sullivan, 2016). However, as the Kan et al. (2011) study shows, gender inequality is quite persistent over time. In particular, men concentrate their contribution in domestic work to non-routine tasks (i.e. tasks that generally require less time, have definable boundaries and allow greater discretion around the timing of performance than the more routine tasks) such as shopping and domestic travel, while women devote a bulk of their time to routine work (cooking, cleaning, care). Women’s reduction in domestic work time (especially in routine tasks) may be largely due to the advancement of household technologies and higher acceptance/demand for women’s participation in the labor market (Gershuny, 1983, 2004). Thus, it appears that the “low-hanging fruit” of gender equality within households has already been picked, and, going forward, further shifting of domestic care responsibilities will be a more difficult task, even in developed countries.

Factors That Perpetuate Unpaid Domestic Care as Primarily Women’s Responsibility

The factors responsible for perpetuating gender roles in domestic work can be grouped into economic (specialization, comparative advantage) and sociological (habits, traditions, social perceptions) aspects.

The economic arguments that have long been used to explain the unequal division of paid and unpaid care work rely on the theory of comparative advantage and gains from specialization. Starting from the seminal work of Becker (Becker, 1985), economic models of the family suggested that a division of labor within the household is driven by different experiences and choices to invest in human capital. Becker argued that efficient households require specialization and the pattern of specialization can be explained at least in part by the differences in the initial investment in human capital (market skills for men and household skills for women) (Becker, 2009). In this model, men’s advantage in paid market activities is explained by historical reasons stemming in part from the more physical nature of market work. And yet, contemporary authors point out that the nature of work has been changing over time, with less emphasis put on physical, and more on cognitive skills. Likewise, the nature of household production has been changing (Greenwood et al., 2017). Birth control gave families a better way to control the number of children (Juhn and McCue, 2017). These changes should make men and women’s productivity more equal, and consequently reduce the gender gap between men and women in both types of work. And yet, despite the fact that in developed countries women often achieve higher educational attainment then men (Goldin, Katz, and Kuziemko 2006; Murphy and Topel, 2014), it has not been enough to eliminate the gender gap in wages and in the division of unpaid domestic work. Moreover, as the study based on 1992 Canadian data by McFarlane et al. (2000) points out, while the wife’s time in housework increases when the husband spends more time in paid work, the opposite is not necessarily true for men (men do not spend significantly more time on household tasks when their wives increase their employment). Alonso et al., 2019, using a sample of 18 advanced and emerging market economies, find that various factors that determine the allocation of time between paid and unpaid work affect men and women asymmetrically. For example, being employed part-time vs. full-time considerably increases the participation in unpaid work for women, while for men the same increase is statistically insignificant.

Thus, a purely “pragmatic” economic argument for the household division of labor is not sufficient to explain the persistence of the unpaid care gender gap. Other sociological factors, such as gender roles determined by social attitudes and cultural norms, tend to play an important role in household labor division (Coltrane, 2000; Juhn and McCue, 2017). Moreover, one can argue that educational choices of women, which contribute to their “comparative advantage” in household production, are themselves not independent of cultural norms and attitudes. These choices tend to be shaped in early childhood and reflect how much a family would invest in/encourage a girl’s education vs. that of a boy; whether boys are engaged in certain household chores – cooking, cleaning, caring for young children, etc. (UNDP, 2020). For example, the high gender gap in unpaid domestic work in the South Caucasus can be traced to family patterns. According to survey data (CRRC, 2015) in Azerbaijan, around 96% percent of women were taught in childhood how to cook, clean the house or do laundry, while only 35% of men were taught how to cook and clean. In Georgia, close to 90% of women reported being taught how to cook, clean and do laundry, while less than 30% of men on average reported being taught these skills (UNFPA, 2014).

The Social Cost of Gender Inequality in the Unpaid Care Work Allocation

Gender inequality is not just an issue of fairness. Inequality results in considerable resource misallocation, where women’s productive potential is not fully realized. The study by Alonso et al., 2019 estimates the GDP gains associated with a potential reduction in gender inequality in domestic work to the level observed currently in Norway. Countries like Pakistan and Japan, where the initial gender gap is quite sizeable, would gain around 3 to 4 percent of GDP. Another source of inefficiency is occupational downgrading, a situation where women take jobs below their level of qualification (Connolly and Gregory, 2007; Garnero et al., 2013) in order to better balance their home and work responsibilities. The perception of women as being primarily responsible for childcare and domestic labor drives statistical discrimination in the workplace and affects the “unexplained” portion of the gender pay gap (Blau and Kahn, 2017). The pay gap, in turn, perpetuates inequality in the division of domestic labor. Moreover, perception of unequal domestic work allocation is found to be associated with lower relationship satisfaction, depression, and divorce (Ruppaner et al, 2017). In addition, earlier sociological studies found that inequity in the distribution, rather than the amount of work, causes greater psychological distress (Bird, 1999).

Policies to Address the Gender Gap

Given the sizeable economic and social costs associated with the gender gap in unpaid care work, policy makers are paying greater attention to gender equality and ways to promote work-life balance for men and women. Currently, most solutions center around “recognize, reduce and redistribute” types of policies (Elson, 2017).

The “recognize” policies acknowledge the value of unpaid care work done by women through cash payments linked to raising young children (i.e. maternity leave policies). Most countries in the world adopt publicly funded paid maternity leave policies, although the adequacy of maternity leave payments and the duration of such leaves is still a stumbling block for many countries (Addati et al., 2014). Data suggests that maternity leave of no longer than 12 months has a positive effect on maternal employment, while long leaves (over two years) increase career costs for women (Kunze, 2016; Ruhm, 1998; Kleven et al., 2019)

The “reduce” policies, aim at the provision of public services that would reduce the burden of childcare and other forms of unpaid work on women and free up their time for participation in the labor force. Among such policies are investments in publicly funded childcare services (quality pre-schools and kindergartens) and physical infrastructure to support the provision of clean water, sanitation, energy, and public transport. Empirical studies generally find a positive effect of affordable childcare on female employment rates (Vuri, 2016; Lefebvre et al., 2009;  Geyer et al., 2014), but with some caveats – in particular, the subsidies may be less effective for female labor supply if affordable childcare just crowds out other forms of non-parental care (such as informal help from family members) (Vuri, 2016; Havnes and Mogstad, 2011).

Finally, the “redistribute” policies aim to promote the redistribution of household chores and childcare among men and women. Among such policies are initiatives aimed at making flexible and reduced-hour work arrangement attractive and equally available for men and women. (e.g. shifting standard weekly hours to a more family friendly 35 hours per week, as for example in France); active labor market programs aimed at retaining women in the labor market can also help reduce hours devoted to unpaid work (Alonso et al. 2019). Moreover, better labor market regulations (e.g. legislation to regulate vacation time, maximum work hours, etc.) would discourage the long working hours and the breadwinner-caretaker gendered specialization patterns within families (Hook, 2006). Other examples include work-life balance policies recently adopted by the EU (EU Directive 2019/1158), and are aimed at providing paid paternity leave and reserving non-transferrable portions of family childcare leave for men. These policies were found to be effective for both increasing father’s participation in unpaid care and for reducing the gender wage gap within families in a number of country studies (Fernández-Cornejo et al., 2018; Andersen, 2018).

It is important to recognize that more research is needed to identify exactly how and why specific policies may benefit families, and to adapt them to the specific country context. While many of the policies outlined above will not solve the problem of the gender gap overnight, they can be an important first step towards greater global gender equality in the workplace and inside the household.

About FROGEE Policy Briefs

FROGEE Policy Briefs is a special series aimed at providing overviews and popularizing economic research related to gender equality issues. Debates around policies related to gender equality are often highly politicized. We believe that using arguments derived from the most up to date research-based knowledge would help us build a more fruitful discussion of policy proposals and in the end achieve better outcomes.

The aim of the briefs is to improve the understanding of research-based arguments and their implications, by covering the key theories and the most important findings in areas of special interest to the current debate. The briefs start with short general overviews of a given theme, which are followed by a presentation of country-specific contexts, specific policy challenges, implemented reforms and a discussion of other policy options.

Additional Reading on Gender Equality and the Gender Gap

For further insights into the gender gap, unpaid care work, and women’s economic outcomes, explore the following related policy briefs:

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

From Russia with Love?

Posted on December 20, 2021 | Policy Brief

Russia Moscow City representing money laundering

Some recently discovered money laundering schemes have funnelled large amounts of illegal money from former soviet states through European banks. This note briefly describes the evolution of the Anti-Money Laundering (AML) regime for financial institutions, the introduction of which was concurrent with the post-soviet transition and the connected illegal flows of funds. It discusses the effectiveness of the current AML regime – and its ability to detect and seize illegal funds. The brief also highlights some of its deficiencies as well as lack of compliance with its prescriptions. It proceeds to stress that after judging the current framework insufficient, the US recently introduced whistleblower rewards for AML-infringements. Europe might want to follow their lead if it really aims at limiting money laundering.

Introduction

In recent years significant deficiencies in Anti-Money Laundering (AML) compliance have been discovered in some European banks (Spagnolo and Nyreröd, 2021). A notable example is the Danske Bank case that emerged in 2018.   Some have called it the largest money-laundering scandal in history: it is estimated that about $230 billion in suspicious funds went through its Estonian branch between 2007 and 2015.

In several of these cases, the sources of a large fraction of the illicit assets were Russia or other former Soviet states (Shaffer and Cassella, 2020).

Prior to the Danske revelations, several schemes have been uncovered that were aimed at laundering illicit money from former soviet states into the western financial system.

In a classic example going back to 2006, about $230 million were stolen in fraudulent tax refunds perpetrated by officials in Russia and then laundered through Moldova, Latvia and then UK shell companies and banks (Browder, 2009). Famously, the tax lawyer Sergei Magnitsky investigated the theft and testified against the fraudsters and was later put in detention for the same tax theft he was investigating. About a year after he was arrested, Magnitsky passed away after allegedly being tortured and denied medical care. This tragic episode gave rise to the Magnitsky Act, which prohibits persons believed to be involved in the theft to enter the US and access its financial system.

Another famous (and partly related) case is the so-called Russian Laundromat (then Global Laundromat), a scheme estimated to have funneled over $70 billion of illegal money out of Russia, through Latvia, Moldova, and then the UK (Tofilat and Negruta, 2019).

Indeed, Russia is widely considered the country with the largest estimated amount of ‘dark’ money hidden abroad, both as a percentage of GDP and in absolute terms (estimated around $1 trillion by Novokmet et al., 2017).

However, the origin of money laundered in the transition region is not limited to Russia. For example, it is estimated that between 2012 and 2014, about $2.9 billion from Azerbaijan were illegally laundered through UK shell companies and then European banks.

Funds from all these schemes appear to have been transacted through Danske bank (Bruun and Hjejle 2018: 33), Swedbank (Clifford Chance 2020: 123), and other European banks.

This evidence warrants some reflection on the effectiveness of the AML framework, particularly in Europe.

The Current AML Regime

The development of the global AML framework has been largely concurrent with the transition from communism and the connected illegal flows of funds.

The Financial Action Taskforce (FATF) was formed in 1989, after an initiative by the G7. FATF’s mission is to develop policies to combat money laundering and blacklist countries that do not comply. The FATF issued its first recommendations in 1999 and continually updates them, most recently in FATF (2021).

These recommendations set out essential measures that countries should have in place to identify money laundering risks, including regulation on preventive measures for the financial and other sectors, powers and responsibilities for competent authorities, coordination of their actions, and the facilitation of international cooperation (FATF 2021: 7).

AML regulation requires financial institutions to know their customers and engage in due diligence to reduce the risk that they onboard criminals seeking to launder money. Information about suspicious transactions and activities should be forwarded to a national financial intelligence unit, usually the financial police. National Financial Services Authorities (FSAs) are usually responsible for enforcing compliance with AML rules – the “preventive” side of money laundering regulation. The “repressive” criminal law or “enforcement” side of the fight against money laundering is usually enforced by the national financial police (Reuter and Truman 2004, Svedberg Helgesson and Mörth 2018).

There are certainly valid questions to be raised regarding the effectiveness of the current AML framework. While the World Bank estimates that between 2 and 5% of global GDP is laundered annually, it is also estimated that less than 1% of the proceeds of crime laundered via the financial system are currently seized by regulators and law enforcement agencies (UNODC 2011: 7).

At the same time, the framework is quite costly to comply with. There have been six EU Directives related to AML. All require legal implementation and impose new demands on banks and other covered institutions. FATF also requires that its members frequently carry out National Risk Assessments, and countries are also subject to Membership Evaluation Reports which imposes additional costs. Compliance costs for banks are estimated in the billions of dollars (Spagnolo and Nyreröd, 2021), and a whole industry surrounding “AML Compliance” has emerged. Part of these costs, not only monetary ones, end up transferred to bank customers.

From a more rigorous policy evaluation point of view, the AML regime is also problematic. There is a remarkable lack of data for assessing the effectiveness of the framework relative to its objectives (see e.g., Halliday et al. 2014, Levi 2018, Levi et al. 2018, Pol 2018, 2020).

Bank’s Failures

A lack of compliance with this preventative framework has been widespread.  In Sweden, for example, most large banks have been fined for various degrees of AML deficiencies. Similarly, many banks in other European countries received fines from local and US regulators (in the order of billions of dollars) for failing to comply with this framework, including HSBC, Credit Suisse, Deutsche Bank (multiple times), BNP Paribas, MagNet Bank, and Barclays Bank. Since 2016, the US has issued AML-related fines on eight occasions to banks with headquarters in European countries for an aggregate amount of $1.7 billion (mean $217 million fine; data from violationtracker.org).

In the case studies we discuss in Spagnolo and Nyreröd (2021), most forms of internal controls failed to some extent. Whereas external whistleblowing was rare or non-existent, internal whistleblowers did not manage to rectify the problems either.

Simultaneously, there were often clear red flags that should have alerted board members and executives. At Danske Bank group, for example, returns on allocated capital in the non-resident portfolio at their Estonian branch, where a substantial part of the money laundering occurred, hit 402% in 2013, compared with the 6.9% average for the whole group, a clear red flag (Schwartzkopff, 2018).

Supervisor’s Failures

The extensiveness of AML non-compliance cannot only be traced to negligent banks – it also has to do with the ineffectiveness of the enforcement of AML rules by supervising authorities.

In the cases reviewed in Spagnolo and Nyreröd (2021), supervisors appeared by and large aware of at least part of the AML deficiencies. Oftentimes, banks were given warnings by regulators, yet continued to violate the same rules.

For example, both the Danish FSA and the Estonian FSA seem to have had some knowledge of the AML deficiencies at Danske Bank’s subsidiary already in 2007, with little consequences.

Coordination between regulators has also been poor. The Danish FSA argues that the primary AML oversight responsibility for the Estonian branch should be the local FSA (Finanstilsynet, 2019), while the Estonian FSA retorts that European rules are not as clear and that the Danish FSA at least has some responsibility to oversee the branches of Danske Group (Finantsinspektsioon, 2019).

On September 24, 2018, the European Banking Authority (EBA) opened an investigation to assess whether the Danish and Estonian FSAs have violated any European laws. On April 16, 2019, it voted to reject an internal draft into supervisory failings that allegedly identified several shortcomings in how Danish and Estonian authorities supervised Danske bank. (Brunsden 2019). The EBA supervisory board’s decision to close the investigation without adopting any findings drew criticism from a range of senior policymakers and spurred calls for its reform. The EBA has also been criticized for its reluctance to pass judgment on its members (Bjerregaard and Kirchmaier 2019: 38).

Conclusion

The limited regulatory enforcement and compliance with the current AML system are likely to only marginally increase the cost of money laundering for criminals. Policymakers should thus wonder whether the current system is delivering value for money. There could be different ways to improve it. Increased fines for non-compliance may for example induce covered entities to comply with the AML framework to a greater extent.

Moving forward, the inconsistent enforcement of AML rules has led experts and policymakers to suggest centralizing some supervision and enforcement of AML regulation at the EU level (Kirschenbaum and Véron 2018, 2020; Unger 2020; JPP 2019; EC 2020, p.8), and improving information sharing between supervisors.

We believe these measures may not be sufficient for facilitating compliance with AML, while imposing substantial enforcing costs.

One way to increase AML compliance at a relatively low cost could be introducing whistleblower reward programs, as done in the US early this year (Nyreröd and Spagnolo, 2021). These programs offer substantial monetary rewards, often in the order millions of dollars, for information on non-compliance, and have proven extremely effective in combating fraud against the government, tax evasion, and securities fraud. While national EU supervisors may not have sufficient resources or competence to manage such programs, centralized actors such as the European Commission appear able to do so. If we see more centralized supervision, together with increased resources and competence, a well-designed and properly implemented whistleblower reward program may become a highly effective way to fight money laundering in the EU.

References

  • Bjerregaard, E., and T. Kirchmaier (2019). “The Danske Bank Money Laundering Scandal: A Case Study.” Copenhagen Business School.
  • Browder, W (2009). “Hermitage Capital, the Russian State and the Case of Sergei Magnitsky.” REP Edited Transcript, Chatham House.
  • Bruun and Hjejle (2018). “Report on the Non-Resident Portfolio at Danske Bank’s Estonian Branch.” Danske Bank.
  • Brunsden, J. (2019). “EBA faces calls to reform after dropping Danske Bank probe.” Financial Times, April.
  • Clifford Chance (2020). “Report of Investigation on Swedbank AB (publ).” Swedbank.
  • EC (2020). “Communication from the Commission on an Action Plan for a Comprehensive Union Policy on Preventing Money Laundering and Terrorist Financing.” 7.5.2020 C(2020) 2800 final.
  • FATF (2021). “International Standards on Combating Money Laundering and the Financing of Terrorism & Proliferation: The FATF Recommendations.”
  • Finanstilsynet (2019). “Report on the Danish FSA’s Supervision of Danske Bank as Regards the Estonia Case.” Danish Financial Services Authority.
  • Finantsinspektsioon (2019). “Response to the Report on the Danish FSA’s Supervision of Danske Bank.” Estonian Financial Services Authority.
  • Halliday, T. C., M. Levi, and P. Reuter (2014). “Global Surveillance of Dirty Money: Assessing Assessments of Regimes to Control Money-Laundering and Combat the Financing of Terrorism.” Center on Law & Globalization. University of Illinois College of Law and American Bar Foundation.
  • JPP (2019). “Joint Position Paper by the Ministers of Finance of France, Germany, Italy, Latvia, the Netherlands, and Spain.”
  • Kirschenbaum, J., and N. Véron (2018). “A Better European Architecture to Fight Money Laundering.” Peterson Institute for International Economics. Policy Brief 18-25.
  • Kirschenbaum, J., and N. Véron (2020). “A European Anti-Money Laundering Supervisor: From Vision to Legislation.” Peterson Institute for International Economics, January.
  • Levi, M. (2018). “Punishing Banks, Their Clients, and Their Clients’ Clients.” In King, C., C. Walker, and J. Gurulé (eds.) The Palgrave Handbook of Criminal and Terrorism Financing Law. Palgrave Macmillan.
  • Levi, M., P. Reuter, and T. Halliday (2018). “Can the AML System Be Evaluated Without Better Data?” Crime, Law and Social Change, 69(2): 307–328.
  • Novokmet, F., Piketty, T., and Zucman, G. (2017). “From Soviets to Oligarchs: Inequality and Property in Russia, 1905-2016”, NBER Working Paper Series, nr23712.
  • Nyreröd, T., and G. Spagnolo (2021). “Myths and Numbers on Whistleblower Rewards.” Regulation and Governance, 15(1): 82–97.
  • Pol, R. (2018). “Uncomfortable Truths? ML=BS and AML=BS².” Journal of Financial Crime, 25(2): 294–308.
  • Pol, R. (2020). “Response to Money Laundering Scandal: Evidence-Informed or Perception Driven?” Journal of Money Laundering Control, 23(1): 103–121.
  • Reuter, P., and E. M. Truman (2004). Chasing Dirty Money: The Fight Against Money Laundering. Peterson Institute for International Economics.
  • Schwartzkopff, F (2018). “Danske’s 402% Return Should Have Raised Red Flag, FSA Says.” Bloomberg, May.
  • Shaffer, Y. and Cassella, S (2020). ” The Causes, Effects, and Manifestations of the Money Laundering Problem in the Former Soviet Union.”, Georgetown Journal of International Affairs, February 21.
  • Spagnolo, G., and T. Nyreröd (2021). “Money Laundering and Whistleblowers.” SNS Report.
  • Svedberg Helgesson, K., and U. Mörth (2018). “Client Privilege, Compliance and the Rule of Law: Swedish Lawyers and Money Laundering Prevention.” Crime, Law and Social Change, 69(2): 227–248.
  • Tofilat, S., and V. Negruta (2019). “The Russian Laundromat – a $70 billion money-laundering scheme facilitated by Moldovan political elites.” Transparency International Moldova.
  • Unger, B. (2020). “Improving Anti-Money Laundering Policy.” Study requested by the ECON Committee, European Parliament.
  • UNODC (2011). “Estimating Illicit Financial Flows Resulting from Drug Trafficking and Other Transnational Organized Crimes.” Research Report, United Nations Office on Drugs and Crime.

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Social Distancing and Ethnic Diversity

Posted on December 14, 2021 | Policy Brief

20211214 Social Distancing and Ethnic Diversity Image 01

Voluntary social distancing plays a vital role in containing the spread of the disease during a pandemic. As a public good, it should be more commonplace in more homogeneous and altruistic societies. For healthy people, social distancing offers private benefits, too. If sick people are more likely to stay home, healthy ones have fewer incentives to do so, especially if asymptomatic transmission is perceived to be unlikely. This interplay may lead to a stricter observance of social distancing guidelines in more diverse, less altruistic societies. Consistent with this prediction, we find that mobility reduction following the first local case of COVID-19 was stronger in Russian cities with higher ethnic fractionalization and cities with higher levels of xenophobia and we confirm that mobility reduction in the United States was also higher in counties with higher ethnic fractionalization. Our findings highlight the importance of creating strategic incentives for different population groups in crafting effective public policy.

During the COVID-19 pandemic, governments in almost all affected countries have imposed restrictions aimed at promoting social distancing. However, enforcing these restrictions is logistically and politically costly. The effectiveness of these measures depends heavily on people voluntarily observing social distancing guidelines. The conventional wisdom is that informal social norms are more difficult to sustain in ethnically diverse societies (Alesina and La Ferrara, 2000; Algan et al., 2016). In Egorov et al. (2021), we challenge this notion by showing that during the COVID-19 pandemic ethnic diversity has increased prosocial behavior in Russia and the United States.

At least at the beginning of the pandemic, most people considered themselves healthy. For them, the decision to stay home has been driven more by the fear of getting infected than by the desire to avoid infecting others. The likelihood of getting infected is higher if sick people cannot be expected to self-isolate, which, in turn, depends on their prosocial considerations. If people are subject to out-group biases and care less about people from other groups, then the sick are less likely to engage in social distancing in more diverse places. This makes people who consider themselves healthy more likely to self-isolate. Since healthy people constitute a majority, at least in the early stages of a pandemic, we expect to see more social distancing in more diverse societies. Generally, in these circumstances, the private benefits of those who consider themselves healthy align with social objectives.

In Egorov et al. (2021) we formalize this argument and provide causal evidence of the differential decline in social distancing based on ethnic diversity in Russia and the United States.

Method

Our theory predicts that people engage in social distancing more in places with higher ethnic fractionalization when the probability of getting infected becomes nontrivial. To test this prediction empirically, we use two approaches. First, we report difference-in-differences estimates, where we compare cities with higher and lower levels of ethnic fractionalization before and after the first reported case of COVID-19 infection in their region. Second, we combine the difference-in-differences approach with a two-stage least-squares approach, in which the timing of the first reported case is instrumented using measures of preexisting migration.

One potential concern with the first approach is that the timing of the first case is not fully random. For example, regions could report late COVID-19 cases because their medical capacity precluded them from correctly identifying the virus in time, or because their testing policies could be ineffective, or because their administration was prone to conceal the first cases for a longer time. To deal with these potential confounds in the first approach we use predicted timing of the first case. Specifically, we use the fact that travel connections between various cities and Moscow (where the first major outbreak occurred) could affect the timing of the first case in those cities’ respective regions. We rely on internal migration as a proxy for these types of connections (Mikhailova and Valsecchi, 2020; Valsecchi and Durante, forthcoming) and use a shift-share instrument for internal cross-regional migration to deal with the endogeneity of migration.

Data and Results

To measure social distancing, we use data on people’s movements provided by Russia’s largest technology company, Yandex, which tracks individuals’ cell phones with its mobile apps. In particular, we use daily averages of the Yandex Isolation Index, which aggregates data on people’s movements at the city level and is analogous to the Google Mobility Index. The index is calibrated for each city to be 0 for the busiest hour of the working day, and 5 for the quietest hour of the night before the coronavirus outbreak. We use daily data for 302 cities with a population over 50,000 from February 23, 2020, through April 21, 2020.

Information on the first reported case of COVID-19 in each region is taken from the government-agency website that contains official information about the pandemic. Data on ethnic fractionalization is based on the 2010 Census. Information on interregional migration and control variables comes from the Russian Federal State Statistics Service.

Figure 1. Isolation Over Time for Places with High and Low Ethnic Fractionalization

Source: Egorov et al. (2021)

Figure 1 shows no visible difference in the behavior of people in cities with low and high levels of ethnic fractionalization before the first coronavirus case. In both groups of cities, people have engaged in more social distancing since the discovery of the first case. However, after one week, people in more fractionalized cities have been more likely to stay home than people in less fractionalized cities. The effect does not manifest itself immediately after the discovery of the first case, which likely reflects the fact that a certain time is needed to disseminate information about the discovery of the coronavirus in the region. Moreover, the growth in self-isolation in more fractionalized cities is somewhat lower in the first days after the discovery of the first case, which may be driven by people catching up on unfinished tasks that require mobility, such as last-minute purchases, in anticipation of more stringent self-isolation in the future.

The results of the difference-in-differences and IV estimation confirm the results of the visual analysis. The magnitudes of the IV estimation imply that a one-standard-deviation increase in ethnic fractionalization leads to 3.7% higher social distancing following the report of the first local COVID-19 case. In other words, a one-standard-deviation increase in ethnic fractionalization can explain 5.7% of the average mobility reduction after the report of the first case or, alternatively, 4.7% of the weekday-weekend gap for an average locality.

To make sure that the results are not Russia- specific, we also show that ethnic fractionalization led to a bigger reduction in mobility following the first local COVID-19 case using the United States county-level data.

Conclusion

Overall, the results in Egorov et al. (2021) highlight the role of ethnic diversity in voluntary adherence to socially beneficial norms, such as self-isolation and social distancing during a pandemic. We show that people in more diverse places were more likely to restrict their mobility following the reports of the first local COVID-19 cases.

Our study has important implications for government policy. It highlights not only that the propensity of different groups of people to engage in prosocial behavior may differ but also that there may be important strategic effects. In the context of the pandemic, decisions by healthy and sick individuals to self-isolate are strategic substitutes. This means, for example, that in a homogeneous society with high levels of tolerance, extensive testing would allow people to learn that they are sick and self-isolate, enabling the rest to go out with little fear. In a heterogeneous society with low levels of tolerance, the same policy may spur people who learn that they are contagious to go out more because they have little to lose, with the exact opposite implications for the healthy population.

References

  • Alesina, A., La Ferrara, E., 2000. Participation in heterogeneous communities. Quarterly Journal of Economics. 115, 847–904.
  • Algan, Y., Hémet, C., Laitin, D.D., 2016. The social effects of ethnic diversity at the local level: a natural experiment with exogenous residential allocation. Journal of Political Economics. 124, 696–733.
  • Egorov, G., Enikolopov, R., A., Makarin, and M. Petrova. 2021. Divided We Stay Home: Social Distancing and Ethnic Diversity” Journal of Public Economics. 194: 104328.
  • Mikhailova, T., Valsecchi, M., 2020. Internal migration and Covid-19 (in Russian). In: Economic Policy in Times of Covid-19, New Economic School, pp. 26–33.
  • Valsecchi, M., Durante, R., forthcoming. Internal Migration Networks And Mortality In Home Communities: Evidence From Italy During The Covid-19 Pandemic. European Economic Review.

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Female Entrepreneurs in Transition: Social Norms, Double Burden and the Next Generation

Posted on December 6, 2021 | Policy Brief

Photo Of People Doing Handshakes representing Belarusian higher education

Nowadays, it is evident that equal participation of both men and women in entrepreneurial activity can boost the world economy, create more diverse teams, and decrease social inequality. While the subject of women-led enterprises is widely discussed and explored, the portraits of women who stand behind these companies are still not complete. This brief focuses on the social aspects a businesswoman faces in a transition economy such as Belarus: Who is she? What are her social roles? And how do entrepreneurial families differ from average families in Belarus?

Introduction

Female entrepreneurship is widely discussed as one of the potential engines of sustainable economic growth (World Bank, 2018; IFC, 2017). This brief utilizes a recent wave of the Global Entrepreneurship Monitor survey to shed light on the key aspects of female entrepreneurship in Belarus – a transition economy with a relatively short history of private entrepreneurship. It looks at the social status and social norms surrounding female businesses to better understand the current situation and future trends in this part of Belarusian society.

The data for the analysis is provided by the Global Entrepreneurship Monitor (GEM) surveys conducted in the summer of 2019:

  • Survey of the adult population of Belarus (GEM APS): 2002 respondents aged 18 to 64.
  • Survey of entrepreneurs based on GEM APS: 208 business owners (107 men and 101 women).

Women Are More Willing to Study Hard

Following a long-standing tradition, women in Belarus are likely to obtain higher education. Based on the GEM surveys of the adult population, 35% of respondents have completed a bachelor’s degree (42% of women versus 27% of men) and 1.5% have completed a master’s degree. Among entrepreneurs, 60% of respondents have the first stage of higher education and 15% have the second stage. While most of the interviewed entrepreneurs have higher education (bachelor’s degree), women are more inclined to continue their studies: 19% of female and 11% of male entrepreneurs choose to enroll in master’s programs.

Access to business education is not a problem in Belarus: almost half of the respondents claim that their education is related to the business they run. A similar fraction also report participating in business training programs (with no significant gender differences). A third of respondents report having had a mentor who helped them start a business (42% and 58% of men and women, respectively). Entrepreneurs in Belarus are not inclined to be members of business associations or (in)formal self-support groups for entrepreneurs.

Are Female Entrepreneur Families More Equal?

Most often, an entrepreneur is married and has 1-2 children under 18 years old (this pattern being the same across genders). The majority of Belarusian families are of the so-called “Soviet” type, in which the most important woman’s role is to be a mother and “keep home”. At the same time, it is perfectly normal for women to have a paid job. In the case of preparing food, cleaning the house, and washing clothes, a comparable share of male entrepreneurs and men in the general population answer that most of these responsibilities are usually carried by women (65-68%). In contrast, half of the female entrepreneurs report having an equal distribution of these household duties [Figure 1]. We observe similar patterns in the caretaking of children: 68% of women entrepreneurs claim to have an equal distribution versus 44% of non-business women. This greater intra-family equality of women-entrepreneurs can be partially explained by the fact that businesswomen earn more than Belarusian women do on average.

Figure 1. How do you and your spouse/partner divide the task of cleaning the house and washing clothes?

Source: based on GEM APS 2019

According to data on the daily time use of the population collected by the National Statistics Committee for 2014-2015, women spend twice as much time as men on housekeeping and childcare. But, surprisingly, only 40-45% of women note that the traditional distribution of social roles in the family imposes an unfair constraint on women’s work and career possibilities. Therefore, we document a trend towards equal relations between spouses in households where the wife is an entrepreneur. At the same time, even a typical businesswoman bears a large burden of unpaid work.

A Successful Woman is a Happy Mother and a Wife

The respondents were asked a rather controversial question of what defines a “successful woman” [Figure 2]. Both entrepreneurs and the general population of Belarus were in solidarity in understanding a successful woman primarily as a happy wife and mother (75% of respondents). In second place, in terms of importance, respondents answered that a woman should be an educated and highly qualified professional (about 50% men and 60% women). Only 23% of male and 42% of female entrepreneurs agreed with the statement that a successful woman is, first of all, a successful entrepreneur. Remarkably, 46% of men in the general population survey completely or to a greater extent disagree with this statement, at the same time,  67% of those with children would like their daughter to run a business.

Figure 2. A successful woman is first of all a/an..

Source: Author’s calculations based on GEM APS 2019

Parental Entrepreneurship or Are There Any Predispositions to Become an Entrepreneur?

According to the research on parental entrepreneurship, the probability that children in entrepreneurial families will also have a career in business is 30-200% above that of children from non-entrepreneurial families (Lindquist et al., 2015).  In the case of Belarus, half of the surveyed entrepreneurs indicated that their fathers were employees, while 5-10% and 17-25% reported having fathers in business and leadership positions. By comparison, out of the 2000 respondents in the general population survey, 4-8% and 14-15% reported having fathers in business and leadership positions, respectively. As the difference is not very significant, parental entrepreneurship cannot play a decisive role in becoming an entrepreneur. This fact can be explained by the relative juvenility of Belarussian businesses, the absence of entrepreneurship in the USSR, and the attitude of society towards entrepreneurship in the 90s.

Nevertheless, the Belarusian business environment is changing as well as the social attitude. Among the 2000 respondents in the general population survey, about 68% would like their daughter to own a business, and 82% want such a future for their son. Among entrepreneurs, aspirations about their children’s future are rather predictable: a third of respondents do not make plans for their children and the majority of the remaining want their children to run their own business. Moreover, among those having preferences for their children’s future, both male and female entrepreneurs reached almost 100% consensus regarding their sons. When it comes to their daughters, 95% of women and 80% of men prefer a future in business while 15% of men would like to see their daughter become a homemaker.

Conclusion

Several key findings can be noted when comparing women entrepreneurs in Belarus with those who are not in business. Entrepreneurs are more likely to obtain higher education, both first and second stage; household chores more equally shared in families with women entrepreneurs. Female entrepreneurs more often want a future in business for their children, especially their daughters. Based on the above, it can be expected that a greater involvement of women in business can positively affect the state of gender equality in Belarus and the quality of human capital.

Nowadays, the promotion of entrepreneurship (let alone female entrepreneurship) is not a priority of the current Belarusian government, and independent development actors, who used to support it in the past, are out of the country. For the future, however, I will outline some general recommendations for developing female entrepreneurship (based on Akulava et al., 2020). With regard to education, the popularization of STEM programs among women can positively affect female involvement in entrepreneurial activity. Additionally, promoting examples of successful women-led enterprises will help combat stereotypes and inspire women to venture into entrepreneurship. Last but not least, an equal division of domestic responsibilities will allow women to spend more time on their careers.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Foreign-Owned Firms and Labor Tax Evasion in Latvia

Posted on November 29, 2021 | Policy Brief

20211128 Foreign-Owned Firms Image 01

It is well-documented that foreign-owned firms often pay higher wages than domestic firms. This phenomenon is usually explained by foreign firms being more productive. In this brief, we discuss another mechanism that drives the wage premium for employees of foreign-owned firms. By comparing income and expenditures of households led by employees of foreign-owned firms, domestic firms and public enterprises in Latvia, we show that employees of foreign-owned firms receive less undeclared cash payments than employees of domestic firms.

Introduction

A vast economic literature documents a wage premium for employees of foreign-owned firms (e.g., Heyman et al., 2007; Hijzen et al., 2013). This can result from self-selection of foreign firms in highly productive sectors (Guadalupe et al., 2012) or from a productivity increase (Harding and Javorcik, 2012). In a recent paper (Gavoille and Zasova, 2021), we provide evidence of a third driver: foreign-owned firms are more (labor) tax compliant than domestic firms.

Envelope wage, i.e., an unreported cash-in-hand complement to the official wage, is a widespread phenomenon in transition and post-transition countries (e.g., Gorodnichenko et al., 2009 in Russia, Putninš and Sauka, 2015 in the Baltic States, Tonin, 2011 in Hungary). Employees are officially registered, but the income reported to tax authorities is only a fraction of the true income, the difference being paid in cash. If domestic firms are more likely to underreport wages than foreign-owned ones, the documented wage premium for employees of foreign-owned firms is overestimated.

Methodology and data

To compare the prevalence of income underreporting in foreign and domestic firms, we use an approach similar to Pissarides and Weber (1989). This approach is based on two main assumptions. First, even though households participating in an expenditure survey can have incentives to misreport their expenditures, they accurately report their expenditure on food.

The second assumption is that if all households would fully report their income, similar households would report a similar share of spending on food. If, however, a group of households is likely to underreport income, their fraction of income spent on food will systematically be higher than that of tax-compliant households. Using the propensity to food consumption of a group of households that cannot evade payroll tax as a benchmark, we can identify groups of tax-evading households by comparing their food consumption with the reference group.

In this brief, we mainly focus on three household groups: households where the head is an (1) employee of a foreign-owned firm (reference group), (2) employee of a public sector enterprise, and (3) employee of a domestic firm. We introduce public sector employees as an additional comparison group, since they cannot collude with employers to underreport wages. Hence, our approach allows us to test whether households in the third group are more likely to receive undeclared payment than households in the first group, and additionally test if our reference group is systematically different from public sector employees.

We estimate Engel curve-type relationships for food consumption for different types of households, i.e., we estimate how households’ food consumption varies with income depending on employment of the main breadwinner (employed in a foreign-owned firm, public sector enterprise, domestic firm or self-employed), controlling for various household characteristics (number of adults, size of household, place of residence, level of education of the main breadwinner, and other).

Our data comes from three sources. First, we use the 2020 round of the Latvian Household Budget Survey (HBS), which provides information on household consumption, income and characteristics in 2019. Second, we use an administrative matched employer-employee dataset providing information on reported wages for the whole population of employees in Latvia. We match the second database with HBS using (anonymized) individual IDs contained in both datasets. Finally, we use (anonymized) firm IDs contained in the second database to merge it with a third data source, which provides detailed information on firms’ foreign-ownership status.

Results

For simplicity, in the rest of the brief we denote “household where the head is an employee of a foreign-owned firm” as simply “foreign-owned households”. A similar simplification applies to other household groups.

Comparing domestic and foreign-owned households, domestic households spend a higher share of their income on food. Figure 1 plots a non-parametric Engel curve for the two groups. The two curves exhibit fairly similar behavior, but the Engel curve for domestic households always lies above the one for foreign-owned households: for a given income, domestic households always spend a larger fraction on food than foreign-owned ones.

Our model estimations provide two main results. First, we find that the net wage premium for employees of foreign firms is 13-35%, depending on the sample and the source of data on income. Second, we show that domestic households are more likely to underreport income than foreign-owned households. On average, domestic firm households are estimated to conceal 26% more income than foreign-owned ones. At the same time, public sector households do not exhibit a significantly different food consumption pattern than foreign-owned firm households. Assuming that public sector households cannot evade, foreign-owned firm households hence do not underreport. The estimated share of concealed income is even larger (about 40%) if we restrict our sample to households where the head is aged below 50 years and is full-time employed.

Figure 1. Engel curve

Source: authors’ calculations. Note: We follow Hurst et al. (2014). We regress (administrative) wage and food consumption separately on demographic controls to condition out these factors. We recenter the residuals at the unconditional averages for each group and use these residuals to estimate the Engel curve with a cubic spline.

Conclusions

In a context of widespread labor tax evasion, the observed wage premium for employees of foreign-owned firms can be driven by payroll tax compliance. How much of the wage premium can underreporting explain? Our results for Latvia suggest a net wage premium of 13% to 35% for the group of foreign-owned households. This roughly corresponds to the magnitude of the underreporting factor, indicating that nearly all of the wage premium can be explained by labor tax evasion. Even though the precise underreporting point estimates should be cautiously interpreted, and this 1-to-1 relation is anecdotal, this nevertheless highlights the potential importance of envelope wages in explaining the wage premium of employees of foreign-owned firms when labor tax evasion is prevalent.

Acknowledgement: This brief is based on a recent article published in Economics Letters (Gavoille and Zasova, 2021). The authors gratefully acknowledge funding from LZP FLPP research grant No.LZP-2018/2-0067 InTEL (Institutions and Tax Enforcement in Latvia).

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

New Insights Concerning the 1970 Nobel Prize in Literature to Aleksandr Solzhenitsyn

Posted on November 15, 2021 | Policy Brief

Image with Aleksandr Solzhenitsyn representing his work and Nobel Prize

The recently declassified proceedings of the Swedish Academy shed new light on why it awarded Aleksandr Solzhenitsyn the literature prize in 1970. His novels reflected unique experiences of many prisoners. The Academy characterized his work as a renewal of the great Russian literary tradition. On the other hand, Soviet authorities prohibited publication of his novels, however, they were widely circulated underground or published abroad. We now know that his novel In the First Circle as it was published in 1968 was only a shortened version that Solzhenitsyn had hoped would pass the censorship. The complete version, published recently in many languages, gives an even better inside picture of the Soviet state, its leaders and ordinary citizens, and thus strengthen the Academy’s motivations for the award.

The decisions by the Nobel prize committees are declassified after fifty years. Therefore, we recently got a better insight on the motivations by the Academy for giving the 1970 prize in literature to Aleksandr Solzhenitsyn. The proceedings of the Academy add to what was known at the time, from leakages to the press and rumours by initiated persons. Remarkable Western journalists and scholars could describe the main events in the Soviet cultural life surrounding Solzhenitsyn and the Nobel prize. (Saraskina 2008; Scammell 1984). What has now been revealed from the Academy archives are the opinions of the Academy members and in particular the motivations in the propositions submitted in 1969–70 from entitled personalities.

The decision to award Aleksandr Solzhenitsyn the 1970 Nobel Prize in literature was preceded by his own struggle in the USSR to make his novels available to a wider public. In the last year of the Second World War, he was sentenced for allegedly subversive correspondence with another officer in the Red Army. Solzhenitsyn was sentenced to a long term in the camps. However, much of this time he spent in a special design bureau operated by MGB, the secret services’ so-called “sharashki”. After his release, Solzhenitsyn worked as teacher in a distant province. Here, he managed to write novels and short stories, based on what he had himself experienced or heard from other prisoners. He must, of course, keep his writings secret.

With the “thaw” under Nikita Khrushchev in the early 1960s, an opening was found for Solzhenitsyn to get his short story “A Day in the life of Ivan Denisovich” published in the renowned journal Novyi Mir. It seemed that he would then get his novels published; a contract was given for the novel The Cancer Ward (Rakovyi korpus). However, the literature climate changed as Khrushchev was ousted in 1964. The authorities stopped all plans to publish Solzhenitsyn’s works. In those days, there circulated many transcripts of unpublished works, in the so-called samizdat. It is even today an open question, for researchers, just how many hundreds or even thousands of readers throughout the Soviet Union were in those days familiar with literature that the censorship authorities would not allow to be printed.

These hardened attitudes of the Communist authorities only spurred Solzhenitsyn to have his works published abroad. He managed to organize a solid network for smuggling his manuscripts abroad, and to have responsible publishers contracted. In the late 1960s, The Cancer Ward – based on his observations during treatment in a Soviet hospital – and In the First Circle (V kruge pervom) – describing a design bureau where sentenced scientists were to develop high-technological equipment – were published in the USA and many countries in Europe.

His books were not only best-sellers, but highly esteemed by literary critics. Already in 1969, the Swedish Academy received applications from their authorized contributors, that the Nobel prize in literature be awarded to Solzhenitsyn. The Academy member and author Lars Gyllensten formulated a detailed analysis of Solzhenitsyn’s books. He emphasized Solzhenitsyn’s talent for psychologically pertinent portraits of a plethora of individuals in the most extreme conditions. However, in 1969, the Swedish Academy decided to award its literature prize to Samuel Beckett, as a dramatist with a much longer career. The next year, Francois Mauriac (Nobel laureate in 1952) jointly with a group of influential French authors formulated a proposition concerning Solzhenitsyn to the Academy. It had also received an anonymous Prize proposition written by a dozen members of the Soviet Union of Authors who emphasized the pathbreaking character of Solzhenitsyn’s novels. After deliberations within the Swedish academy, with only one dissenting member, it was announced that the 1970 prize in literature was awarded to Solzhenitsyn.

The Soviet authorities had a dilemma. In 1965, the appraised Soviet novelist Mikhail Sholokhov had received the prize in Stockholm and lectured here on his renowned novel And Quiet flows the Don (Tikhii Don). On the other hand, in 1958, the equally famous Boris Pasternak was nominated for his novel Doctor Zhivago. However, Pasternak was forced, under humiliating circumstances, to renounce the prize. The situation in 1970 for Solzhenitsyn thus presented several dilemmas. He rightly feared, as the nowadays available documents also confirm, that if he would go to the Nobel prize ceremony in Sweden, the Communist party leaders would most probably withdraw his citizenship and thus force him into exile. Consequently, he informed the Academy that he was honored and would accept the prize, but that he was not prepared to travel to Stockholm. Discussions with Swedish diplomats in Moscow concerned the alternative to arrange a ceremony at our embassy. Finally, this option was cancelled in 1971 when the chairman of the Swedish academy Karl Ragnar Gierow was denied a visa to the USSR.

Solzhenitsyn’s Later Path-breaking Contributions

In the meantime, Solzhenitsyn would continue his writing of the multi-volume historical novel The Red Wheel (Krasnoe Koleso) on the last period of Imperial Russia and his interpretation of the 1917 February revolution. He was also more engaged than before in publishing manifestoes and letters to the authorities, in a struggle against the oppressive regime. Much changed as more dissident voices in the Soviet Union manifested themselves in the early 1970s. A new landmark in Soviet literature would come in early 1974, with the publication of the first parts of The GULAG Archipelago. Although concerned Western readers had a vague notion of the Soviet camp system, Solzhenitsyn had managed to assemble hundreds of eye-witness stories from former prisoners that really shocked the public. In France and several other countries, the intellectual climate changed dramatically as The GULAG Archipelago made its imprint. In the 1980s, it was not yet possible to undertake serious historical research on the Soviet penitential, prison and camp system. Only with glasnost and Gorbachev’s perestroika was the seal on the secret archives opened and many of Solzhenitsyn’s originally earth-shaking revelations could be put into a solid factual framework. We now know who the more than two hundred personalities were who had sent Solzhenitsyn their stories in the early 1960s, as they had read his “Ivan Denisovich” short story. Solzhenitsyn’s guesswork, in the absence of statistics, concerning the economic significance of the GULAG camp system can instead be analyzed by the solid documentary collections from the archives (Jesipov 2018). A major contribution was made by the French historian Nicolas Werth and his colleagues, who jointly with archivists in Russia, assembled and wrote commentaries to the exhaustive, seven volumes Istoriia stalinskogo GULAGa. Solzhenitsyn’s original work undertaken under the direst possible circumstances stand out as pioneering. He could not even dream of having his manuscript fact-checked by experts, let alone read in wider circles. It deserves emphasis therefore that President Putin took the initiative to have an abridged version of The GULAG Archipelago edited for the Russian school. Solzhenitsyn’s widow, Natalia Dmitrovna accomplished this careful selection and added commentaries as necessary for young readers.

The 1970 Nobel Literature Prize Reconsidered in Hindsight

Finally, a reflection on how Swedish opinions on Solzhenitsyn has changed over time – from the enthusiastic reception in the 1960s of his novels to the skeptical attitude in the 1990s and early 2000s to Solzhenitsyn’s allegedly nationalistic worldview. It cannot enough be emphasized under how horrible circumstances he wrote classical contributions to world literature. To take only one example. If the Swedish Academy – hypothetically – had known the original version of The First Circle, and not only the abridged version published in the late 1960s, with its far less political implications, they could with even greater emphasis have nominated him for the Literature Prize. It demands a lot from contemporary readers to imagine how one man like Aleksandr Solzhenitsyn, who even in his early age in the late 1930s dreamt of writing novels on the Russian revolution, after much suffering in the camps managed to vividly describe, in the novels here presented, the many-faceted Soviet system from inside its prisons, camps and deportation cities.

References

  • Carlisle, Olga, Solzhenitsyn and the Secret Circle, London: Routledge & Kegan Paul 1978.
  • Jesipov, Valerii, Kniga, obmanuvshaya mir: Ob “Arkhipelage GULAG” A. Solzhenitsyna nachistotu, Moscow: Letnii Sad, 2018; Swedish abbridged translation Boken som lurade världen: Om Aleksandr Solzjenitsyns GULAG-arkipelagen, Stockholm 2020.
  • Ostrovskii, Aleksandr, Solzhenitsyn – Proshchanie s mifom, (Farewell to the Myth) Moscow: Jauza 2004.
  • Samuelson, Lennart, ”Nya ingångar i Solzjenitsyns Nobelpris när sekretessen hävs”, Respons, 3/2021, http://tidskriftenrespons.se/artikel/nya-ingangar-i-solzjenitsyns-nobelpris-nar-sekretessen-havs/.
  • Saraskina,:Liudmila, Aleksandr Solzhenitsyn, Moscow: Molodaya Gvardija 2008;
  • Saraskina, Liudmila (ed.), Aleksandr Solzhenitsyn: Vzgliad iz XXI veka: materialy Mezhdunarodnoi nauchnoi konferentsii, posviashchennoi 100-letiiu so dnia rochdeniia, Moscow, Russkii Put, 2019.

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Russian Exporters in the Face of the COVID-19 Pandemic Crisis

Posted on November 8, 2021 | Policy Brief

20211108 Russian Exporters in the Face of the COVID-19 Image 01

This brief summarizes the results of recent work on the effects of the COVID-19 pandemic on Russian exporting companies (Volchkova, 2021).  We use data from the CEFIR NES survey of exporters conducted in 2020. 72% of respondents reported that they were affected by the crisis. We scrutinize this impact. Contrary to popular wisdom, we observe little difference in delays of inputs by domestic and foreign suppliers. On the other hand, exporters experienced more disruptions in their sales in foreign destinations than in the domestic market. Possible reasons for this may be due to restrictions on international travel.

Introduction

According to experts at the Gaidar Institute (Knobel, Firanchuk, 2021), in 2020, Russia’s non-resource non-energy exports, decreased by 4.3%, while export prices fell by 4.1 % on average. The export of high-tech goods decreased by 14% due to a reduction in the physical volume of export. These changes in export intensity are mainly associated with the COVID-19 pandemic crisis. But are exporting firms more affected by the crisis than firms only active in the domestic market? What are the main channels through which the crisis influenced exporters?  And how do exporters adjust to the COVID-19 related shocks?

The analysis in this brief is based on forthcoming publication in the Journal of New Economic Association (Volchkova, 2021). We use data from a survey of Russian non-resource exporters conducted in 2020. We show that involvement in international trade did not affect the company’s vulnerability to the crisis on the production side: supply delays were equally likely to occur from domestic and foreign suppliers. These findings are consistent with Bonadio et al. (2021) who consider a numerical multi-sectoral model for 64 countries around the world linked by supply chains. They show that, in the face of the employment shocks associated with quarantine measures and switching to a remote work format, the contribution of global chains to the decline of real GDP is about one quarter. Importantly, the authors show that the “re-nationalization” of supply chains does not make countries more resilient to shocks associated with quarantine measures on the labor market because these shocks are also bad for domestic industries.

At the same time, our results indicate that exporting companies are exposed to additional risks associated with the need to adjust to shocks in the sales markets. According to the data, exporters find it more difficult to adjust their sales in foreign markets than in the domestic one. This is consistent with the fact that, during the pandemic, all countries introduced a strict ban on international travel, reducing the possibility of establishing new business ties through personal contacts. Similarly, Benzi et al. (2020) show a significant negative effect of international travel restrictions on the export of services.

Survey of Non-resource Exporters

The survey of exporters was carried out in June – November 2020 by CEFIR NES. The primary purpose of the survey was to identify and estimate barriers to the export of non-primary non-energy products. In the context of the developing economic crisis caused by the COVID-19 pandemic, we have added several questions to identify how the crisis influenced companies’ operations and how the respondent firms adjusted to the new conditions.

The survey was conducted using a representative sample of Russian exporting firms. As a control group, we interviewed non-exporting firms with (observable) characteristics (region, industry, labor productivity) similar to those of the surveyed exporters. Altogether, 928 exporting companies and 344 non-exporting companies were interviewed during the field stage of the study.

Most exporting companies that took part in the survey produce food products, chemicals, machinery and equipment, electrical equipment, metal products, and timber. On average, a surveyed exporter had 827 full-time employees; 25% of the firms had fewer than 26 employees. More than half of the surveyed exporting firms (53%) are also importers: 81% import raw materials and other inputs, 66% import equipment, and 22% import technology. Most interviewed exporters sell their products both abroad and on the domestic market. On average, an enterprise supplies 67% of its output to the domestic market and 32% abroad.

Impact of the COVID-19 Crisis on Firms’ Performance

Among exporters that participated in the survey, 25% reported that their business was not affected by the COVID-19 crisis, while 72% of respondents stated that the crisis did have an impact. Like any crisis, the COVID-19 pandemic created problems for some enterprises and provided new beneficial opportunities for others. According to the data, exporting businesses were significantly more likely to be negatively affected by the crisis than their non-exporting counterparts, and the impact of the crisis was not correlated with the size of the enterprise. Figure 1 presents the exporters’ answers to the question of how their sales in the domestic and foreign markets have changed with the COVID-19 pandemic.

The distribution of changes in sales volume in domestic and foreign markets significantly differ from each other. Estimates of the mean values of changes in sales volumes also differ significantly: the average drop in sales in the domestic market was 5%, while for the external market, it reached 17%. Hence, in times of the COVID-19 crisis, opportunities for growth were less prominent in foreign markets than in the domestic one, while significant market losses were more frequent.

Figure 1. Change in sales of export companies associated with the COVID-19 pandemic

Source: Survey of non-resource exporters, CEFIR NES, 2020.

Adjustment to the Crisis

The most frequently used crisis adjustment measure was employees transition to remote work – it was reported by 70% of the surveyed companies. 25% of exporters were forced to suspend their work during the crisis, while 72% were not. 14% of respondents stated they had to cut their payroll expenditures and other non-monetary benefits for employees (food, insurance, etc.), 12% of companies sent workers on unpaid leave. Only 6.5% of export firms had to lay off workers, while 91% handled the crisis without layoffs.

Comparing exporters’ answers with those of non-exporters while controlling for enterprise size, we conclude that exporting firms were more rigid in their adjustment  to the crisis. They were significantly more likely to suspend enterprise activities, dismiss of employees, send workers on unpaid leave, and reduce of wages. Also, these events were more likely to occur for smaller companies than for larger ones.

At the same time, flexible adjustment measures such as remote work were equally likely to be used by exporters and non-exporters, as well as by firms of different sizes. In general, Russian exporters of non-primary goods maintained their efficiency mainly by adjusting the labor relations to the new epidemiological conditions rather than by reducing employee-related expenses.

Dealing with Counterparties

Delays in the supply of components and raw materials were reported by 36% of the surveyed companies, and such delays were equally likely for shipments from abroad and domestic shipments. There is a perception that international supply chains in the context of the pandemic crisis are an additional risk factor. Our results indicate that domestic and international supply chains were equally challenged in 2020. Nevertheless, non-exporting companies faced the problem of delayed deliveries significantly less often than exporters did, and about 60% of companies experienced no problems at all on the input supply side.

27% of surveyed exporters stated that they delayed payments to counterparties. Non-exporting companies reported these reactions much less frequently regardless of firm size.

On the sales side, half of the surveyed exporters experienced delays in payments from their customers during the pandemic crisis. Non-exporting enterprises encountered the problems with the same frequency, and companies of all sizes were affected by this obstacle equally.

The cases of planned purchases cancellation on behalf of buyers were reported by 34% of exporting companies. Exporters experienced these problems significantly more often than non-exporters, and smaller companies experienced them much more often than larger ones.

Crossing international borders presented a certain problem for Russian exporters when it concerns product delivery. Just over half of the respondents indicated that they had to delay deliveries due to difficulties with border crossing. However, about the same share of companies (48%) reported that they delayed products delivery due to the introduction of lockdowns. Thus, during the COVID-19 pandemic, exporters’ operations were complicated to the same extent by problems related to border crossings as by those associated with lockdown regimes.

Conclusion

It is widely believed that international exposure of companies in the context of the COVID-19 pandemic crisis creates additional risks. Our study shows that, regarding existing inputs supply, international relations pose problems for Russian companies just as often as relations with domestic partners. As far as sales are concerned, adjustment to the crisis was better on the domestic market than on foreign markets. A possible explanation of this phenomenon is that, in addition to the shocks associated with quarantine measures in the labor market, access to foreign markets was hampered by restrictions on international travel, which is essential for readjusting contractual relations to explore new opportunities brought by crises (Cristea, 2011). Without personal interaction, new contracts were more difficult to launch. Thus firms’ opportunities to adjust foreign sales were more restricted than the ones in the domestic market.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Media mentions: Key takeaways from this policy brief have been published by one of the most influential media outlets in Russia Kommersant – Коммерсант: «Ковид сильнее ударил по экспортерам». Исследование ЦЭФИР РЭШ.