Author: Cecilia Smitt Meyer

What Is the Evidence on the Swedish “Paternity Leave” Policy?

20240204 Swedish Paternity Leave image representing fathers parental leave policy

Since 1995, Sweden has earmarked an increasing number of parental leave days to each parent, creating a strong incentive for fathers to increase their (traditionally low) parental leave uptake. The literature on the causal impacts of these policies establishes several important findings. First, the incentive seems to work, as fathers tend to increase their uptake of paternity leave. However, who responds to the incentive, the timing of the leave and how mothers adjust to it is heterogenous, depending on the policy design and the underlying couple characteristics. Second, there is no strong support in the data for the argument, popular in public opinion and among policy-makers, that paternity leave should improve the balance of childcare duties within a couple and ultimately enhance women’s labor market position. However, in order to estimate causal effects, the studies reviewed in this policy brief focus on the first cohort of families affected by earmarked parental policies, whereas impacts on mothers’ labor market outcomes are more likely to manifest in the long run. Further, paternity leave policies in the broader sense have benefitted mothers’ health post childbirth and they may also have broken the social stigma on fathers taking time off to care for their children. Finally, recent evidence suggests that earmarking has improved gender attitudes in the next generation, making men less likely to hold stereotypical views about gender roles in society.

Parental Leave in Sweden

All parents in Sweden have been entitled to paid parental leave benefits since 1974, with no difference between birthing and non-birthing parents (for simplicity referred to as mothers and fathers henceforth). Despite this, fathers’ parental leave take-up has historically been very low (see Figure 1).

To change this pattern, the legislator has introduced a few reforms over the years. In 1995, 30 of the wage-replaced days (i.e. parental leave days compensated at almost the rate of the daily wage) were earmarked to each parent, creating the so called ”mum/dad month”. When a parent failed to take up these 30 days these would be “lost”, as earmarked days could not be transferred to the other parent. Through two subsequent reforms, effective from 2002 and 2016 respectively, the number of earmarked wage-replaced days increased, first to sixty days and then to ninety days.

Today, the total allowance is 480 benefit days, of which 390 are wage-replaced (paid at about 80 percent of the parent’s wage), and the remaining 90 are compensated at a low flat rate (approximately 15 euros per day). 90 of the wage-replaced days are earmarked to each parent. The parental leave days can be utilized until the day the child turns 12 or until the child finishes 5th grade, but 80 percent of these days must be used by the time the child turns 4.

As shown in Figure 1, father’s share of the total parental leave steadily grew over the years when the earmarking reforms occurred but has since 2018 stalled at a rate of 69/31 (i.e., mothers and fathers take 69 and 31 percent respectively of the total number of leave days claimed in Sweden during one year).

Figure 1. Men’s share of parental leave days in Sweden, 1974-2021, in percent.

Source: Author’s compilation based on data from Statistics Sweden.

One could speculate, based on these trends, that earmarking might have successfully increased father’s take-up of parental leave. However, without rigorous statistical analysis, it is virtually impossible to distinguish between the role of the earmarking polices and secular trends in preferences over parental leave. Thankfully, a few papers have studied the Swedish parental leave reforms, using state-of-the art techniques to understand their respective causal impacts. What is the research-based evidence on the Swedish parental leave earmarking reforms? Did they successfully incentivize fathers to increase their take-up? Did they succeed in their broader goal of balancing child responsibilities within couples, ultimately helping women improve their position in the labor-market? How were children affected by them? What lessons from the Swedish experience can be useful for fine-tuning of the Swedish policy or for similar designs in other countries?

This policy brief delves into the academic literature on the impacts of the Swedish earmarking reforms. The review is by no means representative of the large amount of academic work produced on the Swedish parental leave reforms. Rather, it is a small selection of studies where results can be more easily interpreted as causal impacts, as they are based on comparing families with children born just before versus just after the relevant date for the policy implementation, and account for so called month-of-birth effects (see e.g. Larsen et al., 2017) when needed. Causal estimates can be more directly used to inform policy-making, which is what motivates the focus of this review.

Earmarking and Take-up of Paternity Leave

As explained above, the Swedish earmarking system creates strong incentives for fathers to increase their take-up of leave days, as these would otherwise be “lost”, leaving couples with the need to resort to potentially more costly arrangements for childcare.

It is thus not surprising that the 1995 reform increased fathers’ take-up of wage-replaced leave by an average of 15 days, 50 percent of the pre-reform take-up (Ekberg et al., 2013). This change seems to mostly stem from the 54 percent of fathers who were taking 0 days of leave before the reform and were induced to take between 20 and 40 days after, so that the percentage of fathers not taking any leave declined to 18 precent.

In a recent working paper, Avdic et al. (2023) complement this evidence, considering all leave days together. They show that the reform induced fathers to increase their take-up of total parental leave by 21 days, whereby mothers decreased it by the same amount. Therefore, on average, the total amount of leave taken by Swedish parents remained unchanged, but the mother’s share decreased by about 5.4 percentage points. The paper also compares changes in parents’ take-up month-by-month, finding that some mothers took some unpaid leave within the child’s first year to compensate for the loss of wage-replaced days. It is not clear why these mothers would not resort to the low flat rate leave, as other mothers seem to have done (see Ekberg at al., 2013). In general, the data points to fathers having mostly, although not exclusively, substituted for mothers’ time with the child during the child’s second year of life.

Avdic and Karimi (2018) extend the policy-evaluation to the 2002 reform, which earmarked one additional month to each parent, but also made one more month of wage-replaced leave available. They find that this reform also caused an increase in take-up of paternity leave, but for a different group of fathers. While in 1995 fathers that otherwise would have taken no leave were induced to take approximately one month, the 2002 shift occurred mostly among fathers who, instead of taking between 30 and 40 days of leave, started taking more than 50 days.

These findings are consistent with those in Alden et al. (2023), who study the characteristics of fathers who do not take any leave. They find that while the 1995 reform changed the composition of this group of fathers, the same thing did not happen with the 2002 and 2016 reforms. Over-time, one group of men consistently stands out for not taking any parental leave regardless of the incentives created by the legislator, namely fathers with worse labor-market positions, and whose earnings are lower than that of the mothers.

Paternity Leave and Gender Gaps

The main motivation for policies that seek to increase the take-up of parental leave among fathers is that this increase can help women, especially high-skilled ones, improve their labor-market position (Ekberg et al., 2013). The economics literature has long established a systematic loss in earnings and employment for women following the birth of their first child (the so-called child penalty; see e.g. Kleven et al., 2019). There are two main mechanisms through which earmarking policies could improve women’s labor market outcomes. First, if firms discriminate against women because of the (perceived) cost of maternity leave, the discrimination should decline once employers expect also men to take parental leave. Ginja et al. (2020) show evidence (although not causal) consistent with long maternity leaves reducing child-bearing aged women’s “attractiveness” among Swedish employers.  Second, by creating a stronger bond between fathers and children, and by reducing mothers’ specialization in childcare, paternity leave should increase the time fathers allocate to childcare as the child grows up, thus re-balancing the division of non-market (and possibly market) work within the couple.

As pointed out in Cools et al. (2015), the first type of effect, more likely to be relevant in the long run, is hard to estimate with data from only one country, as virtually all employers in the country should be somewhat affected by the change in perceptions.

Instead, Ekberg et al. (2013) study the effect on intra-household division of childcare responsibilities, by estimating the impact of the 1995 reform on the amount of time that fathers and mothers claim off work when their child is sick. They find no evidence that the 1995 reform increased the share of time off taken by fathers to care for sick children. Consistently, the study also fails to find evidence of large and robust changes in mothers’ earnings for thirteen years post childbirth. Similarly, Avdic et al. (2023) show that mothers affected by the 1995 reform did not increase, on average, their labor supply, except during the first year of the child’s life.

While these analyses are extremely valuable for our understanding of the reforms’ effects on the first cohort of families affected, they fall short of capturing long-term dynamics. For instance, it is important to acknowledge that the decision on who takes time off when the child is sick depends on many factors, including the availability of flexible arrangements at work. Women are known for selecting into occupations and jobs that allow a more flexible schedule (Goldin, 2014). This pattern might change if the increase in take-up of paternity leave leads to updated expectations among women on partners’ willingness to share daycare responsibility. This is most likely a long-term development, which the design used in the above outlined studies does not capture.

Another effect of the Swedish parental leave system, not directly linked to earmarking but nevertheless indicative of the importance of fathers’ time off work during the child’s first year of life, is that on mothers’ health. Persson and Rossin-Slater (2019) show that a Swedish 2012 reform that in practice allowed fathers to take 30 days of parental leave in concomitance with the mother during the child’s first year of life reduced the likelihood of mothers experiencing health issues due to post-partum complications.

An important aspect that the literature has so far not emphasized is also that earmarking reforms might affect another gender gap, namely the “freedom” to take the leave. Given the traditional division of roles across genders, there might be a stigma at a societal level against men taking parental leave. By creating strong economic incentives for taking paternity leave, the earmarking policies may downplay the stigma in the short-term and break it in the long-term. There is some suggestive, although not definitive, evidence that norms around paternity leave might have changed. Avdic and Karimi (2018) show that between 1995 and 2002 the share of fathers who were taking more than one month of leave had already started increasing before the second month was earmarked. More research would be needed, however, to assess the role of policies in changing societal perceptions around paternity leave.

Paternity Leave and Children’s Outcomes

An obvious question to ask is how children are affected by earmarking of parental leave days. Avdic et al. (2023) study this question in the context of the 1995 reform. By looking separately at different groups of children by sex and parents’ education, they find that the 1995 reform caused a decline in GPA for sons of non-college-educated fathers and mothers. The most likely channel for this relationship, according to the authors, is boys’ diminished access to fathers’ time, due to the 1995 reform increasing the likelihood of couple dissolution within the child’s first three years of life (for households with low-earning mothers). At that time children tended to live predominantly with the mother in case of parental separation. However, a potential additional channel could be the worsened economic situation caused by the paternity leave. In households with low-earning mothers, mothers’ and family earnings declined post-reform due to mothers compensating for “lost” leave days by taking unpaid leave. Very conflictual separations could also be behind the effect on children’s GPA.

These findings highlight the importance of considering potential unintended consequences of the parental leave policies, and the diverse effects they might have on different demographic groups. Such considerations could improve the design of future policies. For instance, Avdic and Karimi (2018) find that the 2002 reform, which earmarked one more month and added one month of wage-replaced parental leave, did not cause couple dissolution. Thus, the authors conclude that not imposing strong constraints on households, while creating incentives for fathers to take paternity leave, is highly desirable.

Finally, in a very recent working paper, Fontenay and Gonzalez (2024) consider the effect of earmarking policies on children’s gender attitudes as adults, leveraging data from online surveys of 3,000 respondents across six European countries, including Sweden. They study changes in attitudes as measured by an Implict Association Test, which is meant to capture subconscious associations between women and family and men and career.  In five of the countries studied they find that male respondents born soon after an earmarking reform have less stereotypical gender attitudes than those born before. No differences are detected for women. The effect in Sweden is one of the largest: in a sample of 237 male respondents, the father being eligible for the “dad-month” makes the child hold more egalitarian gender-attitudes as an adult by 0.3 standard deviations. The authors suggest that a role model effect might be at play, whereby boys who observe their fathers being more involved in childcare are nurtured to hold more egalitarian beliefs about gender roles.

Conclusion

Since 1995, Sweden has earmarked an increasing number of parental leave days to each parent, creating strong incentives for fathers to increase their previously very low parental leave uptake. This policy brief has reviewed the literature that studies the causal impacts of these earmarking reforms, highlighting a number of important conclusions as well as gaps in the knowledge on the effects of these policies.

First, the incentives created by the earmarking policies seem to work, as fathers tend to increase their uptake of paternity leave, while mothers tend to increase their labor supply during their child’s first year of life. However, such effects are heterogeneous, depending on the policy design and the underlying couple characteristics. Designs that impose strong constraints on household choices seem to have adverse effects on low-income or low-education households, reducing mothers’ earnings, triggering couple dissolution, and negatively affecting children’s GPA. Future increases in earmarking or similar policies in other countries should consider these design details carefully.

Second, there is no strong support in the data for the argument, popular in the public opinion and among policy makers, that paternity leave improves the balance of childcare duties within a couple and that it ultimately enhances women’s labor market position. However, to estimate causal effects, the studies analyzed in this policy brief focus on the first cohort of families affected by the earmarked reforms, whereas impacts on mothers’ labor market outcomes are more likely to be seen in the long run. After all, Sweden is one of the countries with the lowest documented child penalty in employment and earnings (see the child penalty atlas), and it is unlikely that policy played no role in narrowing gender gaps among parents. Consistently, recent evidence suggests that earmarking has improved gender attitudes in the next generation, making men less likely to hold stereotypical views about gender roles in society.

Further, it is important to mention that paternity leave policies in general have benefitted mothers’ post-childbirth health and that they may have broken a societal stigma around fathers taking time off to care for their children.

References

  • Aldén, L., Boschini, A. and Tallås Ahlzen, M. (2023). Fathers but not Caregivers. http://dx.doi.org/10.2139/ssrn.4405212
  • Avdic, D. and Karimi, A., (2018). Modern family? Paternity leave and marital stability. American Economic Journal: Applied Economics, 10(4), pp. 283-307.
  • Avdic, D., Karimi, A., Sundberg, E. and Sjögren, A. (2023). Paternity leave and child outcomes. IFAU, Working Paper 25.
  • Ekberg, J., Eriksson, R., and Friebel, G. (2013). Parental leave—A policy evaluation of the Swedish “Daddy-Month” reform. Journal of Public Economics, 97, pp. 131-143.
  • Ginja, R., Karimi, A. and Pengpeng Xiao. (2023). Employer responses to family leave programs. American Economic Journal: Applied Economics, 15(1), pp. 107-135.
  • Goldin, C., (2014). A grand gender convergence: Its last chapter. American Economic Review, 104(4), pp. 1091-1119.
  • Gonzalez, L. and Fontenay, S. (2024). Can Public Policies Break the Gender Mold? Evidence from Paternity Leave Reforms in Six Countries. BSE, Working Paper 1422.
  • Kleven, H., Landais, C., Posch, J., Steinhauer, A. and Zweimüller, J. (2019). Child penalties across countries: Evidence and explanation”. AEA Papers and Proceedings, 109, pp. 122-126.
  • Larsen, E. R. and Solli, I. F. (2017). Born to run behind? Persisting birth month effects on earnings. Labour Economics, 46, pp. 200-210.
  • Persson, P., and Rossin-Slater, M. (2019). When dad can stay home: fathers’ workplace flexibility and maternal health. National Bureau of Economic Research, Working Paper 25902.

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.

Ukrainian Refugees: Who Returns and Why?

Image depicting Ukrainian refugees, including a child holding a teddy bear, eagerly awaiting their return to Ukraine

Of the 17 million Ukrainians who have fled the country since the full-scale Russian invasion in spring 2022, over 60 percent have returned to the country. Based on survey data of Ukrainians who were previously abroad but have returned and those who have remained abroad, we look at the factors that impact their respective decisions to return or to stay. We find that having family in Ukraine is an important factor, but so is missing one’s home, a wish for children to study in Ukraine and a desire to participate in the reconstruction of Ukraine. People who emigrated with their spouse, and those who had planned to emigrate prior to the full-scale war, are more likely to stay abroad. We also find that those staying in a host country are highly involved in Ukrainian affairs and argue that the Ukrainian government should consider them a resource rather than lost human capital.

One of the major consequences of the Russian war on Ukraine has been the mass exodus of Ukrainians fleeing the war. As of February 2022, the Ukrainian statistical agency has ceased publishing population data for both technical and security reasons, so the exact number of Ukrainians that have left the country is unknown. However, on the basis of  mirror statistics from other countries, data from international organizations or surveys, it can be estimated that about 17 million people have fled the country since February 2022. Out of those, over 60 percent have returned to Ukraine, while 6 million Ukrainians have remained abroad.

As people are key in the future reconstruction and development of Ukraine, it is of great importance to understand what factors drive people to return (or not to return) to Ukraine. A recent paper (Sologoub, 2024) aims at addressing this question using a representative survey implemented by the Factum Group in July-August 2023. The survey includes 1400 people who, since early 2022, have fled Ukraine.  Half of the respondents had returned to Ukraine at the time of the survey while the other half remained abroad. The first group is from here on referred to as returnees and the latter as refugees.

To look at the factors that determine individual’s decisions to return or stay abroad, the paper specifically considers the factors that impact three probabilities:

  • the probability that a person stays abroad;
  • the probability that a person who stays abroad plans to return (64 percent of the refugees);
  • and the probability that a person who returned plans to stay in Ukraine (56 percent of the returnees).

This policy brief briefly describes the survey data, summarizes the key findings and concludes with policy implications and recommendations.

Main Characteristics of the Survey Respondents

The survey data shows that out of the entire sample of people who have returned to Ukraine and who have remained abroad, over 80 percent are women, and out of these 44 percent emigrated from Ukraine with children. About a quarter of our respondents stay or have stayed in Poland or Germany, 7 percent in the Czech Republic, while other countries have accommodated up to 4 percent of the Ukrainian migrants in our sample. The main reason for emigration is safety – almost half of the respondents reported it being the main reason for leaving Ukraine (see Figure 1).

Figure 1. Stated reasons for migration choices.

Source: Factum Group survey, own calculations. Note: Blue bars are for returnees, orange bars are for refugees (i.e. individuals who have stayed in host country). A dark color denotes the main reason, and a light color denotes other reasons.

Half of the respondents who had a job in Ukraine prior to the war lost their jobs at onset of the full-scale invasion, 18 percent quit their jobs and 30 percent continued to work remotely. 53 percent of the refugees had a job at the time of the survey, and 9 percent of those who remained abroad worked online for a Ukrainian organization. Of those who worked abroad at the time of the survey, 61 percent remained on the same qualification level, while 37 percent changed their qualification level – the majority of those changed to a lower qualification level.

39 percent of all respondents had school-aged children. A quarter of them reported that their children studied only online in Ukrainian schools in 2022/23. Over 60 percent stated that their children studied in a host country, but most of these children took additional classes within the Ukrainian school program – in an online or offline environment, with tutors or on their own.

When asked to compare different aspects of their life abroad and in Ukraine, approximately equal shares of the respondents reported an improvement or a worsening of these aspects. Worsening aspects was mainly reported to concern relations with friends, psychological state, and healthcare. The respondents also stated reasons for their return to Ukraine (or willingness to return), which allowed for estimation of the significance of these reasons. Generally, we found that pull factors (factors attracting people to return to Ukraine) are much more powerful than push factors (factors that force people out of host countries).

Main Results from the Probability Models

Demographic factors (age, education, family status, or income group) are non-significant across all models with the exception of marital status. People who are single are more likely to return to Ukraine, while those who migrated together with their spouse and those who do not have children are more likely to stay abroad.

Significantly positive for the probability that a person had returned at the time of the survey were pull factors such as missing family or home, the wish for children to study in Ukraine, better job opportunities in Ukraine, having property in Ukraine, and returning friends. Some significant push factors were loneliness or integration hardship, as well as feeling humiliated for living on subsidies/state support.

Among respondents who lived abroad at the time of the survey, 64 percent planned to return to Ukraine someday, 13 percent did not plan to return to Ukraine and the rest were undecided. One should however keep in mind that peoples’ intentions can change rather quickly – in the qualitative part of the survey, some respondents explained that their decision to return was spontaneous.

The probability that a person plans to return was lower for people who had planned to emigrate prior to 2022, for people who hadn’t been to Ukraine since they fled, and for people with refugee status (in some countries, people may lose refugee protection status if they exit the host country and travel to Ukraine).

Safety improvements and better job prospects increase the probability that a refugee plans to return, as well as a wish for children to study in Ukraine and a desire to participate in Ukraine’s reconstruction. Over 70 percent of the respondents believe that their experiences from abroad will be useful for the reconstruction and over 50 percent state that the new skills they’ve gained abroad can be applied during the reconstruction of Ukraine.

Significant push factors are lacking integration into the local community and an inferior social life abroad compared to life in Ukraine. Higher levels of general well-being and life satisfaction abroad expectedly reduce the probability that a person plans to return.

Lastly, those who had returned to Ukraine at the time of the survey were asked whether or not they planned to stay in Ukraine. 56 percent said yes, 7 percent plan to emigrate again, while the rest will consider the circumstances. The main factors that keep a person in Ukraine are family, the wish for one’s children to study in Ukraine and a willingness to participate in the reconstruction of the country. Improved safety is also a significant factor – which might explain why people who are originally from the Western part of Ukraine are more likely to stay (the regional factor is significant only in this third probability model). Finally, people who planned to emigrate prior to 2022, or those whose life in Ukraine is considerably inferior to that abroad, are less likely to stay.

Ukrainians’ Liaison with Their Country

60 percent of the refugees read Ukrainian news daily, and over 90 percent read them at least several times a week. The majority of the readers spread these news in their local communities and/or in their social networks. Generally, Ukrainian refugees are quite active, over 40 percent attend rallies in support of Ukraine, almost 40 percent participate in volunteer projects, over 70 percent donate to Ukrainian organizations (and the same share help their relatives in Ukraine) and 15 percent work at a non-governmental organization.

Not surprisingly, the opinion among Ukrainian refugees on reforms in Ukraine is very similar to the opinion among returnees: anti-corruption and judicial reform have the highest priority. In line with this, the fear of corruption derailing the reconstruction of Ukraine is greater than the fear that Russia will continue with their missile attacks on Ukraine. Therefore, the determination of the Ukrainian government to fight corruption will likely not only improve life for people in Ukraine but also increase the probability that refugees return to Ukraine.

Conclusion

Most of the Ukrainians who initially fled the war have already returned to Ukraine, with the majority planning on staying in the country. For those who are still abroad, the majority wish to return when safety improves. When analysing the factors behind such wishes, it is evident that among the pull factors lie not only personal drivers, such as missing one’s home or family, but also civic factors such as a willingness to participate in the reconstruction of Ukraine or a wish for one’s children to study in Ukraine, thus contributing to preserving their identity. Moreover, Ukrainians who are living abroad are highly involved in Ukrainian affairs.

Therefore, we suggest that the Ukrainian government consider refugees as a valuable resource rather than as a loss. For example, government representatives could ask refugees to donate to Ukraine, and engage in individual or collective actions (e.g. inform their local friends about the situation in Ukraine, join rallies or flashmobs in support of Ukraine etc.). Such “peoples diplomacy” is important to ensure continued support for Ukraine.

We also recommend that the governments of host countries make it easier for refugees to stay connected with Ukraine. Specifically, refugees should be allowed to travel to Ukraine without losing their protection status.

Lastly, the strongest precondition for refugees’ return to Ukraine is supplying the country with weapons and other crucial support to win the war. A Ukrainian victory will not only bring about reconstruction and development of Ukraine but also promote and enforce global democracy.

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.

Gender Equality and Women’s Economic Empowerment in Times of Crisis

20240122 Gender Equality Image 01

On October 19-20, 2023, the International School of Economics at Tbilisi State University Policy Institute (ISET Policy Institute), in partnership with the Forum for Research on Gender Economics (FROGEE), organized the conference “Gender Equality and Women’s Economic Empowerment in Times of Crisis”. The conference addressed critical issues surrounding gender equality and women’s economic empowerment. By bringing together academics and practitioners from various sectors it served as a dynamic platform for knowledge sharing and collaboration on actionable solutions and commitments to address multifaceted challenges faced by women globally. This policy brief outlines the keynote, academic and other presentations and discussions featured at the conference.

Introduction

Gender equality and women’s economic empowerment are vital issues that have gained increasing global attention in recent years. Their significance is even more pronounced in times of crisis, such as during economic downturns or global health emergencies. Such challenging circumstances often exacerbate existing gender disparities and vulnerabilities, making it crucial to address the specific challenges women face in accessing economic opportunities and resources. Discussions on these matters delve into the complex intersection of gender equality and economic empowerment and how empowering women economically can contribute to more resilient and equitable societies.

The October 19-20 conference was aimed at examining and addressing the various aspects of gender equality and female empowerment. The conference begun with opening introductions by Tamar Sulukhia, Eva Atterlöv and Kaori Ishikawa (see the participant list at the end for all associations). Following the opening remarks were two distinctive keynote presentations, a policy panel discussion, and academic presentations. This policy brief summarizes the key takeaways from the conference.

Keynote Addresses

The conference’s first keynote speaker, Elizabeth Brainerd, deliberated on the impact of World War II on marriage and fertility among Russian women. Brainerd show that the war affected these women’s lives for decades, leading to lower rates of marriage and fertility and higher out-of-wedlock births and divorce rates in urban areas than would have been the case in absence of the war. These effects were likely exacerbated by a war and post-war institutional environment that encouraged nonmarital births (in part by expanding the child benefit program) and increased the cost of binding commitments through marriage, particularly for men (absolving fathers of any financial or legal responsibility for children fathered outside marriage). As shown by Brainerd the shock to sex ratios in the Soviet Union due to World War II was among the largest experienced by any country in the twentieth century. In this sense, the effect on Russian women and men was unique and arguably not directly relevant to other countries or time periods. Yet, highly unbalanced sex ratios characterize many populations – whether due to war, immigration and emigration, or preferences for sons etc., – and the analysis can therefore shed light on the effects of sex ratio imbalance also in other contexts. Brainerd’s work supports the conclusion that sex ratios matter for marital and fertility outcomes, both on the marriage market itself and within marriage. The insights from the Soviet Union also highlights that the institutional context matters for determining both the size and direction of the sex ratio’s impact on marriage markets and family formations.

In the conferences second keynote presentation, Maria Floro discussed the findings from a time-allocation survey in Georgia. Evident from the results, women’s work differs from men’s in the sense that women more often perform unpaid household tasks, and since they are primarily responsible for household and caregiving duties, including childcare and elderly care. Such combined responsibilities, coupled with working in typically low-paid jobs can negatively affect women’s physical and mental wellbeing. As the data shows, 66 percent of Georgia’s population engage in unpaid domestic work, with women (88.3 percent) and men (39.6 percent) participating at starkly different rates. Rural women’s participation is the highest, at 90,3 percent. On average, the Georgian population spends 2.1 hours per day on unpaid domestic services for household and family members – with a large gender disparity. In general, the time spent per day by men is 0.7 hours while, in contrast, the time spent by women on these activities is 5 times higher in rural areas (3.6 hours) and 4.7 times higher in urban areas (3.2 hours). Women working full time spend 2.7 hours per day on unpaid domestic services, five times higher than the 0.5 hours spent by men working full time. For all areas of residence, the time spent on unpaid domestic services by women increases with age up until 64 years of age when the numbers drop. Further, women’s time spent on unpaid caregiving work (0.9 hours per day) is 4.5 times higher than the time spent by men. Even for full time working women, the daily time spent on unpaid caregiving work (0.6 hours) is three times higher than that of their male counterparts (0.2 hours). Women who have completed a higher level of education spend higher time on unpaid caregiving services (0.9-1.1 hours per day) than those with a lower level of education (0.4-0.7 hours per day). The difference in women’s and men’s time spent on unpaid caregiving work is greatest for Georgians aged 25-44. Such unequal sharing of household and caregiving responsibilities limits women’s job prospects and is a major reason behind their low participation rate in the labor force, as well as the gender pay gap.

The South Caucasus Gender Equality Index

Following the keynote presentations, Davit Keshelava, presented the ISET Policy Institute’s most recent work on the South Caucasus Gender Equality Index (SCGEI). The index, developed by ISET Policy Institute in close collaboration with Swiss Cooperation Office in Georgia and updated on an annual basis, draws inspiration from the European Institute for Gender Equality’s Gender Equality Index. It comprises of six domains: work, money, knowledge, time, power, and health, alongside eleven subdomains and nineteen indicators.

The index is calculated for three South Caucasus countries, Georgia, Armenia, and Azerbaijan, and nine benchmark countries: Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, and Slovenia. The 2023 edition, mainly based on data from 2021-2022, reveals that within the South Caucasus Armenia is ahead concerning gender equality in the work domain, while Georgia trails behind its regional counterparts. Gender equality in the work domain is lower in the South Caucasus (64.0) than in the baseline countries (67.3).

Georgia stands out as the South Caucasus leader in gender equality within the money domain but significantly trails the baseline countries (South Caucasus – 51.1 vs. baseline countries – 80.5). This discrepancy is the most prominent across all six domains. Azerbaijan leads in the knowledge domain (with Armenia displaying the greatest inequality), yet the South Caucasus slightly outpaces baseline countries in this domain (South Caucasus – 59 and baseline countries – 58.8). This is however the sole equality domain where the South Caucasus surpasses the benchmark countries.

Georgia and Armenia exhibit higher equality in the power domain than Azerbaijan while, in the time domain, Georgia takes the lead in the South Caucasus. In the health domain, Armenia leads in equality, although the difference in index values is marginal.

In the overall index, Georgia emerges as the regional leader in gender equality (60.4), followed by Armenia (57.5) and Azerbaijan (53.0). However, South Caucasus countries as a whole have a lower index (55.4) than the baseline countries (64.1).

Panel Discussion: Topics and Takeaways

The SCGEI presentation was followed by a policy panel discussion, moderated by Tamar Sulukhia and including the panelists Nino Okribelashvili, Nino Chelidze, Nani Bendeliani and Nino Lortkipanidze. The panelists discussed gender inequalities in different areas such as within academia and the tech industry as well as the role of women during crises and the progress made in Georgia towards ensuring gender equality.

Nino Okribelashvili deliberated on the role of women in academia emphasizing that gender inequalities in higher education attainment become obvious when looking at the representation of women across different fields of science. The share of women in subjects such as social work, education and nursing is more than 80 percent, while it is 20 percent in subjects such as computer science, electrical engineering and mechanical engineering. Science, technology, engineering, and mathematics (STEM) oriented institutions are still generally perceived as male dominated. The second glaring gap concerns the representativeness of women in higher rank and leadership positions in academia, where women remain underrepresented in academic and professorial positions across all subjects.

While Nino Okribelashvili discussed the role of women in academia in general, Nino Lortkipanidze focused specifically on the tech industry. She discussed the industry’s potential to create job opportunities for women through various strategies and initiatives such as STEM education and training, diverse hiring practices, leadership development and flexible work policies – including remote work possibilities. Lortkipanidze emphasized that with the right support and opportunities, the rapidly growing tech industry could allow working mothers to thrive in their careers while also enjoying the advantages of a family-friendly work environment.

Shifting the focus to women in times of crisis, Nino Chelidze emphasized the aggravated impact of war on women using the example of the Nagorno-Karabakh conflict. Chelidze highlighted the need for urgent, coordinated action from the donor community to address the challenges of internally displaced persons, most of whom are women and children.

The panel discussion wrapped up with Nani Bendeliani highlighting Georgia’s advancements in gender equality and female empowerment over the past three decades. Bendeliani mentioned different institutional mechanisms adopted in the country for the advancement of women alongside legislative initiatives implemented in different areas concerning for instance maternity and paternity leave, changes to the labor code and the election code. According to Bendeliani, the progress towards gender equality is visible but slow, with available data and multiple assessments showing there is still much to be done.

Academic Presentations

The remainder of the conference was comprised of several academic sessions all contributing to the overall theme of multifaceted gender-related issues. The topics, as detailed below, were: gender disparities in the labor market, violence against women, gender dynamics during the Covid-19 pandemic, the gender divide in education, women in academia and female empowerment and access to services.

Gender Disparities on the Labor Market

The presenters focused on gender disparities on the labor market, exploring aspects such as the implications of labor protection regulations on both men and women, biases and discrimination in employment and wage negotiation, and the impact of female labor force participation on the advancement of women’s rights.

In his presentation, Michal Myck outlined the consequences of labor protection policies in Poland for employees within four years of retirement (regulation that protects them against layoffs, a lowering of their wages or adjustment of their responsibilities). Preliminary results indicate no economically or statistically significant adverse impacts on the employment of men and women approaching labor protection eligibility. These findings suggest that either the anticipated negative effects are absent, or that any concerns employers may have harbored regarding prospective employment protection were counteracted by robust labor demand during the reform period. The general conclusion is that extending protection to specific groups of workers, both men and women, does not necessarily lead to the adverse outcomes often highlighted in standard economic theory.

While Michal Myck focused on labor protection regulations, Francisco Lagos addressed the topic of weight-related employment discrimination and its impact on hiring outcomes. In an experiment, job applications accompanied either by a facial photo of a normal-weight person or by a photo of the same person manipulated to look overweight were sent out to real job opening across 12 occupations in Spain. The results reveal a significant disparity in callback rates for weight-manipulated male applicants, who received fewer callbacks compared to their normal-weight counterparts, with a more pronounced effect in female-dominated occupations. Conversely, weight-manipulated female applicants experienced a slight increase in callbacks, particularly in female-dominated fields. For men, the weight manipulation effect is attributed to the overweight making them appear less attractive, which translates into an attractiveness wage premium. On the contrary the findings for women suggest evidence of an attractiveness penalty, which is also combined with a weight penalty.

The topics of discrimination and biases were also central to Ramon Cobo Reyes Cano’s presentation, which outlined the results of a field experiment on anticipated discrimination and wage negotiation. The findings show that female applicants ask for a lower salary than male applicants in the baseline treatment group – when the full name of the applicant is visible. In the main treatment group, when the gender of the applicant was no longer visible to the employer, the wage requested by female applicants increased by 86 percent, whereas male applicants’ wage requests were 18 percent lower. Evidently, the gender gap in requested wages completely disappears (and even slightly reverses) when the applicants know that their sex is not visible for the potential employer.

The presentations on gender inequalities in the labor market were concluded by Nisar Ahmad, who empirically investigate the impact of women’s labor force participation on women’s rights.  In general, female labor force participation has a positive effect on women’s rights in countries with at least some legal economic rights for women. In countries where women’s rights are extremely limited or non-existent, female labor force participation has a negative or negligible impact on women’s rights.

Violence Against Women

In the academic session devoted to violence against women, the presenters elaborated on the primary factors influencing such violence in various countries at different time periods, including during the Covid-19 pandemic.

Monika Oczkowska explores how social norms, values, and stereotypes determine beliefs about abuse, including recognition of abuse, what is considered as abuse, whether abuse is ever justified, and societal consent towards gender-based discrimination. In countries where gender inequality is rampant, reported rates of abuse in standard surveys are sensitive to the socio-economic status and beliefs about gender norms of the participants, highlighting a high scale of variation in the perception of gender-based discrimination in Central and Eastern Europe.

These findings are in line with the results presented by Salome Gelashvili, who consider potential determinants of gender-based violence (GBV) in South Caucasus. According to the research, key factors contributing to GBV in Armenia, Azerbaijan and Georgia include alcohol abuse, social stigma, being a member of a marginalized groups, a pervasive patriarchal culture, adherence to traditional gender roles, a high level of bureaucracy when reporting GBV to the police, generally weak legal support, limited awareness about various forms of GBV, and economic factors such as financial dependence on an abusive partner.

Similar outcomes, but with more emphasis put on norms and the patriarchal system, were found by Reina Shehi, who assesses gender-based violence in Albania. The results show that the patriarchal system and gender-based norms are the two main factors contributing to gender-based violence. However, there is a growing awareness of the importance of patriarchal institutions and gender norms when addressing GBV in Albania.

Violence against women increase in times of crisis, as shown by Velan Nirmala, who studies women’s empowerment and intimate partner violence (IPV) in India. The findings reveal that, regardless of socio-economic factors, the main types of IPV during the Covid-19 lockdown were physical and emotional violence. The results also highlight that a large majority of victims, regardless of education, wealth, region, household structure, religion, and caste, do not disclose the abuse due to societal taboos.

Gender Dynamics During the Covid-19 Pandemic

The unequal effect from the Covid-19 pandemic was further examined in an academic session in which the presenters keyed in on repercussions of the pandemic on women in terms of employment outcomes, decisions related to time allocation, and the division of unpaid household labor.

Nabamita Dutta presented work on gender inequality in employment during Covid-19 related lockdowns in India. The results show that during the pandemic, women were, in general, 8 percent less likely to be employed than men. While return migrants generally suffered less in terms of finding alternative jobs, being a female return migrant, increased the probability of joblessness to about 17 percent. For female return migrants belonging to marginalized castes, the probability of joblessness was about 10 percent, an interesting result considering that women belonging to marginalized castes (but not being return migrants) experience a higher likelihood of being unemployed then women that are not part of marginalized castes.

Anne Devlin further elaborated on this topic, assessing the economic impact of the Covid-19 pandemic on people living in disadvantaged areas in Ireland. The results indicate that Pandemic Unemployment Payment (PUP) rates were higher in more deprived areas during lockdown periods and that woman, on average, receive PUP for a slightly longer duration than men. Further, female unemployment has a negative and statistically significant relationship with the length of PUP claims. The findings show that average PUP durations tend to be shorter in areas with a higher share of individuals with lower education levels, and in areas with historically higher levels of female unemployment.

Jacklyn Makaaru Arinaitwe presented work on how gender, culture, norms, and practices contributed to the unequal distribution of unpaid care work during Covid-19 in Uganda. The findings reveal that there are policy gaps in addressing the issue, as current policies don’t acknowledge the value of unpaid care work at a personal and national level. This lack of recognition and failure to come up with new ways to reduce or share women’s disproportionate burden of unpaid care work creates obstacles to girls’ education and hinder women’s economic empowerment in Uganda.

Also, on the topic of the Covid-19 pandemic impacts on women, Alessandro Toppeta presented work on the impacts of the pandemic on the role of parental beliefs in England. The results show that parents believe that the time they spend with their children is more valuable and less risky than the time children spend in formal childcare or with friends and that parents’ beliefs can predict the choices they make in investing time with their children. Further, the findings align with previous indications of the increased burden on women’s time experienced during the pandemic being a consequence of limited availability of alternative childcare options.

The Gender Divide in Education

Within the topic of gender in education, the presenters delved into the connection between education and gender roles and the importance of parental education for children’s education.

Sumit S. Deole presented work on the causal impact of education on gender role attitudes based on evidence from European datasets. The results suggest that an additional year of education prompts egalitarian gender role attitudes. Furthermore, the impact of increases in education is particularly prominent among women and, to some extent, in urban areas.

Fethiye Burcu Türkmen-Ceylan focus specifically on the importance of maternal education for children’s education in Turkey. Preliminary results indicate that maternal education has a distinctive positive impact on households’ budget allocation for children’s education among Turkish households.

Saumya Kumar also presented work on the importance of maternal education, considering the impacts of paternal education as well. The presented research finds that both maternal and paternal education reduce the gender gap in educational enrollment. However, having an educated mother is more important when it comes to increasing girls’ enrollment as compared to boys’ enrollment. The research also indicates that as mothers’ education levels rise, there is a greater increase in spendings on education for both boys and girls.

Further on the gender divide within education, Lubna Naz deliberated on how drought affects school attendance in rural Pakistan. The income decline caused by drought leads to a four-month decrease in schooling for all children, and a six-month decrease for boys. Asset ownership also has a negative impact on school attendance, suggesting a possible reverse causality or Simpson’s paradox. The combined effect of asset ownership and drought, however, has a positive impact on school attendance, Naz concluded.

Women in Academia

Gender inequalities are apparent also in the academic sphere. Liis Roosaar’s research looks into the impact of having children on women’s careers within academia. Roosaar find that becoming a mother doesn’t impact earnings per hour, but that mother’s do work fewer hours. More than four years after having a child, women in academia have lost the equivalent of two years of full-time work. Interestingly, men don’t face the same reduction in work hours after becoming fathers. The study also reveals that the career setback for women in academia after having a child is shorter compared to the general population. However, female academics experience a decline in citations as a consequence of the reduced working hours.

Barbara Będowska-Sójka’s research on women in academia focus on female representation on editorial boards of finance journals.  According to Będowska-Sójka women account for 20 percent of all editors on average, with considerable variance between countries. When it comes to editor’s affiliations they are strongly concentrated in the United States, and to a lesser extent in the United Kingdom. Additionally, a small number of extremely well-connected editors sit on many boards. The gender ratio is consistent in substructures for editors that are better connected (have so-called a high degree of centrality in terms of network analysis) or editors who serve on a large number of boards, yet men outnumber women.

Female Empowerment and Access to Services

Although their research focuses on distinct topics, Fazle Rabbi and Ulrich Wohak both presented research on the overarching theme of women’s empowerment and enhanced access to goods and services.

In his paper, Fazle Rabbi and his co-authors consider a new way to support marginalized individuals, most of whom are women, through the introduction of a new donation model where development agencies provide goats to project beneficiaries. Goat ownership might help beneficiaries generate income and devote more time to education. The research results show that the proposed donation model significantly enhances the economic empowerment of participants, providing them a steady income, better access to education, and more access to the financial system – with the results being more pronounced for women.

Ulrich Wohak evaluated tampon tax reforms (efforts to reduce the taxation of menstrual hygiene products, including tampons, pads, and menstrual cups) as a means to address gender-based tax discrimination. Using transaction-level scanner data, the study finds that when countries lower their standard VAT rates, the extent to which these reductions are passed on to consumers ranges from 57 percent to 119 percent.

Concluding Remarks

The ISET conference “Gender Equality and Women’s Economic Empowerment in Time of Crisis” brought together diverse voices, perspectives, and expertise from various sectors to engage in discussions and knowledge sharing on how to advance gender equality in times of normality and in times of crises. The conference also served as a platform to inspire actionable solutions and commitments to address the multifaceted challenges women face worldwide.

List of Participants

  • Alessandro ToppetaAssistant Professor at SOFI, Stockholm University, Sweden. “Parental Beliefs, Perceived Health Risks, and Time Investment in Children: Evidence from COVID-19” (in collaboration with Gabriella Conti and Michele Giannola).
  • Anne DevlinResearch Fellow, Economic and Social Research Institute, Ireland. “The Impact of COVID-19 on Women’s Employment in Ireland” (in collaboration with Adele Whelan, Seamus McGuinnes, Paul Redmond).
  • Aswathi Rebecca AsokPhD Fellow, University of Portsmouth, United Kingdom. “Unveiling Gendered Dimensions of “Volunteerism”: The COVID-19 Story of Kerala, India”.
  • Barbara Będowska-SójkaHead of Department, Poznań University of Economics and Business, Poland. “Editorial boards of finance journals: the gender gap and social networks” (in collaboration with Claudia Tarantola, C., Mare, C., Ozturkkal, B., Paccagnini, A., Perri, R., Pisoni, G., Shala, A., Skaftad´ottir, H., K.).
  • Davit KeshelavaLead Economist, ISET Policy Institute.
  • Elizabeth BrainerdSusan and Barton Winokur Professor of Economics and Women’s, Gender and Sexuality Studies, Brandeis University.
  • Eva AtterlövDeputy Head of Development Cooperation, Embassy of Sweden.
  • Fazle RabbiDeputy Head of School of Business, Crown Institute of Higher Education, Australia. “From Goats to Education: An Innovative Approach to Community Empowerment” (in collaboration with Laurel Jackson and Zahid Hasan).
  • Fethiye Burcu Türkmen-CeylanResearch Fellow, Ahi Evran University, Turkey. “Educate a Woman, And You Educate a Generation: How Does Maternal Education Affect Intro Household Resource Allocation for Education among the Children?” (in collaboration with Ulucan, H., Çakmak, S.).
  • Francisco LagosProfessor of Economics, Georgetown University, USA. “Weight, Attractiveness, and Gender when Hiring: a Field Experiment in Spain” (in collaboration with Catarina Goulão, Juan Antonio Lacomba, and Dan-Olof Rooth).
  • Jacklyn Makaaru ArinaitweDirector, Ace Policy Research Institute, Uganda. “Gender, culture, norms, and practices that promote gender gaps in the allocation of time to unpaid domestic work in the context of COVID-19 in Uganda” (in collaboration with Twinomugisha David).
  • Kaori IshikawaUN Women Country Representative to Georgia.
  • Liis RoosaarLecturer at the Chair of Economic Modelling, University of Tartu, Estonia. “Child penalty in academia: Event study estimate” (in collaboration with Jaan Masso, Jaanika Meriküll, Kärt Rõigas, and Tiiu Paas).
  • Lubna NazAssociate Professor, Institute of Business Administration. Pakistan. “Left High and Dry: Gendered impacts of Drought on school attainment in Rural Pakistan”.
  • Maria FloroProfessor Emerita Economics, American University in Washington, DC.
  • Michal MyckDirector, Centre for Economic Analysis (CenEA), Poland. “Pre-retirement employment protection: no harm when times are good” (in collaboration with Paweł Chrostek, and Krzysztof Karbownik).
  • Monika OczkowskaSenior Research Economist, CenEA, Poland. “Patterns of harassment and violence against women in Central and Eastern Europe. The role of the socio-economic context and gender norms in international comparisons” (in collaboration with Kajetan Trzcinski and Michal Myck).
  • Nabamita DuttaProfessor of Economics, University of Wisconsin-La Crosse, USA. “Lockdown and Rural Joblessness in India: Gender Inequality in Employment?” (in collaboration with Kar, S.).
  • Nani BendelianiProject Analyst, UN Women Georgia.
  • Nino ChelidzeProgram Director of Women’s Initiative for Security and Equity at Mercy Corps.
  • Nino LortkipanidzeWomen in Tech Ambassador for Georgia and Chief Innovation Officer at The Crossroads.
  • Nino OkribelashviliVice Rector for Research at Ivane Javakhishvili Tbilisi State University.
  • Ramon Cobo Reyes CanoProfessor of Economics, Georgetown University, USA. “Anticipated Discrimination and Wage Negotiation: A Field Experiment” (in collaboration with Gary Charness and Simone Meraglia).
  • Reina ShehiPrimary Appointment Lecturer, Epoka University, Albania. “Patterns of Geographic Gender-Based Violence in Albania” (in collaboration with Endi Tirana and Ajsela Toci).
  • Salome GelashviliLead Economist, ISET Policy Institute, Georgia. “Gender-based violence in the South Caucasus” (in collaboration with Lobjanidze, G., Seturidze, E., Shubitidze I.).
  • Saumya KumarAssistant Professor (Economics), University of Delhi, India. “Gender Differential in Parental Investment in Education: A Study of the Factors Determining Children’s and Adolescents’ Educational Investment in India” (in collaboration with Jawaharlal Nehru).
  • Sumit S. DeoleScientific Assistant, Trier University, Germany. “The Causal Impact of Education on Gender Role Attitudes: Evidence from European Datasets” (in collaboration with Zeydanli, T.).
  • Tamar SulukhiaDirector ISET and ISET Policy Institute.
  • Ulrich WohakTeaching and Research Associate, Vienna University of Economics and Business, Austria. Free the Period? Evaluating Tampon Tax Reforms using Transaction-Level Scanner Data (in collaboration with Kinnl, K.).
  • Velan NirmalaProfessor of Economics, Pondicherry University, India. “Women Empowerment and Intimate Partner Violence in India” (in collaboration with Lusome, R).

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.

How to Undermine Russia’s War Capacity: Insights from Development Day 2023

Image from SITE Development Day conference

As Russia’s full-scale invasion of Ukraine continues, the future of the country is challenged by wavering Western financial and military support and weak implementation of the sanction’s regime. At the same time, Russia fights an information war, affecting sentiments for Western powers and values across the world. With these challenges in mind, the Stockholm Institute for Transition Economics (SITE) invited researchers and stakeholders to the 2023 Development Day Conference to discuss how to undermine Russia’s capacity to wage war. This policy brief shortly summarizes the featured presentations and discussions.

Holes in the Net of Sanctions

In one of the conference’s initial presentations Aage Borchgrevink (see list at the end of the brief for all presenters’ titles and affiliations) painted a rather dark picture of the current sanctions’ situation. According to Borchgrevink, Europe continuously exports war-critical goods to Russia either via neighboring countries (through re-rerouting), or by tampering with goods’ declaration forms. This claim was supported by Benjamin Hilgenstock who not only showed that technology from multinational companies is found in Russian military equipment but also illustrated (Figure 1) the challenges to export control that come from lengthy production and logistics chains and the various jurisdictions this entails.

Figure 1. Trade flows of war-critical goods, Q1-Q3, 2023.

Source: Benjamin Hilgenstock, Kyiv School of Economics Institute.

Offering a central Asian perspective, Eric Livny highlighted how several of the region’s economies have been booming since the enforcement of sanctions against Russia. According to Livny, European exports to Central Asian countries have in many cases skyrocketed (German exports to the Kyrgyzs Republic have for instance increased by 1000 percent since the invasion), just like exports from Central Asian countries to Russia. Further, most of the export increase from central Asian countries to Russia consists of manufactured goods (such as telephones and computers), machinery and transport equipment – some of which are critical for Russia’s war efforts. Russia has evidently made a major pivot towards Asia, Livny concluded.

This narrative was seconded by Michael Koch, Director at the Swedish National Board of Trade, who pointed to data indicating that several European countries have increased their trade with Russia’s neighboring countries in the wake of the decreased direct exports to Russia. It should be noted, though, that data presented by Borchgrevink showed that the increase in trade from neighboring countries to Russia was substantially smaller than the drop in direct trade with Russia from Europe. This suggests that sanctions still have a substantial impact, albeit smaller than its potential.

According to Koch, a key question is how to make companies more responsible for their business? This was a key theme in the discussion that followed. Offering a Swedish government perspective, Håkan Jevrell emphasized the upcoming adoption of a twelfth sanctions package in the EU, and the importance of previous adopted sanctions’ packages. Jevrell also continued by highlighting the urgency of deferring sanctions circumvention – including analyzing the effect of current sanctions. In the subsequent panel Jevrell, alongside Adrian Sadikovic, Anders Leissner, and Nataliia Shapoval keyed in on sanctions circumvention. The panel discussion brought up the challenges associated with typically complicated sanctions legislation and company ownership structures, urging for more streamlined regulation. Another aspect discussed related to the importance of enforcement of sanctions regulation and the fact that we are yet to see any rulings in relation to sanctions jurisdiction. The panelists agreed that the latter is crucial to deter sanctions violations and to legitimize sanctions and reduce Russian government revenues. Although sanctions have not yet worked as well as hoped for, they still have a bite, (for instance, oil sanctions have decreased Russian oil revenues by 30 percent).

Reducing Russia’s Government Revenues

As was emphasized throughout the conference, fossil fuel export revenues form the backbone of the Russian economy, ultimately allowing for the continuation of the war. Accounting for 40 percent of the federal budget, Russian fossil fuels are currently mainly exported to China and India. However, as presented by Petras Katinas, the EU has since the invasion on the 24th of February, paid 182 billion EUR to Russia for oil and gas imports despite the sanctions. In his presentation, Katinas also highlighted the fact that Liquified Natural Gas (LNG) imports for EU have in fact increased since the invasion – due to sanctions not being in place. The EU/G7 imposed price cap on Russian oil at $60 per barrel was initially effective in reducing Russian export revenues, but its effectiveness has over time being eroded through the emergence of a Russia controlled shadow fleet of tankers and sales documentation fraud. In order to further reduce the Russian government’s income from fossil fuels, Katinas concluded that the whitewashing of Russian oil (i.e., third countries import crude oil, refine it and sell it to sanctioning countries) must be halted, and the price cap on Russian oil needs to be lowered from the current $60 to $30 per barrel.

In his research presentation, Daniel Spiro also focused on oil sanctions targeted towards Russia – what he referred to as the “Energy-economic warfare”. According to Spiro, the sanctions regime should aim at minimizing Russia’s revenues, while at the same time minimizing sanctioning countries’ own costs, keeping in mind that the enemy (i.e. Russia) will act in the exact same way. The sanctions on Russian oil pushes Russia to sell oil to China and India and the effects from this are two-fold: firstly, selling to China and India rather than to the EU implies longer shipping routes and secondly, China and India both get a stronger bargaining position for the price they pay for the Russian oil. As such, the profit margins for Russia have decreased due to the price cap and the longer routes, while India and China are winners – buying at low prices. Considering the potential countermoves, Spiro – much like Katinas – emphasized the need to take control of the tanker market, including insurance, sales and repairs. While the oil price cap has proven potential to be an effective sanction, it has to be coupled with an embargo on LNG and preferrable halted access for Russian ships into European ports – potentially shutting down the Danish strait – Spiro concluded.

Chloé Le Coq presented work on Russian nuclear energy, another energy market where Russia is a dominant player. Russia is currently supplying 12 percent of the United States’ uranium, and accounting for as much as 70 percent on the European market. On top of this, several European countries have Russian-built reactors. While the nuclear-related revenues for Russia today are quite small, the associated political and economic influence is much more prominent. The Russian nuclear energy agency, Rosatom, is building reactors in several countries, locking in technology and offering loans (e.g., Bangladesh has a 20-year commitment in which Rosatom lends 70 percent of the production cost). In this way Russia exerts political influence on the rest of the world. Le Coq argued that energy sanctions should not only be about reducing today’s revenues but also about reducing Russian political and economic influence in the long run.

The notion of choke points for Russian vessels, for instance in the Danish strait, was discussed also in the following panel comprising of Yuliia Pavytska, Iikka Korhonen, Aage Borchgrevink, and Lars Schmidt. The panelists largely agreed that while choke points are potentially a good idea, the focus should be on ensuring that existing sanctions are enforced – noting that sanctions don’t work overnight and the need to avoid sanctions fatigue. Further, the panel discussed the fact that although fossil fuels account for a large chunk of federal revenues, a substantial part of the Russian budget come from profit taxes as well as windfall taxes on select companies, and that Russian state-owned companies should in some form be targeted by sanctions in the future. In line with the previous discussion, the panelists also emphasized the importance of getting banks and companies to cooperate when it comes to sanctions and stay out of the Russian market. Aage Borchgrevink highlighted that for companies to adhere to sanctions legislation they could potentially be criminally charged if they are found violating the sanctions, as it can accrue to human rights violations. For instance, if companies’ parts are used for war crimes, these companies may also be part of such war crimes. As such, sanctions can be regarded as a human rights instrument and companies committing sanctions violations can be prosecuted under criminal law.

Frozen Assets and Disinformation

The topic of Russian influence was discussed also in the conference’s last panel, composed of Anders Ahnlid, Kata Fredheim, Torbjörn Becker, Martin Kragh, and Andrii Plakhotniuk. The panelists discussed Russia’s strong presence on social media platforms and how Russia is posting propaganda at a speed unmet by legislators and left unchecked by tech companies. The strategic narrative televised by Russia claims that Ukraine is not a democracy, and that corruption is rampant – despite the major anti-corruption reforms undertaken since 2014. If the facts are not set straight, the propaganda risks undermining popular support for Ukraine, playing into the hands of Russia. Further, the panelists also discussed the aspect of frozen assets and how the these can be used for rebuilding Ukraine. Thinking long-term, the aim is to modify international law, allowing for confiscation, as there are currently about 200 billion EUR in Russian state-owned assets and about 20 billion EUR worth of private-owned assets, currently frozen.

The panel discussion resonated also in the presentation by Vladyslav Vlasiuk who gave an account of the Ukrainian government’s perspective of the situation. Vlasiuk, much like other speakers, pointed out sanctions as one of the main avenues to stop Russia’s continued war, while also emphasizing the need for research to ensure the implications from sanctions are analyzed and subsequently presented to the public and policy makers alike. Understanding the effects of the sanctions on both Russia’s and the sanctioning countries’ economies is crucial to ensure sustained support for the sanction’s regime, Vlasiuk emphasized.

Joining on video-link from Kyiv, Tymofiy Mylovanov, rounded off the conference by again emphasizing the need for continued pressure on Russia in forms of sanctions and sanctions compliance. According to Mylovanov, the Russian narrative off Ukraine struggling must be countered as the truth is rather that Ukraine is holding up with well-trained troops and high morale. However, Mylovanov continued, future funding of Ukraine’s efforts against Russia must be ensured – reminding the audience how Russia poses a threat not only to Ukraine, but to Europe and the world.

Concluding Remarks

The Russian attack on Ukraine is military and deadly, but the wider attack on the liberal world order, through cyber-attacks, migration flows, propaganda, and disinformation, must also be combatted. As discussed throughout the conference, sanctions have the potential for success, but it hinges on the beliefs and the compliance of citizens, companies, and governments around the world. To have sanctions deliver on their long-term potential it is key to include not only more countries but also the banking sector, and to instill a principled behavior among companies – having them refrain from trading with Russia. Varying degrees of enforcement undermine sanctions compliant countries and companies, ultimately making sanctions less effective. Thus, prosecuting those who breach or purposedly evade sanctions should be a top priority, as well as imposing control over the global tanker market, to regain the initial bite of the oil price cap. Lastly, it is crucial that the global community does not forget about Ukraine in the presence of other conflicts and competing agendas. And to ensure success for Ukraine we need to restrain the Russian war effort through stronger enforcement of sanctions, and by winning the information war.

List of Participants

Anders Ahnlid, Director General at the National Board of Trade
Aage Borchgrevink, Senior Advisor at The Norwegian Helsinki Committee
Torbjörn Becker, Director at the Stockholm Institute of Transition Economics
Chloé Le Coq, Professor of Economics, University of Paris-Panthéon-Assas, Economics and Law Research Center (CRED)
Benjamin Hilgenstock, Senior Economist at Kyiv School of Economics Institute
Håkan Jevrell, State Secretary to the Minister for International Development Cooperation and Foreign Trade
Michael Koch, Director at Swedish National Board of Trade
Iikka Korhonen, Head of the Bank of Finland Institute for Emerging Economies (BOFIT)
Martin Kragh, Deputy Centre Director at Stockholm Centre for Eastern European Studies (SCEEUS)
Eric Livny, Lead Regional Economist for Central Asia at European Bank for Reconstruction and Development (EBRD)
Anders Leissner, Lawyer and Expert on sanctions at Advokatfirman Vinge
Tymofiy Mylovanov, President of the Kyiv School of Economics
Vladyslav Vlasiuk, Sanctions Advisor to the Office of the President of Ukraine
Nataliia Shapoval, Chairman of the Kyiv School of Economics Institute
Yuliia Pavytska, Manager of the Sanctions Programme at KSE Institute
Andrii Plakhotniuk, Ambassador Extraordinary and Plenipotentiary of Ukraine to the Kingdom of Sweden
Daniel Spiro, Associate Professor, Uppsala University
Adrian Sadikovic, Journalist at Dagens Nyheter
Kata Fredheim, Executive Vice President of Partnership and Strategy and Associate Professor at SSE Riga
Lars Schmidt, Director and Sanctions Coordinator at the Ministry for Foreign Affairs, Sweden

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.

Cognitive Dissonance on Belarus: Recovery and Adaptation or Stalemate?

20240107 Cognitive Dissonance on Belarus Image 02

A closer look at the Belarusian economy over the recent year, produces two initially competing narratives. The first one emphasizes that tough sanctions have led to a deadlock for the Belarusian economy. The second one stresses that output losses have turned out to be much lower than expected, and that the economy has displayed a rather high degree of adaptability – securing an early and rapid recovery. This policy brief shows that these narratives are not mutually exclusive but rather elements of the same bigger picture. A short-term focus gives the impression that the current stance is ‘more good than bad’. This reflects the fact that output has recovered and almost reached historically high levels, made possible due to a combination of exports protection mechanisms and compensatory effects on output. However, this does not eliminate the disappointing medium- and long-term prospects for the country. On the flip side of the immediate survival of the Belarusian economy is the country’s economic and political stalemate. This includes the lack of opportunities for future sustainable growth and Belarus’ enormous and continuously growing dependence on Russia. Within this stalemate, stagnation is the best plausible scenario. At the same time, much worse scenarios, both economically and politically, are also highly likely. Ultimately, breaking the deadlock is the only way to a better future for Belarus.

The Belarusian Economy and the Changing Narratives

About 1.5 years ago, Western countries introduced tough sanctions against Belarus, punishing the Lukashenka regime for its role in Russia’s invasion of Ukraine. This gave rise to a huge uncertainty regarding Belarus’ economic prospects. A FREE policy brief published about a year ago (Kruk & Lvovskiy, 2022) presented a model-based estimate of a potential rock-bottom for the Belarusian economy in the new environment, which amounted to 20 percent of output losses. The authors however argued that actual output losses might be significantly lower given Russia’s support and policy responses, which were unaccounted for in the model. At the same time, downside risks and a lack of output consistency seem to have become permanent traits of the Belarusian economy.

Expectations of a large and prolonged recession in Belarus prevailed into mid-2023. International institutions (IMF, World Bank) and rating agencies (S&P, Fitch Ratings) mainly expected a recession in Belarus up to 10 percent 2022-2023.  The reality has however turned out to be quite different with the recession being relatively contained and short-lived. The output losses between the peak (Q2-2021) trough Q3-2022 amounted to 6.8 percent. In Q4-2022 a recovery began, and in Q3-2023 the economy had almost fully recovered, reaching nearly the same levels as in Q2-2021 (see Figure 1). Further, in terms of average real wages and household consumption, the situation appears to be even more positive. The real average wage reached its pre-war level in Q1-2023 and has since displayed record high levels, and household consumption follow a similar trend (see Figure 1).

These dynamics have given rise to a new narrative. As of lately, the Belarusian economic situation is at times treated as ‘more good than bad’. Further, most international financial institutions currently forecast a continued weak recovery growth in the coming years (EBRD, 2023; IMF, 2023; Izvorski et al., 2023).

Figure 1. Real GDP, Average Real Wages, and Real Household Consumption (index, seasonally adjusted, 2018=100).

Source: Author’s estimations based on Belstat data.

Factors Behind the Recent Recovery Growth

The underlying reasons for the recovery growth can be divided into two groups: (i) export protection mechanisms under sanctions and (ii) positive shocks and compensatory effects on output.

Export protection mechanisms under sanctions are twofold. Firstly, the Belarusian regime turned out to be somewhat successful in adjusting to the new sanctions-environment. This partly due to a somewhat geographical U-turn of Belarusian exports, underpinned by new logistics and payment schemes. The best example of this turn is the re-orientation of oil product exports from the EU and Ukraine to Russia (Kharitonchik, 2023). Moreover, some exports to traditional markets, which were challenged by logistics and payment barriers rather than sanctions, were secured by crossing these barriers. The best such example is the recovery of potash fertilizer exports to China, Brazil and India. Since early 2023 these displayed a rapid recovery due to Belarus finding logistic solutions through Russian sea ports instead of EU ports, and by using railway transportation.

Secondly, the practices of sanctions evasion may also have played a significant role. The scope of sanctions evasion is however difficult to assess due to its secretive nature. Moreover, the difference between avoiding and evading sanctions is not always clear.

Export protection mechanisms allowed Belarus to cushion actual export losses, making them transitory (see Figure 2). Actual losses in exports were close to the rock-bottom scenario estimates for only a couple of months. Instead of an expected level shift in exports by roughly 40 percent (from the pre-war level), exports displayed a recovery trajectory. Hence, what was modelled as a permanent shock in Kruk & Lvovskiy (2022), turned out to be transitory.

Figure 2. Physical Volume of Exports (index, seasonally adjusted, 2018=100).

Source: Author’s estimations based on Belstat data.

One important aspect to mention is that part of this recovery is due to oil-product exports taking place already in 2022 (Kharitonchik, 2023). In Kruk & Panasevich (2023) the authors show that the oil-refinery industry is of extreme importance for the entire Belarusian economy. Due to inter-industrial linkages, the oil-refinery industry indirectly accounts for about 11 percent of Belarus’ output, despite its modest direct contribution to the GDP (slightly more than 1 percent). Hence, due to protecting these exports (and the corresponding production of oil products), a large amount of output losses was avoided. A similar situation unfolded also for potash fertilizer exports and the chemical industry producing them (although inter-industrial linkages and effects on output are much weaker for that industry).

Besides export protection mechanisms, the recovery of exports and output stem largely from various positive and compensatory effects on output Some of them arose from Belarus’ and Russia’s respective regimes responses to sanctions, and from Russia’s readiness to support Belarus. Others are classical external positive shocks (to no degree related to sanctions) while some are a combination of both. They include: (i) increasing energy (gas) subsidies from Russia, (ii) a prolonged period of extra-high price competitiveness, especially in the Russian market, (iii) expanded access to the Russian market, (iv) other forms of Russian support (debt restructuring, budget transfers, new loans), (v) favorable trade conditions and export prices (apart from on the Russian market), (vi) a (macro)economic environment that allow for more  room for domestic economic policy interventions.

Taken together, these positive output drivers largely contributed to curbing the recession in 2022 and to the output recovery in 2023. A straightforward decomposition of the actual output growth path is unfeasible (due to the close interconnection of export protection mechanisms and output drivers, and the lack of available statistics). However, approximating the actual path in a model environment results in the following: between Q2-2021 and Q3-2022, about 12 percent of losses due to sanctions (taking into account the export protection mechanisms) and a deprivation of the Ukrainian market, and 5.2 percent of gains due to output shocks, resulted in actual output losses of 6.8 percent. Later in 2023, due to increasing effects from the export protection mechanisms, the sanctions-related output losses shrank to about 6.6 percent, while output shocks expanded output by roughly the same level. This allowed output losses to be zeroed out, i.e. the level of output in Q3-2023 was almost identical to Q3-2021.

An Economic Stalemate

Is the ‘more good than bad’ economic situation sustainable? Does the recent recovery mean that Belarus has overcome the major challenges to the economy? The short answer is no. Even with short-term thinking, there are still numerous downside risks. Sanctions still form a permanently challenging environment for the Belarusian economy, putting exports and output in jeopardy. The export protection mechanisms are not persistent, and they largely depend on Russia’s political will to support them. Moreover, the updated logistics and payment chains may also be vulnerable and sensitive to changes in the sanctions’ environment, and short-term trends in external prices. The aforementioned positive output effects are short-term by their nature and there are indications of them starting to fade already in 2023 (BEROC, 2023). Hence, even short-term projections for 2024 are challenging: the output growth is expected to weaken significantly or even fade away, while inflation spikes and financial destabilization risks are high (BEROC, 2023). Therefore, a return to a stagnant economic environment appears to be the most plausible short-term outlook.

The medium-term outlook seems even worse. According to Kruk (2023), the Belarusian macroeconomic balance (a) is very fragile, (b) is subject to numerous and huge downside risks, and (c) cannot be secured by macroeconomic policies because of the structural weaknesses in their design and the lack of room for maneuver. This means that even the existing weak long-term growth potential cannot be realized in the medium term, while the likelihood of recessions, inflation spikes and financial destabilization is high.

Re-shifting focus to a long-term and international perspective makes the viewpoint ‘more good than bad’ appear inconsistent. First, the long-term growth potential for Belarus, which was very weak even before the sanctions, keeps on worsening. This as adverse supply shocks and a deterioration of the productivity determinants continue eroding it (Kruk & Lvovskiy, 2022). Estimations of the growth potential (that rely on historical time series) are mainly within the range of 0-1 percent per annum. However, even such disappointing estimates might be optimistic bearing in mind the current political and sanctions-related risks and uncertainty (absent in the historical data). This makes stagnation the best possible long-term outlook, although it cannot be guaranteed.

Second, despite the milder recession and rapid recovery, the well-being gap between Belarus and its EU neighbors keeps on expanding (see Figure 3).

Figure 3. Well-being in Belarus vs the average among its EU neighbors (Latvia, Lithuania, Poland), 1990-2022, in percent.

Note: The GDP per capita PPP in 2017 constant international dollars is considered as well-being. The average well-being for EU Neighbors is the simple average in GDP in Latvia, Lithuania, and Poland.
Source: Author’s estimations based on World Bank data.

The average well-being in Belarus (measured in GDP per capita in constant international dollars) vs. that among its EU neighbors reached an (almost) historically low level in 2022. After attaining a level of well-being of roughly 75 percent of the average in Latvia, Lithuania, and Poland in the early 2010s, the well-being in Belarus has fall to about 52.5 percent, almost as low as in the mid-1990s. Given the economic stagnation as the most likely outlook, this means that the country will, in relative terms, keep on getting poorer in comparison to its EU neighbors.

A Political Stalemate

The hypothetical way out of the economic stalemate is more or less obvious. For instance, there is somewhat of a consensus among Belarusian economists about strengthening the long-term growth and securing macroeconomic stability (see Daneyko & Kruk, 2021; Kruk, 2023, for an overview of a collective view from a group of Belarusian economists). This vision, however, clashes with the views of the Lukashenka regime, which has inhibited its implementation throughout decades. Hence, democratic transition, or at least deprival of power of the Lukashenka regime has long appeared to be a highly likely precondition for moving away from the stalemate.

This, however, has changed in the last couple of years. The Belarusian economy’s dependence on Russia has moved from large to absolute. Prior to 2022, Russia was an important market for Belarusian exports (about 40 percent), the single energy supplier, and de facto the lender of last resort. To date, Russia’s role has expanded dramatically. The share of exports to Russia has increased up to about 65 percent. Moreover, the majority of the remaining 35 percent is exported with the assistance of or through Russia, using Russian infrastructure. Therefore, it would be fair to argue that Russia in some form “controls” roughly 90 percent of Belarusian exports. Further, being Belarus’ sole energy supplier, Russia has increased its significance for Belarus through expanded energy subsidies. The size of the energy subsidies reached a historical high in 2022, and the mechanism of the energy subsidies has become a cornerstone for macroeconomic stability in Belarus. Furthermore, Russia has turned out to be the only effective creditor for Belarus. Overall, Russia has accumulated a significant number of tools to undermine Belarus at any given moment.

A democratic transition or at least deprival of power of the Lukashenka regime might therefore not be sufficient preconditions for breaking the economic deadlock. Even if domestic political will to do so should emerge, the risk that Russia will successfully suppress it using the above outlined economic tools is very high. Hence, apart from a democratic transition, the way out of the economic stalemate requires a way out of the political stalemate. This seems to only be possible through either a politically weakened Russia, and/or an external political force, allied to the Belarusian democratic forces, and strong enough to suppress Russia.

Conclusions

Recently, the narrative on the Belarusian economy has changed. The prevailing expectations of a large and prolonged recession has been substituted by expectations of a gradual recovery. The narrative ‘the jig is up’ has somehow been crowded out by the ‘more good than bad’ viewpoint on the Belarusian economy. However, these narratives are not mutually exclusive. Behind the current ‘more good than bad’ viewpoint on the Belarusian economy, a severe economic and political deadlock prevails. Moreover, future economic and political deadlocks are the actual price being paid for the recent survival and recovery of the Belarusian economy.

From a positive perspective, the economic and political deadlock means that the country is likely to, at least, be bogged down in stagnation. Belarus’ total dependency on Russia makes the country hostage to Russia’s political preferences and country-specific risks. Should Russia decide to exert further economic and/or political influence over Belarus, it is likely to succeed. Consequently, any economic downturn faced by Russia would automatically impact Belarus.

From a normative perspective, breaking the economic and political deadlock might be the only solution, and for this, the order might matter. Prior to 2020 there was a widespread opinion that breaking the economic deadlock must be prioritized, and that it could – in turn – break the political deadlock. As of now, the tables have turned. The current order postulates the political deadlock comes first, as it seems to be the only way of breaking the economic stalemate. However, breaking the political deadlock appears to require external political will.

With these conclusions in mind, the recent Belarusian democratic forces’ manifest regarding Belarus’ EU membership aspiration, deserves attention (BDF, 2023). At first, such aspiration might appear schizophrenic given the actual political situation inside of the country. However, taking a Belarusian EU membership serious (within the EU and among Belarusians) might be the answer to Belarus’ political and economic deadlock. From this perspective, the task for the Belarusian society is thus to convince EU counterparts that this is not madness, but rather a feasible solution. It is rather evident why this solution is both desirable and feasible for the Belarusian society. The main question to be answered is therefore whether, and why it would be desirable and feasible for the EU.

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.

Democratic Backsliding and Electoral Autocracies: Research Shared at the 2023 FROMDEE Conference

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On October 13th, 2023, the Stockholm Institute of Transition Economics (SITE) and the Forum for Research on Media and Democracy in Eastern Europe (FROMDEE) hosted an academic conference on “Democratic Backsliding and Electoral Autocracies”. This brief provides a short summary of the keynote lecture and research presentations featured at the conference.

The most recent report by the V-Dem Institute concludes that “72 percent of the world’s population […] live in autocracies by 2022” and “the level of democracy enjoyed by the average global citizen in 2022 is down to 1986 levels” (V-Dem Institute, 2023). In Europe, these declines have manifested in the previous Polish government undermining judicial independence, in tightened political repression in Belarus, and most prominently in Putin’s invasion of Ukraine. But the rise of electoral autocracies and democratic backsliding are not confined to Europe – their strategies of propaganda, corruption, electoral manipulation, as well as attacks on judicial and media independence are a global phenomenon. The October 13th FROMDEE Conference gathered researchers from economics, law and political science to bring insight into why and where reversals are taking place, and what measures are needed to reverse the negative trend. This policy brief provides an overview of the research shared at the conference.

Populism and Autocracy – the Case of Russia

In the keynote lecture, Arturas Rozenas (New York University) focused on the roots of populism, challenging the common view of illiberal democracies as a mix between democracies and dictatorships. Rather, dictatorships evolve into populist dictatorships that then take one of two paths: either the path to democracy, or the path towards electoral autocracy, illiberal democracy, or totalitarianism. In this framework, populist dictatorships have historically made use of populist elements we recognize from modern times, i.e., democratic-seeming institutions misused for the ruler’s purposes.

In a populist dictatorship, Rozenas continued, there is a monopoly of power. Institutions such as elections and parliamentary representation, serve not to allocate power but to legitimise it. The transition from passive to active dictatorships coincided with a move away from the common notion of a king or similar leader deriving rightful power from God to rule the masses, to a reality built on the idea that the ruler’s legitimacy stems from the masses. This historic transformation should however not be interpreted as a transition to democracy. In fact, Rozenas showed that for most of recent history, the majority of elections and expansions of suffrage took place in dictatorships rather than in democracies. These seemingly populist institutions serve not only to legitimise governments, but also to coopt the population in a public display of the ruler’s strength. Rozenas argued, that in an active populist dictatorship, the ruler creates a setting which suppresses dissent and expectations of dissent, through institutionalised expressions of support (in the form of political participation, elections, large rallies etc.).

Turning to the Russian setting, the first thing to notice is the deep tradition of autocracy – from tsarism to Stalinism. In Russia, the words “society” and “the people” briefly blossomed during past revolutions or uprisings but have largely been absent in the Russian language and are once again on the decline under the rule of Putin. Further, the Russian population has time and again been exploited by its rulers during succession crises for displays of power and dominance. Examples of this are the mandatory elections held under Stalin two weeks after the invasion of the Baltic States in 1939 and more recently under Putin in the occupied territories of Luhansk and Donetsk in Ukraine in 2021. Such populist autocratic strategies are nothing new in Russia, concluded Rozenas – rather they derive from the internal logic of dictatorship that has played out throughout Russian history.

Continuing the notion of the “absent” Russian society, Olha Zadorozhna (Kozminski University) began her presentation by explaining that protests are infrequent in Russia and have surprisingly few attendees given the country’s large population. While there were mass protests in the run-up to the collapse of communism in the 1980’s and protests took place against corruption in 2017-2018, and in relation to the arrest of Alexey Navalny in 2021, protests in Russia are typically not motivated by an overarching ideology or broader political questions. Rallies in favor of authoritarianism and ethno-nationalism are a more common occurrence. Moreover, there are few indications that the invasion of Ukraine, sanctions and subsequent economic downturn have negatively affected the Russian population’s support for the regime. Still, literature has shown that war-related deaths can mobilize opposition against war participation (e.g., the U.S. participation in the Vietnam War). Considering this, Zadorozhna evaluates whether the deaths of Russian soldiers provoke a reaction among the Russian population. By combining social media data on fallen soldiers with protest activity for the first four months of the Russian invasion in 2022, the study find that casualties lead to an increase in protest activity, indicating that deaths can in fact mobilize public opposition in Russia.

Other populist strategies to ensure support for Putin in Russia relate to political participation and the judiciary. Nicholas James (University of Oxford) analysed electoral rule changes in the Russian Duma – from mixed member majoritarianism to proportional representation (PR) – by measuring their effect on floor participation. Applying a difference-in-differences framework, James found that deputies experiencing a change from PR included less words in their speeches following the switch (about 15-20 percent of an average speech). This effect should be understood in the political context of the ruling party’s (United Russia) increased influence during this time period (2010s). In fact, James concluded, the results point in the direction of the regime tampering with the Duma in an impromptu and reactionary manner with the overall goal of obtaining closer control and the appearance of support for the regime.

Yulia Khalikova’s (University of Hamburg) presentation gave further insight into how ostensibly democratic institutions can be exploited to make an authoritarian regime appear legitimate. In her work, Khalikova considers judicial references to international law that may be employed strategically, without necessarily adhering to the spirit or content of the law. Looking specifically at international law citations in 601 judgements made in the Russian Constitutional Court (RCC) between 2000 and 2021, Khalikova find evidence that the RCC has increasingly cited international courts when making judgements on topics related to politics and physical rights, indicating that state policy influences citation patterns. The change in citation patterns also points to the RCC currently using international law to support the regime and uphold its legitimacy, meaning that international law – adopted with the ambition of enhancing democratic values and ensuring human rights – is misused for undemocratic and repressive purposes.

Censorship and Propaganda

Information control is an important feature of autocratic regimes. Philine Widmer (ETH Zurich) considers the Chinese setting – where the regime controls the amount of foreign information available on the internet via a countrywide firewall. Research has shown that autocracies make use of censorship strategies to control their citizens, but these are associated with high reputational costs and can be overcome by tech-savvy citizens. Using a machine learning algorithm, Widmer first predicts a newspaper article’s alignment with the Chinese regime before comparing the placement of more/less aligned articles on news websites. Her results show that front-page news stories in Chinese newspapers are more aligned with the regime’s stance than other content. Front-page placement in turn matters for information uptake. Widmer ended the presentation by comparing the additional cost of finding less aligned articles to the technological costs required to access outside media (e.g. VPNs). For an autocracy to achieve its information control objectives, independent news may just need to be relatively harder to access. It does not need to make it impossible to access for all citizens.

Censorship is typically accompanied by, and complementary with, propaganda. Restricting other narratives allows autocratic regimes to spread their own. While propaganda is a common feature within autocracies, Jaakko Meriläinen’s (Stockholm School of Economics) presentation evaluated the effect of autocratic propaganda in a democratic setting.

Meriläinen’s study focuses on a rogue experiment in which some Finnish children in the 1970’s were taught history and social sciences using material from the Soviet Union – material which was in essence Soviet propaganda. By exploiting geographical and cohort variation, Meriläinen use a difference-in-differences approach to compare the 213 exposed children to children taught the regular Finnish curriculum. The long-term outcomes show that exposed children had lower incomes in adulthood, worked fewer months per year and were engaged in more left-leaning and publicly beneficial occupations (such as, nurses and firefighters).

Information and Accountability

The use of technological innovations to access otherwise restricted information was central to Arieda Muço’s (Central European University) presentation. She studies the spread of the Xerox photocopying machine in communist Hungary in the 1980’s – a setting characterised by limited freedom of speech and restrictions on the media. She reported that areas with early placement of Xerox machines are found to exhibit higher shares of pro-democratic voting. Muço ascribes these outcomes to the fact that the machines allowed for the spread of information and eased coordination of the opposition, suggesting that new technologies and information can act as key facilitators in the fall of autocratic regimes.

Providing citizens with information was also a key feature in Enrique Seira Bejarano’s (Michigan State University) presentation. He began by discussing two potentially related trends: in Latin America recent years have seen (i) increased levels of corruption and (ii) increased dissatisfaction with democracy among citizens. The number of corruption-related news articles have increased threefold in Spanish and doubled in English and the share of people perceiving corruption to be the greatest challenge to their country has doubled in the last decade. The study uses two empirical strategies to identify the effect of corruption on democratic values. Firstly, Seira Bejarano described an observational study, in which data on major corruption scandals were combined with Latinobarometer data on support for democracy. The authors find that corruption scandals increase corruption perceptions while decreasing stated support for democracy. Secondly, Seira Bejarano reported the results of a randomized controlled trial in which some respondents were shown videos of a politician accepting bribes. This had a negative effect on preferences for democracy and on trust more broadly. Both studies show that revelations of corruptions decrease the support for democracy, suggesting a potential tradeoff between the public’s belief in democratic institutions and increased transparency which is important for accountability but can also expose corruption.

Right-wing Populism

Yet another threat to democracy is the rise of right-wing populism – currently a reality in many well-established democracies across Europe. In Germany, the far-right party Alternative für Deutschland (AfD) enjoys around 21 percent of voters’ support according to recent polls. To understand their rise in popularity, Navid Sabet (Goethe University Frankfurt) builds on previous literature on cultural conflict as a driver for right-wing party support. The paper he presented examines the role of violent conflict in the form of terrorist acts. It evaluates whether acts of terror can alter the political landscape and shift support to the far-right. To avoid selection problems, the authors compare successful terror attacks to attacks that failed. Sabet reported that successful small-scale attacks (predominantly targeting migrants) increase AfD’s vote share by about 6 percentage points in state elections (in the time period 2013-2021). The acts of terror were found to increase voter turnout, by mobilizing otherwise idle voters, but also by gaining votes at the cost of other parties. Exploring the mechanisms behind these results, the authors study the language used by political parties and the way successful attacks were covered in the media. Relative to coverage of unsuccessful attacks, media coverage used a more negative tone, more words related to Islam and terror and fewer words related to right-wing populism. This suggests that media plays an important role in shaping the public’s response to acts of terror and that far right parties are able to exploit this dynamic.

Concluding Remarks

The 2023 FROMDEE Conference brought together academics from different fields to shed light on some of the main challenges to democracy today. In part, the research presented supported the prevailing narrative that democracies are backsliding in many parts of the world. However, by analysing how autocracies and populist leaders operate, the presenters also highlighted the vulnerability of dictatorships.

Arturas Rozenas cited the example of a rally in Bucharest in 1989, which was organised to display support for Ceauşescu’s regime and descended into an anti-government protest. Dictatorships can benefit by coopting the populist elements of democracy but, in doing so, they risk creating a vehicle for genuine democratic expression.

The audience learned about autocracies’ efforts to control the flow of information but also about citizens’ ability to circumvent restrictions whether in 1980s Hungary or present-day China. Several presentations focused on the extent of autocratic control in Russia but even in this setting, the death of soldiers in Ukraine motivates citizens to participate in protests.

Recent trends suggest that democratic institutions should not be taken for granted in any country. Societies can become more resilient to the threat of democratic backsliding, in part by better understanding how both democracies and autocracies operate and what makes them vulnerable. Researchers around the world are using innovative methods to expand our knowledge in this area, as reflected in the presentations at the 2023 FROMDEE Conference.

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.

The Impact of Rising Gasoline Prices on Households in Sweden, Georgia, and Latvia – Is This Time Different?

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Over the last two years, the world has experienced a global energy crisis, with surging oil, coal, and natural gas prices. For European households, this translates into higher gasoline and diesel prices at the pump as well as increased electricity and heating costs. The increase in energy related costs began in 2021, as the world economy struggled with supply chain disruptions caused by the Covid-19 pandemic, and intensified as Russia launched a full-scale invasion of Ukraine in late February 2022. In response, European governments have implemented a variety of energy tax cuts (Sgaravatti et al., 2023), with a particular focus on reducing the consumer cost of transport fuel. This policy paper aims to contextualize current transport fuel prices in Europe by addressing two related questions: Are households today paying more for gasoline and diesel than in the past? And should policymakers respond by changing transport fuel tax rates? The analysis will focus on case studies from Sweden, Georgia, and Latvia, countries that vary in economic development, energy independence, reliance on Russian oil, transport infrastructure, and transport fuel tax rates. Through this study, we aim to paint a nuanced picture of the implications of rising fuel prices on household budgets and provide policy guidance.

Record High Gasoline Prices, Historically Cheap to Drive

Sweden has a long history of using excise taxes on transport fuel as a means to raise revenue for the government and to correct for environmental externalities. As early as in 1924, Sweden introduced an energy tax on gasoline. Later, in 1991, this tax was complemented by a carbon tax levied on the carbon content of transport fuels. On top of this, Sweden extended the coverage of its value-added tax (VAT) to include transport fuels in 1990. The VAT rate of 25 percent is applied to all components of the consumer price of gasoline: the production cost, producer margin, and excise taxes (energy and carbon taxes).

In May 2022, the Swedish government reduced the tax rate on transport fuels by 1.80 SEK per liter (0.16 EUR). This reduction was unprecedented. Since 1960, there have only been three instances of nominal tax rate reductions on gasoline in Sweden, each by marginal amounts in the range of 0.04 to 0.22 SEK per liter. Prior to the tax cut, the combined rate of the energy and carbon tax was 6.82 SEK per liter of gasoline. Adding the VAT that is applied on these taxes, amounting to 1.71 SEK, yields a total excise tax component of 8.53 SEK. This amount is fixed in the short run and does not vary with oil price changes.

Figure 1. Gasoline Pump Price, 2000-2023.

Source: Drivkraft Sverige (2023).

Figure 1 shows the monthly average real price of gasoline in Sweden from January 2000 to October 2023. The price has slowly increased over the last 20 years and has been historically high in the last year and a half. Going back even further, the price is higher today than at any point since 1960. Swedish households have thus lately been paying more for one liter of gasoline than ever before.

However, a narrow focus on the price at the pump does not take into consideration other factors that affect the cost of personal transportation for households.

First, the average fuel efficiency of the vehicle fleet has improved over time. New vehicles sold in Sweden today can drive 50 percent further on one liter of gasoline compared to new vehicles sold in 2000. Arguably, what consumers care about the most is not the cost of gasoline per se but the cost of driving a certain distance, as the utility one derives from a car is the distance one can travel. Accounting for vehicles’ fuel efficiency improvement over time, we find that even though it is still comparatively expensive to drive today, the current price level no longer constitutes a historical peak. In fact, the cost of driving 100 km was as high, or higher, in the 2000-2008 period (see Figure 2).

Figure 2. Gasoline Expenditure per 100 km.

Source: Trafikverket (2023) and Drivkraft Sverige (2023).

Second, any discussion of the cost of personal transportation for households should also factor in changes in household income over time. The Swedish average real hourly wage has increased by more than thirty percent between 2000-2023. As such, the cost of driving 100 km, measured as a share of household income, has steadily declined over time. Further, this pattern is consistent across the income distribution; for instance, the cost trajectory for the bottom decile is similar to that of all wage earners (as illustrated in Figure 3). In 1991, when the carbon tax was implemented, the average household had to spend around two thirds of an hour’s wage to drive 100 km. By 2020, that same household only had to spend one third of an hour’s wage to drive the same distance. There has been an increase in the cost of driving over the last two years, but in relation to income, it is still cheaper today to drive a certain distance compared to any year before 2013.

Figure 3. Cost of Driving as a Share of Income, 1991-2023.

Source: Statistics Sweden (2023).

Taken all together, we see that on the expenditure side, vehicles use fuel more efficiently over time and on the income side, households earn higher wages. Based on this, we can conclude that the cost of travelling a certain distance by car is not historically high today.

Response From Policymakers

It is, however, of little comfort for households to know that it was more expensive to drive their car – as a share of income – 10 or 20 years ago. We argue that what ultimately matters for households is the short run change in cost, and the speed of this change. If the cost rises too fast, households cannot adjust their expenditure pattern quickly enough and thus feel that the price increase is unaffordable. In fact, the change in the gasoline price at the pump has been unusually rapid over the last two years. Since the beginning of 2021, until the peak in June 2022, the (nominal) pump price rose by around 60 percent.

So, should policymakers respond to the rapid price increase by lowering gasoline taxes? The perhaps surprising answer is that lowering existing gasoline tax rates would be counter-productive in the medium and long run. Since excise taxes are fixed and do not vary with the oil price, they reduce the volatility of the pump price by cushioning fluctuations in the market price of crude oil. The total excise tax component including VAT constitutes more than half of the pump price in Sweden, a level that is similar across most European countries. This stands in stark contrast with the US, where excise taxes make up around 15 percent of the consumer price of gasoline. As a consequence, a doubling of the price of crude oil only increases the consumer price of gasoline in Sweden by around 35 percent, while it increases by about 80 percent in the US. Households across Sweden, Europe, and the US have adapted to the different levels of gasoline tax rates by purchasing vehicles with different levels of fuel efficiency. New light-duty vehicles sold in Europe are on average 45 percent more fuel-efficient compared to the same vehicle category sold in the US (IEA 2021). As such, US households do not necessarily benefit from lower gasoline taxation in terms of household expenditure on transport fuel. They are also more vulnerable to rapid increases in the price of crude oil. Having high gasoline tax rates thus reduces – rather than increases – the short run welfare impact on households. Hence, policymakers should resist the temptation to lower gasoline tax rates during the current energy crisis. With imposed tax cuts, households will, in the medium and long run, buy vehicles with higher fuel consumption and thus become more exposed to price surges in the future – again compelling policymakers to adjust tax rates, creating a downward spiral. Instead, alternative measures should be considered to alleviate the effects of the heavy price pressure on low-income households – for instance, revenue recycling of the carbon tax revenue and increased subsidies of public transport.

Conclusion

To reach environmental and climate goals, Sweden urgently needs to phase out the use of fossil fuels in the transport sector – Sweden’s largest source of carbon dioxide emissions. This is exactly what a gradual increase of the tax rate on gasoline and diesel would achieve. At the same time, it would benefit consumers by shielding them from the adverse effects of future oil price volatility.

The most common response from policymakers regarding fuel tax rates however goes in the opposite direction. In Sweden, the excise tax on gasoline and diesel was reduced by 1.80 SEK per liter in 2022 and the current government plans to further reduce the price by easing the biofuel mandate. Similar tax cuts have been implemented in a range of European countries. Therefore, the distinguishing factor in the current situation lies in the exceptional responses from policymakers, rather than in the gasoline costs that households are encountering.

Gasoline Price Swings and Their Consequences for Georgian Consumers

The energy crisis that begun in 2021 has also made its mark on Georgia, where the operational expenses of personal vehicles, encompassing not only gasoline costs but also maintenance expenses, account for more than 8 percent of the consumer price index. The rise in gasoline prices sparked public protest and certain opposition parties proposed an excise tax cut to mitigate the gasoline price surge. In Georgia, gasoline taxes include excise taxes and VAT. Until January 1, 2017, the excise tax was 250 GEL per ton (9 cents/liter), it has since increased to 500 GEL (18 cents/liter). Despite protests and the suggested excise tax reduction, the Georgian government chose not to implement any tax cuts. Instead, it initiated consultations with major oil importers to explore potential avenues for reducing the overall prices. Following this, the Georgian National Competition Agency (GNCA) launched an inquiry into the fuel market for motor vehicles, concluding a manipulation of retail prices for gasoline existed (Georgian National Competition Agency, 2023).

The objective of this part of the policy paper is to address two interconnected questions. Firstly, are Georgian households affected by gasoline price increases? And secondly, if they are, is there a need for government intervention to mitigate the negative impact on household budgets caused by the rise in gasoline prices?

The Gasoline Market in Georgia

Georgia’s heavy reliance on gasoline imports is a notable aspect of the country’s energy landscape. The country satisfies 100 percent of its gasoline needs with imports and 99 percent of the fuel imported is earmarked for the road vehicle transport sector. Although Georgia sources its gasoline from a diverse group of countries, with nearly twenty nations contributing to its annual gasoline imports, the supply predominantly originates from a select few markets: Bulgaria, Romania, and Russia. In the last decade, these markets have almost yearly accounted for over 80 percent of Georgia’s total gasoline imports. Furthermore, Russia’s share has substantially increased in recent years, amounting to almost 75 percent of all gasoline imports in 2023. The primary reason behind Russia’s increased dominance in Georgia’s gasoline imports is the competitive pricing of Russian gasoline, which between January and August in 2023 was almost 50 percent cheaper than Bulgarian gasoline and 35 percent cheaper than Romanian gasoline (National Statistics Office of Georgia, 2023). Given the dominance of Russian gasoline in Georgia, the end-user (retail) prices of gasoline in Georgia, are closer to gasoline prices in Russia than EU gasoline prices (see Figure 1).

Figure 1. End-user Gasoline Prices in Georgia, Russia and the EU, 2013-2022.

Source: International Energy Agency, 2023.

However, while the gasoline prices increased steadily in 2020-2022 in Russia, gasoline prices in Georgia increased sharply in the same period. This more closely replicated the EU price dynamics rather than the Russian one. The sharp price increase in gasoline raised concerns from the Georgian National Competition Agency (GNCA). According to the GNCA one possible reason behind the sharp increase in gasoline prices in Georgia could be anti-competitive behaviour among the five major companies within the gasoline market. Accordingly, the GNCA investigated the behaviour of major market players during the first eight months of 2022, finding violations of the Competition Law of Georgia. Although the companies had imported and were offering consumers different and significantly cheaper transport fuels compared to fuels of European origin, their retail pricing policies were identical and the differences in product costs were not properly reflected in the retail price level. GNCA claims the market players coordinated their actions, which could have led to increased gasoline prices in Georgia (National Competition Agency of Georgia. (2023).

Given that increased gasoline prices might lead to increased household expenditures for fuel, it is important to assess the potential impact of recent price developments on household’s budgets.

Exploring Gasoline Price Impacts

Using data from the Georgian Households Incomes and Expenditures Survey (National Statistics Office of Georgia, 2023), weekly household expenditures on gasoline and corresponding weekly incomes were computed. To evaluate the potential impact of rising gasoline prices on households, the ratio of household expenditures on gasoline to household income was used. The ratios were calculated for all households, grouped in three income groups (the bottom 10 percent, the top 10 percent and those in between), over the past decade (see Figure 2).

Figure 2. Expenditure on Gasoline as Share of Income for Different Income Groups in Georgia, 2013-2022.

Source: National Statistics Office of Georgia, 2023.

Figure 2 shows that between 2013 and 2022, average households allocated 9-14 percent of their weekly income to gasoline purchases. There is no discernible increase in the ratio following the energy crisis in 2021-2022.

Considering the different income groups, the upper 10 percent income group experienced a slightly greater impact from the recent rise in gasoline prices (the ratio increased), compared to the overall population. For the lower income group, which experienced a rise in the proportion of fuel costs relative to total income from 2016 to 2021, the rate declined between 2021 and 2022. Despite the decline in the ratio for the lower-level income group, it is noteworthy that the share of gasoline expenditure in the household budget has consistently been high throughout the decade, compared to the overall population and the higher-level income group.

The slightly greater impact from the rise in gasoline prices for the upper 10 percent income group is driven by a 4 percent increase in nominal disposable income, paired with an 8 percent decline in the quantity of gasoline (Figure 3) in response to the 22 percent gasoline price increase. Clearly, for this income group, the increase in disposable income was not enough to offset the increase in the price of gasoline, increasing the ratio as indicated above.

For the lower 10 percent income group, there was a 23 percent increase in nominal disposable income, paired with a 9 percent decline in the quantity of purchased gasoline (Figure 3) in response to the 22 percent gasoline price increase . Thus, for this group, the increase in disposable income weakened the potential negative impact of increased prices, eventually lowering the ratio.

Figure 3. Average Gasoline Quantities Purchased, by Household Groups, per Week (In Liters) 2013-2022.

Source: National Statistics Office of Georgia, 2023.

Conclusion

The Georgian energy market is currently fully dependent on imports, predominantly from Russia. While sharp increases in petrol prices have been observed during the last 2-3 years, they do not seem to have significantly impacted Georgian households’ demand for gasoline. Noteworthy, the lack of impact from gasoline price increases on Georgian households’ budgets, as seen in the calculated ratio (depicted in Figure 2), can be explained by the significant rise in Georgia’s imports from the cheap Russian market during the energy crisis years. Additionally, according to the Household Incomes and Expenditures survey, there was in 2022 an annual increase in disposable income for households that purchased gasoline. However, the data also show that low-income households spend a high proportion of their income on gasoline.

Although increased prices did not significantly affect Georgian households, the extremely high import dependency and the lack of import markets diversification poses a threat to Georgia’s energy security and general economic stability. Economic dependency on Russia is dangerous as Russia traditionally uses economic relations as a lever for putting political pressure on independent economies. Therefore, expanding trade and deepening economic ties with Russia should be seen as risky. Additionally, the Russian economy has, due to war and sanctions, already contracted by 2.1 percent in 2022 and further declines are expected (Commersant, 2023).

Prioritizing actions such as diversifying the import market to find relatively cheap suppliers (other than Russia), closely monitoring the domestic market to ensure that competition law is not violated and market players do not abuse their power, and embracing green, energy-efficient technologies can positively affect Georgia’s energy security and positively impact sustainable development more broadly.

Fueling Concerns: The True Cost of Transportation in Latvia

In May 2020, as the Latvian Covid-19 crisis began, Latvia’s gasoline price was 0.99 EUR per liter. By June 2022, amid the economic effects from Russia’s war on Ukraine, the price had soared to a record high 2.09 EUR per liter, sparking public and political debate on the fairness of fuel prices and potential policy actions.

While gas station prices are salient, there are several other more hidden factors that affect the real cost of transportation in Latvia. This part of the policy paper sheds light on such costs by looking at some of its key indicators. First, we consider the historical price of transport fuel in Latvia. Second, we consider the cost of fuel in relationship to average wages and the fuel type composition of the vehicle fleet in Latvia.

The Price of Fuel in Latvia

Latvia’s nominal retail prices for gasoline (green line) and diesel (orange line) largely mirror each other, though gasoline prices are slightly higher, in part due to a higher excise duty (see  Figure 1). These local fuel prices closely follow the international oil market prices, as illustrated by the grey line representing nominal Brent oil prices per barrel.

The excise duty rate has been relatively stable in the past,  demonstrating that it has not been a major factor in fuel price swings. A potential reduction to the EU required minimum excise duty level will likely have a limited effect on retail prices. Back of the envelope calculations show that lowering the diesel excise duty from the current 0.414 EUR per liter to EU’s minimum requirement of 0.33 EUR per liter could result in approximately a 5 percent drop in retail prices (currently, 1.71 EUR per liter). This at the cost of a budget income reduction of 0.6 percent, arguably a costly policy choice.

In response to recent years’ price increase, the Latvian government opted to temporarily relax environmental restrictions, making the addition of a bio component to diesel and gasoline (0.065 and 0.095 liters per 1 liter respectively) non-mandatory for fuel retailers between 1st of June 2022 until the end of 2023. The expectation was that this measure would lead to a reduction in retail prices by approximately 10 eurocents. To this date, we are unaware of any publicly available statistical analysis that verifies whether the relaxed restriction have had the anticipated effect.

Figure 1. Nominal Retail Fuel Prices and Excise Duties for Gasoline and Diesel in Latvia (in EUR/Liter), and Nominal Brent Crude Oil Prices (in EUR/Barrel), January 2005 to August 2023.

Source: The Central Statistical Bureau of Latvia, St. Louis Federal Reserve’s database, OFX Monthly Average Rates database, The Ministry of Finance of Latvia, The State Revenue Service of Latvia.

The True Cost of Transportation

Comparing fuel retail prices to average net monthly earnings gives insight about the true cost of transportation in terms of purchasing power. Figure 2 displays the nominal net monthly average wage in Latvia from January 2005 to June 2023 (grey line). During this time period the average worker saw a five-fold nominal wage increase, from 228 EUR to 1128 EUR monthly. The real growth was two-fold, i.e., the inflation adjusted June 2023 wage, in 2005 prices, was 525 EUR.

Considering fuel’s share of the wages; one liter of gasoline amounted to 0.3 percent of an average monthly wage in 2005, as compared to 0.12 percent in 2023, with diesel displaying a similar pattern. Thus, despite recent years’ fuel price increase, the two-fold increase in purchasing power during the same time period implies that current fuel prices may not be as alarming for Latvian households as they initially appeared to be.

Figure 2. Average Nominal Monthly Net Wages in Latvia and Nominal Prices of One Liter of Gasoline and Diesel as Shares of Such Wages (in EUR), January 2005 to June 2023.

Source: The Central Statistical Bureau of Latvia.

Another factor to consider is the impact of technological advancements on fuel efficiency over time. The idea is simple: due to technological improvements to combustion engines, the amount of fuel required to drive 100 kilometers has decreased over time, which translates to a lower cost for traveling additional kilometers today. An EU average indicator shows that the fuel efficiency of newly sold cars improved from 7 liters to 6 liters per 100 km, respectively, in 2005 and 2019. While we lack precise data on the average fuel efficiency of all private vehicles in Latvia, we can make an informed argument in relation to the technological advancement claim by examining proxy indicators such as the type of fuel used and the average age of vehicles.

Figure 3 shows a notable change in the fuel type composition of the vehicle fleet in Latvia. Note that the decrease in the number of cars in 2011 is mainly due to a statistical correction for unused cars. At the start of the 21st century, 92 percent of Latvian vehicles were gasoline-powered and 8 percent were diesel-powered. By 2023, these proportions had shifted to 28 percent for gasoline and 68 percent for diesel. Diesel engines are more fuel efficient, usually consuming 20-35 percent less fuel than gasoline engines when travelling the same distance. Although diesel engines are generally pricier than their gasoline counterparts, they offer a cost advantage for every kilometer driven, easing the impact of rising fuel prices. A notable drawback of diesel engines however, is their lower environmental efficiency – highlighted following the 2015 emission scandal. In part due to the scandal, the diesel vehicles growth rate have dropped over the past five years in Latvia.

Figure 3. Number of Private Vehicles by Fuel Type and the Average Age of Private Vehicles in Latvia, 2001 to 2023.

Source: The Central Statistical Bureau of Latvia, Latvia’s Road Traffic Safety Directorate.

Figure 3 also shows that Latvia’s average vehicle age increased from 14 years in 2011 to 15.1 years in 2023. This is similar to the overall EU trend, although EU cars are around 12 years old, on average. This means that, in Latvia, the average car in 2011 and 2023 were manufactured in 1997 and 2008, respectively. One would expect that engines from 2008 have better technical characteristics compared to those from 1997. Recent economic research show that prior to 2005, improvements in fuel efficiency for new cars sold in the EU was largely counterbalanced by increased engine power, enhanced consumer amenities and improved acceleration performance (Hu and Chen, 2016). I.e.,  cars became heavier, larger, and more powerful, leading to higher fuel consumption. However, after 2005, cars’ net fuel efficiency started to improve. As sold cars in Latvia are typically 10-12 year old vehicles from Western European countries, Latvia will gradually absorb a more fuel-efficient vehicle fleet.

Conclusion

The increase of purchasing power, a shift to more efficient fuel types and improvements in engine efficiency have all contributed to a reduction of the overall real cost of transportation over time in Latvia. The recent rise in fuel prices to historically high levels is thus less concerning than it initially appears. Moreover, a growing share of cars will not be directly affected by fuel price fluctuations in the future. Modern electric vehicles constitute only 0.5 percent of all cars in Latvia today, however, they so far account for 10 percent of all newly registered cars in 2023, with an upward sloping trend.

Still, politicians are often concerned about the unequal effects of fuel price fluctuations on individuals. Different car owners experience varied effects, especially when considering factors like income and location, influencing transportation supply and demand.

First, Latvia ranks as one of the EU’s least motorized countries, only ahead of Romania, with 404 cars per 1000 inhabitants in 2021. This lower rate of vehicle ownership is likely influenced by the country’s relatively low GDP per capita (73 percent of the EU average in 2022) and a high population concentration in its capital city, Riga (32 of the population lives in Riga city and 46 percent in the Riga metropolitcan area). In Riga, a developed public transport system reduces the necessity for personal vehicles. Conversely, areas with limited public transport options, such as rural and smaller urban areas, exhibit a higher demand for personal transportation as there are no substitution options and the average distance travelled is higher than in urban areas. Thus, car owners in these areas tend to be more susceptible to the impact of fuel price volatility.

Second, Latvia has a high Gini coefficient compared to other EU countries, indicating significant income inequality (note that the Gini coefficient measures income inequality within a population, with 0 representing perfect equality and 1 indicating maximum inequality. In 2022, the EU average was 29.6 while Latvia’s Gini coefficient was 34.3, the third highest in the EU). With disparities in purchasing power, price hikes tend to disproportionately burden those with lower incomes, making fuel more costly relative to their monthly wages.

These income and location factors suggest that inhabitants in rural areas are likely the most affected by recent price hikes. Distributional effects across geography (rural vs urban) are often neglected in public discourse, as the income dimension is more visible. But both geography and income factors should be accounted for in a prioritized state support, should such be deemed necessary.

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.

Risks of Russian Business Ownership in Georgia

Image of Tbilisi at night representing risks of Russian business ownership in Georgia

This policy brief addresses risks tied to Russian business ownership in Georgia. The concentration of this ownership in critical sectors such as electricity and communications makes Georgia vulnerable to risks of political influence, corruption, economic manipulation, espionage, sabotage, and sanctions evasion. To minimize these risks, it is recommended to establish a Foreign Direct Investment (FDI) screening mechanism for Russia-originating investments, acknowledge the risks in national security documents, and implement a critical infrastructure reform.

Russia exerts substantial influence over Georgia. First and foremost, Russia has annexed 20 percent of Georgia’s internationally recognized territories of Abkhazia and South Ossetia. Further, it employs a variety of hybrid methods to disrupt the Georgian society including disinformation, support for pro-Russian parties and media, trade restrictions, transportation blockades, sabotage incidents, and countless more. These tactics aim to hinder Georgia’s development, weaken the country’s statehood, and negatively affect pro-Western public sentiments (Seskuria, 2021 and Kavtaradze, 2023).

Factors that may also increase Georgia’s economic dependency on Russia concern trade relationships, remittances, increased economic activity driven by the most recent influx of Russian migrants, and private business ownership by Russian entities or citizens (Babych, 2023 and Transparency International Georgia, 2023). This policy brief assesses and systematizes the risks associated with Russian private business ownership in Georgia.

Sectoral Overview of Russian Business Ovnership

Russian business ownership is significant in Georgia. Recent research from the Institute for Development of Freedom of Information (IDFI) has addressed Russian capital accumulation across eight sectors of the Georgian economy: electricity, oil and gas, communications, banking, mining and mineral waters, construction, tourism, and transportation. Of the eight sectors considered by IDFI, Russian business ownership is most visible in Georgia’s electricity sector, followed by oil and natural gas, communications, and mining and mineral waters industries. In the remaining four sectors considered by IDFI, a low to non-existent level of influence was observed (IDFI, 2023).

Figure 1. Overview of Russian Ownership in the Georgian Economy as of June 2023.

Source: IDFI, 2023.

There are several reasons for concern regarding the concentration and distribution of Russian business ownership in the Georgian economy.

First, it is crucial to keep Russia’s history as a hostile state actor in mind. Foreign business ownership is not a threat in itself; However, it may pose a threat if businesses are under control or influence of a state that is hostile to the country in question (see Larson and Marchik, 2006). Business ownership has been a powerful tool for the Kremlin, allowing Russia to influence various countries and raising concerns that such type of foreign ownership might negatively affect national security of the host country (Conley et al., 2016). Similar concerns have become imperative amidst Russia’s full-scale war in Ukraine (as, for instance, reflected in Guidance of the European Commission to member states concerning Russian foreign acquisitions).

Further, Russian business ownership in Georgia is particularly threatening due to the ownership concentration within sectors of critical significance for the overall security and economic resilience of the country. While there is no definition of critical infrastructure or related sectors in Georgia, at least two sectors (energy and communications) correspond to critical sectors, according to international standards (see for instance the list of critical infrastructure sectors for the European Union, Germany, Canada and Australia). Such sectors are inherently susceptible to a range of internal and external threats (a description of threats related to critical infrastructure can be found here). Intentional disruptions to critical infrastructure operations might initiate a chain reaction and paralyze the supply of essential services. This can, in turn, trigger major threats to the social, economic, and ecological security and the defense capacity of a state.

Georgia’s Exposure to Risks

Identifying and assessing the specific dimensions of Georgia’s exposure to risks related to Russian business ownership provides a useful foundation for designing policy responses. This brief identifies six distinct threats in this regard.

Political Influence

Russia’s business and political interests are closely intertwined, making it challenging to differentiate their respective motives. This interconnectedness can act as a channel for exerting political influence in Georgia. Russians that have ownership stakes in Georgian industries (e.g. within electricity, communications, oil and gas, mining and mineral waters) have political ties with the Russian ruling elite facing Western sanctions, or are facing sanctions themselves. For instance, Mikhail Fridman, who owns up to 50 percent of the mineral water company IDS Borjomi, is sanctioned for supporting Russia’s war in Ukraine. Such interlacing raises concerns about indirect Russian influence in Georgia, potentially undermining Georgia’s Western aspirations.

Export of Corrupt Practices

The presence of notable Russian businesses in Georgia poses a significant threat in terms of it nurturing corrupt practices. Concerns include “revolving door” incidents (movement of upper-level public officials into high-level private-sector jobs, or vice versa), tax evasion, and exploitation of the public procurement system.  For instance, Transparency International Georgia (2023) identified a “revolving door” incident concerning the Russian company Inter RAO Georgia LLC, involved in electricity trading, and its regulator, the Georgian state-owned Electricity Market Operator JSC (ESCO). One day after Inter RAO Georgia LLC was registered, the director of ESCO took a managerial position within Inter RAO Georgia LLC. Furthermore, tax evasion inquiries involving Russian-owned companies have been documented in the region, particularly in Armenia, further highlighting corruption risks. We argue that such corrupt practices might harm the business environment and deter future international investments.

Economic Manipulation

A heavy concentration of foreign ownership in critical sectors like energy and telecommunications, also poses a risk of manipulation of economic instruments such as prices. The significant Russian ownership in Armenia’s gas distribution network exemplifies this threat. In fact, Russia utilized a price manipulation strategy for gas prices when Armenia declared its EU aspirations. Prices were then reduced after Armenia joined the Eurasian Economic Union (Terzyan, 2018).

Espionage

Russian-owned businesses within Georgia’s critical sectors also pose espionage risks, including economic and cyber espionage. Owners of such businesses may transfer sensitive information to Russian intelligence agencies, potentially undermining critical infrastructure operations. As an example, in 2022, a Swedish business owner in electronic trading and former Russian resident, was indicted with transferring secret economic information to Russia. Russian cyber-espionage is also known to be used for worldwide disinformation campaigns impacting public opinion and election results, compromising democratic processes.

Sabotage

The presence of Russian-owned businesses in Georgia raises the risk of sabotage and incapacitation of critical assets. Russia has a history of using sabotage to harm other countries, such as when they disrupted Georgia’s energy supply in 2006 and the recent Kakhovka Dam destruction in Ukraine (which had far-reaching consequences, incurring environmental damages, and posing a threat to nuclear plants). These incidents demonstrate the risk of cascading effects, potentially affecting power supply, businesses, and locations strategically important to Georgia’s security.

Sanctions and Sanction Evasion

Russian-owned businesses in Georgia face risks due to Western sanctions as they could be targeted by sanctions or used to evade them. Recent cases, like with IDS Borjomi (as previously outlined) and VTB Bank Georgia – companies affected by Western sanctions given their Russian connections – highlight Georgia’s economic vulnerability in this regard. Industries where these businesses operate play a significant role in Georgia’s economy and job market, and instabilities within such sectors could entail social and political concerns. There’s also a risk that these businesses could help Russia bypass sanctions and gain access to sensitive goods and technologies, going against Georgia’s support for international sanctions against Russia. It is crucial to prevent such sanctions-associated risks for the Georgian economy.

Assessing the Risks

To operationalize the above detailed risks, we conducted interviews with Georgian field experts within security, economics, and energy. The risk assessment highlights political influence through Russian ownership in Georgian businesses as the foremost concern, followed by risks of corruption, risks related to sanctions, espionage, economic manipulation, and sabotage. We asked the experts to assess the severity level for each identified risk and notably, all identified risks carry a high severity level.

Recommendations

Considering the concerns detailed in the previous sections, we argue that Russia poses a threat in the Georgian context. Given the scale and concentration of Russian ownership within critical sectors and infrastructure, a dedicated policy regime might be required to improve regulation and minimize the associated risks. Three recommendations could be efficient in this regard, as outlined below.

Study the Impact of Adopting a Foreign Direct Investment Screening Mechanism

To effectively address ownership-related threats, it’s essential to modify existing investment policies. One approach is to introduce a FDI screening mechanism with specific functionalities. Several jurisdictions implement mechanisms with similar features (see a recent report by UNCTAD for further details). Usually, such mechanisms target FDI’s that have security implications. A dedicated screening authority overviews investment that might be of concern for national security and after assessment, an investment might be approved or suspended. In Georgia, a key consideration for designing such tool includes whether it should selectively target investments from countries like Russia or apply to all incoming FDI. Additionally, there’s a choice between screening all investments or focusing on those concerning critical sectors and infrastructure. Evaluating the investment volume, possibly screening only FDI’s exceeding a predefined monetary value, is also a vital aspect to consider. However, it’s important to acknowledge that FDI screening mechanisms are costly. Therefore, this brief suggests a thorough cost and benefit analysis prior to implementing a FDI screening regime in Georgia.

Consider Russian Ownership-related Threats in the National Security Documents

Several national-level documents address security policy in Georgia, with the National Security Concept – outlining security directions – being a foundational one. Currently, these concepts do not specifically address Russian business ownership-related threats. When designing an FDI screening mechanism, however, acknowledging various risks related to Russian business ownership must be aligned with fundamental national security documents.

Foster the Adoption of a Critical Infrastructural Reform

To successfully implement a FDI screening mechanism unified, nationwide agreement on the legal foundations for identifying and safeguarding critical infrastructure is needed. The current concept for critical infrastructure reform in Georgia envisages a definition of critical infrastructure and an implementation of an FDI screening mechanism. We therefore recommend implementing this reform in the country.

Conclusion

This policy brief has identified six distinct risks related to Russian business ownership in several sectors of the Georgian economy, such as energy, communications, oil and natural gas, and mining and mineral waters. Even though Georgia does not have a unified definition of critical infrastructure, assets concentrated in these sectors are regarded as critical according to international standards. Considering Russia’s track record of hostility and bearing in mind threats related to foreign business ownership by malign states, this brief suggests regulating Russian business ownership in Georgia by introducing a FDI screening instrument. To operationalize this recommendation, it is further recommended to consider Russian business ownership-related threats in Georgia’s fundamental security documents and to foster critical infrastructural reform in the country.

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.

Employment and Envelope Wages During the Covid-19 Crisis in Latvia

20231113 Envelope Wages Tax Evasion Image 01

The Covid-19 pandemic created one of the most substantial negative exogenous shocks in decades, forcing firms to rapidly adapt. This brief examines an adjustment mechanism that played a significant role in Latvia, and potentially in other countries in Eastern and Central Europe. Specifically, we focus on the role of envelope wages as a buffer for absorbing the shock. Our analysis demonstrates that this form of tax evasion indeed acted as a cushion during the Covid-19 pandemic. Our results indicate that, in the short run, tax-evading firms experienced smaller employment losses in response to the Covid-19 shock compared to compliant firms.

Introduction

The Covid-19 pandemic generated one of the largest negative, exogenous shocks in decades. To absorb this shock, firms had to swiftly adapt. Prior literature has demonstrated that firms responded by reducing employment and investment (Lastauskas, 2022; Fernández-Cerezo et al., 2023; Buchheim et al., 2020). In this brief, we discuss another margin of adjustment – potentially important for many countries in the region. We focus on the role of envelope wages as a buffer for negative shock absorption.

Envelope wages is a widespread form tax evasion, in which, for employees that are formally registered, a portion of their salary (often at the minimum wage level) is reported to tax authorities, while the remaining ‘envelope’ portion is paid unofficially. The prevalence of this phenomenon has been extensively documented in Eastern and Central Europe (see Kukk and Staehr (2014) and Paulus (2015) for Estonia, Gorodnichenko et al. (2009) for Russia, Putniņš and Sauka (2015) for the Baltic States, Tonin (2011) and Bíró et al. (2022) for Hungary).

In addition to the evident objective of reducing tax obligations, a primary incentive for firms to employ this evasion scheme is the extra flexibility it provides. The unreported portion of wages operates outside of the legal framework, offering firms a means of adaptation in the face of production restrictions, supply chain disruptions, and overall substantial uncertainty caused by the Covid-19 pandemic. In this brief, we argue that firms utilizing envelope wages reduced their employment less than compliant firms during the pandemic in Latvia.

Identifying Firms That Pay Envelope Wages

We identify firms that paid (at least partly) their employees in cash before the pandemic using a rich combination of Latvian administrative and survey data and the methodology proposed by Gavoille and Zasova (2021).

The idea is as follows: We use a subsample of firms for which we can assume that we know whether they pay envelope wages and, using this subsample, train an algorithm that is capable of distinguishing compliant and evading firms based on their observed characteristics and reported financials.

Following Gavoille and Zasova (2021), we use firms owned by Nordic investors as a subsample of tax-compliant firms. To obtain a subsample of non-compliant firms, we combine data on administrative (i.e., reported) wages with several rounds of Labor Force Survey data in order to spot employees who are paid suspiciously little given their personal characteristics (education, experience, etc). Firms employing these employees form the subsample of evading firms. Using these samples of compliant and evading firms, we train a Random Forest algorithm to classify firms according to their type. We then use the algorithm to classify the universe of firms used in this study. Table 1 shows the classification results.

Table 1. Classification results: share of tax-evading firms and employees.

Source: Authors’ calculations.

We find that almost 40 percent of firms (employing about 20 percent of employees) underreport at least some of their workers’ wages. The cross-sectoral heterogeneity is consistent with survey evidence: the construction and transport sectors are the sectors with the highest prevalence of envelope payments. Comparing the share of tax-evading firms with the share of workers working within these firms also indicates that on average, tax-evading firms are smaller than tax-compliant ones. This is yet again in accordance with survey evidence.

Employment Response During Covid-19

Figure 1. Average firm-level change in employment during the Covid-19 pandemic.

Note: This figure shows the average change in employment between January 2020 and any subsequent month, weighted by firm size (average turnover 2017-2019).
Source: Authors’ calculations.

The Covid-19 crisis had a severe impact on Latvia. The government declared a state of emergency as early as March 13, 2020, which entailed significant restrictions on gatherings and on-site work, leading to a six-fold increase in the proportion of remote workers within a matter of months.

During the second wave, in Autumn 2021, Latvia had the highest ranking in the world in terms of new daily positive cases per capita. A substantial number of firms were directly affected by the pandemic (see Figure 1).

We study firm-level employment response at a monthly frequency in compliant and tax-evading firms, from January 2020 to December 2021. Our empirical approach is in the spirit of Machin et al. (2003) and Harasztosi and Lindner (2019), who study the effect of minimum wage shocks. In essence, this approach consists of a series of cross-section regressions, where the dependent variable is the percentage change in employment in a firm between a reference period (set to January 2020) and any subsequent month until December 2021. Our key interest is the difference in cumulative employment response between tax-compliant and evading firms, controlling for a set of (pre-pandemic) firm characteristics, such as the firm’s age, average profitability, average export share, and average labor share over the 2017-2019 period.

The Aggregate Effect

Figure 2 shows the estimated coefficients that measure the difference between employment effects in compliant and tax-evading firms, aggregate for all sectors. Period 0 denotes our reference period, i.e., January 2020, while the estimated coefficients in other periods show the cumulated difference between tax compliant and tax-evading firms in the respective period relative to January 2020 (e.g., the estimated coefficient in period 10 shows the cumulated differential employment response in October 2020 vis-à-vis January 2020).

We document a noticeable difference in the employment response between the two types of firms starting in April 2020. The positive coefficient associated with evading firms indicates that the change in employment growth was not as negative in evading firms as in compliant firms (see Figure 2). Labor tax-evading firms exhibit, on average, a less sensitive employment response than tax-compliant firms. In March 2021, the point estimates are about 0.025, implying that compared to March 2020, tax-evading firms contracted, on average, 2.5 percentage points less than compliant ones. This difference however fades over time and turns insignificant (at the 95 percent level) about halfway through 2021.

Figure 2. Evasion and total employment.

Note: This figure shows the cumulative difference between employment effects in compliant and tax-evading firms, aggregate for all sectors, by month, with respect to January 2020 (reference period).
Source: Authors’ calculations.

Differences by Sector

Figure 3 displays the estimated difference in employment response, disaggregating the sample by sector. We show the results for two sectors: trade and transportation. These two sectors exhibited the most significant differences in employment response between evading and non-evading firms.

For trade, evading firms have been able to maintain employment losses at approximately 5 percentage points less than compliant firms (see Figure 3(a)). This is consistent with the envelope wage margin mechanism. Contrary to the aggregate results, the difference in employment response does not fade over time. This suggests that this margin is not a shock absorber only in the very short run.

The decrease of the evader effect at the aggregate level is caused by negative point estimates of the evasion indicator in the transportation sector, starting in the first quarter of 2021 (see Figure 3(b)). In this sector, evading firms have on average experienced a larger employment decline in 2021 than compliant firms.

Figure 3. Employment effect – by sector.

Note: These figures show the cumulative difference between employment effects in compliant and tax-evading firms, disaggregated by sectors. Source: Authors’ calculations.

The outcome in the transportation sector is likely influenced by the taxi market. There were two major changes in 2021 that particularly affected taxi drivers receiving a portion of their remuneration through envelopes. Firstly, amendments to State Revenues Service’s (SRS) regulations made it more difficult to underreport the number of taxi trips, as each ride was now automatically recorded in the SRS system through taxi apps. Secondly, commencing in July, legal amendments mandated a minimum social security tax, which had to be paid based on at least the minimum wage. Given that many taxi drivers work part-time, and that those associated with evading firms tend to underreport their rides, this new requirement was more binding for evading firms. Additionally, there was a significant shift of taxi drivers to the food delivery sector, where demand for driver services surged during the pandemic.

Conclusion

Our results indicate that employment losses in response to the Covid-19 shock were smaller in tax-evading firms than in compliant firms in the short run. We also demonstrate that by the end of 2021, the discrepancy between the two types of firms had disappeared. This can be explained by significant heterogeneity in employment responses across sectors.

These findings contribute to our understanding of the pandemic’s impact on the size of the informal sector. Despite tax-evading firms generally having more restricted access to finance, the added flexibility provided by unreported wages may have increased their resilience to the negative shock.

Acknowledgement

This brief is based on a forthcoming working paper COVID-19 Crisis, Employment, and the Envelope Wage Margin. The authors gratefully acknowledge funding from EEA and Norway, grant project “Micro-level responses to socio-economic challenges in face of global uncertainties” (Grant No. S-BMT-21-8 (LT08-2-LMT-K-01-073)).

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. 

The EU Gas Purchasing Mechanism: A Game-Changer or a Storm in a Teacup?

Image of the LNG tanker in the Baltic Sea representing EU gas purchasing mechanism

Marking a milestone in the tumultuous journey towards a unified energy policy, the European Union (EU) member states have initiated joint procurement of a portion of their gas consumption. This coordinated effort has been facilitated through a gas purchasing mechanism, the AggregateEU, as of May 2023. In this policy brief we discuss the challenges this mechanism faces, given its design characteristics and the altered dynamics of the gas market following the energy crisis.

The necessity for a coordinated approach to energy security within the EU has been recognized at least since 2009, when its legal base was explicitly introduced in Article 194 of the Treaty of Lisbon. However, the de facto implementation of the solidarity principle has been lagging for many years. In response to the 2022 surge in gas prices, the EU has at last taken the solidarity approach to common energy security seriously. One of the most prominent steps is the creation of the AggregateEU mechanism, launched at the end of 2022. This mechanism aggregates the demand of registered buyers from different member states and matches it with competitive bids from external gas suppliers. It aims at improving and diversifying the EU gas supply, avoiding unnecessary buyer competition within the EU and building up the buyer power of EU member states. Furthermore, the mechanism is meant to reduce uncertainty and mitigate price volatility by providing information about accessible energy supplies. The mechanism covers both pipeline natural gas and Liquified Natural Gas (LNG) and organizes tenders every two months. While  EU member states are required to submit demand bids for 15 percent of their 90 percent storage targets for the upcoming 2023-24 season through the mechanism, there is no obligation to sign any contracts based on the resulting match (more details can be found here and here).

The first three rounds of tendering via the mechanism, which took place May-October 2023, matched approximately 34 billion cubic meters of natural gas, exceeding the anticipated initial volumes. This outcome is currently perceived as a great achievement, enabling more vulnerable countries to benefit from coordinated purchases and resulting in increased bargaining power. Driven by this success, the European Commission (EC) has considered making demand aggregation via the mechanism a permanent feature of the EU’s gas market – and even extending it to hydrogen. However, while these agreed trades are a positive development, they may not reflect the mechanism’s overall success. Demand submission obligations may increase the number of demand calls which could project into more matches, but as they are not binding the subsequent agreements may not necessarily result in finalized contracts or lower prices.

In this brief, we argue that the mechanism’s benefits remain uncertain, primarily due to the current state of the EU’s gas market and the design flaws arising from efforts to address disparities in energy security among member states. These considerations call for a direct impact assessment, which however remains impossible due to the EC’s inability (or even reluctancy?) to collect and disclose the contracted outcomes resulting from the mechanism matches. This is especially problematic in light of the EC’s intentions to extend the mechanism’s coverage.

Limited Mechanism Benefits Under New Market Trends

Over the past two years, the EU has undertaken drastic efforts to address the energy security concerns within its gas market caused by the radical reduction in Russia’s natural gas exports to Europe. The EU has managed to sizably improve the diversification of its gas imports (see Figure 1), fill its storage facilities, and lower its gas demand (see McWilliams, Sgaravatti, and Zachmann (2021) and McWilliams and Zachmann (2023)).

Figure 1. Composition of EU natural gas imports.

Source: Authors’ calculations based on McWilliams, Sgaravatti and Zachmann (2021).

As a result, a certain balance of supply and demand has been achieved, and the gas prices in the EU market have fallen to pre-war price levels (though they are still somewhat higher than their earlier long-term trend), as depicted in Figure 2. The ease of market tensions in 2023 has led many to argue that market forces are sufficient to resolve potential problems in the EU gas market and that mechanism costs would not be justified (see, e.g., Eurogas or International Association of Oil and Gas Producers opinions).

However, in the coming years the EU gas market is expected to be relatively tight due to capacity constraints both in the LNG market and for pipeline gas producers (as noted by, e.g., Bloomberg and IEA). This tightness makes the market highly sensitive to shocks, and a twofold increase in exposure to LNG – with its global liquidity – only adds to the problem. A good illustration of this concern is the recent market reaction to the Israel-Palestine war:  the fear of supply disruptions lead to a whopping 55 percent increase in the European gas tariff TTF in the second week of October and to an EC initiative to prolong the emergency gas price cap, initially introduced in February 2023. This despite the EU’s gas storage nearing 98 percent of capacity and relatively low current prices.

Such a “seller market” situation implies that buyers’ ability to exercise buyer power and negotiate down prices may be highly limited when needed the most. Specifically, buyer power would be most effective when buyers have a credible outside option, e.g., the ability to claim that their gas demand needs can be facilitated elsewhere. The tighter the market, the more difficult it would be to find such volumes elsewhere, further limiting buyers’ ability to negotiate down prices. To put it differently: current market conditions may undermine the original purpose of the mechanism.

The current “shock-sensitivity” of the gas market may also give rise to additional concerns regarding the mechanism’s mere purpose – demand aggregation for vulnerable buyers. One of the by-products of demand aggregation is that (pooled) buyers are more likely to face correlated risks, e.g., by purchasing gas from the same producer. If markets are highly shock-sensitive – as they currently seem to be – such aggregation may further increase market volatility, implying that vulnerable buyers would be affected the most.

Figure 2. Natural gas prices in the EU, January 2021-October 2023 (prices in EUR).

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

Mechanism Design: Constraints vs. Efficiency

Some design elements of the purchasing mechanism may also challenge the mechanism’s ability to deliver an efficient outcome. First, quantity and price under the matching process are not binding, and buyers and sellers are expected to continue negotiations individually after the matching. This feature was introduced due to the concern that it would be challenging to offer a “one size fits all” binding contract to incorporate all participants of the pooled demand. This, as argued by Le Coq and Paltseva (2012; 2022), was one of the reasons for the previous failure to implement a mutual insurance and solidarity mechanism across the EU. However, the non-binding matching outcome will likely give rise to re-negotiations, price increases, and failure to exercise consolidated “buyer power”.

Moreover, a company can act on behalf of small or financially constrained buyers, purchase gas for them, and become an “Agent-on-behalf” and “Central Buyer”. In the process, companies will inevitably exchange sensitive information. This may limit competition and increase the market power of the “Central Buyer” company. In addition, firms may choose not to participate in the mechanism for at least two reasons. First, they may fear the threat of revealing valuable private information. Second, demand aggregation may discourage market participants with stronger buyer positions from participating, as being pooled with weaker participants would undermine their bargaining power. Both these cases would create a so-called adverse selection effect, where the more performant market participants would choose to avoid the joint purchasing mechanism. As a result, the joint buyer power may be strongly undermined, and the price-suppressing effect seems uncertain. This may explain why some firms, like several large German firms, have opted to sign long-term contracts with gas suppliers directly rather than via the mechanism

Several of these concerns arise not from the mechanism design per se but rather in combination with the inherent asymmetries between EU buyers, including variations in gas demand, risk exposure, etc. To put it differently: it is well justified that a “one size fits all” approach would fail in ensuring broad (and voluntary) mechanism participation; however, the choice of a more flexible solution, as implemented by the AggregateEU mechanism, creates commitment issues and adverse selection, and may undermine an effective use of buyer power.

Impact Assessment: Necessary but Currently Impossible

The new EU gas purchasing system is a significant step towards creating a unified energy policy. However, the design of such a procurement auction raises concerns about its contribution, especially under the new gas market dynamics. The current low gas prices make the immediate cost-benefit tradeoff of the mechanism nonobvious. More importantly, the tightness of the EU gas market in the next few years makes the “seller” power unlikely to be counteracted by the EU’s buyer power. Further, the absence of legal commitment between matched participants, and increased market volatility can lead to repeated ex-post renegotiations. These elements undermine the mechanism’s role and raise doubts about its benefits. Some of the mechanism’s inherent features, such as incentives for abuse of market power, also contribute to potential efficiency loss.

Hence, while the motivation behind this tool is clear, the implementation and potential design flaws may undermine the gains. It is therefore particularly important to understand whether the mechanism is effectively meeting its objectives, especially given the recent initiative to make it a permanent feature of the EU gas market and a key solution for the European Hydrogen Bank in the future. These considerations make a strong call for an impact assessment. An unbiased measure of AggregateEU’s impact would be necessary to assess the benefits of the mechanism (and to weigh them against the bureaucratic implementation costs). Currently, however, the EC has chosen not to collect, let alone disclose, the contractual outcomes resulting from matches. In a recent interview, Matthew Baldwin, deputy director-general at the EC’s energy directorate, said, “The reality is we’ve had relatively little feedback so far because companies are not required to give that to us in terms of the deals”. One may argue that many of the potential deficiencies of the mechanism design – e.g., non-binding matching and adverse selection – are justified by asymmetries across participants and other inherent market features. However, the absence of (appropriately desensitized) data about actual outcomes resulting from mechanism matches is more difficult to justify. The lack of data prevents us from evaluating the AggregateEU’s performance and raises additional concerns about its efficiency. Thus, gathering relevant information and conducting a comprehensive impact assessment based on sensible criteria are essential prerequisites for the future use, and expansion of the AggregateEU mechanism.

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.