Shadow Economy in Latvian Construction

According to the study, the size of the shadow economy in the construction sector in 2015 was 40%, whereas in 2019 it had fallen to 30.7%, decreasing by 9.3% over five years.

The size of the shadow economy in the construction sector still remains relatively large, however its positive dynamic reduces the gap between the total presence of the shadow economy in the national economy, which was 24.2 percentage points in 2018.

Compared to 2018, the construction output in 2019 increased by only 2.9%. With the conclusion of the previous period’s EU fund projects, the sector could experience a decline of up to 30% without new investment sources. The study concludes, that such a trend could also significantly affect the size of the shadow economy by increasing it.

The author of the study, Professor of Stockholm School of Economics in Riga Arnis Sauka, states: “The positive trends in the decline of the shadow economy levels in 2019 were mainly related to the fact that construction output remained relatively high. Currently, with the expectations of an economic downturn, the amount of orders in construction will also decrease. This, in turn, intensifies competition and will most likely also have a very negative impact on the involvement of builders in the shadow economy. In Latvia, the construction sector as a whole is characterised by sharp declines during the economic downturn, and rapid growth during economic growth, which is neither good for the industry itself, nor the national economy. One of the ways to reduce this problem is via smarter public procurement planning, which is especially important during an economic downturn.”

The latest shadow economy calculations demonstrate that the construction sector shows small improvements (reduction) in all the major components of the shadow economy - envelope wages, unreported corporate income, undeclared employees and the amount of corruption, however the indicators remain below the Latvian average. Envelope wages, which are one of the most important components of the shadow economy, accounted for 27.2% in 2019, while the level of corruption in the shadow economy decreased from 16.4% in 2018 to 12.2% in 2019.

In regard to the industry collective agreement, entrepreneurs emphasise that it was only adopted recently, therefore a positive trend in the reduction of the shadow economy is certainly to be expected in the long term. The collective agreement entered into force on 3 November last year, setting a minimum wage of 780 euros for those employed in the construction sector. 60% of the surveyed construction sector entrepreneurs admit that they have not felt the impact of the collective agreement, but approximately the same number of respondents, 9% and 10% of respondents respectively, believe that the impact of the collective agreement has been either very negative, or very positive. Electronic working time recording was also introduced prior to the introduction of the collective agreement, the burden of which is assessed by the builders as proportionate on average. The managers of large companies note that administrative costs have risen significantly, which was caused by the implementation of the aforementioned system; however, the measure is considered important and necessary for the sector, emphasising that the electronic working time recording system is also necessary for smaller objects.

Analysing the circumstances that have affected the decrease of the shadow economy, the majority of the surveyed managers of large Latvian construction companies note that positive trends in 2019 were observed where construction volumes increased.

Namely, company managers emphasise that during the period of the survey, i.e. March 2020, both private, as well as state and municipal orders decreased, which intensifies competition and will most likely leave a negative impact on the involvement of builders in the shadow economy.

The managers of large Latvian construction companies also indicate the specifics of procurement policies as one of the main factors facilitating the shadow economy in the sector, which in practice usually manifests as competition for the lowest price. Company managers also point out the excessive bureaucracy in the work of controlling authorities.

During the study, building contractors were also surveyed to assess the impact of Covid-19 and possible solutions to reduce it. The managers of large Latvian construction companies pointed out that the state needs to urgently consider injecting money into the sector via state and municipal procurements, including minimising the bureaucracy needed to implement this process and planning to attract EU funding.

About the study

This report contains shadow economy estimates in the construction sector in 2019 and trends in the 2015-2019 period. It also examines the main factors affecting the shadow economy. In order to calculate the size of the shadow economy in the construction sector, a representative survey of 254 managers and leading specialists of Latvian construction companies was conducted in March 2020. On the other hand, in order to obtain more detailed information on the situation regarding the shadow economy, including the impact of the collective agreement and electronic working time recording system, as well the assessment on the impact of COVID-19 on the industry, expert interviews were conducted in early April 2020 with managers of 10 large construction companies with extensive experience in the industry and who actively participate in representing the sector.