A formation of a long term economic strategy, fighting the informal economy, improving the rule of law and workers’ rights are identified as top priorities to improve Kosovo’s economy argues Bedri Peci.
Many barriers hinder Kosovo’s economic development, but there are five key steps that require immediate attention. These priority measures are prerequisites for greater economic growth, as well as an increase in employment and social security for the citizens of Kosovo.
The five steps are as follows: formulating a long-term economic development strategy, strengthening the rule of law and good governance, protecting workers’ rights in the private sector through strict implementation of the Law on Labor, fighting the informal economy and fighting corruption.
Serious reforms aimed at building a market-based economy and creating economic and political stability are key for helping grow economies that are in transition, and these measures are preconditions for taking further steps that have a more direct impact on economic development and generating employment.
The formulation of a long-term economic development strategy
Currently, Kosovo does not have a long-term economic development strategy that describes the country’s development flow and orientation. The country has numerous and detailed sector strategies, but faces difficulties in coordinating and implementing them. This is one of the main obstacles to sustainable economic development.
The government should formulate a long-term economic development strategy for 2030, synchronizing it with the EU’s Sustainable Development Agenda, which also extends to 2030. This strategy must also be approved by the Kosovo Assembly.
Formulation of such a strategy is of multidimensional importance for Kosovo. As soon as is possible, the state should establish a National Intersectoral Coordination Center led by local and international experts for its creation, defining Kosovo’s development objectives based on its resources and serving as a basis for proper planning.
The importance of creating this strategy is economic, financial and fiscal.
Its economic importance is because the strategy is a prerequisite for the development of branches of the economy and increasing employment, as it will address the major obstacles to Kosovo’s economic development. The right combination of economic policies can generate an economic model that ensures self-sustaining economic growth.
But the long-term strategy is also necessary for the sustainable public financing of Kosovo. This is because sustainable public financing in a country is conditioned by the existence of three basic documents: a long-term economic development strategy, a medium-term expenditure framework and a budget. The medium-term expenditure framework is a derivative of the long-term economic development strategy, while the budget is a derivative of the medium-term public expenditure framework.
Kosovo has a medium term expenditure framework and a budget but lacks the long-term economic development strategy, which is the key document based on which the following two documents should be compiled. That is why Kosovo cannot have consistent results but only fragmented and temporary ones.
An indispensable condition for a sustainable economy is the existence of a sustainable and long-term fiscal policy, one that can continue to exist without the need for modifications. Unstable fiscal policy is when its existence is conditioned by the undertaking of certain changes.
In the case of Kosovo, there have been constant modifications to public spending, especially in recent years, giving the country’s fiscal policy an ‘ad-hoc’ character. This expression generally means a solution designed for a specific problem or task, one which is not generalized and not intended to be capable of adapting to other purposes.
In the case of budgetary policy in Kosovo, ‘ad-hoc’ means providing financing for a “priority” case without taking into consideration other cases of equal priority.
Kosovo governments through their budgetary policy has not sought to reallocate resources in line with economic priorities (profit maximization) and social priorities (public welfare) but through the budget, while ad-hoc spending has sought to neutralize social discontent at different elements of the public sector.
In terms of increasing revenue, governments in post-independence Kosovo have mainly made changes to tax rates, including VAT, Corporate Income Tax and Personal Income Tax. These changes, are boastfully labelled as ‘tax reforms.’
Proper fiscal reform is not just about changes in tax rates. The main problem is that Kosovo’s tax system still relies heavily on customs, and fiscal policy designers must find other sources of revenue within the territory of Kosovo as a replacement.
The fiscal system and fiscal policy in Kosovo need deep and genuine reform in line with the long-term strategy and its implementation.
Fighting the informal economy
The informal economy is part of an economy that is neither taxed (as it is avoided or operated illegally) nor monitored by any form of government. Unlike the formal economy, activities in the informal economy are not included in a country’s gross domestic product (GDP).
As such, the informal economy mainly encompasses concepts such as tax evasion (the grey economy, smuggling, and other illegal activities), informal employment and under-reporting of worker’s salaries, including income derived from illegal activities, etc.
The informal economy is at the top of the list of barriers to doing business in Kosovo. It also reduces state revenues, and has a direct impact on unfair competition between businesses. A business environment characterized by high informality prevents new, legal and innovative firms from growing and creating new jobs in the market and sends disturbing signals to foreign investors, discouraging them to invest in Kosovo.
The informal economy lies everywhere. Most prominent currently is tax and customs evasion through smuggling done through alternative routes in northern Kosovo, but the informal economy, either in the form of smuggling or in the form of the grey economy, continues throughout the territory of Kosovo, where natural and legal persons use every form of evasion to avoid paying tax. As a result, the state budget is damaged by hundreds of millions of euros annually.
The most problematic industries in relation to the informal economy are construction and the service industry: especially hotels, restaurants, trade, and transport.
The state of the informal economy in Kosovo is not clearly identifiable. However, local and international reports point out that the informal economy in Kosovo is more than 30 per cent of GDP, or about 1.8 billion euros annually.
A recent sectoral assessment of the informal economy conducted by EU, measured in 2017 with statistical data from 2015, found that the informal economy rate in Kosovo reached up to 31.7 per cunt (EU Further Support to Kosovo Institutions in fights against organized crime, corruption, and violent extremism, 2017, p.37).
Such a degree of non-declaration of income means that businesses contribute less than they should, to the national budget and as a result, public services which could be financed by business taxes, are one-third smaller than they should be.
This high level of the informal economy causes direct damage to competition and regular businesses that pay tax to the state. Another negative effect relates to foreign direct investment because serious investors will not come to a country where tax evasion accounts for over 30 per cent of GDP.
In this regard, it also presents a major obstacle in measuring macroeconomic indicators such as gross domestic product (GDP), economic growth and unemployment, which are reflected in economic policymaking. The informal economy in Kosovo is influenced by many factors such as the perception of the quality of public governance, including tax policies, tax administration behavior, the perceived tax burden, the tax structure in general, and the strategy of using coercive measures.
These are just some of the factors that affect taxpayers’ willingness to pay taxes. In the case of Kosovo, I consider that the main influencing factors of the informal economy in general, and tax evasion in particular, are the poor quality of institutional governance and the lack of rule of law.
The lack of rule of law in Kosovo has led to reduced transparency in the activities of public institutions, increased corruption, and increased mistrust from taxpayers. As a result, taxpayers hesitate to finance the government by paying taxes and consequently, they evade tax.
Nearly three centuries ago Adam Smith stated that: “When there’s at least a common suspicion of unnecessary spending and mismanagement of public expenditure, the legislation that keeps it safe is not respected.” The responsibility of institutions lies in creating mechanisms that ensure quality governance and safe fiscal policy. This has not been sufficiently achieved in Kosovo.
The actions of Kosovo institutions in fighting the informal economy have been weak and not coordinated by all governments so far. The most serious step regarding this is the adoption in May this year of a revised strategy and action plan to fight the informal economy.
However, this strategy will only be considered successful if it is implemented in practice by taking the actions envisaged and if there’s a strong political will of the government to combat this phenomenon.
From the practices of the state’s “war” against the informal economy, we learn that success in fighting the informal economy has resulted only when this phenomenon has been accompanied by a strong political will.
The high level of the informal economy is also referred to in the EU Enlargement Report on Kosovo, which was delivered to Kosovo Institutions this year. The report notes that tax evasion and informality continue to hamper the economy and further efforts are needed, particularly in the risk-based field inspections and inter-institutional cooperation.
The Tax Administration needs further strengthening for its administrative and professional capacity and to ensure merit-based and transparent selection processes. The EU report recommends that “Kosovo should systematically implement the strategy for fighting the informal economy, money laundering, terrorist financing, and financial crime (2019-2023) and its action plan, and enhancing cooperation with the existing of the judicial framework to ensure timely adjuration of tax evasion and fraud cases.”
So, the strategy of fighting the informal economy, money laundering, financing of terrorism and financial crime have been drafted, but it needs to be implemented. Finding a solution for the informal economy is of great importance, if viewed from economic and socio-political perspectives. In this context, I consider that fiscal policymakers in Kosovo will be more successful if they focus on finding ways to gradually incorporate the informal sector into the formal rather than eliminating it.
Rule of Law
The two most important priorities that have a direct impact on the economy are the rule of law and the fight against corruption. Both of these priorities have been long explained how to be improved upon.
The absence of the rule of law causes legal uncertainty, discourages investment and causes inequality in an open and competitive market resulting in reduced economic growth. Article 10 of the Constitution of Kosovo, has sanctioned Kosovo’s economic orientation as a state with a market economy and free competition.
The practice of states with a market economy, has shown that commercial contests cannot be settled by regular courts, which are competent to settle criminal, civil and administrative disputes, and therefore specialized courts should be established. In this context, the emphasis is on the Tax Court, the Commercial Court, etc.
Specialized Courts are the main pillars of ensuring legal certainty for local businesses and foreign investors, and will directly impact on attracting foreign investors and reducing unemployment.
Fighting corruption is also important for the country’s economic development, as corruption is currently a large-scale phenomenon in Kosovo. Widespread corruption in combination with weak institutions continues to hamper the business environment. Kosovo has made the fight against corruption formally a priority on the national agenda, but it must be a real priority and concrete steps must be taken to combat this phenomenon.
The last and fifth measure of sustainable economic development is the protection of workers’ rights in the private sector through the strict implementation of the Labor Law as well as the development of the private sector.
In the private sector, there are over 222,000 employees (not counting informality), which is much higher than the number in the public sector, which is around 80,000. Private businesses can generate the largest number of new jobs and represents the backbone of the local economy.
In Kosovo, the law that protects workers’ rights has been in force since 2011, but this law has not been fully implemented, especially for workers employed in the private sector.
The average wage is considered to be higher in the public sector and this has made the private sector, not a desirable employer for Kosovars. Moreover, often unfavorable working conditions, and a failure to comply with employment contracts contribute to the private sector being considered an unsafe place to work.
In 2018, the Labor Inspectorate performed 9,531 inspections, which in relation to the number of businesses is a very small number of inspections. Failure to respect workers’ rights in the private sector directly hinders Kosovo’s economic development.
Follow up measures
After taking the aforementioned measures, undertaking actions that would affect the reduction of unemployment can come into play, for example through the development of medium and small enterprises.
One of the emergent needs is the provision of credit through the creation of the Development Bank of Kosovo, which would credit the businesses with very low-interest rates and would give priority to lending to economic sectors like agriculture and livestock. Another measure is to support certain sectors through tax relief dependent on the employment they generate.
In addition to the bank, an infusion to private business would also be the use of money currently managed by the Retirement Trust Fund and the Privatization Fund. These funds, to a large extent, should be invested in our banking system. The legal basis and the possibility of returning the funds of the Kosovo Retirement Trust to Kosovo should be analyzed, as well as the possibility of using the frozen funds of the Privatization Fund.
As well as securing financing, businesses in Kosovo need to formalize their business ideas, which would best be done through an agency that provides business advice. In addition to providing advice for uncomplicated business plans, the agency could also advise consolidated businesses on rules and standards in the global economy, including business registration, tax incentives, salaries, recruitment, and human resources consulting.
The opinions expressed in the opinion section are those of the authors only and do not necessarily reflect the views of BIRN.
Bedri Peci is a Professor at the Faculty of Law at the University of Prishtina, a permanent associate at the International Bureau of Fiscal Documentation Amsterdam, and a regular member of the European Association of Tax Law Professors in Amsterdam.
25 October 2019 - 11:04