i occasional paper41920 18 Improving the Business Environment in Latvia The Impact of FIAS Assistance Sanda Liepina Jacqueline Coolidge Lars Grava www.fias.net © 2008 The International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org E-mail: feedback@worldbank.org All rights reserved 1 2 3 4 5 10 09 08 07 This volume is a product of the staff of the International Bank for Reconstruction and Development / The World Bank. The findings, interpretations, and conclusions expressed in this volume do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: pubrights@worldbank.org. ISBN: 978-0-8213-7189-3 eISBN: 978-0-8213-7190-9 DOI: 10.1596/978-0-8213-7189-3 Library of Congress Cataloging-in-Publication Data has been applied for. iii Through FIAS, the International Bank for Reconstruction and Development and the International Finance Corpo- ration, using their best efforts in the time available, endeavored to provide high-quality services hereunder and have relied on information provided to them by a wide range of other sources. However, they do not make any repre- sentations or warranties regarding the completeness or accuracy of the information included this report, or the results that would be achieved by following its recommendations. ABOUT FIAS For 20 years, FIAS has advised more than 130 member country governments on how to improve their investment climate for both foreign and domestic investors and maximize its impact on poverty reduction. FIAS is a joint service of the International Finance Corporation, the Multilateral Investment Guarantee Agency, and the World Bank. FIAS receives funding from these institutions and through contributions from donors and clients. FIAS also receives core funding from: Australia New Zealand Canada Norway France Sweden Ireland Switzerland Luxembourg United Kingdom Netherlands iv CONTENTs contents Preface vii Acknowledgments vii Acronyms viii Executive Summary 1 IMPROVING THE BUSINESS ENVIRONMENT IN LATVIA: THE IMPACT OF FIAS ASSISTANCE 5 Rationale for the Case Study 5 The Study 5 FIAS Follow-Up Assistance to and Collaboration with the Government of Latvia 7 Did the Business Environment Improve? 8 From Improvements in the Business Environment to Greater Welfare 16 Did FIAS Succeed in Measuring Economic Improvements? 24 APPENDIX 1: OVERVIEW OF THE FIAS PROGRAM IN LATVIA 1998­2004 27 Chronology of FIAS Work in Latvia since 1998 28 APPENDIX 2: DETAILED DESCRIPTION OF FIAS' LATVIA PROGRAM 31 Project Inputs and Activities 31 Project Outputs and Outcomes 32 Inspections 33 Customs Administration, Border-Crossing, and Import/Export Procedures 40 Tax Administration 48 Expatriate Immigration 53 Procedures for Land Acquisition and Construction Permits 56 Structured Dialogue between the Government and the Business Community 61 APPENDIX 3: INTERMEDIATE IMPACT ON THE INVESTMENT CLIMATE IN LATVIA 65 Defining the Investment Climate 65 Scope of FIAS' Administrative Barrier Work and the Investment Climate 66 Customs, Border-Crossings, and Import/Export Procedures 67 Regulatory Barriers to Business 68 Corruption 74 APPENDIX 4: FINAL IMPACT: INVESTMENT, GROWTH, AND POVERTY ALLEVIATION 77 Private Sector Investment 77 Trade Openness 79 Economic Growth 80 Formalization and Tax Revenues 80 Employment and Living Standards 84 Poverty and Human Development 85 CONTENTs v APPENDIX 5: METHODOLOGY NOTE ON COST-BENEFIT CALCULATIONS OF THE FIAS LATVIA ADMINISTRATIVE BARRIERS PROJECT 89 Assumptions 89 Qualification of Calculations 89 REFERENCES 91 Boxes Box 1. Inspections Reform: More Professional Inspections, More Accountability in the Inspection Process 14 Figures Figure 1. FIAS Monitoring and Evaluation Framework 5 Figure 2. Cycle of Reforms 6 Figure 3. Areas of Regulation Considered by Businesses to Impede Their Operation and Growth, 2001, 2003, and 2005 10 Figure 4. Business Registration in EU Accession Countries, 2004 and 2005 13 Figure 1B.1. Average Duration of Inspections, 2001 and 2003 15 Figure 1B.2. Changes in Quality of Inspection Work between 2001 and 2003 16 Figure 5. Annual FDI in Latvia, 1996 through September 2005 21 Figure 6. Rates of Unemployment and Job Seekers, 1999­2004 22 Figure 7. Comparison of Average Wage and the Cost of Minimum Subsistence, 1997­2005 23 Figure 8. GDP Per Capita, PPS, 1999 and 2005 24 Figure 9. Change in GDP Per Capita, PPS, 1999­2005 25 Figure 10. Poverty Trends in Latvia, 1998­2004 25 Figure 2A.1. Average Duration of Inspections, 2001 and 2003 36 Figure 2A.2. Changes in Quality of Inspection Work between 2001 and 2003 42 Figure 2A.3. Business Opinions on Customs Services Obstacles to Operation and Growth, 2003 47 Figure 2A.4. Customs Control Work, 1998­2003 48 Figure 2A.5. Number of Customs Declarations (Import, Export, Transit), 1998­2003, and Amount of Calculated Tax, 2000­03 49 Figure 2A.6. Time Required for Tax Preparation, 2001 and 2003 54 Figure 2A.7. Building Permits Issued Nationally for Houses, Nonresidential Buildings, and Engineering Structures, 1999­2003 59 Figure 2A.8. Building Permits Issued in Riga, 1998­2003 59 Figure 2A.9. Length of Real Estate and Construction Procedures, 2001, 2003, and 2005 60 Figure 3A.1. Business Registration in EU Accession Countries, 2004 and 2005 70 vi Contents Figure 3A.2. Property Registration 72 Figure 4A.1. Gross Fixed Capital Formation as a Share of GDP, 1999­2005 77 Figure 4A.2. Per Capita Net FDI Inflows in EU Accession Countries, 1994­2005 78 Figure 4A.3. Growth in GDP Per Capita and Per Capita Real GDP 80 Figure 4A.4. Minimum Wage in Eastern Europe, 2004 81 Figure 4A.5. Wages and Subsistence 84 Figure 4A.6. Poverty Trends in Latvia, 1998­2004 86 Tables Table 1. Changes in Obstacles to Doing Business between 2002 and 2005 12 Table 2. Summary of the Quantifiable Impact of Reform 18 Table 3. Key Indicators of Economic Development, 1999­2005 22 Table 4. Key Poverty and Inequality Statistics, 1998­2004 25 Table 1A.1. Logical Framework for Removal of Administrative Barriers to Investment 29 Table 2A.1. Inspections: Recommended Reforms and Their Outcomes 34 Table 2A.2. Average Number of Annual Inspections per Company Inspected 36 Table 2A.3. Changes in Selected Performance Indicators of the State Labor Inspectorate 37 Table 2A.4. Selected Performance Indicators of the Fire and Rescue Service and the State Labor Inspectorate 38 Table 2A.5. Government Information Available to Enterprises 39 Table 2A.6. Evaluation of Inspectorate Web Sites, August 2004 40 Table 2A.7. Customs Administration, Border-Crossing, and Import/Export Procedures: Reform Recommendations and Their Outcomes 43 Table 2A.8. Tax Administration: Recommended Reforms and Their Outcomes 51 Table 2A.9. Work Permits: Recommended Reforms and Their Outcomes 55 Table 2A.10. Land and Construction Procedures: Recommended Reforms and Their Outcomes 58 Table 2A.11. Structured Dialogue with the Business Community: Recommendations and Their Outcomes 62 Table 3A.1. Trade Policy Rulings in Latvia, 1995­2006 67 Table 3A.2. Changes in Customs Services between 2001 and 2003 69 Table 3A.3. Business Regulation Ratings 73 Table 3A.4. Corruption Ratings 75 Table 4A.1. Trade Openness, 1995­2005 79 Table 4A.2. Number of Taxpayers by Type of Employment, 1999 and 2005 81 Table 4A.3. Tax Revenues, 1995­2004 82 Table 4A.4. Employment, 1996 to September 2005 83 Table 4A.5. Wages and Cost of Minimum Subsistence, 1997­2005 85 Table 4A.6. Key Poverty and Inequality Statistics, 1998­2004 86 Table 4A.7. Human Development in EU Accession Countries, Selected Years, 1995­2003 87 preface vii preface This paper tracks the process through which FIAS, The first draft of this case study was prepared in August the investment climate advisory service of the World 2004. It was updated after a series of discussions and Bank Group advised the government of Latvia from comments during the first half of 2006. 1998 to 2004 on ways to improve the business envi- The executive summary presents a concise account of ronment, achieve higher rates of economic growth, the findings and the arguments used in the case study. and thereby alleviate poverty. The main report contains a detailed analysis of the key The case study was developed on the basis of interviews elements of the reform program in Latvia and the rea- with many of the stakeholders involved in the reform soning behind the conclusions. process; surveys of the business environment in Latvia The appendixes contain an overview of the FIAS pro- in 2001, 2003, and 2005 (including independent gram in Latvia (appendix 1) and details of the reforms econometric findings prepared by a researcher in 2004 enacted (appendix 2). The outcome of reforms as expe- and 2006, which the authors used in their conclusions); rienced by businesses are discussed at length in appendix legal research; and materials generated by governmental 3, and the higher level impact of these reforms and institutions, including the Business Environment improvements in the business climate is assessed in Improvement Unit at the Latvian Investment and appendix 4. Details of the methodology of the analysis Development Agency and the Ministry of Economy. are described in appendix 5. acknowledgments The authors thank Domagoj Ilic and Gregory Kisunko, and checked the math and benefit­cost logic; Nessa who provided critical leadership in the survey work; Busjeet, who helped with formatting and presentation; Aminur Rahman, who drafted some of the appendixes; Terry Anderson and Christine Bowers, who provided Jevgenijs Steinbuks and Reinis Viba, who contributed editorial assistance; and peer reviewers Vincent Palmade to survey analysis; Geeta Batra, Thomas Davenport, and and Susan Rose-Ackerman. Errors and omissions are Frank Sader, who provided helpful comments on an those of the authors. earlier draft; Peter Kusek, who reviewed a recent draft viii acronyms acronyms ARCS Administrative and Regulatory Cost Survey BEEPS Business Environment and Enterprise Performance Survey CC-BEST Candidate Country­Business Environment Simplification Task Force CM Cabinet of Ministers CMIB Citizenship and Migration Issues Board CPI Corruption Perceptions Index EBRD European Bank for Reconstruction and Development EU European Union FDI foreign direct investment FIAS Foreign Investment Advisory Service FICIL Foreign Investors' Council in Latvia GCR Global Competitiveness Report GDP gross domestic product HDI Human Development Index LDA Latvian Development Agency LIDA Latvian Investment and Development Agency LVL Latvian lats NGO Nongovernmental Organization PCR Project Completion Report PIMS Project Implementation Monitoring System PPP purchasing power parity PPS purchasing power standards SES State Employment Service SME small and medium enterprise SRS State Revenue Service UNDP United Nations Development Programme VAT value-added tax executive summary 1 Executive summary The primary mission of the World Bank Group is of Latvia with an initial diagnostic study of the key reducing poverty. FIAS, the multidonor investment problems and offered recommendations for improve- climate advisory service of the World Bank Group, ment. FIAS also helped establish both the institutional supports this mission by advising and management frameworks for these reforms and a Aim developing country governments on regular business environment monitoring system of the how to improve their investment through which policy makers and businesses could paper climate through private sector obtain regular information on key issues being development. Poverty-reducing addressed through the reform program. As the economic growth is most sustain- Government of Latvia progressed with its reform able where the private sector is flourishing; where agenda, FIAS also changed its mode of intervention to there are efficient, competitive, and dynamic markets; serve more as a trusted adviser that could mobilize its and where the government intervenes only when resources relatively quickly to provide high-quality needed to correct market failures and to improve advisory services. opportunities for the poor--and then does so in the The most significant reforms between 1999 and 20041 most efficient manner. were achieved in the following areas: There is now an increasing demand in the development Enterprise registration: Procedures were stream- community to verify the relationships between advisory Successful lined and simplified, company and tax regis- assistance on reforms to improve the business environ- reforms tration procedures were combined, and the ment and the actual enactment of such reforms; and time for basic business registration processes beyond that, to verify whether such reforms are indeed was reduced to three days. associated with higher rates of investment, economic Tax administration: An appeals body was established growth, job creation, and poverty reduction. This paper in the State Revenue Service; and tax legislation was attempts to track the practical connection between FIAS drafted and posted on the Internet for comment, projects and poverty alleviation, focusing on FIAS assis- which helped resolve tax problems that businesses tance to the Government of Latvia and the government's identified by amending relevant tax laws and by con- reforms to improve the business environment and solidating methodological guidelines and manuals. remove administrative barriers to investment from Inspections: The rights and responsibilities of govern- 1998 to 2004. ment inspectors relative to those being inspected The core objective of the were specified, greater information about the inspec- Mode of FIAS Government of Latvia Reform tion process was made available to businesses, com- assistance Program to Improve the Busi- pulsory annual performance reports were established, ness Environment was to re- and training programs for inspectors were devised to duce administrative barriers to investment. Over time, improve their relationships with clients. other elements needed attention, such as labor skills Customs and border crossing: Responsibilities of the and access to finance. FIAS assisted the Government border guard and customs service were better defined 1. Although FIAS conducted a study of administrative barriers to investment in 1998, the reform program to implement recommendations from that study began in 1999. 2 executive summary and delineated, customs procedures were simplified, action plan updates (i.e., regular government review manuals were prepared and made available to busi- and updating of mechanisms/instruments to address nesses, a Consultation Department was established, issues of concern to the business community) and simplified clearance procedures for regular a monitoring system to track the views and experiences importers/exporters were set up. of the business community (i.e., the government is Construction and real estate: Information on cadastral funding a regular independent and representative valuations for determining the real estate tax was im- business survey to assess the scale of administrative proved; a state duty of 2 percent of the transaction burdens and to identify problem areas). value or real estate cadastral value to register title According to the results of surveys conducted between transfer was capped; a uniform set of fees and duties 2001 and 2005, businesses operating in Latvia have seen for construction were introduced; and the construc- improvements in the overall tion permit process was simplified, streamlined, and The business business environment and in made more transparent. environment did specific regulatory areas and ad- Expatriate residency: Procedures for issuing work and improve. ministrative procedures. residence permits were simplified and new service centers for foreigners were established by the Citi- Several key international indicators of the investment zenship and Migration Issues Board. climate have shown clear signs of improvement (although not all indicators did). Reform dynamics resulted in the simultaneous institu- tionalizing of Although FIAS cannot claim direct credit for the impact of its recommendations, improvements to the invest- the public/private dialogue (i.e., government officials ment climate in the broader economy clearly have are more willing and able to engage the business yielded improvements in private investment. For exam- community in constructive dialogue to identify prob- ple, whereas gross fixed capital formation in the private lems and solutions, government agencies more sector in 1997 was 16 percent of gross domestic product actively seek private sector comments on draft (GDP), by 2004 it had increased to 27.5 percent of legislation, and information on various business-related GDP; and the number of active taxpaying firms procedures has become more accessible) Many reforms were initiated in the period 1999 through 2002, and the Administrative and Regulatory Cost Survey carried out in Latvia in late-2001 and again in late-2003 and 2005 showed many signs of continuing improvement: · a steady reduction in the share of businesses that regard regulations as an obstacle to their operation and growth · improved access to information and updates regarding tax issues · reduced frequency and duration of inspections · declines in the incidence and severity of fines imposed on businesses · There have been reductions in the time and money costs of administrative procedures, such as time spent registering a company and registering title transfer in Land Books. executive summary 3 increased by 31 percent between 1997 and 2004 (from 2001, but our baseline survey took place only in 2001, 35,259 to 51,440 active companies, respectively). so some improvements were entirely missed in the ben- efits calculation. Also, given the range of reforms that After a period of high economic growth in the mid- have been implemented (including some for which 1990s (GDP growth averaged 6 percent), the Latvian quantifiable data are not readily available), it is likely economy suffered a downturn in mid-1998 as a result of that the effect of the business environment improve- the Russian currency crisis and a slowdown in reforms. ment program is much more substantial. The new wave of reforms--not the least of which were efforts to improve the business environment--along Most important is the likelihood that the dismantling of with favorable external conditions resulted in a recovery barriers to investment and reduction in regulatory risk that began in early 2000 with industrial output and in- (for example, the risk of severe bureaucratic delays or vestment growing and business confidence improving. spurious fines imposed by government inspectors) did GDP growth reached 10.2 percent in 2005 with con- indeed help stimulate more private investment than tinued strong domestic demand, and the July 2006 fore- would have taken place without the reforms, the value cast was that strong investment would continue to of which has not been quantified for this analysis. Along maintain GDP growth at 8 percent in 2006. with the growth in investment came a growth in the overall number of firms in the Latvian economy--an Beyond these figures, Latvia achieved substantial indication of increased competition as a result of lower progress in poverty reduction. The effect of high GDP barriers to entry. growth has been to lift an estimated 325,000 people out of poverty (World Bank 2006, p. vii).2 The labor mar- It must be noted that the analysis is more "after vs. ket provided the primary channel through which more before" rather than the more accurate "with reform vs. people are now living above the poverty line. without reform," for which we lack a counterfactual. As a control, Estonia and Lithuania might be reasonable The quantifiable benefits of business environment comparators. Latvia has enjoyed the highest growth rates improvements accruing to businesses were at least of the three countries over the period 1998­2005, with US$170 million between 2001 an average annual GDP growth rate of 7.1 percent, and 2005, discounted to 1998 Quantifying the compared with 6.3 percent in Estonia and 6.0 percent in dollars (for details, see the main benefits for Lithuania (http://ddp.worldbank.org/ddp/home.do). text and appendixes). It is Latvian society Whereas these are impressive figures, it is not possible to worth noting that these are prove conclusively that Latvia's growth advantage during very conservative estimates of this period is attributable to its reform program. the benefits from only a few reforms undertaken between 1999 and 2004 for which we have measurable FIAS, along with many other stakeholders,3 reasonably results. Some important reforms took place in 2000 and can claim some credit for assisting the Government of 2. See appendix 4 for a full discussion of economic growth, employment, and living standards. 3. Other stakeholders include, for example, a World Bank project in support of public administration reform following the FIAS recommendations, and various projects sponsored by the European Union. 4 executive summary Latvia in its efforts to improve workplace accidents, and so forth. To the degree that the investment climate. FIAS the reforms promoted growth in investment and new Cost-Benefit Ratios recommendations for reform- company formation, however, the increased workload FIAS and the Government of ing the processes of govern- for public servants might have held back improvements Latvia inputs: $1 million; ment inspections and customs in the time required to complete various administrative World Bank loan: $45 million; and tax administration have procedures (such as the Doing Business indicator for the quantifiable benefits: $170 million yielded tangible benefits to time required to start a business, which suffered during businesses in the form of the period covered here because of a one-off require- lower costs. ment for re-registration of companies and which creat- ed a significant backlog in 20054). By way of comparison, it is appropriate to examine the cost of the design and implementation of the program. This case study shows that it is reasonable to describe The FIAS interventions were relatively inexpensive: be- how assistance by FIAS led to an improved business en- tween 1998 and 2005, FIAS carried out six projects at a vironment. The role that FIAS advice played may be total cost less than $500,000. The Government of Latvia discerned at the level of benefits accruing to the target also provided major in-kind contributions of staff time population (i.e., the amount of resources freed up by to oversee the reforms, and it covered most of the costs lower costs associated with administrative procedures). of the second and third business surveys. Its contribu- Whether these benefits accruing to the business com- tion may have been roughly another $500,000 over the munity translated into higher rates of investment and period 1998 to 2005, putting the total cost of the work productivity, and thus to higher economic growth and at roughly $1 million. Many of the FIAS recommenda- reduced poverty, is a function of the entire political, so- tions also were supported by a World Bank loan of cial, and economic structure in Latvia. It is evident that about $45 million for public administration reform there are many links in the chain of causation, and that (including tax and customs reform). the direct attribution FIAS can claim diminishes at every step downstream from its activities. Credit for The investment climate reforms, which clearly im- success must be shared with the Government of Latvia proved efficiency and lowered costs for businesses, were and its immediate stakeholders (i.e., the businesses and carried out without any discernible harm to broader their associations), the European Union accession welfare in Latvia. For example, there is no evidence that process, the input of many other complementary proj- a reduction in inspections of businesses has been associ- ects, market forces, and fortuitous timing. ated with any increase in the rates of industrial fires, 4. Latvia ranked among the best countries in the Doing Business 2004 report for ease of starting a new business, but its ranking was slightly lower in the Doing Business 2005 report because of this backlog. IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE 5 IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE RATIONALE FOR THE CASE STUDY FIGURE 1: FIAS MONITORING The overriding mission of the World Bank Group is AND EVALUATION poverty alleviation, a goal that is shared by FIAS, the mul- FRAMEWORK tidonor investment climate advisory service of the World Bank Group, and all its donors. For more than 20 years, Identification of Project recommendations FIAS has advised more than 130 member country gov- Activities for policy/ ernments on ways to improve the investment climate for regulatory changes foreign and domestic investors alike, and in the process, to reduce poverty. Policy/regulatory changes implemented Outcomes The FIAS mandate: Advise The purpose of this developing country case study is to meas- Improved investment climate governments on how to ure the effects of FIAS improve the investment recommendations Increased domestic climate for both foreign (i.e., through project and foreign direct investment and domestic investors and activities) on out- Impact maximize its impact on comes (such as newly Growth and poverty poverty reduction. enacted legislation alleviation leading to an improved investment climate), and to assess their impact Source: Authors' illustration. (i.e., investment flows, economic growth and employ- ment, and poverty alleviation [figure 1]). The study already been achieved by 1998 when Latvia joined the attempts to track how FIAS' work has led to poverty World Trade Organization. Despite legislative reforms, alleviation by focusing on its efforts in Latvia from 1998 to the investment climate was characterized by recurring 2004. (For a chronology of projects, see appendix 1.) problems in the day-to-day realities of conducting business--a typical situation in many other post- Latvia, one of the THE STUDY Communist transition countries. Until 1998, the effects three Baltic States, of administrative procedures were not consistently Latvia's desire to integrate covers an area of addressed in Latvia. 64,589 km2. As of into the economic and securi- ty structures of Western 2006, its population As a result, complaints from foreign investors and local Europe after regaining inde- was 2.27 million. entrepreneurs alike concerned recurring problems associ- pendence in 1991 created a ated with conducting business (for example, unclear broad consensus for reform.5 Its economic policy was immigration procedures for foreign citizens, delays in based on the tenets of a liberal market economy: creating transferring property rights, burdensome and unmotivated the necessary institutional structures while maintaining a visits by government inspectors, and an unnecessarily large consistent macroeconomic policy. Some progress had number of permits required for construction approval). 5. Latvia is a unitary state and a parliamentary democracy with a proportional electoral system. The prime minister presides over a coalition government, typically formed by three to five parties that compose a majority in the parliament. 6 IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE Latvia attained its goal of EU To address these issues, in 1998 the Ministry decree of the prime minister and, using both the membership on of Finance and the Latvian Investment and recommendations from FIAS and suggestions from sub- May 1, 2004. Development Agency (LIDA) requested committees,7 it developed the first "Action Plan to FIAS' assistance. FIAS believed it was appro- Improve the Business Environment in Latvia." priate to work with Latvia because it was a transition The action plan was the government's key reform country that strongly aspired to join the European instrument. It was first adopted by the Cabinet of Union (EU), but it was not considered part of the likely Ministers on May 11, 1999, and subsequently revised first wave of countries that would receive accession on the basis of new problems and suggestions (the latest approval; rather, it was expected that Latvia would join version was adopted in early 2006). The plan was an the EU at a later time, along with Romania, for exam- interministerial planning document that summarized ple. There was a consensus among almost all political the problems, listed the specific tasks to be undertaken parties that Latvia should join the EU at the earliest to solve the problems, designated the institutions with possible date. the responsibility for doing so, imposed implementa- Thus, at the request of the Government of Latvia, in tion deadlines, and identified performance indicators. late 1998 FIAS began to advise the government on The action plan followed the "cycle of reforms" ways to dismantle administrative barriers to investment. depicted in figure 2. The plan called for amendments FIAS provided assistance to implement various adminis- trative reforms from 1999 to 2002, and conducted an FIGURE 2: CYCLE OF REFORMS impact analysis in 2003­05. The initial study evaluated many problems related to company registration, licens- ing, inspections, expatriate work permits, taxation and 1. 2. Identifying problems Agreeing on reform customs procedures, real estate and construction proce- priorities and action plan dures, and other issues of importance to entrepreneurs. The study then offered detailed recommendations for removing those barriers. 4. 3. To initiate an open discussion about the problems iden- Monitoring the Enacting and impact of reforms implementing actions tified in the FIAS study, the LIDA invited business implemented representatives and government officials to the presenta- tion of the draft report. The prime minister established a steering group to seek solutions to the issues identified Source: Authors' illustration. in the 1998 study.6 The steering group was created by a 6. The steering group was composed of leading civil servants in the ministries of economy, finance, justice, and regional development, and heads of government agencies responsible for implementing the Reform Program to Improve the Business Environment in Latvia. It also included representatives of the Foreign Investors Council in Latvia (which includes the foreign chambers of commerce), the Latvian Chamber of Commerce and Industry, and other business associations. The steering group has since been formalized and meets regularly to monitor the progress of reform implementation. 7. Four technical subcommittees were created to examine (1) inspections problems; (2) expatriate residency and work permit issues; (3) registration, tax, and customs matters; and (4) land acquisition and construction issues. IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE 7 In 2000, the European Commission's Directorate- to legal acts, revision and simplification of procedures, FIAS FOLLOW-UP General for Enterprise ASSISTANCE TO AND improvement of coordination among different institu- awarded Latvia's business COLLABORATION WITH tions, preparation and publication of information, and THE GOVERNMENT OF environment reform training for officials. LATVIA activities "CC-BEST" status, signifying that LIDA's Business Environment Improvement Unit was The initial study that FIAS con- Latvian policies for assigned the tasks of supervising the implementation of ducted in 1998 was well received improving its the action plan and institutionalizing the dialogue and led the Government of competitiveness were between the investment community and the Latvia to request FIAS assistance exemplary for other EU government. Revisions to the action plan are guided to implement reforms in inspec- candidate countries. by the results of regular monitoring of the business tions and construction approval environment via business focus groups, consultations, issues, and to provide further and company surveys (three successive, representative guidance to establish the public/private dialogue and surveys of businesses were undertaken in 2001, 2003, improve the business environment monitoring system. In and 2005) and by detailed studies of specific issues addition to substantive advice, an important component and analyses performed by various government of FIAS assistance was the transfer of methodological entities. knowledge on the management and monitoring of investment climate reforms and as-needed collaboration The most significant results between 1999 and to prepare the initial and subsequent action plans. 2004 were achieved in enterprise registration, tax administration, inspections, customs and border- By 2000, the LIDA Business Environment Improve- crossing procedures, construction permit and real ment Unit had developed Latvia's approach to invest- estate procedures, and expatriate residency. ment climate reform and the initial results of this Significant achievements were made in institution- reform program were becoming evident. While FIAS alizing the public/private dialogue, updating the was continuing its assistance to the Government of action plan, and monitoring. According to the Latvia, primarily in the form of as-needed substantive progress reports on implementing the action plan, advice on specific issues and reform options, it simulta- 91 of 106 tasks included in the action plan had been neously engaged in deeper collaboration with the implemented successfully by December 31, 2003, LIDA to design a set of standardized instruments for Appendix 2 describes these specific reforms and assessing the business environment that could be their outcomes in detail, starting with the repeated over time in Latvia and replicated in other recommendations provided by FIAS, formulation of client countries. the reform measures included in the action plan, FIAS then also helped the Government of Latvia carry reforms enacted by the government, and improve- out its own self-assessment update of administrative bar- ments in Latvia's investment climate as evidenced by riers in 2001­02, which provided a new set of insights various indicators. 8 IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE into the problems and options for reform. FIAS maintained steady progress in implementing reforms (even assistance was twofold: (1) to provide best-practice through many changes in government)--steady progress information and overall quality assurance of the recom- that may be considered the outcome of all these projects. mendations included in the final self-assessment report, The assistance provided by FIAS (i.e., the inputs at the and (2) to design and implement a representative front end of the chain of causation) is described in detail Administrative and Regulatory Cost Survey (ARCS) to in the first section of appendix 2, including the key establish a monitoring system to track the experiences of resources and activities of the relevant projects. business representatives with specific administrative requirements and changes in their perceptions about the DID THE BUSINESS ENVIRONMENT overall business environment.8 IMPROVE? Use of the ARCS shows In 2003 and 2005, the Govern- Investment climate is a broad concept; essentially, it is a key how external know-how ment of Latvia financed the determinant of whether an economy is able to respond was internalized and second and third ARCSs of busi- dynamically to the opportunities offered by globalization. eventually institutionalized nesses and, in 2005, produced an The investment climate is affected by a number of factors: by reform-oriented updated assessment of the busi- technocrats within the ness environment (i.e., a policy macroeconomic stability government and eventually report). In the latest survey, FIAS bureaucratic harassment, especially in the administra- moved to become a policy- involvement was designed to be tion of regulations and taxes defining instrument. limited to providing minor quality strength of financial institutions supervision of the company that rule of law (including law enforcement), corruption, conducted the survey and to assist in developing an and crime oversight function, independent of the government, to quality of infrastructure (including power and oversee such efforts in the future. It reasonably can be telecommunications) expected that this type of monitoring by the government government effectiveness in providing sound regula- is now institutionalized and will continue in the future tory structures for the private sector (including without the need for FIAS assistance. In this regard, the promotion of competition and regulation of natural Latvian experience constitutes a best practice of main- monopolies) streaming governance and regulatory survey work and effective provision of public services or the frame- its use in monitoring and advancing a reform agenda. work for such services quality of the labor force (Batra and Mody 2003). In addition to FIAS projects, there were other World Bank Group projects in Latvia and extensive assistance Thus, investment climate is multidimensional, and a from the EU PHARE9 program and from many bilateral great deal of overlap and correlation exists between its donors. Most important, the Government of Latvia various elements. 8. LIDA also was making use of support from the EU PHARE program and the Swedish International Development Agency to cofinance some of this work. 9. The acronym PHARE originally stood for "Poland and Hungary: Assistance for Restructuring Their Economies." The PHARE program later was expanded to provide assistance to other countries seeking EU accession. IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE 9 The core objective of the Government of Latvia's The following improvements to specific procedures Reform Program to Improve the Business Environment were achieved, directly as a result of specific advice from 1999 to 2004 was predominantly to reduce provided by FIAS advisers from 1999 to 2004. administrative barriers to investment. Over time, other Tax administration and enterprise registration: elements were added to the government's program An appeals body in the State Revenue Service was (such as addressing labor skills and access to finance). established. However, assistance by FIAS primarily concerned the Draft tax legislation was posted on the Internet for removal of regulatory barriers to business. Given the comment. aim of this case study to track the effect of FIAS' work, Tax and enterprise registration were combined. we focus on indicators that concern regulatory proce- The time required to register a company at the dures to illustrate the improvements in the business Enterprise Register was reduced from approxi- environment. mately 20 days in 1998 to 3 days in 2005.10 The process of electronic submission and accept- Although many reforms had already been initiated in ance of tax declarations has commenced. 1999 and 2000 and again in 2001 and 2002, an evalua- Various specific tax-related problems identified by tion of the results of these reforms and those of the businesses were resolved via amendments to ARCSs carried out in Latvia in late 2001, late 2003, and separate tax laws (i.e., the Law on VAT [value- 2005 showed many signs of continuing improvement added tax], the Law on Social Insurance Contribu- (figure 3). For example, there was a steady reduction in tions, and the Law on Corporate Income Tax). the share of businesses that saw various regulations as Access to information and updates regarding tax obstacles to operating and expanding. issues has improved. The following changes in the administrative culture in Customs: Latvia occurred: Only incoming traffic was controlled at many inter-Baltic border checkpoints (until EU accession Government officials were more willing and able to in 2004, when inter-EU customs controls were engage the business community in constructive abolished). dialogue and to identify problems and solutions. The responsibilities of the border guard and cus- Government agencies were more active in seeking toms services were better defined and delineated. private sector comments on draft legislation. Customs procedures were simplified, and manuals The capacity of business associations gradually were prepared and made available to businesses. increased to meet the challenge of engaging the Since September 1, 2001, the Consultations government in dialogue. Department of the Legal Division of the National Accessibility of information on various business- Customs Board has been providing information and related procedures improved. consultations to clients of the customs authorities. 10. Three days are required for the core registration procedure. The figure of 18 days cited in Doing Business 2006 includes additional procedures required for starting a new business. Discrepancies between FIAS ARCS data for Latvia and the Doing Business indicators are further accounted for by the fact that Doing Business indicators are based on a narrowly defined "case," whereas the ARCS data are based on actual experiences of a representative sample of companies in Latvia. 10 IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE FIGURE 3: AREAS OF REGULATION CONSIDERED BY BUSINESSES TO IMPEDE THEIR OPERATION AND GROWTH: 2001, 2003, AND 2005 72.3 ...inflation 48.1 39.4 ...instability and unpredictability of changes in laws 60.7 71.2 and regulations 73.1 60.6 ...tax rates 70.2 73.4 52.3 ...tax laws and regulations/tax administration 57.0 54.4 ...cost of infrastructure services - phone, electricity, 33.2 49.0 water, roads 44.8 31.1 ...competition with gray/shadow economy 40.4 44.6 23.9 ...favoritism/cronyism 27.5 28.6 23.3 ...corruption in public sector 28.5 35.5 ...obtaining licenses and permits necessary for doing 18.8 30.6 business 27.8 15.6 ...labor legislation and regulations 27.8 17.5 14.5 ...standards for product and service certification 21.5 15.7 ...inspections of premises (fire, workplace safety, 13.6 20.6 sanitary) 16.4 13.3 ...obtaining construction permits 16.8 21.0 ...access to land (possibility to purchase or conclude 12.9 16.2 long-term contract) 18.4 12.0 ...environmental legislation and regulations 14.0 10.6 7.1 ...registering a new business 14.9 14.2 6.1 ...customs legislation and regulations 16.1 17.2 3.6 ...expatriate employment regulations (work permits) 5.0 5 2 0 10 20 30 40 50 60 70 80 percent 2001, n=541 2003, n=502 2005, n=701 Source: ARCSs 2001, 2003, and 2005; survey report by Marketing and Public Opinion Research Centre SKDS in 2005. IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE 11 Expatriate employment and residency: in the incidence and severity of fines imposed on Procedures for issuing work and residence permits businesses. have been simplified. Real estate and construction procedures: New service centers for foreigners were established Information on cadastral valuation for determining by the Citizenship and Migration Issues Board. the real estate tax was clarified. Government inspections: A state duty in the amount of 2 percent of the An Inspectorate Coordination Council functioned transaction value or real estate cadastral value for between 1998 and 2002 to coordinate the work of the registration of title transfer was capped at the various inspectorates, to serve as a forum to 30,000 Latvian lats (LVL). exchange information and experiences, and to The time and cost of several administrative design and implement common training programs. procedures (such as title transfer in the land books) The rights and responsibilities of inspectors and decreased. those being inspected were standardized. Each A uniform set of fees and duties for construction inspection agency and its controlling institution permits and procedures was introduced, making prepared internal regulations on the basis of the construction process less bureaucratic and more guidelines provided in an Instruction of the transparent. The construction preparation and the Cabinet of Ministers, which was adopted on state expertise procedures were simplified and January 18, 2000. A requirement that inspections streamlined by adopting amendments to the would be accompanied by written inspection General Construction Regulations. reports was introduced. Additional information on changes in the regulatory Greater information was made available to busi- environment appears in the World Bank/European nesses about the inspection process in general and Bank for Reconstruction and Development (EBRD) about each specific inspection. Annual meetings Business Environment and Enterprise Performance between inspectorates and client groups for selected Survey (BEEPS). Comparing results for Latvia in 2002 inspectorates were held in the regions. and 2005 with those of other countries in Eastern Performance indicators in several key inspectorates Europe shows improvements in business regulation, were developed, and compulsory annual perform- institutions, property rights, and taxation. ance reports were made publicly available, thereby helping to track the progress of internal manage- An examination of the figures in table 1 shows that ment changes in the inspectorates. businesses operating in Latvia have seen improvements Inspectors received training to improve their in the business environment and in specific regulatory strategic focus and to develop a client orientation areas and administrative procedures. in their work. These reforms resulted in a reduction in the In addition, other key international indicators of the frequency and duration of inspections while investment climate show clear signs of improvement. maintaining the quality of supervision for The Fraser Institute's Index of Economic Freedom showed consumers and the public at large (see appendix 2). improvements in regulatory trade barriers. The Heritage Greater compliance and a shift in approaches to Foundation indexes showed significant improvements enforcement by the inspectorates led to a reduction in "administrative conditions for new businesses." The 12 IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE TABLE 1: CHANGES IN OBSTACLES TO DOING BUSINESS BETWEEN 2002 AND 2005 percent Czech Slovak Obstacle Latvia Republic Estonia Hungary Lithuania Poland Republic Slovenia Business ­5 8 ­6 6 4 ­7 ­16 1 regulation Institutions and ­4 16 ­2 1 ­5 ­9 ­19 ­2 property rights Macroeconomic 8 5 ­23 14 ­18 ­18 ­44 ­9 instability Taxation ­7 26 ­20 14 ­10 ­5 ­26 17 Infrastructure 2 14 ­4 2 2 ­3 ­8 2 Skills and labor 5 17 2 3 15 ­4 ­12 7 regulations Access to and cost ­8 7 ­9 11 ­2 ­5 ­29 ­2 of financing Sources: World Bank/EBRD Business Environment and Enterprise Performance Survey 2005; World Bank 2006. Note: Positive values indicate deterioration (a higher percentage of firms seeing particular regulations as an obstacle to doing business); negative values indicate improvement. World Bank's regulatory quality index and government Progress Reports (prepared until 2004) consistently effectiveness indexes both showed that ratings for Latvia praising the "serious efforts of Latvia to improve the have improved (Kaufmann, Kraay, and Mastruzzi 2003). business climate." In its Corruption Perceptions Index (CPI), Transparency In 2006, the Doing Business indicators ranked Latvia International placed Latvia on par with Pakistan in 2003 24th among 175 countries for overall "ease of doing (with CPI scores of 2.7, both countries were tied for business," placing it in the top quintile of countries, just 71st place out of 113 countries surveyed) and on par behind the Republic of Korea (World Bank 2007, p. 6). with Jamaica in 2003 (each country having a CPI score In 2004, the Doing Business indicators showed that the of 3.8), with further improvements over the following regulatory environment in Latvia was one of the best years (the 2006 survey tied Latvia and the Slovak among the EU accession countries in terms of business Republic for 49th place among 163 countries surveyed-- registration (see figure 4). each with a CPI score of 4.7) (TI various years). For a more detailed example of the types of reforms under- Both the European Commission and the EBRD's Tran- taken, see box 1 about the reform of Latvia's inspectorates. sition Reports noted steady improvements, with the EU IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE 13 FIGURE 4: BUSINESS REGISTRATION IN EU ACCESSION COUNTRIES, 2004 AND 2005 a. Number of procedures to start a business 12 10 8 procedures Year 2004 6 of Year 2005 4 number 2 0 Latvia Estonia Hungary Lithuania Slovak Slovenia Czech Poland Republic Republic b. Time to start a business 80 70 60 days 50 of Year 2004 40 Year 2005 30 number 20 10 0 Latvia Slovak Lithuania Poland Estonia Hungary Czech Slovenia Republic Republic c. Minimum capital to start a business 250 income 200 150 capita Year 2004 Year 2005 per 100 of 50 percent 0 Slovenia Latvia Czech Slovak Estonia Lithuania Hungary Poland Republic Republic Sources: Doing Business, 2004 and 2005. 14 IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE BOX 1: INSPECTIONS REFORM: MORE PROFESSIONAL INSPECTIONS, MORE ACCOUNTABILITY IN THE INSPECTION PROCESS The 1998 FIAS report on removing administrative barriers to investment cited complaints about intimidating behavior and aggressive and suspicious attitudes of inspectors, and about a lack of transparency in inspecting procedures. Entrepreneurs generally were unaware of the objectives of inspections, the legal framework in which they occurred, the rights and authori- ty of the inspectors, and the rights of the inspected. Multiple public institutions frequently handled similar or overlapping areas, with little cooperation or coordination among them. To address a grievance, an entrepreneur had the unpleasant choice of approaching the institution's management or following an expensive formal court procedure. FIAS made several recommendations to improve the inspections regime, which resulted in numerous reforms. Here are some of those recommendations: Recommendation: Give inspectors basic marketing training and customer service training. Outcomes: · The heads of inspections services and inspectors were offered tailored training in strategic planning, performance man- agement, customer service skills, and administrative law. · Inspectorates have demonstrated a meaningful change in attitude; inspectorate heads have acknowledged that their actions directly affect the business environment in Latvia. Recommendation: Ensure that written reports are prepared and issued on the spot.The right of the person being inspected to see the inspection report should be well publicized. Outcomes: · Inspectorates prepared internal rules with standardized information on the rights and duties of inspectors and those being inspected, appeals mechanisms, and payment methods; these rules make the work of each inspectorate more transparent and understandable. · A number of inspections introduced carbon-copy forms for their administrative protocols and decisions, and checklists of items to be inspected. Recommendation: Improve the ways that information concerning the legal framework and the rights and obligations of the inspected are disseminated. Outcome: · Guidelines prepared by inspectorates were published as brochures and publicly distributed via the Internet and official gazettes. Recommendation: Clarify appeals procedures and improve the handling of appeals. Outcome: · Appeals were partially addressed in guidelines, internal regulations, and revised forms for administrative acts to be used by individual inspectorates.This issue was later addressed through parallel initiatives such as the Administrative Procedure Law.a (continued) IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE 15 BOX 1: INSPECTIONS REFORM: MORE PROFESSIONAL INSPECTIONS, MORE ACCOUNTABILITY IN THE INSPECTION PROCESS (CONTINUED) Recommendation: Either merge the Riga Municipal Language Inspectorate and the State Language Inspectorate into a single unit, or define their specializations. Outcome: · In early 2001, following establishment and enforcement of a new language law, municipalities had no ability to enforce the old language law.The Riga Municipal Language Inspectorate was eliminated, and some of its functions were trans- ferred to the Riga City Language Service. The business surveys carried out in 2001 and 2003 indicate that entrepreneurs enjoyed significant savings as a result of the reforms (see figures 1B.1 and 1B.2). By 2003: · The average inspected firm was subject to three fewer inspections for a time savings of almost 40 hours for each firm. · The Labor Inspectorate had 17 percent more firms under its supervision, but the number actually inspected increased just 5 percent.An increase of only 2 percent to the team of inspectors was enough to handle the larger caseload. · A firm's probability of paying a fine for labor, sanitation, or fire safety infractions fell by more than 80 percent. · Businesses indicated that "the inspectorates are no longer penalizing us for little mistakes, they are just writing or telling [us] that these problems have to be averted." FIGURE 1B.1: AVERAGE DURATION OF INSPECTIONS, 2001 AND 2003 14 12 Sanitary Inspectorate 10 Labor Inspectorate 8 Construction hours Inspectorate 6 Environmental Inspectorate 4 Fire and Rescue 2 Service 0 2001 2003 Sources: ARCS 2001 and 2003. (continued) 16 IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE BOX 1: INSPECTIONS REFORM: MORE PROFESSIONAL INSPECTIONS, MORE ACCOUNTABILITY IN THE INSPECTION PROCESS (CONTINUED) FIGURE 1B.2: CHANGES IN QUALITY OF INSPECTION WORK BETWEEN 2001 AND 2003 Environmental Inspectorate -1.2 11 Labor Inspectorate -1.9 12.6 Sanitary Inspectorate -4 11.5 Fire and Rescue Service -2.2 6.1 Construction Inspectorate -4.4 4.4 Municipal Police -10.4 9.5 -15 -10 -5 0 5 10 15 worsened improved Source: ARCS 2003. Note: Survey respondents were asked whether the quality of work by various agencies had improved or worsened from 2001 to 2003. Besides time and cost savings, the quality and professionalism of inspectors have improved, as have internal operating proce- dures. In early 2004, focus group participants said the professional standards of most inspectorates had increased over the pre- vious five years, and that cash bribes associated with inspections had decreased. a. A detailed assessment of the administrative appeals mechanisms before the new Administrative Procedure Law came into force, and an assessment of the preparations made by individual institutions as of January 2004 are available in Putnina and Russell-Einhorn (2004). FROM IMPROVEMENTS IN THE any benefits accruing to the target population (i.e., busi- BUSINESS ENVIRONMENT TO nesses), to the broader economy, or to both. GREATER WELFARE Logic would dictate that if the reforms led to a reduction We have determined that the business environment in in time and costs for administrative procedures, then the Latvia did improve. But what interests the development beneficiaries should enjoy cost savings­­essentially community most is whether those improvements led to IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE 17 resources freed up for more productive uses, such as new Latvia.12 According to Ministry of Economy data, there investment. More generally, there is evidence that by were 40,668 economically active firms in 2001 and eliminating unnecessary procedures and streamlining reg- 45,300 in 2003. The change in the way inspections were ulations, governments can encourage new investment, conducted enabled businesses to free up more than and thereby improve economic growth and employment US$3.8 million in 2003 alone. This is a conservative esti- opportunities and alleviate poverty. According to the mate of the benefits from just a subset of reforms 2005 Doing Business report, reducing key barriers to entry supported by the FIAS projects in only one year.13 can result in a 0.25 percent increase in the annual income growth of a developing country (World Bank 2005). Because the absolute number of inspected businesses did Similarly, trade openness leads to an approximate not decrease, the cost savings represent improved effi- 0.7 percent increase in per capita income growth in well- ciency in the way inspections were conducted (i.e., regulated countries (Bolaky and Freund 2004). inspections became shorter and led to fewer repeat inspections of the same business). More important, the Benefits Accruing to Businesses reduction in the inspection burden on business did not We attempted to calculate a quantitative estimate of the lead to any worsening of outcomes for broader human effect on Latvian businesses of at least some of the health and safety (such as workplace accidents and fires). reforms that were undertaken since 1998. We performed similar calculations of reform effects for The surveys of businesses Change in the way licensing, company registration, access to real estate, and in 2001 and 2003 con- inspections are tax administration. Table 2 summarizes the results, firmed that the average conducted enabled amounting to about US$3,760 per enterprise. repetition and duration businesses to free for the five most com- Thus the quantifiable benefits from implementing up more than mon inspections (state improvements in the business environment accruing to US$3 million in 2003. revenue, fire safety, businesses in Latvia were in the range of US$170 million labor, sanitary, and (the majority of the benefits were associated with municipal police inspections) fell between 2001 and reforms to improve tax administration). These are con- 2003, resulting in a time saving of more than 38 hours servative estimates of benefits from only a few reforms per year for an average Latvian enterprise.11 If we undertaken between 1999 and 2004 (see the methodol- assume each firm needed to assign one staff member to ogy note, appendix 5). The decision to select these accompany a government inspector for the entire dura- reforms for analysis was driven by the data available tion of the inspection (at an average hourly wage of from the business surveys and other sources. Given the about US$2.2 in 2003), this represents a savings of range of reforms that were implemented, the impact of US$85 per year for each active enterprise operating in FIAS assistance to the Government of Latvia through (continued on p. 21) 11. This excludes many other inspections (such as construction and environmental inspections) that affect significantly fewer firms. 12. This benefit does not include other aspects of the reforms that reduced the incidence of arbitrary and severe fines, and improved transparency and accountability in government inspections. 13. Data from 2005 suggest that improvements in the burden of inspections leveled off, as is to be expected. Inspections cannot be reduced to zero, but there has been no significant backtracking or erosion of the reforms. 18 IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE TABLE 2: SUMMARY OF THE QUANTIFIABLE IMPACT OF REFORMS Quantifiable effect Reform area of improvements Explanation Inspection $3,011,839 Resources freed up for the entire economy from improvements in inspection reforms procedures (2001 vs. 2003) The cost savings primarily represent improved efficiency (i.e., inspections became shorter and led to fewer repeat inspections of the same business). Total savings are calculated as a reduction in the cost of labor hours that need to be spent on inspections. Reduction in inspection hours is calculated as a reduction in both the duration and frequency of inspections. Total time savings are multiplied further by average salary and num- ber of active enterprises in the economy. The probability of not being inspected also is taken into account. Licensing $4,275,459 Decrease in official payments for obtaining licenses for business operations (2001 vs. 2003) $7,956,766 Decrease in official payments for obtaining licenses for business operations (2003 vs. 2005) The cost savings primarily represent lower payments to institutions for obtaining licenses and fewer licenses required to maintain business operations. The result is derived by considering a reduction in the average number of licenses necessary to operate and a reduction in official fees when obtaining a license. Savings per enterprise are generalized further by multiplying by the total number of economically active enterprises. $322,264 Decrease in payments to intermediaries for obtaining licenses for business operations (2001 vs. 2003) $143,487 Decrease in payments to intermediaries for obtaining licenses for business operations (2003 vs. 2005) The cost savings primarily represent the use of fewer intermediaries and lower payments to those used for obtaining licenses because of improved application processes. The result is derived by considering a reduc- tion in the percentage of cases when intermediaries are used and a reduction in payments to intermediaries when obtaining licenses. Savings per enterprise are generalized further by multiplying the result by the total number of economically active enterprises. 7.3 Days Increase in average time per enterprise to obtain all necessary licenses for business operations (2001 vs. 2003) 4.3 Days Decrease in average time per enterprise to obtain all necessary licenses for business operations (2003 vs. 2005) Although a favorable decrease in the amount of time needed to obtain all necessary licenses for business operations can be noticed for 2005 vs. 2003, the opposite was true for 2003 vs. 2001. The total effect in efficiency improvement expressed as the time to obtain all licenses is slightly negative. This reasonably may be explained by a rapidly growing number of active enterprises and consequent increase in the number of applications for licenses. Although the time required to obtain licenses has increased by 16 percent, the total number of active enterprises has grown by 33 percent, indicating that the time to obtain licenses is increasing, (continued) IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE 19 TABLE 2: SUMMARY OF THE QUANTIFIABLE IMPACT OF REFORMS (CONTINUED) Quantifiable effect Reform area of improvements Explanation but at a slower rate than the number of enterprises. Also, in 2005 vs. 2001, the average enterprise needed more licenses (1.14 vs. 0.96), showing that the number of license applications has increased even more than the number of active enterprises. Thus, in 2005, more licenses could be obtained at lower cost, but the duration of obtaining a license was longer. Company 3.7 days Decrease in duration of business registration process in the Enterprise Register registration (calendar days, 26 in 2000­01 vs. 22 in 2004­05) The decrease in the business registration process primarily represents improved efficiency in the procedure. Duration is decreasing despite an increasing number of applications. The decrease is derived from the average duration of the registration process as reported by survey respondents and by considering the year of registration. $317,797 Total decrease in costs of using an intermediary for business registration (2000­01 vs. 2002­03) Improvements represented by a decrease in the costs of using an intermediary are twofold. First, the proce- dure is less complex and fewer intermediaries are needed. Second, even if intermediaries are used, business registration has become cheaper. The lower monetary result is derived by considering the reduction in the percentage of cases when intermediaries are used and a reduction in payments to intermediaries when obtaining licenses. Savings per enterprise are generalized further by multiplying the result by the total number of economically active enterprises. $59,147 Total decrease in official fee payments (2000­01 vs. 2002­03) A decrease in official fee payments represents a reduction in another type of cost when registering a business. The lower monetary result is derived by considering the reduction in official payments to intermediaries when registering a business. Savings per enterprise are generalized further by multiplying the result by the total number of enterprises registering in the Enterprise Register in 2003. Real estate 11 days Decrease in the duration of real estate registration procedures for an average enter- prise (agency days, 2003 vs. 2005)a 31 days Decrease in the duration of real estate registration procedures for an average enter- prise (calendar days, 2001 vs. 2005)b This decrease is almost entirely attributable to the decreased probability of having to perform individual procedures between the particular two years. The number of agency days necessary for each procedure increased between 2003 and 2005. This would be a negative development for the Doing Business report; in our analysis, however, we multiplied the number of days by the probability of going through the procedure, and the final result implies a positive development. ­$616,146 Added cost for businesses due to increase in official fees for all enterprises undergoing any registration procedure in 2005 vs. 2001 (continued) 20 IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE TABLE 2: SUMMARY OF THE QUANTIFIABLE IMPACT OF REFORMS (CONTINUED) Quantifiable effect Reform area of improvements Explanation The total dollar amount collected in the form of official fees increases with the number of applications for real estate registration. Tax administration $156,072,400 Savings on preparation of declarations (2001 vs. 2003) Savings represent improved procedures, easier preparation, and consequently lower duration and labor costs for preparing tax declarations. Total savings are calculated as a reduction in the cost of labor days needed to complete declarations. The reduction in days is calculated as a reduction in the duration of declaration pro- cedures. Total time savings are multiplied further by an average salary and the number of active enterprises in the economy. The portion of companies not filling the specific declarations also is taken into account. Total $171,543,014 Total quantifiable effect from the above-cited factors Quantifiable monetary benefits accruing annually per average enterprise Inspections reforms $66.49 The amount of resources freed up by improvements in inspection procedures (2001 vs. 2003) Licensing $94.38 Decrease in official payments to obtain licenses for business operations (2001 vs. 2003) $147.19 Decrease in official payments to obtain licenses for business operations (2003 vs. 2005) $7.11 Decrease in payments to intermediaries to obtain licenses for business operations (2001 vs. 2003) $2.65 Decrease in payments to intermediaries to obtain licenses for business operations (2003 vs. 2005) Company registration $7.01 Total decrease in costs for using intermediaries in business registration (2000­01 vs. 2002­03) $1.31 Total decrease in official fee payments (2000­01 vs. 2002­03) Real estate ­$11.40 Added cost for businesses due to increase in official fees undergoing any registration procedure (2001 vs. 2005) Tax administration $3,445.31 Savings in preparation of declarations (2003 vs. 2001) Total $3,760.06 Total quantifiable effect per enterprise from the above-cited factors Source: Authors' calculations. Note: All figures are discounted to 1998 U.S. dollars. a. Agency days are the number of days an agency takes to process documents that have been submitted. b. Calendar days are the total number of days a procedure requires from start to finish. IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE 21 the business environment improvement program is likely The 2004 Consensus assessed a large range of projects to be much more substantial. whose goals were to improve governance, combat corruption, and reduce red tape. It concluded that the FIAS interventions were relatively inexpensive. Between monetary costs of such projects are quite low, and that 1998 and 2005, FIAS carried out six projects for a total documented benefits are usually very high if meaningful cost of less than US$500,000. The Government of reforms are enacted (Rose-Ackerman 2004). Latvia also provided major in-kind contributions of staff time and assistance with translation and interpretation, Economywide Impact and it paid for most of the second and third business Improvements in the investment climate have yielded surveys. Those expenses were an additional improvements in private investment. In 1997, gross fixed US$500,000 over the period 1998 to 2005, placing the capital formation in the private sector was 16 percent of total cost of the work at approximately US$1 million. GDP; by 2004, it had increased to 27.5 percent of GDP. The number of active, taxpaying firms also Such high cost-benefit ratios are well documented glo- increased by 31 percent between 1997 and 2004 (from bally. For example, the Copenhagen Consensus in 2004 35,259 to 51,440 active companies).14 determined that reforms to reduce barriers to business are among the top 10 most cost-effective interventions Trends in foreign direct investment (FDI) are even more to improve the "greatest global challenges" (http://www. striking (figure 5).15 In 1994, FDI per capita was less copenhagenconsensus.com/Default.aspx?ID=699). than US$100; in 2004, it was more than US$280. At the FIGURE 5: ANNUAL FDI IN LATVIA, 1996 THROUGH SEPTEMBER 2005 698.8 144.0 600 521.1 539.8 54.4 450 381.7 111.9 412.5 302.6 52.7 356.7 347.5 140.3 253.7 300.0 251.7 300 127.7 87.7 80.2 132.1 millions 28.4 34.8 59.9 28.4 89.2 59.2 35.9 84.7 $S 150 356.5 219.2 209.1 248.8 253.3 233.7 178.1 213.0 216.9 179.1 U 0 -120.7 -23.5 -150 1996 1997 1998 1999 2000 2001 2002 2003 2004 9 months of 2005 equity capital reinvested capital other capital Source: Ministry of Economy 2005. 14. Data are available at the Web site of Latvia's Central Statistical Bureau (www.csb.lv). 15. As noted in FDI and Poverty (Klein, Aaron, and Hadjimichael 2001): "FDI is a key ingredient for successful economic growth in developing countries. This is because the very essence of economic development is the rapid and efficient transfer and adoption of `best practice' across borders. FDI is particularly well suited to affect this and translate it into broad-based growth, not least by upgrading human capital. As growth is the single-most important factor affecting poverty reduction, FDI is central to achieving that goal....However we may look at it--among the tools available--FDI remains among the most effectives ones in the fight against poverty" (p. 2). 22 IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE TABLE 3: KEY INDICATORS OF ECONOMIC DEVELOPMENT, 1999­2005 Indicator 1999 2000 2001 2002 2003 2004 2005 GDP (growth against the preceding year, %) 3.3 8.4 8.0 6.5 7.2 8.6 10.2 Unemployment rate (% of economically 9.7 8.5 8.3 8.0 8.0 8.0 -- active population) FDI (net inflows, % of GDP) 4.5 5.0 2.0 4.0 2.9 3.8 3.9 FDI (growth against the preceding year, %) 9.2 21.1 ­57.6 120.0 ­12.3 64.0 15.6 Total active enterprises 37,628 41,992 40,668 42,549 45,300 51,440 n.a. Sources: Central Statistical Bureau of Latvia, June 2006; EBRD 2005. Note: -- = not available; FDI = foreign direct investment; GDP = gross domestic product; n.a. = not applicable. end of 2004, accumulated FDI in Latvia amounted to FIGURE 6: RATES OF US$4.454 billion (Ministry of Economy 2005). UNEMPLOYMENT AND JOB SEEKERS, 1999­2004 The increase in investment and number of active com- panies had its payoff in economic growth. Whereas 16.0 growth in GDP per capita was under 5.0 percent in 14.0 1995 and 1996, the average annual growth of GDP population 12.0 ev between 2000 and 2004 was 7.7 percent. In 2004, it acti 10.0 was 8.5 percent, and it reached 10.2 percent in 2005. 8.0 New investment also created new employment 6.0 opportunities: unemployment dropped from 9.7 percent economically 4.0 of of the labor force in 1999 to 8.0 percent in 2004 (table 3). 2.0 cent That in turn implies approximately 19,000 fewer regis- per 0.0 tered unemployed people in 2004 than in 1999. The 1999 2000 2001 2002 2003 2004 rate of job seekers also improved, from 14.3 percent to nonworking job seekers 10.3 percent in the period 1999­2004 (figure 6). Real registered unemployed people income in the period 2000­04 increased by 24 percent; and the average net monthly wage increased from US$179 in 1999, to US$284 in 2004, and to US$317 in Source: Central Statistical Bureau of Latvia, June 2006. 2005, outpacing a more moderate increase in the cost of living (figures 7­9). IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE 23 Overall, these economic indicators show that the FIGURE 7: COMPARISON OF reforms carried out in the previous decade have AVERAGE WAGE AND THE COST strengthened the private sector, and that the business OF MINIMUM SUBSISTENCE environment is improving. Investments continued to 1997­2005 grow rapidly, encouraging modernization of production and the introduction of new, more productive technolo- WAGE PER MONTH gies. Clearly, membership in the EU has had a positive 350 effect on the development of the Latvian economy, but the reforms and the improved business environment 300 have enabled the economy to outpace that of Poland, for example, which made excellent progress with structural 250 reforms in the early years of transition but then failed to 200 implement robust improvements in other aspects of the $S U investment climate. 150 The broad-based economic growth in Latvia has helped 100 alleviate poverty. A recent study conducted by the 50 World Bank (2006) concluded that, between 1998 and 2004, Latvia achieved substantial progress in poverty 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 reduction, with an estimated 325,000 people moving out of poverty over the period. Using household average net wage per capita cost of subsistance budget survey data from the period 1998­2004 and an absolute poverty line,16 the World Bank report pub- Source: Central Statistical Bureau of Latvia, June 2006. lished in June 2006 for the first time identified trends in poverty for this extended period on the basis of a con- The population was able to share widely in the expand- sistent definition of poverty (p. vii). The poverty head ed labor market. Along with higher employment rates count rate fell significantly, from 19.4 percent of the came greater labor productivity, which spurred higher total population in 1998 to less than 6.0 percent in 2004 real wages, incomes, and living standards. Simultane- (figure 10). The distribution in income inequality has ously, maintenance of a broad-based system of social improved since 2000, and the poverty gap declined sub- transfers ensured that vulnerable groups, such as pen- stantially from 5.5 percent to 1.2 percent (table 4). sioners and the poorest people, were protected even as targeted local government benefits were improving (World Bank 2006, p. vii). 16. This paper uses the same poverty line as that used in the World Bank's earlier living standards assessment for Latvia; namely, LVL 28 per person monthly in 1998 prices. It is adjusted for inflation to hold constant the real value of the poverty line over time. 24 IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE "FIAS came in as a FIAS recommendations FIGURE 8: GDP PER CAPITA, PPS, neutral third for reforms in the area 1999 AND 2005 party....Well it's of government inspec- definitely a great tions, customs, and tax 120 improvement. Five administration have 1999 110 2005 years and actually 10 yielded tangible benefits 100 years ago, foreign to businesses in the form S 90 investors would have a of lower costs. Beyond PP 80 very difficult time in these benefits, it may be capita, 70 areas such as tax reasonable to describe per 60 compliance, under- linkages between lower GDP 50 standing the environ- costs for businesses and 40 ment. Now, the higher rates of invest- 30 government welcomes ment, productivity, and 20 foreign investors. The formalization of busi- Latvia Poland Lithuania Slovak Estonia Hungary Czech Slovenia EU15 Republic Republic government is putting nesses. These reforms in economy in place structures that turn contributed to encourage foreign higher rates of economic Sources: World Bank staff calculations based on Eurostat data; World Bank 2006. investment." (J. C. growth, higher tax Note: GDP = gross domestic product; PPS = purchasing power standards. EU25 is Cole, real estate revenues, more employ- equivalent to 100 percent. Data for 2005 are estimates. developer and former ment opportunities, chair, American higher wages, and lower investment and productivity and into greater economic Chamber of Commerce rates of poverty. At a growth and less poverty depends on the entire political, in Latvia; interviews minimum, the data social, and economic structure in Latvia. There are many conducted in Latvia for show that the benefits of links in the chain of causation, and the direct attribution FIAS video, Riga, reforms reaped by that FIAS can claim diminishes at every link farther away Latvia, September businesses took shape in from FIAS activities. Credit for success must be shared the context of growing with the Government of Latvia and with the businesses general prosperity in Latvia, with benefits also accruing and their associations, the EU accession process, the to workers and the poor. input of many other complementary projects, market forces, and fortuitous timing. DID FIAS SUCCEED IN MEASURING ECONOMIC IMPROVEMENTS? Outlook for Latvia The role of FIAS advice may be discerned through the Investment climate is a key determinant of whether an benefits accruing to businesses in Latvia (i.e., resources economy is able to respond dynamically to opportuni- freed up by lower costs for administrative procedures). ties offered by globalization. The dynamic growth of Whether these benefits translate into higher rates of the Latvian economy over the past few years indicates IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE 25 TABLE 4: KEY POVERTY AND FIGURE 9: CHANGE IN GDP INEQUALITY STATISTICS, PER CAPITA, PPS, 1999­2005 1998­2004 45 Statistic 1998 2000 2002 2004 40 S PP 35 Poverty head-count 30 rate (%) 19.4 14.0 7.5 5.9 capita, 25 per Poverty gap (P1) 20 measure 5.5 4.1 2.0 1.2 GDP 15 in e 10 Poverty line (% of 5 mean consumption) 50 41 34 30 chang 0 Gini coefficient 33.5 37.3 35.1 33.5 -5 EU15 Poland Slovenia Czech Slovak Hungary Lithuania Latvia Estonia Republic Republic Source: World Bank 2006. economy that the quality of the investment climate is quite good. On one hand, Latvia compares well with Sources: World Bank staff calculations based on Eurostat data; World Bank other countries in the region on the processes 2006. Note: GDP = gross domestic product; PPS = purchasing power standards. Data associated with starting and closing a business and for 2005 are estimates. Change for country i equals [Yi(2005)/Yi(1999)] / on the burdens of obtaining licenses and permits, [Yeu(2005)/Yeu(1999)] x 100 ­ 1000, where eu stands for EU24 and Y stands for GDP in PPS. registering property, and enforcing contracts. On the other hand, Latvia has rigid labor markets and FIGURE 10: POVERTY TRENDS inefficient procedures for construction project IN LATVIA, 1998­2004 approval. However, sustaining relatively high 25 output growth rates in Latvia in the face of increasing competition from other new EU- 20 member countries will require continued strong (%) reform momentum and monitoring. 15 rate The government views continued monitoring of 10 the business environment and ongoing dialogue head-count as important instruments for assessing business 5 regulation. A structured dialogue has continued with private sector organizations, and problems 0 1998 2000 2002 2004 have continued to be incorporated into the Action Plan to Improve the Business Environ- ment (the latest version of which was adopted in Source: World Bank 2006. early 2006). Now that this mechanism has entered 26 IMPROVING the Business Environment in Latvia: THE IMPACT OF FIAS ASSISTANCE its fifth year, there are signs that it needs to be revital- made evident by the business survey results. Attention to ized and better integrated with the wider initiative to the means of public service delivery and communication, reform regulations being promoted within the EU. and further enhancement of the flexibility of labor mar- kets, land markets, and the legal/regulatory environment Business demands on the quality of the public service and for businesses, must be key priorities. the regulatory environment are growing constantly, as Appendix 1 27 Appendix 1: Overview of the FIAS Program in Latvia, 1998­2004 This case study attempts to describe and quantify the Investors complained about a lack of information following key elements of FIAS assistance to the regarding the reasons for inspections and the regulations Government of Latvia from 1998 to 2004: they were intended to enforce, a lack of consistency in interpretation and enforcement of the relevant regula- project inputs (budget, human resources, government tions, a lack of coordination between inspections, inputs, and so forth); unreasonable fines, and the lack of recourse. project outputs (primarily FIAS recommendations), as 2. Customs administration. Because trade is vitally well as advice and guidance provided in "implemen- important in Latvia, competitiveness requires efficient tation assistance" projects; procedures for import, export, and transit of goods project outcomes (primarily reforms enacted in and services. Although only a minority of firms in response to FIAS recommendations, but also FIAS Latvia are involved in international trade, their methodologies adopted by the Government of Latvia complaints about confusion, delays, and corruption in the course of its own institutional development); had to be treated as a high priority. improvements in Latvia's investment climate, using 3. Procedures for land acquisition. Relatively few various indicators; businesses need land (many small firms only need to improvements in Latvian investment/business rent premises within buildings owned by others). For growth, based on foreign direct investment data, gross firms trying to expand, however, administrative pro- domestic private investment data, numbers of new cedures for access to land were often severe obstacles, businesses registered in Latvia, and the like; involving long delays and considerable uncertainty. improvements in Latvian economic growth (for Claims frequently were disputed. Potential buyers example, in GDP per capita and private sector needed a cadastral survey to register in both the employment); and cadastre and the "Land Book," and sometimes they improvements in Latvia's poverty reduction, using needed to request a change in land use designation. various indicators. 4. Construction permits. Once investors had secured land, they usually needed to obtain a long list of This appendix assesses seven areas of reform in Latvia, permissions to legally begin construction. Although all of which have relatively long track records in that there had been some effort at coordinating some of the they were covered in the initial administrative barriers key permits in Riga City, the process was complex, study in 1999, were included in the first action plan, lengthy, and prone to corruption. saw at least some reforms enacted (including, in some 5. Tax administration. Almost all business cases, FIAS implementation assistance), and have some representatives complained about tax administration. survey results to show impact (except for immigration). Their concerns included legislation and regulations Here are the key areas and some comments about that were unclear and often changed, frequent and them17: onerous inspections, heavy fines often levied on the 1. Inspections. FIAS learned that inspections were one basis of minor technical infractions, and the lack of of the complaint topics most often mentioned in Latvia. appeals mechanisms. 17. In all cases, the paper makes note of other identifiable "influences" (for example, other projects), but it does not attempt to quantify them. 28 Appendix 1 6. Expatriate immigration. Many foreign investors that may link the results of the project to the ultimate (and some domestic investors who tried to hire expatri- poverty alleviation goals of the World Bank Group and ate specialists) complained that the Immigration Service FIAS donors. was known to deport people summarily on the basis of minor technical infractions of the law. Although that CHRONOLOGY OF FIAS WORK IN did not happen often, the stories were well known and LATVIA SINCE 1998 created a climate of fear that undermined Latvia's efforts FIAS began its consultation work in Latvia in autumn to attract FDI. More common problems included 1998, with a letter of request from the Minister of unclear regulations and lengthy delays. Finance asking for FIAS assistance in removing adminis- 7. General Recommendations. In addition to trative barriers to foreign and domestic investment. The recommending that specific administrative barriers chronology of events was as follows: to investment be dismantled, FIAS made many cross- October 1998: FIAS mission to Latvia cutting recommendations, including December 1998: draft report delivered to the improving access to information about administrative Government of Latvia procedures January 1999: seminar to present draft report improving the service orientation component of April 1999: final administrative barriers report administrative procedures May 1999: government action plan established on the introducing a regular, structured public/private basis of FIAS recommendations (subsequently updated dialogue six to eight times) developing a specific action plan for reform and a Summer 1999: letter of request from the Government system for updating it regularly. of Latvia for implementation assistance, especially We discuss these areas of reform on the basis of the with inspections reform, construction permits, and logical framework matrix (table 1A.1). Appendix 2 monitoring examines the issues presented in the framework and the December 1999: FIAS seminars on inspections reform indicators of project achievement in each of the seven and construction permit reform areas of reform. 2000: Development of monitoring instruments 2001: Request to collaborate with FIAS on The links between project inputs/activities and project "self-assessment" as a pilot outputs and outcomes can be described with a reason- December 2001: First ARCS able degree of confidence. However, the links to effects 2002: "Templates" exercise as part of self-assessment on investment rate and beyond are more tenuous. In all study to gather information from government cases, a FIAS project was only one input among many, institutions and it is not possible to state conclusively that FIAS was January 2003: Latvia "self-assessment" update report responsible for improved investment rates. Neverthe- finalized, with fresh recommendations (which were less, we can offer qualitative descriptions of the logic made part of an updated action plan) Appendix 1 29 Table 1A.1: LOGICAL FRAMEWORK FOR REMOVAL OF ADMINISTRATIVE BARRIERS TO INVESTMENT Objectively verifiable Sources of Intervention logic indicators verification Assumptions General objective/ Increased investment, Statistics on FDI, Data from reports Higher levels of ultimate impact formalization, productivity gross domestic by Ministry of investment and growth, economic growth, private investment, Economy, SRS, productivity lead employment, and alleviation GDP growth, Enterprise Register, to higher levels of of poverty incidence of and others; IMF, growth, which, poverty, and IFS, World Bank, in turn, create others UNDP more employment opportunities and better-paying jobs. Direct objective/ Improvement of the Various indicators EBRD Transition Removal of ultimate outcome investment climate through of investment Report, BEEPS, administrative removal of administrative climate Heritage barriers to invest- barriers to investment Foundation, ment contributes Transparency (among other International, things) to an and others improved investment climate, and thus leads to higher levels of investment. Outputs and Specific recommendations Reduced burden of Doing Business Recommendations immediate to remove administrative government database, ARCS, are enacted by outcomes barriers in procedures and focus groups, data government · inspections regulations in terms from government and supported · customs administration of reduced time/ agencies, and through the · construction permits cost, reduced others implementation · acquisition of land incidence of bribery, level (for example, · tax administration fewer fines/sanctions, training for civil · expatriate immigration improved quality of servants, improved · improved transparency, procedures, and transparency and public/private dialog, the like accountability in and others support of basic legislative reforms). (continued) 30 Appendix 1 Table 1A.1: LOGICAL FRAMEWORK FOR REMOVAL OF ADMINISTRATIVE BARRIERS TO INVESTMENT (CONTINUED) Objectively verifiable Sources of Intervention logic indicators verification Assumptions Activities · Study of administrative FIAS reports, survey FIAS PCRs and Project research barriers to investment, reports (some PIMS, government and dialogue including input from both available on Internet) project status reports lead to sound public and private sectors recommendations. and other relevant stakeholders · Development of recommendations · Input from international experts in specific areas (for example, inspections reform) · Assistance in initiating public/private dialogue · Monitoring of impact Resource inputs · Initial administrative FIAS PCRs and FIAS PCRs and Resources allocated barriers study: $152,000 PIMS, government PIMS, government are adequate (plus government project status reports project status for the job. resources of staff time reports and materials) · Implementation assistance: $98,300 (plus government resources) · Self-assessment update: $139,000 (plus government resources) Source: FIAS. Note: ARCS = Administrative and Regulatory Cost Survey; BEEPS = Business Environment and Enterprise Performance Survey; EBRD = European Bank for Reconstruction and Development; FDI = foreign direct investment; GDP = gross domestic product; IMF IFS = International Monetary Fund International Financial Statistics; PCR = Project Completion Report; PIMS = Project Implementation Monitoring System; SRS = Latvia State Revenue Service; UNDP = United Nations Development Programme. December 2003: second ARCS, funded by the September 2005­May 2006: third ARCS, funded by the Government of Latvia, with methodological Government of Latvia, with methodological assis- assistance from FIAS tance from FIAS and quality review of the policy Spring 2004: case study of the impact of inspections report prepared by the LIDA. reform in Latvia appendix 2 31 Appendix 2: Detailed Description of FIAS' Latvia Program PROJECT INPUTS AND ACTIVITIES The Government of Latvia specifically requested that the key recommendations for reforms to inspections The first FIAS study of administrative barriers to invest- and construction permit processes be included in a ment in Latvia began in autumn 1998. The study team World Bank structural adjustment loan conditionality consisted of one FIAS task manager and two international matrix. The government made a specific request to experts working with three to four counterparts from the FIAS for follow-up assistance in those two areas, along Latvian Development Agency (LDA), which later with assistance in institutionalizing the public/private became the Latvian Investment and Development dialogue, improving the appeals system for key adminis- Agency. The project cost approximately US$152,000 trative procedures, and developing a system for moni- and took less than six months. The study included a field toring the reforms. mission of three weeks in October 1998, the direct assis- tance of an LDA counterpart in writing the draft paper, Thus, the second FIAS administrative barriers project in delivery of the draft paper at the end of December 1998, Latvia was an implementation assistance project. This a workshop in late January 1999, feedback on the draft project began in autumn 1999; cost about US$98,000 paper, and delivery of the final paper in April 1999. (plus additional resources supplied by the Government of Latvia); and occupied a FIAS task manager, two Meanwhile, the Government of Latvia began communi- international consultants, and two local consultants. cating with the business community on the development of an action plan to implement the reforms to be The project involved two workshops (one each on reform recommended in the administrative barriers study. The of inspections and construction permit processes), a num- government agreed to implement the recommendations ber of field missions by an international expert on appeals that were considered to be the highest priority, and they systems, and several missions by the FIAS task manager. formed four technical subcommittees to examine The project produced several reports with recommenda- (1) problems with inspections; (2) expatriate residency tions that were included in the government's regular and work permit issues; (3) registration, tax, and customs updates to its action plan. The monitoring system includ- matters; and (4) land acquisition and construction issues. ed a simple business survey questionnaire that was com- pleted by members of several business associations. Each working group comprised six to eight individuals, including relatively equal numbers of technocrats (from The third FIAS project in the series was a self-assessment the relevant government agencies) and representatives update of the original administrative barriers study. This from the private sector. The resulting action plan was project enabled Latvia to serve as the pilot country for approved by the prime minister and the Cabinet of new FIAS self-assessment tools (primarily a standard Ministers in May 1998, and implementation began business survey and templates of the views of government immediately. Many of the elements of the action plan agency officials of administrative procedures). It began in were combined with related, ongoing projects (for autumn 2001 and was mostly completed in 2002. The example, customs and tax reform) usually supported by project cost approximately US$140,000 on budget (plus other donors (such as the EU PHARE program; see additional expenditures by the Government of Latvia, off footnote 10 in the main text). the FIAS budget). Project staffing included a FIAS task 32 appendix 2 manager, one other FIAS staff person (for one work- procedures and changes in perception by businesses. The shop), one international survey consultant, two local con- results of the latest ARCS corroborate the trend revealed sultants, and a local survey company that administered by the results of the 2003 ARCS. and analyzed the business survey. The key challenge in identifying, collecting, and The fourth and fifth FIAS projects in the series were presenting these outcomes was that very few--if any-- devoted primarily to documenting the effects of reforms. statistical indicators were collected nor were quantita- The fourth project focused on reforms to the inspections tive evaluations performed prior to 1999--the year system, and it cost about US$37,000 (including a repeat of when the reforms discussed here began. Therefore, the business survey); the fifth project (of which this paper there is no rigid baseline to use in assessing the objective is the main output) was intended to document the effects reductions in time and relative cost of each procedure; of all the key FIAS administrative barriers work in Latvia, however, the best available data are used to approximate and its estimated cost is approximately US$41,000. the changes in quantifiable terms to calculate the impact of reforms where possible. In addition, although they In 2005, the Government of Latvia decided to carry out are crucial for simplifying the procedures, many other a third survey, and it requested help from FIAS only to legal changes implemented as a result of the FIAS rec- supervise the survey and train a group of independent ommendations might not be directly measurable in clear observers to supervise such surveys in the future. The quantitative terms. For that reason, the discussion relies FIAS work for that small project was about US$15,000. greatly on expert assessments of actual changes as presented in various studies and as experienced by PROJECT OUTPUTS AND OUTCOMES businesses. Where possible, the most pertinent of the quantitative indicators are used in this section, whereas This section describes the main project outputs (i.e., key more information on applicable investment climate indi- FIAS recommendations for reform) and the immediate cators can be found in the last section of this appendix. outcomes (such as changes in government policy, laws, and regulations)18 in these areas of reform: inspections; Each of the following substantive areas of reform is pre- customs administration, border-crossing, and sented in a separate section: import/export procedures; tax administration; expatriate immigration; construction permits; and procedures for inspections acquisition of land. This section also identifies the ultimate customs administration, border-crossing, and outcomes--i.e., the performance indicators for relevant import/export procedures government institutions, results of the business focus tax administration groups, other sources of evaluation including various expatriate immigration reports, and the results from the FIAS ARCS regarding construction permits changes in the time and cost demands of specific procedures for acquisition of land. 18. This information was largely compiled from the FIAS study finalized in 1999, the first action plan adopted by the government in May 1999, subsequent reports to the Cabinet of Ministers on the status of action plan implementation, reports and status notes prepared by the LDA, the FIAS assessment of progress, and reports prepared by the LDA as part of the PHARE project that supported the business environment improvement effort at the LDA. appendix 2 33 In addition, a cross-cutting area of reform--structured of the effort to reduce administrative barriers to invest- dialogue between the government and the business ment (which later was renamed the Reform Program to community--is presented separately. Improve the Business Environment, although the focus continued to be on administrative barriers). The foreign Each section follows the same format. First, a summary of chambers of commerce and business associations (such the 1998 FIAS findings and recommendations is presented as the Foreign Investors Council established in Latvia in with a summary of activities undertaken by the govern- summer 1999) also played a role in the initial stages of ment in response to those recommendations and in formulating the problems and suggesting solutions. Cer- response to its discussion of the problems identified with tain aspects of inspections reform were included in the the business community. After identifying outcomes government's action plan to reduce administrative barri- achieved by the government, we examine the available ers in 1999, based on the FIAS administrative barriers indicators to assess the immediate impact of reforms. report. When an opportunity arose to strengthen these efforts and find them appropriate institutional support, INSPECTIONS however, the inspectorate improvement tasks were incorporated in the World Bank's programmatic struc- One of the cross-cutting deficiencies identified in the tural adjustment loan and a Policy and Human Resources 1999 FIAS study was inconsistent implementation and Development grant was used to retain the required spe- interpretation of laws and regulations, particularly for cialized expertise and leverage the activities of the FIAS government inspections. This deficiency was caused implementation project. Overall, these activities resulted largely by an apparent lack of formalization in adminis- in the following reforms: trative procedures and interactions between govern- ment inspectors and businesses. The 1999 recommenda- reduced inspection burden on businesses (including tions (presented in the "Findings and incidence of inspections from labor, sanitary, con- Recommendations" column of table 2A.1) were aimed struction, and municipal police, and a shorter average specifically at these problems. The government recog- duration of inspections at one enterprise); nized the issues and embarked on a coherent reform development and implementation of a compliance- initiative to improve the legal and procedural conduct oriented approach in the inspectorates (at least to of inspections, the communication skills of inspectors, some extent) so that the imposition of sanctions and the provision of information.19 would no longer be seen as an end in itself, but as one of the means for achieving compliance with and Outcome of Reform enforcement of safety regulations; Most of the key legal and procedural reforms were improved provision of legal, procedural, and techni- planned and enacted during 1999 and 2000 through the cal information to businesses by the inspectorates via assistance of the FIAS implementation project. The bulk brochures, Web sites, and training seminars; and of initial training took place during 2001 and early 2002 greater quality and professionalism of inspectors in as part of the Inspectorate Improvement Program. The their relationships with those they were inspecting. formulation of that program started as one component 19. For a more detailed discussion of the government's Inspectorate Improvement Program, see Coolidge, Grava, and Putnina (2004). 34 appendix 2 TABLE 2A.1: INSPECTIONS: RECOMMENDED REFORMS AND THEIR OUTCOMES FIAS Findings and Recommendations Project Outcomes from Reforms Enacteda · Finding: There is an absence of a cooperation and coordina- · The coordination and cooperation of various inspectorates tion mechanism among various public institutions dealing improved as a result of the establishment of the Inspectorate with similar or overlapping competence. Coordination Council in April 2000. The council was respon- · Recommendation: Inspectors should receive basic marketing sible for implementing the inspections improvement program. training and customer service skills. · Tailored training was offered to the heads of inspectorates and to inspectors, including strategic planning, performance management, customer service skills, administrative law, and so forth. · The inspectorates have demonstrated a meaningful change of attitude. The heads of the inspectorates have acknowl- edged that their actions directly affect the business environ- ment in Latvia, and that they share certain problems that could be addressed most effectively by joint action. · Findings: Inconsistent attitude by inspectors when inspecting · On January 18, 2000, the Cabinet of Ministers issued an enterprises. Administrative statements are not always issued Instruction on the Procedures for Drafting Internal Rules on the spot in writing. When administrative statements are Governing the Work of Inspectorates, based on the recom- not written (particularly after a positive inspection), inspec- mendations in the FIAS report and activity of the LDA in tors in many institutions are not obliged to prepare a close cooperation with the Bureau for Public Administra- description of the inspection so that it is accessible to the tion Reform, the inspectorates, and the private sector. investor. Such weaknesses give rise to business' concerns · By September 1, 2000, the inspectorates prepared internal about the transparency of inspectors' operation and the rules that contain standardized information on the rights and reporting mechanisms. duties of inspectors and those being inspected, appeals · Recommendation: Ensure mandatory preparation of a written mechanisms, payment methods, and other information that report (administrative statement) and its immediate issuance. makes the work of each inspectorate more transparent and The right of the person being inspected to see the inspec- understandable to those being inspected. tion report should be well publicized. · A number of inspections introduced carbon-copy forms for their administrative protocols and decisions, as well as checklists of items to be inspected. · Pilot projects for reform were initiated in the State Labor Inspectorate and the State Education Inspectorate. These projects introduced risk assessment methodology and per- formance measurement systems in the pilot inspectorates. · Finding: Entrepreneurs often lack information about inspec- · On the basis of internal rules described above, guidelines in tions, their objectives, legal framework, inspectors' rights the form of brochures were published by inspectorates and and authority, and rights of the inspected. publicly distributed via the Internet and official gazettes. · Recommendation: Improve the dissemination of information on the legal framework, rights, and obligations of the inspected. (continued) appendix 2 35 TABLE 2A.1: INSPECTIONS: RECOMMENDED REFORMS AND THEIR OUTCOMES (CONTINUED) FIAS Findings and Recommendations Project Outcomes from Reforms Enacteda · Findings: Mechanisms to appeal the operation of public · Appeals concerns were addressed partially in guidelines and institutions are inappropriate. The typical mechanism is to internal regulations, and revised forms for administrative acts appeal to the management of the institution, which are to be used by individual inspectors. This issue was later investors do not find attractive. Appeals to the court system addressed through parallel initiatives, such as introduction of are time consuming and expensive. the Administrative Procedure Law.b · Recommendation: Clarify the existing avenues for appeals, and improve the handling of appeals within the institutions. · Recommendation: The Riga Municipal Language Inspectorate · As of early 2001, following establishment and enforcement of and the State Language Inspectorate should either merge a new Language Law, municipalities had no ability to enforce into a single unit or define their specializations. the Language Law. The Riga Municipal Language Inspec- torate was eliminated and some of its information functions were transferred to the Riga City Language Service. Sources: FIAS 1999; follow-up research by FIAS. a. Reforms were enacted primarily in response to FIAS recommendations; also, FIAS methodologies were adopted by the government in the course of its own institutional development. b. Detailed assessment of the administrative appeals mechanisms before enactment and enforcement of the new Administrative Procedure Law, and assessment of preparations undertaken by individual institutions as of January 2004, are available in Putnina and Russell-Einhorn (2004). Although some significant improvements occurred in and risks imposed on businesses. These reforms are most national-level inspectorates, the municipal police noteworthy because many transition and developing force, which also was empowered to inspect businesses, countries have found it difficult to implement a coordi- still seemed to exert its strong discretionary power in nated reform program of this nature across a range of 2003--more prominently in Riga than elsewhere in the different agencies. The sections below provide some country. Businesses continued to complain about the more detail on the key immediate impact of reforms. work of the municipal police, which was not included Changes in Inspection Burden in the original reform efforts. This serves as a good illus- The intent of the ARCS is to examine objective and tration of--and contrasts with--the success of the measurable indicators of administrative procedures that national inspectorate reform effort. can provide information on changes occurring over One can conclude that the inspectorate reform program time. For inspections, these changes included the num- was largely successful in maintaining and improving the ber of on-site inspections that a business incurs in a government's goals of safeguarding public health, safety, year, the duration of these inspections, and the number and the environment while reducing the associated costs of inspectors at one on-site inspection.20 20. Because the reforms were enacted between 1999 and 2001, it is reasonable to expect that any meaningful impact of the reforms could be discerned at the earliest in 2002 and more realistically in 2003 and beyond. It is in this context that the results of the 2001 and 2003 ARCSs presented here should be viewed (that is, although the 2001 survey was not carried out in a strict prereform setting, the measures that were discussed could have only partially [if at all] affected the on-the-ground reality). 36 appendix 2 TABLE 2A.2: AVERAGE NUMBER OF ANNUAL INSPECTIONS PER COMPANY INSPECTED Inspecting Agency 2001 2003 2005 Sanitary Inspectorate 4.3 2.6 2.10 Municipal Police 2.9 3.1 3.40 Construction Inspectorate 2.7 1.7 1.55 Environmental Inspectorate 2.3 2.1 1.60 State Revenue Service 2.2 1.9 1.90 Fire and Rescue Service 1.6 1.5 1.20 Labor Inspectorate 1.4 1.4 1.50 Total 17.3 14.3 13.30 Sources: ARCS 2001, 2003, and 2005. The survey data indicate that although the average fre- FIGURE 2A.1: AVERAGE quency of inspections did not change substantially for DURATION OF INSPECTIONS, the labor and fire inspectorates between 2001 and 2003 2001 AND 2003 (table 2A.2), the average duration of on-site inspections decreased substantially for all major inspections (figure 14 2A.1). The business surveys confirmed that the average 12 frequency and duration of inspections for the five most Sanitary Inspectorate burdensome inspections (fire safety, labor, construction, 10 Labor environmental, and sanitary) fell between 2001 and Inspectorate 8 2003, resulting in a time saving of around 39 hours per Construction year for an average firm.21 If we further assume that each hours Inspectorate 6 Environmental firm needed to assign one staff member to accompany a Inspectorate 4 government inspector, and the average wage was about Fire and Rescue US$2.2 per hour, saving that time alone represented a 2 Service cost saving of US$85 per year for an average firm.22 0 2001 2003 What is more, according to the data from Latvia's Central Statistical Bureau, there were about 45,300 active enter- Sources: ARCS 2001 and 2003. prises in Latvia in 2003. Thus, an average US$85 savings Note: This question was not included in the 2005 ARCS. 21. This excludes many other inspections such as construction and environmental inspections that each affect a smaller number of firms. 22. This benefit does not include other aspects of the reforms, which improved transparency and accountability in government inspections. appendix 2 37 per firm multiplied by 45,300 firms equals roughly TABLE 2A.3: CHANGES IN US$3.8 million saved in labor costs for a single year. Note SELECTED PERFORMANCE that this benefit calculation is very conservative; it is only INDICATORS OF THE STATE for a subset of inspections that were subject to reform. It LABOR INSPECTORATE assumes that a worker with an average wage accompanied % Change, the inspector (rather than a manager with a higher oppor- Indicator 2001 vs. 2003 tunity cost). It excludes any other benefit resulting from the reforms (such as a decrease in fines or bribes). Number of inspectors +2 A comparison of this information with statistics provid- Number of identified organizations +17 and enterprises under supervision ed by the inspectorates shows both a reduction in the relative number of inspected entities and greater target- Number of employees in the super- +25 ing of inspections. For example, data from the Labor vised organizations and enterprises Inspectorate (see table 2A.3) indicate that although the Number of inspected organizations +5 number of enterprises under its supervision in 2003 and enterprises increased by 17 percent over 2001, the number of Number of organizations and ­3 inspected entities in the same period increased by only 5 enterprises inspected more than percent. This finding is consistent with the survey find- once a yeara ings discussed above. It is also noteworthy that, at the same time, the number of inspectors increased by only 2 Sources: ARCS 2001 and 2003. percent (from 96 to 98 inspectors). The number of noted, "The length of the inspection depends on the repeat inspections is also fairly small--at 6.7 percent for qualifications of inspectors--if they know where to 2002, a decrease of 3 percent compared with 2001. look and what to look for, the inspection is shorter. In interviews, the heads of inspectorates indicated their The inspectors have become more professional and they belief that implementing better risk targeting methods do not look just for anything but have developed their accounts for these changes. There is also a general routines and standard procedures." understanding that overall public health and workplace Changes in Administrative Sanctions safety have not deteriorated because of changes in the and Penalties frequency and duration of on-site inspections. The practice and procedures for imposing fines was one Another factor that accounts for these measurable focus of the reform efforts. One aspect of that focus was changes was a qualitative improvement in the the development and implementation of a compliance- professionalism and competence of inspectors. In oriented approach in the inspectorates to the extent that addition to the information provided by inspectorates the imposition of sanctions was no longer seen as an end indicating that training of inspectors has been given in itself, but as one of the means for achieving compli- much more attention than previously was true, this ance with and enforcement of safety regulations (and, assertion was confirmed in business focus group discus- crucially, one not to be applied without considering sions held in March 2004. One business representative alternatives). Another aspect was the improvement of 38 appendix 2 operational procedures for handling applications of fines did the number of cases of suspended equipment so they are properly registered and recorded. (44 percent). The number of administrative penalties and warnings issued by the Fire and Rescue Service As shown by the results of business surveys,23 the proba- followed a similar pattern. bility of inspectorates imposing fines was reduced by the following amounts between 2001 and 2003: Changes in Provision of Information Another critical objective of reform was to improve the Labor Inspectorate, 84 percent type and amount of information that businesses were Sanitary Inspectorate, 82 percent given regarding the legal and procedural aspects of inspec- Fire and Rescue Service, 87 percent tions, including substantive requirements and explana- municipal police, 73 percent. tions. Although no information materials were available in 1998, the situation has improved considerably since then. Focus group discussions provided more detail on these figures. One business representative indicated that "the The self-assessment templates of 2002 asked the inspectorates are no longer penalizing for little mistakes, responding inspectorates to identify the methods they they are just writing or telling [us] that these problems use to communicate information on the requirements to have to be averted." Those conclusions are also supported enterprises. The responses are presented in table 2A.5. by the performance data of the State Labor Inspectorate (table 2A.4), which reveal that the number of adminis- In addition to more traditional forms of knowledge trative penalties imposed decreased by 23 percent from dissemination, the Internet has been one of the most 2001 to 2003. Similarly, the number of warnings issued effective tools for distributing detailed information on for suspension of activities decreased by 22 percent, as laws, requirements, and guidance for achieving TABLE 2A.4: SELECTED PERFORMANCE INDICATORS OF FIRE AND RESCUE SERVICE AND STATE LABOR INSPECTORATE, 1999­2003 Fire and Rescue Service Labor Inspectorate (% changes, Indicator (% change, 1999 vs. 2003) 2001 vs. 2002 and where available 2003) Administrative ­12 ­23 penalties imposed Administrative penalties 3 ­7 Warnings issued for suspension of ­52 ­22 activities/equipment Suspended equipment n.a. ­44 Source: Performance data provided to FIAS and LIDA by the relevant inspectorates. 23. For a summary of data analysis, see Coolidge, Grava, and Putnina (2004), annex D. appendix 2 39 TABLE 2A.5: GOVERNMENT INFORMATION AVAILABLE TO ENTERPRISES No additional information Individual disseminated; Information inquiries answered relevant laws and posted on by phone, with regulations Printed leaflets Seminars and Internet letters, in person, Inspectorate are sufficient and brochures training sessions home page and so forth Labor X X X X Sanitarya X X Firefighting and X X X Rescue Service Construction X X X Environmental X X X X State Revenue X X Service Source: FIAS 2003b. a. The Sanitary Inspectorate also uses mass media to inform businesses about requirements. compliance. Web sites for Latvia's inspection agencies the Fire and Rescue Service and the Language were practically nonexistent in 1998­99. Most inspec- Inspectorate) still have room for improvement, whereas torates doubted the utility of such a vehicle and they others can boast informative and useful Web sites. argued about the lack of funding. Although no specific funding had been earmarked for these purposes, the Lat- Evaluation of Services vian inspectorates found resources to invest in providing Complaints about intimidating behavior, such as information via the Internet and developing Web aggressive and unpleasant attitudes by inspectors during resources. By now, all inspectorates have embraced dis- on-site inspections, and about lack of transparency in semination of information as a core function and regard inspecting procedures were major concerns described in it is as an effective tool for reaching a wider audience the 1998 FIAS report. There are, however, clear indica- and promoting compliance. A snapshot of the status of tions that the quality and professionalism of inspectors the Web sites of key inspections appears in table 2A.6 have improved (see figure 2A.2), as have internal This snapshot indicates that some institutions (such as operating procedures. 40 appendix 2 TABLE 2A.6: EVALUATION OF INSPECTORATE WEB SITES, AUGUST 2004 Contact information Information about Inspectorate Legislation and working time procedures Downloadable forms Food and Veterinary Service (http://www.pvd.gov.lv) Labor (http://www.vdi.lv) Sanitary (www.vsi.gov.lv) Environmental (http://www.vvi.gov.lv) a Firefighting and Rescue Service (http://www.vugd.gov.lv) -- Language (http://www.tm.gov.lv/index.php) -- Source: LIDA, August 2004. Note: = very good; = good; = bad; -- = nonexistent. a. Hard to find. b. Gives statistics about fires. Focus group discussions held in early 2004 confirmed CUSTOMS ADMINISTRATION, BORDER- CROSSING, AND IMPORT/EXPORT the survey findings, and added that PROCEDURES participants found the professional standards of most When the FIAS administrative barriers study was inspectorates had increased over the previous five years released in early 1999, Latvia was in the process of cash bribes associated with inspections had decreased aligning its customs legislation with that of the EU (although, in some cases, bribes may have been Customs and Implementation Codex.24 The Govern- replaced with more sophisticated forms such as ment of Latvia received significant support from the EU pressure to take on a business partner or to hire for this process in the form of PHARE-financed projects someone recommended by an inspector). aimed at improving and strengthening different aspects 24. This section covers the reforms adopted before May 1, 2004, when Latvia became an EU member and the Customs Administration ceased control of intracommunity trade, which had constituted two-thirds of international trade. After May 1, 2004, customs matters were governed by the EU Customs and Implementation Codex, which means that national laws can be adopted only to govern issues not covered by EU regulations. The legislation discussed in this section became void as of May 1, 2004. appendix 2 41 Online submission of Analysis and other suggestions and questions E-newsletter performance data Links Other languages User friendliness English English -- -- English -- -- b English -- -- -- -- English of customs administration. With this in mind, the FIAS these weaknesses had a negative effect on the invest- analysis in 1999 was limited to those issues that were ment climate. deemed prevalent problems and, from the perspective of businesses, had not been addressed adequately within FIAS Recommendations and the large-scale, ongoing projects. Thus the critical role for Government's Response FIAS was to highlight the immediate and short-term Table 2A.7 summarizes the findings and recommenda- concerns of businesses that were overlooked by the tions that FIAS developed, and the reforms enacted by customs administration, which had been more attuned the government. to long-term and political goals. Businesses' key practical and immediate complaints in A new Customs Law had been in force since July 1998 were related to inconsistent treatment and poor 1997; however, a significant portion of the secondary availability of information on basic procedures and legislation had not been adopted. That delay in requirements. These were the issues that the FIAS imple- adoption allowed broad interpretation and inconsistent mentation project focused on in the dialogue it facilitated application of the law, and inhibited the daily opera- between businesses, the Customs Administration (as part tions of businesses. Although Latvia had positioned of the State Revenue Service [SRS]) and the Ministry of itself as a strategic transit route between west and east, Finance (which oversees customs legislation and policy). 42 appendix 2 Speedier adoption of the missing Cabinet of Ministers' FIGURE 2A.2: CHANGES IN implementing regulations during 1999 and 2000. Publicly QUALITY OF INSPECTION and continuously highlighting the detrimental effect WORK BETWEEN 2001 AND 2003 of the lack of clear normative acts in the new Customs Law played a substantial role in moving this Environmental Inspectorate ­1.2 11 higher up the agenda of the Ministry of Finance. The Labor Inspectorate ­1.9 12.6 FIAS implementation project actively solicited busi- nesses' opinions on draft regulations and facilitated Sanitary Inspectorate ­4 11.5 more open approaches to discussing the draft norma- Fire and Rescue Service ­2.2 6.1 tive acts. Improved coordination among customs agents and border Construction Inspectorate ­4.4 4.4 guards. A key contribution of the FIAS implementa- Municipal Police ­10.4 9.5 tion project was the initiation of open discussions between the SRS and the National Border Guard ­15 ­10 ­5 0 5 10 15 worsened improved Service about the deficiencies in their organizational management of border checkpoints and overlapping control functions. These discussions led to practical Sources: ARCS 2003. Note: Survey respondents were asked whether the quality of work by various agencies delineation of duties between border guards and had improved or worsened from 2001 to 2003. customs officials in cargo control, and to elaboration of site-specific technological schemes for the border The first Action Plan for Removal of Administrative checkpoints. Traders say this has produced significant Barriers, adopted by the Cabinet of Ministers in May improvements. 1999, contained a series of measures aimed at increasing Another aspect of improved coordination was the the legal certainty of customs procedures. The timing of joint implementation and analysis of the Border the action plan formulation process in early 1999 coin- Control Point Survey by the National Customs cided with the start of practical activities of the SRS Board, border guards, the Sanitary Border Inspec- Modernization Project. That project was financed torate, and the LDA. This survey, conducted at the through a loan from the World Bank, and was imple- five largest border crossing points during one week in mented from 1998 to 2002. The customs problems that June 2001, covered a random sample of 500 truckers FIAS identified and detailed in the implementation crossing these five points, and it was implemented by project found their way into activities funded under the a professional survey company. The idea for such a Modernization Project, where they received higher survey emerged in discussions between the FIAS priority, and they were further incorporated into the cus- implementation team and the director of the customs toms service strategic business plan for subsequent years. service. The FIAS implementation project then pro- posed that the border guards and the Sanitary Border The activities the government undertook in response to Inspectorate present at border crossing points also par- the FIAS project findings and recommendations result- ticipate in such an exercise, and they agreed to do so. ed in the following improvements: (continued on p.45) appendix 2 43 TABLE 2A.7: CUSTOMS ADMINISTRATION, BORDER-CROSSING, AND IMPORT/EXPORT PROCEDURES: REFORM RECOMMENDATIONS AND THEIR OUTCOMES FIAS Findings and Recommendations Project Outcomes from Reforms Enacteda · Finding: Major upgrading of national customs · The Cabinet adopted the following regulations regarding application of legislation was in process as part of harmonizing the Customs Law during 1999­2001: Procedure for Declaring Goods, legislation with that of the EU Procedure for Completing Customs Pre-clearance, Procedure for · Recommendation: Speed improvement and Completing Customs Procedure--Export, and Procedure for adopt import- and export-related legislation. Completing Customs Procedure--Import. Entrepreneurs eagerly awaited these new regulations so that many discrepancies in the application of the Customs Law could be resolved. · Following the suggestion of a number of business associations that it is necessary to separate liability for technical errors from liability for delib- erate infringements, amendments to the Administrative Violations Code were adopted by the Saeima (parliament) on June 14, 2001, and came into force on July 16, 2001. · An exchange rate calculation methodology for customs payments has been included in the Customs Law in accordance with the EU Customs Code, and came into force in July 2002. · Regular discussions with business tackled issues to be clarified and developed in secondary legislation; for example, procedures for granting deferment of customs payments, procedures for implementing the sim- plified customs declaration procedures, and clarifying the application of natural resources tax. · Finding: Transit companies transporting goods · A precise delineation of the duties and authority relating to decisions by through Latvia complained of inconsistent pro- customs officials was implemented. A resolution of the SRS was adopted cedures at border posts and even among work on July 7, 2000. shifts at the same border post. More generally, · The Manual of Customs Procedures was distributed to customs authori- there were perceptions of a lack of coordina- ties and businesses, and was posted on the Internet at tion and lack of a central authority channeling http://www.vid.gov.lv in early 2000. It contained the following the same information about regulations and sections: Release for Free Circulation (Import), Import into a Customs their interpretation to the different customs Warehouse, Pre-clearance and Temporary Storage, Temporary posts. Export, Re-import, Re-export, Free Port, Supply, Destruction, · Recommendation: The inconsistency of border Refusal in Favor of the State, Customs Control of Persons and Vehi- post procedures for import and export of goods cles, Customs Clearance and Declaration, Simplified Declaration, should be addressed as a matter of urgency. ATA Manual, and TIR Manual. The National Customs Board also This inconsistency can lead to delays in ship- prepared sections on Temporary Import, Free Zones, Customs Debt, ping and creates opportunities for corruption. Guaranties, and Customs Brokers. The customs service should develop and pub- · Manuals for key procedures (i.e., import, export, and transit) were trans- lish clear guidelines and manuals for its lated into English. employees and for businesses. · The SRS home Web page is regularly updated and amended with legal acts regulating customs (see www.vid.gov.lv). (continued) 44 appendix 2 TABLE 2A.7: CUSTOMS ADMINISTRATION, BORDER-CROSSING, AND IMPORT/EXPORT PROCEDURES: REFORM RECOMMENDATIONS AND THEIR OUTCOMES (CONTINUED) FIAS Findings and Recommendations Project Outcomes from Reforms Enacteda · Since September 1, 2001, the Consultations Department of the Legal Division of the National Customs Board has provided information and consultations to customs clients concerning any customs issues. · Finding: Investors maintain that border guards · The coordination between border guards and customs officials improved create obstacles for investors to declare goods at both the institutional and practical levels. imported to Latvia, saying that border guards · A new cooperation methodology was introduced at major border-cross- engage in unnecessary vehicle inspections. ing checkpoints, ensuring that the functions of the border guards and · Recommendation: Eliminate duplicate customs customs officials did not overlap. The process of formulating the gov- and border guard functions related to control- ernment's Action Plan for Removal of Administrative Barriers served as ling goods and conventionally prohibited arti- the impetus for preparing this technological scheme, which was signed cles, thus accelerating border crossing. on December 21, 1999. · FIAS contributed to prioritizing the introduction of incoming-traffic border controls. In 2000, one-way border checks were instituted at all road crossings on the Estonia­Latvia border, on the Lithuania­Latvia border at GrenctÆale, and at all pedestrian border-crossing points. · Recommendation: Accelerate the introduction · The system for processing customs declarations, ASYCUDA++, was of a customs declaration processing system. introduced at the major customs points. A simplified declaration system was introduced incrementally in 2000. · The SRS issued orders on procedures for issuing electronic declaration permits and procedures for document preparation. Issuance of permits for electronic declaration began December 18, 2000. · Recommendation: Customs should create a · The Customs Board initiated a regular survey of those crossing the fast-track system for receiving and acting on border to obtain their opinions of customs and the attitude of customs complaints and appeals. officers, and to identify existing problems and major reasons for dissatis- faction. Customs officials found the 1999 LDA survey to be useful, and they wanted to ascertain more information on client satisfaction. · A feedback questionnaire on the effectiveness of border-crossing and clearance procedures at border checkpoints was designed and imple- mented jointly by the SRS Customs Board, Border Guards, Sanitary Border Inspection, and the LDA in 2001. (More than 500 truckers filled out the questionnaire.) The results were used by each institution to develop its institutional improvement plans. Sources: FIAS 1999; follow-up research by FIAS. Note: EU = European Union; SRS = State Revenue Service. a. Primarily reforms enacted in response to FIAS recommendations; also FIAS methodologies adopted by the government in the course of its institutional development. appendix 2 45 The four institutions involved shared the cost of the by telephone, in writing, and by e-mail. One of its survey; conducted joint preparations, analysis, and key responsibilities is to inform others about applica- discussion of the results; and followed up on the ble normative acts and their interpretation. The suc- measures to which they had agreed. cess of the unit is best evidenced by the demand for This was a very successful demonstration of the its expertise. The number of consultations provided benefits of an improved and rigorous feedback and has increased tremendously since it was established: monitoring mechanism that enabled the institutions to jointly assess the functioning of specific border Jan. 1­May crossing points; identify the shortcomings in physical Year/period 2001 2002 2003 31, 2004 infrastructure, organizational management, and Number of 1,506 6,971 12,083 7,318 border-crossing procedures; and benchmark the consultations effectiveness and quality of their representatives' work at five different border crossing points. The The ability of customs authorities to effectively com- FIAS implementation project initiated this and municate upcoming changes in customs procedures provided the much needed expertise and skills in was tested to capacity as the EU accession date of designing, implementing, analyzing, presenting, and May 1, 2004, approached. The customs service could applying the results of such a monitoring exercise. have performed better but, to be fair, confusion over Improved access to information on procedures, requirements, customs functions after that date were fairly common and targeted consultations. After procedural aspects in across the new EU member-states for a few months Cabinet regulations had been prescribed, consistent before and after accession. SRS methodological guidelines and implementation Change in speed of clearance and introduction of simplified explanations had to be delineated in procedures clearance. The speed of clearance was not among the manuals. The government agreed to improve regular most critical issues identified in the 1998 FIAS processes to update the SRS Web site, to consolidate study. However, improvements introduced in 2000 guidance letters into procedure-specific method- to coordinate the work of border guards and ological guidelines, to prepare manuals and post customs officials, the introduction of one-way them on the Internet, and to establish a customs checks, and clarification of customs officials' consultation unit. decision-making authority have led to improvements The customs consultation unit seems to have in the speed of clearance. served an especially important function in alleviating The FIAS study released in the beginning of 1999 concerns and answering questions about legislation reported that the SRS' claim of a one-hour clearance and procedures. It is part of the Legal Division of the time was accurate, in the view of companies, and SRS National Customs Board, and was established on there were some complaints about delays stretching September 1, 2001, as part of the Action Plan for up to five hours at key Latvian-Lithuanian border Removal of Administrative Barriers. Its employees posts. The best comparison of these figures can be provide consultations on general customs problems found in the results of the June 2001 survey 46 appendix 2 conducted at the five largest border crossing points. 2003. Most important, the availability of information on Those findings revealed actual clearance times. The customs regulations/procedures and on customs authori- survey indicated that more than 50 percent of ship- ties' treatment of firms has improved (now, nearly 70 ments were cleared within 30 minutes, and a little percent of businesses do not view these as obstacles).25 more than 80 percent were cleared within one hour. This is a remarkable change from the level of dissatisfac- This was also true for the border crossing point on tion found on these two issues in 1998. the Latvian-Lithuanian border that was singled out Changes in Approaches to Control in the 1998 FIAS study. Another important point promoted by the FIAS Although trade facilitation is an important component implementation project and embraced by the National of customs services, it is also the responsibility of the Customs Board was to speed up inland clearances by customs service to collect taxes from international introducing simplified declarations and local clearances. trade transactions and to ensure that legitimate traders Legislation permitting these was introduced in 2002. are protected via the curbing of illegal trade and smug- Gradual implementation started in 2002 and 2003. gling. Therefore, the customs service must implement Statistics provided by the National Customs Board as effective controls, such as post-clearance audits that of August 17, 2004, indicate that the following tech- ideally have minimum interference with commercial niques have been introduced successfully: activity. Licenses for simplified declaration had been issued Strengthening the customs control function and improv- to 78 companies. ing its ability to effectively identify illegal trade were at Licenses for local customs clearance had been the pinnacle of the European Commission's attention in issued to 41 companies. the process of Latvia's negotiations to join the EU, not Agreements to use simplified customs clearance least because the Latvian customs service would assume procedures were concluded with two companies. responsibilities for admitting third-country goods to the EU market after accession. The local business community, Changes in the Perception of Customs however, was often more concerned with the practical Obstacles and immediate implications of any strengthening of Businesses engaged in clearance processes and those that control on the flow of goods and the comparative attrac- responded to the 2003 ARCS were asked to evaluate tiveness of Latvia as a transit and distribution route. The whether customs administrative procedures presented an customs service always has had to balance these two obstacle to their work (figure 2A.3). Although this was a objectives and find ways to achieve both. question of perception, and it was not possible to make a direct comparison of 2003 results with those of the 2001 In this respect it is interesting to ascertain the impact of ARCS, the ranking of these obstacles and a discussion of amendments to the Administrative Violations Code that the results in a focus group in April 2004 shed some light came into force in July 2001. The amendments were on the positive changes that occurred between 1999 and discussed in the framework of the dialogue between the 25. Another similar category--availability of information on changes in customs procedures--ranked as the most important obstacle in a survey conducted in autumn 2003, in anticipation of EU membership occurring on May 1, 2004. Subsequent focus group discussions confirmed that this temporary phenomenon was captured in responses to this category of obstacles. appendix 2 47 FIGURE 2A.3: BUSINESS OPINIONS ON CUSTOMS SERVICES OBSTACLES TO OPERATION AND GROWTH, 2003 completing customs declarations 13 76 11 availability of information on customs 18 68 11 regulations/procedures treatment of your firm by customs authorities 18 68 11 el effectiveness of appeals procedures 24 26 47 stacbo severity and proportionality of penalties 24 39 37 frequency of changes in 26 58 16 regulations/procedures burden of cargo inspections 32 55 11 availability of information on changes 45 37 18 in customs procedures 0 10 20 30 40 50 60 70 80 90 100 percent obstacle not an obstacle hard to say/not applicable Sources: ARCS 2003. government and the business community, which was infer whether the cause of this decline was the facilitated by the FIAS implementation project, and enactment of these specific legal changes or some other they were made a part of the action plan. Reasons for factors, but it definitely has brought the issue to the complaints included increased aggressiveness by the cus- attention of officials and changed (at least a little) their toms service in identifying technical errors and impos- approach to penalizing offenders. The statistics also ing administrative fines. This trend can be observed draw more attention to post-clearance audits, which is until 2001 in figure 2A.4. consistent with best-practice guidelines for modern cus- toms administrations. The amendment that was adopted stipulated that administrative liability was not to be applied for techni- Changes in theVolume of Customs cal errors--thus separating liability for technical errors Declarations from liability for deliberate infringements, which had The quality of customs administration is an important been the problem that businesses raised. The statistics consideration for existing and potential investors, and provided by the National Customs Board indicate a for domestic enterprises that became increasingly slight decrease in the incidence of Administrative Viola- engaged in international trade at the end of the 1990s. tion Protocols (drawn up by customs officials) in the The primary task of an efficient customs administration total volume of clearances performed in 2002 and 2003, is to collect duties and taxes while ensuring prompt and a relative reduction in fines imposed. We can only clearance of goods. Therefore, modern customs 48 appendix 2 FIGURE 2A.4: CUSTOMS CONTROL WORK, 1998­2003 14 12 10 percent of postclearance audits 8 among all declarations percent of administrative misdemeanor cent protocols among all declarations erp6 fines as percent of total tax payment calculated by customs service 4 2 0 1998 1999 2000 2001 2002 2003 Sources: National Customs Board, SRS. procedures are designed to implement effective controls The results of the ARCS conducted at the end of 2003 while facilitating international trade. Customs adminis- indicated that clearances had also increased--i.e., trations ideally should have minimum interference with businesses that were engaged in international trade were commercial activity. The same is true for other institu- more active (as shown by more customs declarations tions involved in the clearance of goods. being cleared than before). One objective measure of the quality of customs work TAX ADMINISTRATION is the number of customs declarations processed and the amount of tax revenues that a customs service High tax rates and burdensome tax administration are at levies. In Latvia, the number of customs declarations the top of the list of complaints for businesses in most has increased from around 850,000 in 1998 to nearly countries. This can be reasonably expected, and govern- 1.2 million in 2003, while the amount of tax calculated ments must understand that the level of complaints is in on these transactions has increased approximately itself not indicative of the severity of problems that 1.6 times (figure 2A.5). entrepreneurs face. Although some complaints are appendix 2 49 FIGURE 2A.5: NUMBER OF CUSTOMS DECLARATIONS (IMPORT, EXPORT, TRANSIT), 1998­2003, AND AMOUNT OF CALCULATED TAX, 2000­03 1.4 800 1.2 700 ats)l 600 of 1 arationsl 500 ionsll 0.8 dec 400 (mi of 0.6 300 l ated ionsll 0.4 cul 200 mi ca es 0.2 100 tax 0 0 1998 1999 2000 2001 2002 2003 SADs on imports, exports and transit shipments tax payments calculated by customs service Sources: National Customs Board, SRS. Note: SAD = single administrative document (customs declaration). grounded, some are based on the fact that people simply except in the direction of a broader definition of do not like paying taxes and will avoid doing so, or will deductibles. The social security contribution rate also even evade paying to the extent they think they can get decreased from 37 percent in 1998 to 33 percent in away with it.26 2004. Other tax rates have remained stable. Com- plaints about high tax rates and poor tax administration FIAS heard complaints about high tax rates in 1998 might be partly the result of the distortions caused by and again in 2005. The flat corporate tax rate was 25 underreporting for tax purposes, whereby some com- percent in 1998 and 15 percent in 2004; and the tax panies pay more and some pay less. The following was base had not changed substantially during that period, 26. Tax avoidance is defined as using legal measures to reduce taxes, usually involving changes in business activities that would not have been made in the absence of specific features in the business tax regime (for example, using "transfer pricing" to shift profits into a jurisdiction or activity that is relatively lightly taxed).Tax evasion is defined as an illegal measure, such as underreporting revenues. 50 appendix 2 noted in the "Latvia Self-Assessment Report" (FIAS The first Action Plan for Removal of Administrative 2003a): Barriers adopted by the Cabinet of Ministers in May On the basis of the self-assessment (including [the] business 1999 contained a series of specific measures that were survey) and comparison with other emerging market designed to improve the provision of information economies, FIAS' assessment of the current priorities needing through the development and dissemination of imple- attention in Latvia include the following: menting guidelines and the development of a targeted Numerous complaints and difficulties in the area of tax appeals division. The work that FIAS did to address the administration [...] tax administration problems helped ensure their ade- The persisting perception of an un-level playing field quate incorporation in the SRS Modernization between those enterprises that operate lawfully and those Project.27 functioning wholly or partially in the shadow economy, or With the commencement of EU accession talks in with benefit of "good connections" with government 1999, the European Commission and individual EU officials (p. viii). member-states devoted substantial attention to the func- The work of the SRS undoubtedly improved (as evi- tioning of the Latvian SRS. The legal, administrative, denced from various outside assessments and from and organizational harmonization problems became the discussions and focus groups with business representa- focus of the following: tives). However, the expectations and demands of taxpay- PHARE 1999 and 2001 projects to address tax policy ers also have grown, especially as the Latvian economy has and tax administration expanded. a bilateral cooperation program between Denmark FIAS Recommendations and the and Latvia Government's Reforms activities organized by the International Organization Table 2A.8 presents a summary of FIAS recommendations of Tax Administrations, the Organisation for Economic and the government's response to tax administration. Co-operation and Development, the European Com- mission Technical Assistance Information Exchange Ultimate Outcome of Reform Office, and others to address the tax administrations of The primary complaints of businesses in 1998 were countries seeking EU accession. inconsistent treatment and poor availability of information on basic procedures and requirements in tax administra- The critical contribution of the FIAS implementation tion, overlapping registration requirements, aggressive project was in opening and maintaining channels of com- enforcement approaches, and lack of reliable appeals. munication among the Ministry of Finance, the SRS, 27. The timing of the action plan formulation process in early 1999 coincided with the commencement of practical activities of this SRS Modernization Project, which was financed through a loan from the World Bank and was implemented from 1998 to 2002. appendix 2 51 TABLE 2A.8: TAX ADMINISTRATION: RECOMMENDED REFORMS AND THEIR OUTCOMES FIAS Findings and Recommendations Project Outcomes from Reforms Enacteda · Finding: Many countries automatically register a company to · Tax and enterprise registration were combined into a single pay taxes when it enters the Enterprise Register, which eas- procedure in 2001. es the company establishment process. · Recommendation: The Enterprise Register and the SRS should continue to work to find technological solutions to end the duplicative registration process. · Finding: Conflicts arise between taxpayers and the SRS · Ongoing progress has been achieved in revising SRS because of unclear interpretation of legislation and inconsis- methodological guidelines on application of legislation, tent application of regulations. taking into account discrepancies and problems indicated by · Recommendation: taxpayers. · The Ministry of Finance, in particular, should make a · The Internet home page of the SRS is regularly updated concerted effort to provide advance rulings to taxpayers with new legislative amendments and SRS methodological who request them, and publicize those rulings. guidelines. A hotline-type service has been established and · Other guidelines for SRS inspectors should be publicized is operating on the Internet (see http://www.vid.gov.lv). as they are developed. · Opinions should be strengthened so that they are more reliable and improve the consistency of implementation. · Finding: Investors are concerned about the ability of the SRS · SRS officials no longer receive a 20 percent bonus for to inhibit a company's operations and about its willingness penalizing taxpayers. to exercise such authority, including imposing significant · The Appeal of Decisions Department in the SRS was set up fines and other measures. Investors are concerned about and began operating on January 17, 2000. Further appeals possibilities of recourse. divisions were established in regional offices. · Recommendation: The government should investigate · Amendments to the Law on Taxes and Duties authorizing measures to mitigate the power of the SRS over legiti- the SRS to reduce penalties (once every three years) were mate business enterprises, including adopted (effective May 17, 2002). · establishing a tax appeal tribunal to accelerate and improve · Amendments to the Law on Taxes and Duties (effective May the review of appeals 17, 2002) strengthened the legal procedure for the SRS to · limiting the enforcement powers of the SRS by stipulating execute its enforcement powers and clarified the rights and that it should not be allowed to seize the bank accounts of responsibilities of both the SRS and delinquent taxpayers. a firm without a court order · The requirement to produce a tax clearance certificate has · abolishing or reducing the need for a business to produce a been eliminated for residence and work permits and for tax clearance certificate for importation, real estate transac- importation. tions, and employment of expatriate labor. Sources: FIAS 1999; follow-up research by FIAS. Note: SRS = State Revenue Service. a. Primarily reforms enacted in response to FIAS recommendations; also FIAS methodologies adopted by the government in the course of its own institutional development. 52 appendix 2 and the business community on the issues of tax policy 2005, as part of the Commercial Law reform, the and tax administration. The large-scale PHARE project Enterprise Register performed the registration process to improve tax administration, which commenced in within three working days. 1999, and the SRS Modernization Project, which com- Improved administrative appeals process for SRS decisions. menced in 1998, focused on rapidly upgrading legislation FIAS recommended that an independent appeal and improving the tax organizational and control meth- tribunal staffed with private sector professionals and ods. The views of business associations were often neg- representatives of the Ministry of Finance and the lected and few discussions and consultations occurred. accounting profession be established, and the govern- The emergence of a neutral moderator or broker (the ment implemented a dedicated appeals review divi- LDA Business Environment Improvement Unit, sup- sion within the SRS. ported by the FIAS implementation project) was instru- The establishment of the dedicated Appeals Division mental in initiating the discussions. was envisaged under the SRS Modernization Project. The FIAS recommendation of establishing an open In addition to the PHARE and SRS modernization process of discussing these issues at a public/private projects, the government's response to FIAS recom- forum, and resulting pressure from the business mendations resulted in the following improvements to community, helped move this issue up the list of tax administration: reform priorities. Following a gradual update in 2000, the SRS Appeals A practical combination of tax and enterprise registration into a single process. The need to consolidate enterprise Division received more pre-court appeals after 2001 registration with SRS registration had been voiced by (Putnina and Russell-Einhorn 2004, table D-8.). The businesses before, but it took the intervention of an number of submitted appeals more than doubled international organization to combine these processes. between 2001 and 2003, with close to 30 percent of In an interview in autumn 2004, the head of the decisions being either fully or partly revised in favor of Enterprise Register noted taxpayers. The doubling of appeals is a good indication As a result of discussions, as a result of conversations, as a of the success of this administrative appeals mechanism; result of the influence of FIAS, this situation was changed and it demonstrates that, although it is part of the tax and the reform as such was undertaken. I think that if there administration, the mechanism is capable of subjecting hadn't been FIAS experts [and] FIAS recommendations, SRS decisions to scrutiny. Although businesses note the situation would still be the same today. significant improvement, they also indicate that the When this change was implemented in 2001, regis- independence of the appeals division could be further tration formalities were reduced to five calendar days.28 strengthened. Reforms to the Commercial Law occurred in 2003 Improved information distribution via published methodolog- and 2004, requiring re-registration. The resulting ical guidelines. The SRS invested heavily in preparing increase in the volume of applications expanded pro- and distributing methodological guidelines and cessing times to two to three weeks, which was cap- information brochures. The aim was to correct the tured in the results of the 2003 ARCS. As of January deficient system that existed in 1998, whereby 28. Results of the 2001 ARCS, average number of calendar days =4.93; outliers removed. appendix 2 53 instructions were issued in the form of letters from the (i.e., total labor-days per month multiplied by average director of the SRS. The letters accumulated at the cost of labor-day multiplied by 12 months). If all other SRS, and they became conflicting and difficult to declarations are studied by applying the same logic, the follow. The need to switch to a consolidated, total effect of tax administration reform is more than methodical system of guideline distribution for each US$199 million in labor cost savings (in current U.S. type of tax was one of the key issues pressed by the dollars). FIAS implementation project. This requirement was Clearly, the calculated cost savings for the Latvian econo- included in the action plan adopted in May 1999. my are substantial. Still, the credibility of some of these It is difficult to directly measure the effect this results may be questioned because of the way the ques- method of SRS instruction consolidation has had on tion was formulated in the surveys. In 2001, respondents the accounting methods of different taxes. Neverthe- were asked how frequently they prepared tax declarations less, we believe that one of the most precise measures and how many labor-days they spent doing so. Although is the time it takes a business to prepare its tax decla- the original intention of the question was to learn the rations. This was measured by the ARCSs in 2001 and 2003 (see figure 2A.6).29 The results indicate that amount of labor-days per every single inspection, the for- mulation leaves uncertain whether some of the respon- the average time decreased for all tax declarations, dents by accident had not provided the person-days per which leads us to conclude that the new information year rather than per inspection. Also, social insurance distribution process was effective. contributions and income tax declarations were separated The ARCS survey data confirm that most declarations in 2001, leaving uncertain whether some of the respon- require substantially less time to prepare than they did dents had not considered these declarations together and before reforms were implemented. According to the had written the total number of labor-days twice. survey, on average, it took 10.1 days less to prepare VAT declarations in 2003 than in 2001. If 91 percent EXPATRIATE IMMIGRATION of survey respondents prepared VAT declarations, this implies that 41,223 enterprises (91 percent of 45,300 During the FIAS study in 1998, the foreign business active enterprises in 2003) were affected by the reform community noted that procedures for obtaining resi- at a savings of 416,000 labor-days per month (legisla- dence and work permits were complicated and lengthy, tion requires that VAT declarations be prepared once and they had to be repeated yearly. The LDA took per month). In monetary terms, an eight-hour labor- these issues seriously, and it actively embarked on day multiplied by US$2.2 per hour implies that one changing the procedures. It was FIAS that identified the labor-day costs US$17.6, resulting in an annual saving issue, raised its prominence, and assisted the govern- in labor cost of over US$87 for the entire economy ment with advice to design more efficient procedures. 29. Because the reforms were enacted from 1999 to 2001, it is reasonable to expect that any meaningful impact of the reforms could be discerned at the earliest in 2002 and more realistically in 2003 and beyond. It is in this context that the results of the 2001 and 2003 ARCSs presented in this section should be viewed (that is, although the 2001 survey was not carried out in a strict pre-reform setting, the measures that were discussed could have affected the actual system only partially). This question was not included in the 2005 ARCS. 54 appendix 2 FIGURE 2A.6: TIME REQUIRED FOR TAX PREPARATION, 2001 AND 2003 8.7 (median=3; Corporate Income Tax mode=1) 2003 (N1=451; N2=303) 8.9 2001 5.4 (median=2; mode=1) VAT (N1=387; N2=272) 19.3 Mandatory Social Insurance 3.5 (median=1; mode=1) Contribution and Personal Income Tax 10.4 (N1=460; N2=328) 2.9 (median=1; Real Estate Tax (N1=120; mode=1) N2=122) 3.0 2.6 (median=1; Excise Tax (N1=31a; mode=1) N2=16a) 5.2 2.2 (median=1; Natural Resource Tax mode=1) (N1=79; N=70) 6.4 1.0 (median=1; Lottery and Gambling Tax mode=1) (N1=7a; N2=1a) 16.0 0 5 10 15 20 person-days Sources: ARCS 2001 and 2003. Note: VAT = value-added tax. Average number of person-days for preparing respective declarations. Base =enterprises that submit those applications; N1 = base in 2003, N2 = base in 2001. a. The number of respondents is not large enough to interpret the obtained results. FIAS Recommendations and the lengthy, complex, and detailed debates with the State Government's Response Employment Service (SES) and the Citizenship and Table 2A.9 summarizes the key FIAS findings and the Migration Issues Board (CMIB) to convince them of the reforms enacted by the government. need for the very substantial changes being proposed. The best-practice information and details on how these Ultimate Outcome of Reform procedures were handled elsewhere helped in convinc- The first Action Plan for Removal of Administrative ing the officials that changes were needed. The changes Barriers adopted by the Cabinet of Ministers in May as agreed were implemented by early 2000. 1999 contained detailed and wide-ranging measures Overall, the activities undertaken by the government in aimed at streamlining the procedures for issuing resi- response to the FIAS project findings and recommenda- dence and work permits, especially for management tions resulted in the following improvements: positions. The measures were elaborated with direct assistance of FIAS experts who contributed best-practice Residence and work permit procedures simplified. The legal advice early in the work and reviewed the proposed changes in early 2000 introduced a combined measures. The FIAS implementation project engaged in issuance process, fewer documentary requirements, appendix 2 55 TABLE 2A.9: WORK PERMITS: RECOMMENDED REFORMS AND THEIR OUTCOMES FIAS Findings and Recommendations Project Outcomes from Reforms Enacteda · Finding: · The procedures for obtaining a work permit have been sim- · Obtaining work permits is a complicated and time-con- plified via new regulations (Procedure for the Employment suming process. of Foreigners and Stateless Persons in Latvia), which were · Excessive documentation is required. adopted on March 28, 2000, and those for obtaining a resi- · Inadequate cooperation exists between the CMIB and the dence permit were simplified by amendments to the relevant SES, and procedures are inconsistent. Investors complain regulations. More specifically, about being sent from one department to another. · the work permit is issued together with the residence per- · CMIB and SES formalities are doubled. mit, thus eliminating three additional visits to the SES · Recommendation: The work permit, authorization of letter of · coordination between the SES and the CMIB has greatly invitation, and residence permit should be combined into a improved, due in large part to the requirement of the action single work permit that would be approved by both the SES plan that they cooperate in preparing informational materials and the CMIB. · the processing time for obtaining work and residence permits was reduced from 50­60 days at the end of 1998 to a maxi- mum of 35 days in mid-2000. · Recommendation: An investor (i.e., the principal · The documentary requirements for work and residence per- owner/director of a company or subsidiary) normally should mits have been eased for executives of companies. not be subject to a work permit. If the government feels · Supervisory and executive board members are not required that a work permit adds value, then the process of authoriz- to obtain authorization for employment from the SES. The ing the work permit and authorization of the letter of invi- residence and work permit are issued by the CMIB together tation for employment should be combined into a single as part of one interaction. process. · Company executives obtain their work permits for free. · Recommendation: Work permits should be issued for a mini- · The revised cabinet regulations on residence permits and mum of two years (or less, if the term of the contract is less work permits envisage issuance of residence permits and than two years). work permits for the duration of a contract, but not longer than four years. · Finding: Entrepreneurs find information available on proce- · Coordination between the SES and the CMIB has dures for obtaining residence and work permits to be inade- improved considerably, due in large part to the requirement quate. of the action plan that they cooperate in preparing informa- · Recommendation: Develop and publish clear guidelines and tional materials. manuals for employees and businesses on the residence and · Informational materials are being publicly distributed at the work permit processes. institutions via the Internet and a brochure that was pub- lished in 2000 (10,000 copies of the English version were published). · Relevant laws and regulations, as well as explanations, guid- ance, and process flowcharts are available on the CMIB (http://www.pmlp.gov.lv) and SES (http://www.nvd.gov.lv) Web sites. Most of the materials are available in Latvian, English, and Russian. (continued) 56 appendix 2 TABLE 2A.9: WORK PERMITS: RECOMMENDED REFORMS AND THEIR OUTCOMES (CONTINUED) FIAS Findings and Recommendations Project Outcomes from Reforms Enacteda · Finding: The Immigration Police have authority to detain · No cases of expulsion have been reported by investors and investors and expel them from the country on the grounds government authorities from the second half of 1999 of minor technical breaches of immigration rules. through 2000. Subsequent expulsions have been applied in · Recommendation: As a matter of urgency, Immigration Police extreme cases. should issue warnings and fines rather than resort to deten- tion and expulsion. Sources: FIAS 1999; follow-up research by FIAS. Note: CMIB = Citizenship and Migration Issues Board; SES = State Employment Service. a. Primarily reforms enacted in response to FIAS recommendations; also FIAS methodologies adopted by the government in the course of its institutional development. and lower fees. Work also started to establish the the table, initiated the dialogue between them and Foreigners' Service Center to improve the quality of businesses, helped reengineer the immigration proce- services delivered to applicants. The number of for- dures, and provided advice on the initial design of eigners who have been served at the new Foreigners' information materials. Service Center since its foundation reached an Excesses by the Immigration Police curbed. No cases of impressive 98,011 by August 16, 2004. expulsion were reported by investors and govern- Less time needed to receive work and residence permits. The ment authorities from the second half of 1999 assessment conducted in mid-2000 indicated that through 2000. Subsequent expulsions have been after the reforms it took a maximum of 35 days to applied in extreme cases. In the 1998­2005 time obtain residence and work permits, whereas it took period, 104,905 residence permits were issued, approximately 50­60 days at the end of 1998.30 including 7,473 residence permits issued by the For- Cooperation and information sharing enhanced. There was eigners Service Center by 2003. The following num- virtually no coordination between the CMIB and the bers of residence permits were issued: SES before these reform efforts. An open dialogue drew the two institutions into the reform process and 1998 1999 2000 2001 2002 2003 2004 2005 led them to acknowledge that ongoing cooperation 12,562 10,556 10,096 12,703 11,460 13,994 15,685 17,849 would be beneficial. A practical expression of this sense of cooperation was best evidenced when CMIB and SES officials collaborated in preparing information PROCEDURES FOR LAND ACQUISITION materials on residence and work permit procedures. AND CONSTRUCTION PERMITS The brochures were published and jointly distributed by the CMIB and the SES. Procedures associated with registering title to real estate The Business Environment Improvement Unit, and obtaining construction permits were among those with the support of FIAS, brought the two parties to receiving the worst ratings in 1998. Investors' 30. Concluding report of the EU PHARE/Latvian Development Agency project to improve the business environment in Latvia: Progress Assessment, published June 15, 2000, p. 16. appendix 2 57 complaints included overlapping coordination require- process under the Action Plan for Removal of Adminis- ments and agency mandates, unclear fee schedules, and trative Barriers resulted in the following improvements: lengthy processing times. For construction, the need for A dedicated working group with participation by the govern- the bulk of procedures to be carried out with local ment, municipalities, investors, architects, and builders was set municipalities complicated the central government's up by the prime minister to discuss the problems and come attempts to streamline administrative procedures. It is in up with viable solutions. this area that the limits of reforms through changes in Legislation was changed and legal barriers to streamlining the laws were put to the greatest test. procedures were minimized. According to the recom- The construction approval processes remained one of mendations of the working group, amendments to the the least transparent. Although some streamlining was construction law and the Cabinet's General Construc- achieved, this had minimal effect on the speed of tion Regulations were passed, which streamlined procedures, primarily because the volume of construc- some aspects of the procedures, more clearly defined tion-related applications increased tremendously. Few the liability of the designers, and introduced transpar- reforms were associated with land procedures because ent fee schedules for municipalities and other institu- it remained a politically charged topic. tions that issue technical specifications for designs. A regular (albeit fairly low-yield) dialogue was established FIAS Recommendations and the with the Riga City Council. If measured by the feeling Government's Response of success in 2000, this was a significant achievement Table 2A.10 summarizes the key findings of the FIAS mainly because previously there had been no forum 1999 study and the changes the government has for candidly discussing these construction approval implemented. procedures and the problems surrounding them. Ultimate Outcome of Reform With a gradual increase in residential construction, At the initiative of the Ministry of Economy, measures more individuals face the awkward coordination process to simplify the construction process were included as themselves, and the pressure for change is mounting. By conditions of the World Bank's programmatic structural now, some municipalities--especially the Riga munici- adjustment loan, which FIAS supported and facilitated. pality--have taken steps to improve their procedures, Introducing these conditions as part of the loan was but significant reforms remain to ensure smooth pro- intended to spur changes within the government and cessing of construction approval applications31 (see municipalities. With hindsight, however, the measures figures 2A.7 and 2A.8 for volume of applications). at the disposal of the central government were insuffi- cient to impose significant changes on municipalities, Although the number of construction permits being the demand by municipalities to improve these services issued is growing steadily, so has the application was not strong, and the political leadership of the processing time (figure 2A.9). The construction municipalities had little to lose (and probably more to approval procedures have not kept up with the increased gain) by doing nothing. Nevertheless, the reform demand. 31. For a more detailed analysis, see FIAS (2003a). 58 appendix 2 TABLE 2A.10: LAND AND CONSTRUCTION PROCEDURES: RECOMMENDED REFORMS AND THEIR OUTCOMES FIAS Findings and Recommendations Project Outcomes from Reforms Enacteda Land procedures · Finding: The evaluation required to register real estate own- · Documents relating to the valuation of real estate now remain ership rights is valid for only six months. Issuance of a effective for an unlimited period of time (they do not expire), repeated evaluation takes one to three months even if the provided the cadastral value of the property has not changed real estate has not changed physically. (which must be certified with a reference obtained from the · Recommendation: Review the period of validity of the evalu- State Land Service). Legislation now allows that such certifi- ation report. cation can be done electronically, but steps still need to be taken to ensure that this can occur on a practical basis. · Finding: Registration of real estate operations with the Land · The relevant legislation was amended. It is now possible to Registry is comparatively long at 30 days. Legislation does not register real estate within three working days. explicitly define whether accelerated registration is possible. · Recommendation: Clarify the expedited service in applicable legislation. · Finding: The 2 percent state duty to register a real estate · A state duty in the amount of 2 percent of the transaction transfer via sale acts as a deterrent to declaring the actual value or real estate cadastral value for the registration of title transfer price, especially for large deals. The government loses transfer was capped at LVL 30,000. valid market data for further reevaluations of real estate for tax purposes. · Recommendation: Review the application of the 2 percent state duty and consider capping it. Construction procedures · Finding: Obtaining a construction permit for a commercial · A dedicated working group was set up by the prime project takes 1.0 to 1.5 years. minister to address construction approval problems. · Recommendations: · The construction preparation process and the state expertise · Undertake process reengineering techniques to find ways to procedure were simplified and streamlined by adopting speed up the approval process, including eliminating unnec- amendments to the general construction regulations. essary or duplicative procedures to ensure efficient approvals. · An information service has been opened in the Architectural · Prepare and publish regulations with guidelines for munic- Department of the Riga City Council. ipal officials on the maximum approval times associated with each stage of the construction approval process. · Finding: There is no uniform system of fees (i.e., every · A uniform set of fees and duties related to construction was service that issues technical specifications charges a fee that is introduced, making the construction process less bureau- regulated by internal normative documents). cratic and more transparent by adopting amendments to the · Recommendation: Create a consolidated fee structure to help general construction regulations. finance the need for increased resources. · A register of municipal duties was instituted at the Municipal Affairs Board, where information concerning all the municipal duties and their rates imposed by local governments is available. Sources: FIAS 1999; follow-up research by FIAS. a. Primarily reforms enacted in response to FIAS recommendations; also FIAS methodologies adopted by the government in the course of its institutional development. appendix 2 59 FIGURE 2A.7: BUILDING PERMITS ISSUED NATIONALLY FOR HOUSES, NONRESIDENTIAL BUILDINGS, AND ENGINEERING STRUCTURES, 1999­2003 2003 2002 Engineering structures 2001 Nonresidential buildings Residential buildings TOTAL 2000 1999 0 2,000 4,000 6,000 8,000 10,000 12,000 number of permits Source: Statistical databases for 1999­2003 on Construction and Investment in Latvia, posted on the Central Statistical Bureau of Latvia's Web site, http://www.csb.gov.lv/. FIGURE 2A.8: BUILDING PERMITS ISSUED IN RIGA, 1998­2003 2003 2002 2001 2000 1999 1998 0 1,000 2,000 3,000 4,000 5,000 6,000 number of permits Source: Riga City Construction Board. 60 appendix 2 FIGURE 2A.9: LENGTH OF REAL ESTATE AND CONSTRUCTION PROCEDURES, 2001, 2003, AND 2005 28 change classification of usage (n1=59; n2=37a; n3=16a) 87 rezone land 18 (n1=17a; n2=22a; n3=8a) 16 83 29 obtain approval of design (n1=56; n2=69; n3=35a) 19 81 31 coordinate design 27 (n1=65; n2=72; n3=44) 79 have a public hearing 33 (n1=9a; n2=27a; n3=11a) 66 reudec 41 obtain final acceptance of the building (n1=45; n2=61; n3=29a) 23 2001 (n1) rop 38 2003 (n2) acquire architectural and 37 2005 (n3) planning task, (n1=57; n2=62; 25 n3=34a) 37 21 obtain municipal right of first 28 refusal (n1=37a; n2=62; n3=26a) 36 gather the technical 44 regulations (2001, n1=48; 22 2003, n2=68; 2005, n3=40) 35 74 obtain Land Book title registration 52 (n1=95; n2=107; n3=65) 34 23 obtain a construction 18 permit (n1=57; n2=68; n3=46) days 29 0 20 40 60 80 100 average total calendar days Sources: ARCS 2001, 2003, and 2005. Note: Base = respondents who performed the respective procedures before using the premises. a. Number of respondents is too small (n < 40) to generalize the acquired results. appendix 2 61 According to the database that serves as the basis of the Ultimate Outcome of Reform Doing Business reports, transfer of title in Riga takes It is this dialogue and action plan process that played nine steps, an average of 54 days, and about 2 percent a substantial role in ensuring that many of the recom- of the property value. This ranks Latvia 89th among mendations and changes discussed in the preceding 155 countries, one of the lowest scores for the country section were implemented in a coherent and coordi- and a significant drag on its ranking for overall ease of nated fashion. The FIAS implementation project doing business. The Doing Business data for construc- assisted the LDA in setting up the Business Environ- tion permits are somewhat better (relative to other ment Improvement Unit to serve as a coordinator of countries): it takes 21 steps, 160 days, and costs about the action plan and facilitator of the dialogue process. 44 percent of per capita income. This ranks Latvia These activities received support from the EU 47th among 155 countries, but it is nevertheless a PHARE program, FIAS, the Swedish International continuing source of complaints by investors Development Agency, and other international donors (http://www.doingbusiness.org/ExploreEconomies/ from 1998 to 2002. Default.aspx?economyid=108). To summarize, the following key developments have taken place since 1999: STRUCTURED DIALOGUE BETWEEN THE GOVERNMENT AND THE BUSINESS Enterprise and tax registration, immigration, and COMMUNITY customs procedures were simplified, with fewer steps One of Latvia's most noteworthy achievements since taking less time. the 1999 administrative barriers report was the estab- Government institutions increased their level of lishment of structured dialogue between representatives cooperation to improve efficiency in areas such as of the public and private sectors to identify problems border crossing and customs, immigration, and and discuss solutions, prepare an action plan to improve inspections. the business environment, and subsequently to review More and better information on procedures for progress made in implementing reforms. FIAS has enterprise registration, inspections, customs, and val- introduced other transition countries to this model, and uation of real estate was made available to the public. the European Commission Enterprise Directorate- Administrative or petty corruption seems to have General has cited this process in Latvia as a receded (although there are indications that other, "CC-BEST" practice that could usefully be shared more sophisticated forms of corruption are still with other EU candidate-countries.32 problematic). There has been improved dialogue between the FIAS Recommendations and the government and the business community about many Government's Response areas of concern to the business community, and there Table 2A.11 summarizes the key recommendations of is better understanding and use of consultations when the FIAS 1999 study and the measures the government policy documents and normative acts are drafted. has taken in response. 32. CC-BEST is the acronym for Candidate Country--Business Environment Simplification Task Force. 62 appendix 2 TABLE 2A.11: STRUCTURED DIALOGUE WITH THE BUSINESS COMMUNITY: RECOMMENDATIONS AND THEIR OUTCOMES FIAS Recommendations Project Outcomes and Reforms Enacteda · Recommendation: Discuss the findings of the report at a public · To openly discuss the issues identified in the FIAS report, workshop with both government and private sector partici- the LDA invited the business community and government pation to design a reform program and prioritize the issues ministers to a presentation of the draft report by FIAS in to be addressed. January 1999. The prime minister established a working group to address the issues raised in the report. The working group was composed of members of the Latvian, American, British, German, and Swedish chambers of commerce, as well as civil servants. · By applying the recommendations of both the FIAS report and the working group's subgroups on specific issues, the working group came up with an action plan containing more than 30 proposed actions and designating the gov- ernment institution responsible for implementing each action. The proposed actions included items such as improving the quality of information on the functions of the government institutions, combining enterprise registration and tax registration into a single process, easing immigration requirements for expatriate workers, amend- ing customs procedures, and establishing a special working group to deal solely with complex construction issues. On May 11, 1999, the CM accepted the action plan in its entirety. The LDA is monitoring its implementation, and the CM is regularly updating the plan. (The last one was adopted in early 2006.) · Recommendation: Set up an ongoing public/private dialogue · The FICIL, composed of the CEOs of foreign companies to monitor the business environment and identify best possi- representing a cross-section of sectors and countries doing ble corrective measures. business in Latvia, was set up in 1999. It holds a semiannual meeting between the CEOs and other top executives of major international investors and the highest government officials, including the prime minister, minister of economy, minister of foreign affairs, minister of finance, and other government officials. Ten council meetings have been held since June 1999. Issues discussed have included tax policy, tax administration and appeals, higher and continuing educa- tion and development of a qualified workforce, customs and border crossing, EU accession, the accessibility of long-term financing in the local currency, the fight against corruption, valuation of land and buildings for determining the real estate (continued) appendix 2 63 TABLE 2A.11: STRUCTURED DIALOGUE WITH THE BUSINESS COMMUNITY: RECOMMENDATIONS AND THEIR OUTCOMES (CONTINUED) FIAS Recommendations Project Outcomes and Reforms Enacteda tax, and the new Commercial Law. Between the semiannual sessions of the council, ad hoc groups of business and government representatives discuss and evaluate issues of concern to foreign investors.b Their recommendations are incorporated into the action plan. · Recommendation: Because policy makers at the ministerial · With more information posted on the Internet, with level work on the development of detailed implementing business associations gaining strength, and as civil servants regulations, guidelines, procedures, and forms, they should gain greater understanding of the need to improve open regularly solicit input and suggestions from stakeholders. consultations and dialogue, more decentralized consultations at various stages of policy making are taking place. · Since 2000, all the draft normative acts prepared by the ministries are available on the CM Web site when they are released. At that point, any NGO, including business associations, can freely access those drafts and submit their comments during the coordination process (which typically takes two to three months or more). · The government has introduced regulations mandating that government institutions that prepare draft normative acts carry out consultations with the private sector and NGOs, and conduct an assessment of the level of administrative burden imposed by new regulations. The requirement for such a regulatory impact assessment was introduced in 2001, and it has helped institutionalize these aspects of analysis in the public administration. · In addition to structured discussions with foreign investors, the government has committed to ongoing broad dialogue with the National Economy Council (a consultative council of businesspeople and representatives of governmental organizations and NGOs) on the concept of developing a national economy, state budget, and other key economic policy documents. The council also reviews drafts of key normative acts. Thirty-five meetings of the council took place between June 18, 1999, and August 10, 2004.c Sources: FIAS 1999; follow-up research by FIAS. Note: CEO = chief executive officer; CM = Cabinet of Ministers; EU = European Union; FICIL = Foreign Investors' Council in Latvia; LDA = Latvian Development Agency; NGO = nongovernmental organization. a. Primarily reforms enacted in response to FIAS recommendations; also FIAS methodologies adopted by the government in the course of its institutional development. b. The LDA estimates that about 40 meetings of the FICIL working groups and meetings with government institutions occur during a year. c. Number of meetings of the National Economy Council: 1999, 6; 2001, 9; 2002, 7; 2003, 8; 2004, 5 (information provided by the Secretariat of the National Economy Council). 64 appendix 2 Early on, the LDA Business Environment Unit, with May­December January­ the support of FIAS, started working on institutionaliz- 2002 2003 July 1, 2004 ing an economic and administrative burden analysis of Number of 347 749 198 the draft normative acts. In 2000 and 2001, the LDA annotations submitted unit worked with the State Chancellery to design the annotations that would be required for draft acts and to Number of 198 include consultation requirements into the annotations. legal acts adopted in The first version of the annotations was piloted in 2001, the CM and a revised version was adopted in 2002 along with an instruction for its completion. The LDA Business An analysis of the annotations from the first half of 2004 Environment Improvement Unit helped draft the indicates that the consultations were carried out most instruction and trained civil servants at the School of commonly with the largest nongovernmental organiza- Public Administration on how best to apply the regula- tions--Latvian Union of Municipalities, Latvian tory impact assessment required in the annotations. Confederation of Employers, Latvian Association of Free Trade Unions, Latvian Traders Association, Currently, all the legal acts reviewed by the Cabinet of Nature Fund of Latvia, Environmental Protection Club, Ministers need to be accompanied by an annotation. Council for Cooperation of Farmers' Organizations, The annotation asks for an assessment of the impact of Convent of Farmers, and Save the Children. different aspects of the proposed regulation--such as impact on the legal system, state budget, international A review of the 198 submitted annotations reveals that commitments, administrative simplicity, human rights, the effect on the business environment and simplification and so on. of administrative procedures was assessed in 21 percent of draft legal acts. Thus, a significant number of legal For the purposes of this study, a two-year period (May acts were subjected to a test of reasonable regulatory 21, 2002, to June 30, 2004) was analyzed to identify policies and minimum necessary administrative require- trends in annotations and consultations with business ments. The key achievement is that this activity is now associations. According to information from the State institutionalized, and the LIDA and the State Chan- Chancellery, a total of 1,294 annotations were submit- cellery can work to improve the quality of assessments. ted during this time period: Appendix 3 65 Appendix 3: Intermediate Impact on the Investment Climate in Latvia DEFINING THE INVESTMENT CLIMATE 2. Risk overall country risk rating Investment climate is a broad concept. Stern (2001) political risk/political instability defined the term as domestic policies and institutions economic risk/economic uncertainty that are necessary to realize the benefits of globalization and essential to minimize risks that may arise from such 3. Policy and institutions an integration process. Hence, as Batra and Mody trade (2003) pointed out, a country's investment climate is openness affected by a number of factors: access to bank finance credit availability macroeconomic stability access to capital markets bureaucratic harassment (especially in the stock market development administration of regulations and taxes) tax rate strength of financial institutions tax administration rule of law (including law enforcement), corruption, crime and crime corruption quality of infrastructure (including power and legal structure telecommunications) court quality government effectiveness (in providing sound confidence in courts regulatory structure for the private sector) environmental protection government effectiveness in providing public services government attitude to business quality of the labor force. government effectiveness customs Thus, investment climate is multidimensional, and a great deal of overlap and correlation exists between the 4. Competition policy and regulation various factors affecting the investment climate. To degrees of competition make the concept of investment climate operational, entry barrier Batra and Mody (2003) categorized factors that influ- level of regulation ence investment climate into six groups or dimensions, enforceability and predictability of laws and with each group having several subgroups (see appendix regulations table A.2 in Batra and Mody [2003]). Their factor firms' compliance with international groups and subgroups are these: standards 1. Macroenvironment 5. Infrastructure growth utilities inflation communication technology monetary policy indicators (inflation rate, exchange road and rail rate constraints) quality of infrastructure 66 Appendix 3 6. Human and technological development Enhancements in those areas have, in turn, a positive human development effect on the macroeconomy and economic growth, technological development and hence they can improve a country's risk ratings. productivity. Similarly, improvements in labor regulations can contribute to job creation and productivity growth SCOPE OF FIAS' ADMINISTRATIVE through a well-functioning and dynamic labor market. BARRIER WORK AND THE INVESTMENT This, in turn, tends to improve the human development CLIMATE dimension of the investment climate. The FIAS study of administrative barriers to investment Once a diagnosis of administrative barriers has been focused primarily on the regulatory barriers to starting performed, FIAS communicates extensively with the gov- up, locating, and operating a business: ernment and the business community and helps facilitate Start-up procedures (immigration; business and tax reg- government/private sector dialogue to develop an action istration procedures; and means of obtaining various plan. The action plan prioritizes the areas that require business licenses, permits, and clearances) reforms; contains recommendations specific to each area of Locating procedures (land allocation and registration, site focus; and defines what reforms will be undertaken, who development, building permits, utility connections, will be responsible for implementing them, when they inspections, and occupancy permits) should be completed, and how they should be assessed. Operating procedures and reporting requirements The areas of focus of the action plan in Latvia were (import/export and foreign exchange procedures, business inspections, customs procedures (including product certification, labor regulations, government border-crossing and import/export procedures), inspections, means of dealing with tax administration). construction permits, land acquisitions, tax administra- Thus, many of the indicators that proxy for policy and tion, expatriate employment and residency, enterprise institutions as well as competition policy and regulation, registration, business regulation, structured dialogue and the productivity dimensions of investment climate between the government and the business community, (as defined by Batra and Mody [2003])--such as the appeal mechanisms, access to information, better service following--are the areas in which FIAS consultants by government officials, activities of business associations focus their assessment of administrative barriers: and consultations on draft legal acts, and corruption. tax administration Hence, to assess the effect of the work that FIAS con- corruption ducted on examining administrative barriers in Latvia, government attitude toward business FIAS considered various indicators from international government effectiveness sources,33 along with the ARCS data, which are related customs logically to the action plan. For each indicator, we entry barriers report the data over the period 1995­2004 (or for regulation whatever years during this period the data are available enforceability and predictability of laws and regulations. for the corresponding indicator) to assess the magnitude 33. Definitions of key indicators are available on request. Appendix 3 67 and direction of change between the eras before and CUSTOMS, BORDER-CROSSING, AND IMPORT/EXPORT PROCEDURES after administrative barriers were assessed (see table 3A.1). The following section further analyzes how the We use the Heritage Foundation trade policy subindex broader dimensions of Latvia's investment climate have and a number of subindexes from the Fraser Institute's changed over the period 1995­2004 through economic Index of Economic Freedom, which are related to growth, foreign and domestic investment, the private freedom to perform international trade to serve as a sector, trade openness, employment and living proxy for the institutional and policy dimensions of the standards, and poverty and human development. TABLE 3A.1: TRADE POLICY RATINGS IN LATVIA, 1995­2006 Index 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Heritage Foundation Index of -- 70 60 76 76 76 75 75 73.6 74.8 75 77.4 Economic Freedom, subindex Trade Freedom (in %, based on 2007 revisions to methodology) Fraser Institute indexes (0 = least free, 10 = most free) Freedom to trade internationally 8.0 -- -- -- -- 7.2 7.6 7.6 7.6 -- -- -- Taxes on international trade/tariffs 9.5 -- -- -- -- 8.3 8.7 8.7 8.7 -- -- -- i. Revenue from taxes on 9.5 -- -- -- -- 9.8 9.8 9.8 9.8 -- -- -- international trade as a % of exports plus imports ii. Mean tariff rate -- -- -- -- -- 8.9 9.2 9.2 9.3 -- -- -- iii. Standard deviation of tariff rates -- -- -- -- -- 6.3 7.0 7.0 7.0 -- -- -- Regulatory trade barriers -- -- -- -- -- 5.3 7.0 7.0 7.1 -- -- -- i. Hidden import barriers: no -- -- -- -- -- 5.3 5.6 6.2 5.8 -- -- -- barriers other than published tariffs and quotas (GCR) ii. Costs of importing: the -- -- -- -- -- -- 8.5 7.8 8.3 -- -- -- combined effect of import tariffs, license fees, bank fees, and the time required for administrative red tape raises costs of importing equipment by (GCR) Sources: Heritage Foundation Index of Economic Freedom, 1996­2006; Fraser Institute indexes for years indicated. Note: -- = not available; GCR = Global Competitiveness Report. 68 Appendix 3 investment climate. These indexes tend to be based on plan and the study of administrative barriers in Latvia. tariffs, quotas, licensing requirements, corruption of The aggregate index of trade deteriorated slightly from customs officials, and other hidden barriers to trade. 8.0 to 7.2 between 1995 and 2000, but it improved from FIAS, however, does not provide advice on tariff rates 7.2 in 2000 to 7.6 in 2002. In 2003, the Fraser Institute or quotas; rather, it focuses on customs procedures, index of freedom to trade maintained its 2002 level. licensing requirements, and corruption in customs Although a score for the late 1990s does not exist, we administration. Thus, changes in these latter areas are see improvement in the scores for regulatory trade likely to be logically linked with the FIAS administra- barriers, including hidden import barriers to trade. Such tive barriers work and recommendations. improvement was a key focus of FIAS work over the The Heritage Foundation trade policy index is based period 2000­03. Similarly, although we cannot com- on a country's tariff rate (the higher the rate, the lower pare the index value of the cost of importing in 2001 the index score); nontariff barriers such as import and 2002 with the preadministrative barrier reform quotas, licensing requirements, and so on; and period (i.e., 1995­97), the index value of the cost corruption within the customs service. Administrative (which includes license fees and the time involved to barriers and corruption in the customs service--as deal with administrative red tape) had a very good score argued by the Heritage Foundation, FIAS, and of 8.5 (out of 10) in 2001. In 2002, the score deteriorat- others--are important barriers to trade because even ed slightly to 7.8, but it improved to 8.3 in 2003. though countries may publish official low tariff rates The ARCSs of 2001 and 2003 indicated that around 30 and no official nontariff barriers, their customs officials percent of firms viewed customs regulation as a major can create a cost or barrier to trade through bribe or severe problem. About 40 percent of the firms rated seeking or stealing. The index is based on a percent the services they received from the customs service as value, reflecting a change in methodology in 2007. "good" or "very good." Fifty percent of firms rated the According to the Heritage Foundation Trade Freedom services for cargo and road transport license as "good" subindex, Latvia's position improved noticeably from a or "very good" in 2001, whereas 70 percent of firms score of 60 percent in 1997 to a score of 77.4 percent gave these ratings in 2003. Thus, available data and in 2006, with some fluctuation in the meantime indicators imply some improvements in customs admin- (see table 3A.1). istration in Latvia (table 3A.2). The Fraser Institute subindex of international freedom to trade also includes components to measure a wide REGULATORY BARRIERS TO BUSINESS variety of restraints to international trade: tariffs, quotas, hidden administrative restraints, exchange rates, and The core objective of the administrative barriers work capital controls. The scale of this index is 0 to 10, with 0 of FIAS is to remove regulatory barriers to business. considered least free to trade and 10 considered most free Overwhelming regulations deter domestic investment, to trade. Table 3A.1 reports both the aggregate freedom raise the cost of doing business, divert FDI, inspire to trade index and its subcomponents, which are corruption and black market activities (which, in turn, particularly relevant from the point of view of the action dampen a country's revenue base), and encourage Appendix 3 69 TABLE 3A.2: CHANGES IN CUSTOMS SERVICES BETWEEN 2001 AND 2003 Category of assessment Description 2001 (%) 2003 (%) Degree of problems with customs regulations Those saying "major "or "severe" problem 31 30 Services received during the process of Those saying "good" or "very good" 50 72 receiving transportation of cargo by road transport licenses Services received from customs service Those saying "good" or "very good" 41 39 Source: ARCS 2001 and 2003. Note: Data for 2005 are not included because, after Latvia's entry into the EU (May 1, 2004), intra-EU trade no longer required customs clearance; thus, data are not comparable. capital flight. Although some regulations could be legit- of the poor (and whose owners also are likely to be imate and necessary, many are not. Poor countries tend comparatively poorer than the owners of large to regulate more than rich countries, despite the low firms)--in that they bear a disproportionately larger bureaucratic quality and often poorly functioning share of the regulatory burden because they have nei- institutions of the former. Not surprisingly, many regu- ther the money to satisfy rent-seekers nor the political lations turn out to be rather inefficient and opaque. power to tame predators. Furthermore, as the World Bank's Doing Business There is evidence that, by eliminating unnecessary pro- reports indicate, complicated regulations rarely get cedures and streamlining regulations, governments can enforced consistently; rather, beneath their shadow the encourage new investment, and thereby improve games of corruption and rent seeking continue. Scarce growth and alleviate poverty. Reducing key barriers to resources are misallocated from productive to unpro- business can result in a 0.25 percent increase in a devel- ductive purposes to deal with bureaucratic red tape. oping country's annual income growth (World Bank FIAS studies of administrative barriers in different 2005). Similarly, trade openness leads to about a 0.7 countries have demonstrated that senior management percent increase in per capita income growth in well- in enterprises waste significant time addressing unnec- regulated countries (Bolaky and Freund 2004). essary government regulations, and they often must pay The Doing Business indicators show that Latvia has some significant sums as bribes to get things done. Failure to of the least complicated registration procedures of all the comply with vague administrative procedures or the new EU member-countries (figure 3A.1). For example, whim of a government officer could result in long Latvia requires only five procedures to start a business, delays, unpredictable sanctions, and disruptions in whereas Estonia and Hungary require six. It takes only day-to-day business activities. Poverty also affects small about 16 days to start a business in Latvia, whereas the and medium-size firms--generally the major employers 70 Appendix 3 FIGURE 3A.1: BUSINESS REGISTRATION IN EU ACCESSION COUNTRIES, 2004 AND 2005 a. Number of procedures to start a business 12 10 8 roceduresp Year 2004 6 of Year 2005 erb 4 num 2 0 Latvia Estonia Hungary Lithuania Slovak Slovenia Czech Poland Republic Republic b. Time to start a business 80 70 60 days 50 of Year 2004 40 erb Year 2005 30 num 20 10 0 Latvia Slovak Lithuania Poland Estonia Hungary Czech Slovenia Republic Republic c. Minimum capital to start a business 250 income 200 itap 150 ca Year 2004 erp Year 2005 100 of 50 ercentp 0 Slovenia Latvia Czech Slovak Estonia Lithuania Hungary Poland Republic Republic Sources: Doing Business, 2004 and 2005. Appendix 3 71 same procedures require about 72 and 52 days in Estonia The Fraser Institute's business regulation subindex is and Hungary, respectively. These figures imply that the designed to identify the extent to which regulatory business registration system in Latvia functions well. restraints and bureaucratic procedures limit competition Latvia also has minimal capital requirements to start a and market operation. The scores for the indexes range business, although it is relatively expensive to do so. from 0 to 10, with 0 being the worst and 10 being the best. A high score indicates that a country allows markets In 2005, it took about 54 days to register property in to determine prices, refrains from regulatory activities Latvia, whereas the process took only 3 days in Lithuania that retard entry and increase the cost of production, (figure 3A.2). There have been recent claims that real and refrains from using power to extract financial estate registration can now be expedited in three days in payments and reward some business at the expense of Latvia. Real estate registration requires 10 procedures in others. The business regulation index score for Latvia Latvia, whereas Lithuania requires only 3. The cost of was around 5 on a scale of 0 to 10 over the period registration is about 2.1 percent of the property value in 2000­02. Latvia's score for ease of business start-up rose Latvia, whereas in Estonia and Lithuania the costs are, from 5 in 2000 to 6 in 2002, whereas the score for respectively, about 0.5 percent and 0.9 percent of the administrative obstacles to starting a new business property value. deteriorated from 7.5 in 2000 to 4.5 in 2002. The index of senior management's time spent addressing govern- In addition to Doing Business indicators, FIAS used the ment bureaucracy remained at about 4. Heritage Foundation's regulation subindex, a number of indicators from the Fraser Institute, and the regula- The results for the Fraser Institute's subindexes on tory quality index from Kaufmann, Kraay, and administrative obstacles from its Economic Freedom Mastruzzi (2003) to assess improvements in the regu- Index are directly in contrast with the Doing Business latory environment in Latvia before and after the indicators on business registration in Latvia. This administrative barriers study was conducted. The contrast might be due to expert opinions that contribute Heritage Foundation's regulation subindex is based on to the Fraser Institute's subindexes. The reliability of licensing requirements to operate a business; ease of expert opinions depends greatly on the ability of small obtaining a business license; corruption within the groups of experts to provide objective and accurate bureaucracy; labor, environmental, consumer safety, assessments of a situation, but this same reliability can be and worker health regulations; and regulations that prone to ideological biases as well.34 impose a burden on business. Another consideration is whether a country has a state planning agency that For the period 1996­2002, there has been a continuous sets production limits and quotas. The index is based improvement in the regulatory quality index developed on a percent value, reflecting a change in methodology by Kaufmann, Kraay, and Mastruzzi (2003) for Latvia. in 2007. According to the Heritage Foundation The index is calculated using an unobserved component Business Freedom subindex (see table 3A.3), starting analysis framework and it aims to more accurately assess from 1998 until 2005, the value for Latvia has been regulation from a wide range of sources, including those 50 percent, with an increase to 90.4 percent in 2006. used in the Heritage Foundation and Fraser Institute 34. For a discussion on the advantages and disadvantages of polls of experts in surveys of market participants, see Kaufman, Kraay, and Zoido-Lobatón (1999) and Kaufmann and Kraay (2002). 72 Appendix 3 FIGURE 3A.2: PROPERTY REGISTRATION a. Number of procedures to register property 12 es 10 8 ocedurrp Year 2004 6 Year 2005 of erb 4 m nu 2 0 Lithuania Slovak Czech Estonia Hungary Slovenia Poland Latvia Republic Republic b. Time to register property 450 400 350 ys da 300 of 250 Year 2004 erb 200 Year 2005 m 150 nu 100 50 0 Lithuania Slovak Latvia Estonia Hungary Czech Poland Slovenia Republic Republic c. Cost of property registration 12 10 uelav 8 of Year 2004 6 Year 2005 cent 4 erp 2 0 Slovak Estonia Lithuania Poland Slovenia Latvia Czech Hungary Republic Republic Sources: Doing Business, 2004 and 2005. Appendix 3 73 TABLE 3A.3: BUSINESS REGULATION RATINGS Index 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Heritage Foundation Index of 50 70 50 50 50 50 50 50 50 50 90.4 Economic Freedom, subindex Business Freedom (in %, based on 2007 revisions to methodology) Fraser Institute indexes (0 = least free, 10 = most free) Business regulation -- -- -- -- 5.8 4.7 5.4 6.2 -- -- -- i. Price controls: extent to which -- -- -- -- 6.0 6.0 6.0 6.0 -- -- -- businesses are free to set their own prices ii. Administrative conditions and -- -- -- -- 7.2 3.3 4.5 3.3 -- -- -- new businesses: administrative procedures are an important obstacle to starting a new business (GCR) iii. Time with government -- -- -- -- 4.7 4.0 4.5 5.8 -- -- -- bureaucracy: senior management spends a substantial amount of time dealing with government bureaucracy (GCR) iv. Starting a new business: -- -- -- -- 5.0 4.6 6.0 5.3 -- -- -- how easy is it to start a new business (GCR)? Regulatory quality (Kaufmann, Kraay, and Mastruzzi 2007) Estimate (­2.5 to + 2.5) 0.53 -- 0.72 -- 0.53 -- 0.92 -- 1.02 -- -- Percentile rank (0­100)a 0.73 -- 0.74 -- 0.73 -- 0.77 -- 0.83 -- -- Sources: Heritage Foundation Index of Economic Freedom, 1996­2006; Fraser Institute indexes for years indicated. Note: -- = not available; GCR = Global Competitiveness Report. a. Author's calculations. 74 Appendix 3 indexes (table 3A.3). While the point estimate of the index and the government's commitment to its policies, one increased from 0.53 (on a scale of ­2.50 to +2.50) in 1996 can infer that significant improvements have occurred to 1.02 in 2004, the corresponding percentile rank for in these dimensions since the late 1990s: Latvia also increased from 73 to about 83. The regulatory quality index focuses on policies and includes measures of Government 1996 1998 2000 2002 2004 the incidence of market-unfriendly policies, such as price Effectiveness Index controls or inadequate bank supervision, as well as percep- Estimate (­2.5 to + 2.5) 0.04 0.19 0.36 0.70 0.60 tions of the burdens imposed by excessive regulation in areas such as foreign trade and business development. Percentile rank (0­100)35 0.63 0.67 0.68 0.75 0.71 Access to Information and Government CORRUPTION Service Provision Lack of transparency and access to information about The detrimental effect of corruption on business, and government regulations, legislation, and policies can thus on domestic and foreign investment, growth, and pose a serious problem for business. FIAS used the poverty, is well known and well documented in the "government effectiveness" index developed by literature. Many of the indexes discussed earlier also Kaufmann, Kraay, and Mastruzzi (2003) for this pur- attempt to account for corruption in the bureaucracy pose. This index combines responses on the quality of and in customs administration. public services, the quality of the bureaucracy, the com- petence of civil servants, the independence of the civil One of the most widely used indicators of corruption is service from political pressures, and the credibility of the Transparency International Corruption Perceptions the government's commitment to policies. Although Index, which ranges from 0 to 10, with 0 indicating the index tends to serve as a proxy for a variety of gov- most corrupt and 10 indicating least corrupt. The index ernance issues, the most relevant issues for the purpose gave Latvia a very low score of 2.70 in 1998; but that of assessing the business environment in Latvia are those score has improved continuously, reaching 4.20 in concerning the quality of public services and the 2004. The overall score is still low, however, implying government's commitment to its policies. The main the need for further improvements in Latvia. focus of this index is inputs required for the govern- Corruption in Latvia is also reflected in the "control of ment to produce and implement good policies and corruption" index developed by Kaufmann, Kraay, deliver public goods. There has been a significant and Mastruzzi (2003), which measures perceptions of improvement in this index for Latvia since 1996. The corruption, conventionally defined as the exercise of point estimate of the index (on a scale of ­2.50 to public power for private gain. It captures different +2.50) increased from 0.04 in 1996 to 0.60 in 2004, aspects of corruption, ranging from the frequency of and the corresponding percentile ranking for Latvia "additional payments to get things done" to the effects similarly increased from 63 to 71. To the extent this of corruption on the business environment, grand index captures the quality of public service provision 35. Author's calculation. Appendix 3 75 corruption in the political arena, and state capture. tax assessments, police protection, or loan applications) The score for Latvia increased from ­0.56 in 1996 to shows that scores for Latvia improved marginally from 0.23 in 2004 (on a scale of ­2.5 to +2.5), and its 5.8 (out of 10.0) in 2000 to 6.0 in 2003. corresponding percentile ranking improved from 32 in The Freedom House Corruption Index 1996 to 63 in 2004. (http://www.transparency.org/publications/gcr/ Although FIAS was not able to obtain data from the late download_gcr/download_gcr_2003#download) 1990s for two other indicators (table 3A.4), the Fraser remained at 3.5 (on a scale of 1.0­7.0, with 1 indicat- Institute's subindex of irregular payments (which tracks ing least corrupt and 7 indicating most corrupt) from irregular, additional payments connected with import 1999 until 2004 (in 2002 the score dropped slightly to and export permits, business licenses, exchange controls, 3.75 but it returned to 3.50 in 2003). The major TABLE 3A.4: CORRUPTION RATINGS Index 1996 1998 1999 2000 2001 2002 2003 2004 2005 Fraser Institute's Index of Economic -- -- -- 5.8 5.4 6.0 6.0 -- -- Freedom, subsection Business regulation, subsection Irregular Payments: irregular, additional payments connected with import and export permits, business licenses, exchange controls, tax assessments, police protection, or loan applications (GCR) (0 = worst, 10 = best) Control of corruption (Kaufmann, Kraay, and Mastruzzi 2007) Estimate (­2.5 to +2.5) ­0.56 ­0.10 0.04 -- 0.09 -- 0.23 -- Percentile rank (0­100) 0.32 0.62 0.60 -- 0.59 -- 0.63 -- Freedom House Corruption Index -- -- 3.50 -- 3.50 3.75 3.50 3.50 2.50 (1 = least corrupt, 7 = most corrupt) Transparency International Corruption -- 2.7 3.4 3.4 3.4 3.7 3.8 4.2 4.2 Perceptions Index (0 = most corrupt, 10 = least corrupt) Sources: Fraser Institute indexes for years indicated; Kaufmann, Kraay, and Mastruzzi 2003; Freedom House Corruption Indexes, various years; Transparency International Corruption Perceptions Index, various years. Note: -- = not available. 76 Appendix 3 improvement, however, appeared in 2005 when the trade, the regulatory environment, access to information score improved to 2.5. and government service provision, and corruption. However, the property registration procedures were On the basis of a wide range of data and information, more complicated in Latvia than in the other countries there have been significant improvements in the then seeking EU accession. investment climate in Latvia--namely, in customs and Appendix 4 77 Appendix 4: Final Impact: Investment, Growth, and Poverty Alleviation PRIVATE SECTOR INVESTMENT Small and Medium Enterprises The burden of regulations often falls disproportionately Gross fixed capital formation has been high and has on small and medium enterprises (SMEs) because they increased over the period 1999­2005 (figure 4A.1). The lack both the resources and the political influence of private sector has been the key contributor to growth larger firms. Indeed, the administrative and regulatory and development in Latvia, which further reinforces the cost surveys that FIAS has conducted reveal significant link between removing administrative barriers to busi- evidence that small firms in Latvia tend to benefit ness and economic growth. Throughout the period more from inspection reforms than do medium and 1995­2003, on average, 87 percent of total investment large firms. SMEs constitute the major part of the in Latvia came from the private sector. The private Latvian economy and play a significant role in sector also held the dominant share of GDP, and that employment and growth. There were about 45,300 share improved from 55 percent in 1995 to 70 percent economically active enterprises in Latvia in 2003, of in 2002.36 which more than 99 percent (i.e., 45,014) were considered SMEs. Among those, the largest proportion FIGURE 4A.1: GROSS FIXED CAPITAL FORMATION AS A SHARE OF GDP, 1999­2005 40 35 30 25 GDP 20 of % 15 10 5 0 1999 2000 2001 2002 2003 2004 2005 Sources: Data from Eurostat; Ministry of Economy 2005. Note: GDP = gross domestic product. 36. The private sector share of GDP is calculated using available statistics from both official (government) and unofficial sources. The share includes income generated from the formal activities of registered private companies, as well as informal activities for which reliable information is available. The term private company refers to all enterprises in which private individuals or entities own the majority of shares (EBRD 2003). 78 Appendix 4 comprises micro- and small enterprises (76 percent in later years (except 2001, when net per capita FDI micro-, 20 percent small, and 4 percent medium inflows declined to US$72). The largest increases enterprises). Seventy percent of private sector employees occurred in 2004 and 2005 (net per capita FDI inflows are employed in SMEs and create 63 percent of the of US$270 in 2005), and the figure for 2005 was roughly GDP (Ministry of Economy 2004). double that of 2003. Although there seems to be an increase in FDI inflows into Latvia in recent years, the Foreign Direct Investment results are volatile, and it is difficult to surmise how Net FDI inflows appear to be volatile in all transition removing administrative barriers has contributed to economies (figure 4A.2).37 In the last decade, the Czech attracting FDI to Latvia. Republic has attracted the largest share of per capita net Although Latvia has one of the least regulated business FDI inflow (US$832 in 2005). In Latvia, per capita net environments among EU accession countries,38 this is FDI inflows improved in the period 1994­97 and not reflected in the Heritage Foundation reached their highest levels in 1997 at US$210 per capita. (http://www.heritage.org/index/) and Freedom House A noticeable temporary decline followed in 1998, but a (http://www.freetheworld.com/) indexes, which are continuous improvement in FDI inflows occurred again FIGURE 4A.2: PER CAPITA NET FDI INFLOWS IN EU ACCESSION COUNTRIES, 1994­2005 900 800 700 600 $ 500 US 400 300 200 100 0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Czech Republic 72.4371 244.53 123.643 123.786 348.98 606.42 481.305 535.812 810.578 185.784 382.52 831.703 Estonia 145.205 147.222 140.141 79.2857 93.5252 415.942 162.044 238.235 252.206 113.333 565.185 582.836 Latvia 109.412 97.2222 152.209 210.204 125.726 138.494 169.198 72.0339 159.829 141.379 231.997 270.435 Lithuania 8.46995 8.53994 19.9446 42.4581 92.1348 260.907 106.838 126.149 205.46 40.9222 147.826 190.962 Poland 47.8983 93.7289 115.096 125.821 156.426 187.248 241.32 150.207 100.984 101.709 138.751 166.909 Slovak Republic 44.1121 44.0299 36.1266 36.9888 15.5844 69.2593 129.815 381.111 269.871 740.665 101.235 233.148 Source: EBRD 2005. Note: EU = European Union; FDI = foreign direct investment. 37. FIAS has been active in advising these and other EU accession countries, in addition to Latvia. 38. Latvia ranked among the best countries in the Doing Business 2004 report for ease of starting a new business. Its ranking was slightly worse in the Doing Business 2005 report because of a temporary deadline for re-registration, which created a backlog. appendix 4 79 largely based on perceptions of foreign investors. One producing goods and services. Recent evidence suggests possible explanation for this is that it takes time to that trade openness complements and often acts as a change the perception of foreign investors ("a first catalyst to reforms in other areas, such as the labor impression is the last impression"). A large portion of market and utilities. FDI is initial investment, and subsequent inflows follow Latvia has a high degree of openness (measured in terms the initial investment. This, in turn, implies that Latvia of trade share in GDP), although the degree of openness has great potential to attract FDI in the future as a result was higher in the period 1996­98 and has declined of reforming administrative barriers. marginally in recent years. Although imports (both of goods and services and of manufacturing) as a share of TRADE OPENNESS GDP increased from 1995 to 2005, exports remained Benefits of trade openness are manifold. Openness tends steady over the same period (table 4A.1). Reforms in to increase economic growth, foreign investment, and customs administration and the removal of administra- efficiency of domestic investment through increasing tive barriers in other areas have led to a growth in competitive pressure; and ideas, knowledge, innovation, exports, underscoring the evidence that trade and technology tend to flow with trade, which enables liberalization leads to higher economic growth in a a country to operate as a leading technology frontier in well-regulated environment.39 TABLE 4A.1: TRADE OPENNESS, 1995­2005 Trade-related indicators 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Trade (% of GDP) 87.5 101.1 101.5 106.8 90.0 90.3 92.7 91.5 96.7 103.7 110.5 Exports of goods and 42.7 46.8 46.8 47.2 40.4 41.6 41.6 40.9 42.1 44.0 48.1 services (% of GDP) Exports of goods -- 20.2 13.1 4.9 ­6.0 11.3 7.5 5.4 5.2 9.4 20.7 and services (annual % growth) Imports of goods and 44.9 54.3 54.7 59.6 49.6 48.7 51.1 50.6 54.6 59.7 62.4 services (% of GDP) Imports of goods -- 28.5 6.8 19.0 ­5.5 3.1 14.3 4.7 13.1 16.6 13.5 and services (annual % growth) Source: Central Statistical Bureau of Latvia, June 2006. Note: -- = not available; GDP = gross domestic product. 39. Trade liberalization leads to a 0.7 percent increase in economic growth in well-regulated countries (Bolaky and Freund 2004). 80 appendix 4 ECONOMIC GROWTH FORMALIZATION AND TAX REVENUES A reduction in regulatory barriers tends to increase Improvements in the investment climate have led to economic growth (see World Bank 2004, 2005), and higher investment levels and productivity, and to reforms to administrative barriers along with other policy greater business formalization and higher tax revenues. reforms have led to economic growth in Latvia. When The data in table 4A.2 show the growth in the number Latvia began to realize the detrimental effect of regulatory of taxpayers by type of employment (i.e., natural burdens on business and initiated its action plan to persons engaged in business and legal entities) between reform administrative barriers in May 1999, the average 1999 and 2005. These data reflect a combination of annual growth rate during the period 1995­99 was new businesses and the formalization of firms that previ- about 3.8 percent. The growth rate has improved to an ously may have been operating in the gray economy. average annual rate of 8.2 percent over the period According to the database used to compile the Doing 2000­04 when many of the reforms were implemented. Business reports, Latvia's informal economy constitutes Consequently, the well-being of the average Latvian about 40 percent of its gross national product. measured in terms of GDP per capita (purchasing power parity [PPP], constant 2000 prices) has increased steadily from about US$2,670 in 1995 to US$5,495 in 2005 (figure 4A.3). FIGURE 4A.3: GROWTH IN GDP PER CAPITA AND PER CAPITA REAL GDP 6,000 0.12 5,000 0.1 growth 4,000 0.08 GDP per capita (in USD at average GDP capita prices of year 2000) 3,000 0.06 per real Per capita real GDP growth (in local 2,000 0.04 GDP currency) capita per1,000 0.02 0 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source: Central Statistical Bureau of Latvia, 2006. Note: GDP = gross domestic product. appendix 4 81 TABLE 4A.2: NUMBER OF TAXPAYERS BY TYPE OF EMPLOYMENT, 1999 AND 2005 Years and calculations Legal entities (n) Self-employed individuals (n) Total (n) 1999 99,233 18,861 118,094 2005 130,772 27,205 157,977 Difference 2005 vs. 1999 31,539 8,344 39,883 % change 2005 vs. 1999 24 31 25 Source: Data from the Central Statistical Bureau of Latvia, http://www.csb.lv. In addition, prevalence and amount of minimum FIGURE 4A.4: MINIMUM WAGES wage, if considered together, may serve as a relative IN EASTERN EUROPE, 2004 indicator of the gray economy (figure 4A.4). A large portion of workers employed at minimum wage may 47.5 indicate that the wage is too high; however, if the eragev (%) 45.0 Slovenia wage is low relative to average in the country and a A 42.5 to vices substantial portion of employees work for minimum Hungary Ser 40.0 Latvia Czech Republic wage, it also may illustrate a substantial informal Lithuania and 37.5 y Poland labor market. Relation e 35.0 Slovakia Estonia Latvia 2002 ag 32.5 W Industr In 2002, a high proportion of employees (15.4 percent) in 30.0 um e in Latvia worked for minimum wage, and the mini- ag 27.5 W mum wage was set at 32.5 percent of the country's Minim 25.0 0 2.5 5.0 7.5 10.0 12.5 15.0 17.5 average wage. In 2004, the minimum wage in Latvia Portion of Full-time Employees on Minimum Wage (%) increased and the proportion of employees working for minimum wage decreased. This also is reflected in a tax Source: Based on data from Eurostat, 2006. increase of LVL 1.2 billion during those two years (table 4A.3).40 40. A billion is 1,000 millions. 82 appendix 4 (13.6) (36.1) (--) (18.6) (6.0) (11.7) (­8.7) 2004 0 3,832 242 824 921 448 32 (11.5) (­14.4) (14.9) (19.9) (19.5) (24.5) 2003 (­99.1) 0 3,149 166 649 811 375 33 (10.1) (11.5) (9.3) 2002 (­82.2) (12.6) (10.3) (­1.6) 2,597 178 0.3 519 622 288 25 (5.8) (33.5) (8.7) (3.8) (­1.9) (6.4) 2001 (­72.1) 2,320 157 2 453 560 25 257 (2.8) (8.9) (6.9) (5.8) (­20.1) 2000 (­81.2) (­10.3) 2,298 8 437 565 275 123 24 (2.3) (­0.2) (9.2) (0) (­8.4) 1999 (­10.6) (­18.6) 2,318 160 42 416 549 269 28 8 (20.6) (17.5) (35.1) (19.7) (9.6) (41.2) 199 (­10.2) 2,249 159 47 379 545 292 34 parentheses. in 1995­2004 (23.7) (37.3) (11.1) (19.9) (7.8) (36.7) (17.9) shown 1997 year 1,886 137 35 320 503 209 38 http://www.csb.lv. previous Latvia, to VENUES, (13.0) (20.5) of (21.9) (14.9) (21.7) (148.7) (2.0) 1996 RE 34 relative 1,597 105 33 280 489 160 Bureau X A increase T (--) (--) (--) (--) (--) (--) (--) Statistical 1995 87 28 Percent 1,425 245 405 65 34 Central 4A.3: the tax available. MILLIONS tax l tax from taxl e ty tax not oratep = Data ABLE or ue-addedl -- T US$ axT otaT nuev erpo re C income Pr ersonaP ustoms income Va tax Excise C duties Source: Note: appendix 4 83 TABLE 4A.4: EMPLOYMENT, 1996­SEPTEMBER, 2005 Employment-related indicators 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005a Population aged 1,642.4 1,623.7 1,611.4 1,601.6 1,599.6 1,595.0 1,594.2 1,591.4 1,589.3 1,587.3 1,583.8 15­64 years (thousands) Economically active -- 1,196 1,167 1,149 1,130 1,100 1,107 1,123 1,126 1,136 1,102 persons (thousands) Employed persons -- 949 990 986 968 941 962 989 1,007 1,018 999 (thousands) Rate of economically -- 60.9 59.7 58.9 57.9 56.3 56.6 61.8 62.0 62.6 69.6 active population (%) Rate of employed -- 48.3 50.6 50.5 49.6 48.2 49.2 54.4 55.4 56.1 63.1 population (%) Unemployment rate (%) 6.6 7.2 7.0 9.2 9.1 7.8 7.7 8.5 8.6 8.5 8.2 Rate of job seekers (%) -- 20.6 15.1 14.1 14.3 14.4 13.1 12.0 10.6 10.4 -- Employment in the -- 183 183 183 170 170 156 167 174 163 156 manufacturing sector (thousands) Manufacturing employment as a share of total employment (%) -- 19.3 18.5 18.6 17.6 18.1 16.2 16.9 17.3 16.0 15.6 Employment in the -- 51 51 54 58 56 68 60 74 87 92 construction sector (thousands) Construction -- 5.4 5.2 5.5 6.0 6.0 7.1 6.1 7.3 8.5 9.2 employment as a share of total employment (%) Source: Central Statistical Bureau of Latvia, June 2006. Note: -- = not available. a. Data as of September 2005 (Ministry of Economy 2005). 84 appendix 4 EMPLOYMENT AND LIVING STANDARDS construction sector. Employment in that sector as a share of total employment also increased from about Reforms to administrative barriers tend to have a 5.45 percent in 1996 to approximately 7.50 percent positive impact on growth and investment, which, in in 2003. turn, leads to job creation and a reduction in poverty. Employment figures in Latvia show a decent improve- A benefit of reform to administrative barriers (and relat- ment over the period 1996­2004. Over that period, the ed reforms) is job creation. In 2003, the highest rate of rate of both the economically active population and employment was found in Riga, which may be logically those employed increased from 60.9 percent and 48.3 linked with the FIAS findings that, on average, the bur- percent in 1996 to about 62.6 percent and 56.1 percent den of administrative barriers is less for firms in Riga in 2004, respectively. The rate of job seekers dropped than elsewhere.41 This, in turn, implies that other from 20.6 percent of the working-age population in regions in Latvia might benefit from greater employ- 1996 to 10.4 percent in 2004 (table 4A.4). Most people ment and productivity growth through the removal of work in the manufacturing sector (17.4 percent in administrative barriers. 2003); followed by wholesale and retail trade and Average nominal and real wages also increased in the services (15.3 percent); and agriculture, forestry, and period 1996­2004, implying an increase in both labor hunting (13.0 percent). In 2002­03, the highest growth productivity and the average living standard in Latvia (about 23.3 percent) in employment occurred in the (figure 4A.5 and table 4A.5). The average standard of living (as represented by the net monthly FIGURE 4A.5: WAGES AND SUBSISTENCE average wage) has improved in absolute terms, and it has diverged from the poverty level. While the average 350 monthly wage was only US$15 higher than the cost of 300 goods and services to meet the minimum subsistence 250 level in 1997, in 2005 the net average monthly wage Average Net Wage 200 (USD) increased to US$317 (compared with the cost of meet- Per Capita Cost of ing the minimum subsistence level of US$189). For the 150 Subsistence (USD) average employee in Latvia, reforms to administrative 100 barriers and other economic reforms have led to greater 50 opportunities for employment, greater productivity, and 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 a higher standard of living. Source: Central Statistical Bureau of Latvia, June 2006. 41. It also may be due to the result of a greater degree of sophistication in Riga than elsewhere in the country. appendix 4 85 TABLE 4A.5: WAGES AND COST OF MINIMUM SUBSISTENCE, 1997­2005 US$ Indicators 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Average monthly wage Gross -- -- 209 229 245 251 254 281 339 399 443 Net -- -- 153 167 179 182 184 201 244 284 317 Value of goods and 118 135 138 141 144 141 139 145 166 187 189 services baskets of complete subsistence, per capita Source: Central Statistical Bureau of Latvia, June 2006. Note: -- = not available. POVERTY AND HUMAN DEVELOPMENT 2006 concluded that, between 1998 and 2004, Latvia achieved substantial progress in poverty reduction, with The economic indicators cited in this appendix show an estimated 325,000 people moving out of poverty that the reforms carried out in the previous decade have over the period. Using household budget survey data strengthened the private sector, and that the business from 1998 to 2004 and an absolute poverty line,42 the environment is improving. Investments continue to World Bank report identifies--for the first time--trends grow rapidly, which is encouraging the modernization in poverty for this extended period on the basis of a of production and introducing new and more produc- consistent definition of poverty. The poverty head- tive technologies. Clearly, accession to the EU has had a count rate fell significantly, from 19.4 percent in 1998 positive effect on the development of the Latvian econ- to less than 6.0 percent in 2004 (figure 4A.6 and table omy, but the reforms and the improved business envi- 4A.6). Inequality in the distribution of income also has ronment have enabled Latvia to reap enormous benefits. improved since 2000. The poverty gap index, which measures the extent of poverty (i.e., how far below the We can positively assert that the broad-based economic poverty line poor people live), has declined substantially growth in Latvia has helped alleviate poverty. A study since 2000--from 5.5 percent to 1.2 percent. conducted by the World Bank and released in June 42. This paper uses the same poverty line as that used in the World Bank's earlier living standards assessment for Latvia: namely, 28 lats per person per month in 1998 prices. It is adjusted for inflation to hold constant the real value of the poverty line over time. 86 appendix 4 Poverty is complex and, although income is a significant FIGURE 4A.6: POVERTY TRENDS IN component in determining quality of life, there are LATVIA, 1998­2004 other aspects to quality of life as well. To address the multidimensionality of quality of life, the United 25 Nations Development Programme constructed the 20 Human Development Index (HDI) using life expectancy at birth, level of education, and real GDP per capita in (%) 15 PPP units. rate 10 According to the HDI, Latvia ranked 50th in 2003 (its rank was 63rd in 2000 and 53rd in 2002). head-count 5 Although, in absolute terms, human development in Latvia has improved from an index of 0.76 in 1995 to 0 0.82 (on a scale of 0 to 1) in 2002, it still ranks last 1998 2000 2002 2004 among EU accession countries (table 4A.7). Although Latvia's GDP per capita improved greatly between Source: World Bank 2006. 1995 and 2003, it is one of the lowest among new EU The labor market provided the primary channel through member-countries. In 1995, Latvia's GDP per capita which the benefits of rapid economic growth were shared was about 29 percent of the EU average; in 2003, the widely across the population. Along with higher employ- corresponding share had increased to approximately ment rates, labor productivity rose appreciably--and that 42 percent. These figures reflect Latvia's having spurred higher real wages, incomes, and living standards. achieved noticeable improvements in its average level At the same time, maintenance of a broad-based system of of well-being; but relative to its comparators, the fig- social transfers has ensured that vulnerable groups, such as ures also reveal that much room remains for develop- pensioners and the poorest people, are protected even as ment, particularly given Latvia's commitment to the targeted effectiveness of local government benefits has reform and development. improved (World Bank 2006, p. vii). TABLE 4A.6: KEY POVERTY AND INEQUALITY STATISTICS, 1998­2004 Statistic 1998 2000 2002 2004 Poverty head-count rate (%) 19.4 14.0 7.5 5.9 Poverty gap (P1) measure 5.5 4.1 2.0 1.2 Poverty line (% of mean consumption) 50 41 34 30 Gini coefficient 33.5 37.3 35.1 33.5 Source: World Bank 2006. appendix 4 87 TABLE 4A.7: HUMAN DEVELOPMENT IN EU ACCESSION COUNTRIES, SELECTED YEARS, 1995­2003 GDP per capita, 2003 Life expectancy Education HDI, HDI Rank Country (PPP US$) index index GDP index 2002 26 Slovenia 19,150 0.86 0.98 0.88 0.895 31 Czech Republic 16,357 0.84 0.93 0.85 0.868 35 Hungary 14,584 0.80 0.96 0.80 0.848 36 Poland 11,379 0.82 0.96 0.79 0.850 38 Estonia 13,539 0.77 0.97 0.82 0.853 39 Lithuania 11,702 0.79 0.97 0.79 0.842 42 Slovak Republic 13,494 0.82 0.91 0.82 0.842 48 Latvia 10,270 0.78 0.96 0.77 0.823 HDI FOR SELECTED YEARS Country 1995 2000 2002 2003 Slovenia 0.852 0.883 0.895 0.904 Czech Republic 0.843 0.856 0.868 0.874 Hungary 0.810 0.837 0.848 0.862 Poland 0.816 0.843 0.85 0.858 Estonia 0.796 0.839 0.853 0.853 Lithuania 0.789 0.829 0.842 0.852 Slovak Republic ­ ­ 0.842 0.849 Latvia 0.765 0.808 0.823 0.836 Source: UNDP, various years. Note: ­ = negligible; EU = European Union; HDI = Human Development Index; PPP = purchasing power parity. 88 appendix 4 At the end of the day, it is extremely difficult to attrib- high cost-benefit ratios and can make significant ute improvements in the standard of living or a reduc- contributions to poverty reduction. In 2004, for exam- tion in poverty to any particular reform or project. ple, the Copenhagen Consensus determined that FIAS reasonably can claim some credit for assisting the reforms to reduce barriers to business are among the top Government of Latvia in its efforts to improve the 10 most cost-effective interventions to improve the investment climate, alongside many other stakehold- "greatest global challenges" (http://www.copenhagen- ers. FIAS recommendations for reforming the process- consensus.com/Default.aspx?ID=699). The study that es of government inspections and customs and tax led to the 2004 Consensus performed a large body of administration have been shown to have yielded tangi- cost-benefit research across a range of projects to ble benefits to businesses in the form of lower costs. improve governance, combat corruption, and reduce Beyond that, it may be reasonable to describe linkages red tape. It concluded that the monetary costs of such between lower costs for businesses and higher rates of projects are quite low; and that documented benefits, if investment, productivity, and business formalization. meaningful reforms are enacted, usually are very high These factors, in turn, logically contribute to higher (Rose-Ackerman 2004). We are confident that the rates of economic growth, higher tax revenues, more FIAS projects in Latvia were good investments from employment opportunities, higher wages, and lower both the investment climate perspective and the human rates of poverty. welfare point of view. A great deal of research supports the proposition that reforms to improve the investment climate have very Appendix 5 89 Appendix 5: Methodology Note on Cost- Benefit Calculations of the FIAS Latvia Administrative Barriers Project ASSUMPTIONS The analysis assumes that the project costs of US$1 million all were incurred at the outset of the program in The absence of annual survey data on benefits, or cost 1998 and, therefore, are not discounted. For a more savings, resulting from reforms of the Latvian business accurate calculation, we could obtain more detailed data environment does not enable us to construct a tradi- on costs borne by FIAS and the Government of tional cost-benefit analysis based on a flow or stream Latvia--particularly in the years in which various of project costs and cost savings over time. As a result, contributions were made--to be able to discount these we have decided to calculate benefits based on the dif- costs and calculate their net present value in 1998. ference of survey-to-survey results. Most of FIAS' programmatic interventions in streamlining the QUALIFICATION OF CALCULATIONS administrative barriers to doing business occurred between the late 1990s and 2004 at the latest. As a Why might we be underestimating? result, we determined that the two available survey years most appropriate for the analysis were 2001 and First and foremost, we are evaluating the benefits 2005. By using 2003 data, we might be committing an only at one point in time--in the year 2005 (or 2003, error of taking the data that represent some time in the where 2005 data are not available) when our survey middle of the reforms because most of the FIAS was conducted. However, benefits and cost savings to reforms were implemented and updated until 2004. businesses occur every year. What is more, the effects of the reforms usually are For the registration procedures, time savings have noticed with some lag (for example, reforms begun in been estimated, but have not been converted to 2002 and/or implemented in 2003 may be reflected monetary output because of the complexities related only in the 2005 survey, when more of the respon- to estimating the corresponding opportunity cost. dents have been affected by the particular reform). Any time savings on registration procedures can be However, in instances where 2005 data are not avail- thought of as reduced costs in the form of forgone able, we will treat the 2001 data as the baseline and revenues (for example, in 2005, the business can be calculate the benefits (mostly cost savings) by compar- registered within four fewer days than in 2001; this ing them to the 2003 data. As a result, all benefits and reduction represents time that can be used to gener- cost savings are calculated in the following underlying ate additional profits from business operations). context: For the period of 12 months preceding the Our analysis of benefits (in terms of cost savings) is 2005 survey, in comparison to the data collected based only on five areas of doing business (company through the 2001 survey, the private sector in Latvia registration, licensing, inspections, property registration, realized the following benefits/cost savings. and tax administration). However, the scope of the FIAS program in Latvia also addressed other areas for All monetized values are discounted (using the standard reform (for example, customs procedures, hiring work- 5 percent annual discount rate) to 1998 U.S. dollars to ers, and so forth). By choosing to quantify only a part obtain a consistent measure--the net present value--of of the overall benefits on the business community, we costs and benefits across different time periods. are providing a very conservative cost-benefit ratio. 90 appendix 5 We multiplied by the average salary to quantify cost potential drawbacks to having shorter or less frequent savings. If we had disaggregated figures for the salary inspections. One potential negative effect of less in the private sector, our calculated benefits might be frequent and shorter inspections may be decreased even higher--provided that private sector salaries are quality control. In the case of fire safety inspections, it higher than public sector salaries--so the current may imply higher probability of fire; in the case of overall figure is probably an underestimate. sanitary inspections, it may imply more sanitary violations; and so on. Still, we are not in a position to Why might we be overestimating? evaluate these potential negative developments, and there is no clear reason to believe that the quality of We are quantifying only the benefits to firms in the control has been affected negatively so far. form of cost savings. However, there could be references 91 References Batra, Geeta, and Jyothsna Mody. 2003. "Investment ------. 2007. "Governance Matters VI: Governance Climate Indicators." Research paper. World Bank, Indicators for 1996­2006." World Bank, Washington, DC. Washington, DC. Bolaky, Bineswaree, and Caroline Freund. 2004. Kaufmann, Daniel, Aart Kraay, and Pablo Zoido- "Trade, Regulations, and Growth." Policy Research Lobatūn. 1999. 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