Emerging from the Darkness: Albania’s Informal Economy

Bruna Blog ImagePhoto of New Bazaar in Tirana, Albania by Flickr user Tokil under an Attribution-ShareAlike 2.0 Generic license.

By Brunilda Kosta

Last year, Albania took the third step in the government’s plan to reduce economic informality, an issue which has long restricted development and prosperity for the country. For this article, the informal economy is defined as activities which are legal but do not fully comply with state regulations. They include tax evasion, lack of business registration, and labor regulation avoidance. Such forms of informal economic activity are detrimental to a country’s economic growth, and seem to occur more frequently in countries that are undergoing structural reforms and transitional economic adjustments, such as Albania.

Numerous studies have showcased the high level of informality in Albania. Friedrich Schneider, Professor of Economics at the Johannes Kepler University (2010), estimated that in 2007 the Albanian informal economy was equivalent to 32.9 percent of GDP. A 2013 study conducted by the European Bank for Reconstruction and Development (EBRD) surveyed business leaders in Albania,  40 percent of whom admitted that they are forced to compete with the informal sector. Finally, in 2015 the Albanian government disclosed that the informal economy makes up 50 percent of GDP. These startling figures encouraged the government to institute reforms. In 2015, the Albanian government elevated its focus on informality and undertook diverse actions to mitigate the associated issues. This article analyzes the Albanian government’s approach to reducing informality and aims to come up with actionable and pragmatic policy recommendations for implementing effective reforms.

The Albanian government has struggled to integrate the informal sector into the economy for many years. The informal economy moved into the spotlight in August 2015 when Albania’s Prime Minister publicly announced that the government would make it a priority, but failed to provide a timeline or specific details on how to do so. Following this announcement, Albania’s Minister of Finance vaguely explained their ideas for addressing informality but did not lay out a public strategy. In April 2016, the Minister of Finance announced the next action, a strategy designed in collaboration with the International Monetary Fund (IMF); however, the strategy remained vague. The business community and economic experts argued that these actions were taken haphazardly and with the purpose of increasing government revenues. The third phase was launched in September 2017 and went into effect at the beginning of October the same year. The government announced that it will spare no efforts to “eradicate” informality. These recurrent actions produced encouraging outcomes such as additional revenues and an increased number of registered businesses and employees. Simultaneously, these actions have had economic and psychological consequences for business operations.

One of the key actors in the informal sector is employees. In Albania, informal employment is manifested in various patterns as displayed in the chart below: 39.75 percent of employees declared not to have a written contract with their employer, while 30.29 percent of employees declared that they do not pay for social and health security benefits (Figure 1). When compared to the averages for Southeastern Europe (SEE), the biggest difference was between the number of employees with no written contract. One reason behind this high level of informal employment could be the short-term benefits to employees such as earning extra income that would otherwise have been taxed. Nevertheless, aside from some rudimentary benefits, the drawbacks of staying informal outweigh the informal benefits. For example, operating in the informal economy prevents employees from reaping the benefits of the formal sector like earning a pension and having a higher salary. A recent study estimates that Albanian workers earn 29.3 percent more in the formal sector than in the informal, despite widespread belief of the opposite.

Figure 1: Informal employment patterns

Bruna Blog Chart

Source: Albanian Center for Economic Research (ACER) & Southeast Europe Leadership for Development and Integrity (SELDI), 2016

Another pattern of informality is underreporting income. This often occurs among firms that utilize only cash transactions, which is a widespread practice in Albania. A study of the National Business Forum in Albania found that businesses underreport around 30 percent of annual turnover.

Many of these statistics support, to some extent, the government’s efforts to address informality in the last several years. The Albanian government’s intentions were positive, but its approach to combating informality has been flawed. The purpose is to incentivize informal firms to transition into the formal market; however, coercing firms out of the shadows carries significant risks. In Albania, formalized firms struggle to survive because regulations are burdensome, which is a contributing factor to informality. Some challenges for Albanian business owners, according to the recently released Global Competitiveness Index include tax rates, corruption, and access to financing. This report is corroborated by the most recent Doing Business report 2018 for Albania, which shows that ‘paying taxes’ is a major obstacle to the ability for businesses to grow and succeed. The Albanian government should decrease the regulations placed on businesses, which could naturally facilitate the formalization process.

Fortunately, sustainable change is starting to occur. For example, it is worth applauding the government’s recent withdraw from its initial plan to include small businesses in the value-added tax scheme. This shows that the government’s genuine efforts to diminish the informal economy, coupled with effective dialogue with the business community, could yield positive results and generate a win-win scenario. Moreover, the government has stimulated notable positive results despite its lack of transparency and collaboration with the business community. For example, in 2016, Albania had an average of 56 registered firms per 1,000 people, while in 2014 it had 40 registered firms per 1,000 people. This shows that there was an increase in the number of businesses registered over the span of two years. On the other hand, more than 100,000 businesses deactivated their status or initiated their forms for closing procedure. The tough actions of putting people in jail raised psychological pressure and fear among businesses which disrupted normal business operations.

The fundamental question remains: how can the government encourage informal businesses to move into the formal sector, while minimizing the negative consequences of doing so? The following policy recommendations should be considered:

  1. The government should stop prematurely talking about actions without the knowledge base to support those actions. Working in the hidden economy in SEE is often socially embedded and not simply a matter of rational choice to maximize personal benefit. Hence, a comprehensive understanding of social norms, cultural customs, and historical facts should be understood first.
  2. The government should include interrelated issues that incentivize formalization. For instance, small businesses often fear that coming out of the shadows will mean more shakedowns by corrupt officials or entanglement in bureaucratic red tape. Corruption is a clear concern and burden for the business community and should be addressed by the government.
  3. Using structural reforms and technology to curb informality could also benefit government finances, growth, and poverty reduction.
  4. Tackling informality should be a joint effort strategy; the government should improve their dialogue with the business community and effectively engage with and accept their reasonable proposals.
  5. Finally, the government should design a clear strategy for informal economy mitigation, drawn on sectoral basis, and associated with a rational action plan.

It is difficult for any economy to eradicate informality entirely. However, bringing informal activity out of the shadow economy has the potential to boost tax revenues, increase productivity, spur economic growth, and improve the quality of life for Albania’s citizens.

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