Corruption in Latvia: Survey Evidence

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Public Disclosure Authorized

REPORT

Public Disclosure Authorized Corruption in Latvia: Survey Evidence

This report was prepared by James Anderson of the World Bank for the Corruption

Public Disclosure Authorized Prevention Council of Latvia under their Corruption Prevention Program.

December 16, 1998 Public Disclosure Authorized This report has benefited from discussions with and comments from Randi Ryterman, Helen Sutch, Normunds Malnacs, Inguna Dobraja, Daniel Kaufmann, Young Lee, and Omar Azfar. Any remaining errors are the author’s alone. I am also grateful to Aigars Freimanis and Latvia Facts for carrying out the surveys, and to the 1,756 people who participated in the surveys. The use of country-level indices of corruption does not constitute endorsement of those indices. The views expressed in this paper are those of the author and should not be attributed to the World Bank, its Executive Directors, or the countries they represent.

Contents

1. OVERVIEW ...... 4

2. METHODOLOGY ...... 6

3. HOW BAD IS CORRUPTION IN LATVIA? ...... 8

4. WHICH ORGANIZATIO NS HAVE THE WORST CORRUPTION PROBLEMS? ...... 11

BRIBE FREQUENCY ...... 11 HONESTY AND INTEGRITY...... 17 IMPACT ON HOUSEHOLDS AND ENTERPRISES...... 17 SUMMARY: THE WORST OFFENDERS...... 20 5. WHAT ARE THE CAUS ES OF CORRUPTION IN LATVIA? ...... 21

THE INHERITANCE OF THE PAST ...... 21 INCENTIVES IN THE PRESENT...... 22 Rents...... 22 Discretion...... 23 Accountability and Conditions in the Civil Service...... 25 SUMMARY OF CAUSES...... 26 6. WHAT ARE THE EFFECTS OF CORRUPTION IN LATVIA? ...... 28

WHO BEARS THE BRUNT OF CORRUPTION?...... 28 Enterprises...... 28 Households and Micro-enterprise...... 29 Age ...... 31 Education ...... 31 Automobile Ownership...... 31 Income ...... 31 Micro-enterprise...... 32 THE UNOFFICIAL ECONOMY...... 34 Competition...... 34 Distortion of the Tax System...... 36 Reduced Quality of Government Services ...... 36 INVESTMENT...... 37 7. SPECIAL ISSUES ...... 39

EDUCATION AND HEALTH...... 39 JUDICIARY...... 39 CUSTOMS AND INTERNATIONAL TRADE...... 41 TAXES...... 42 POLICE...... 43 THE CIVIL SERVICE ...... 44 Buying Jobs...... 44 Sharing Bribes...... 46 TENDERS AND AUCTIONS...... 46 IS CORRUPTION “NORMAL”?...... 48 COMMITMENT OF THE GOVERNMENT TO FIGHT CORRUPTION...... 49 1. OVERVIEW

In 1996, the President of the World Bank offered to support member countries in the battle against corruption. Latvia was among the first to accept Mr. Wolfensohn’s offer, and the first Government-sponsored (World Bank-supported) Workshop in February 1997 adopted a three-pronged strategy of prevention, enforcement, and education. The anti-corruption program continued to gather momentum even through changes in government, and the program was unveiled at a public Conference in June 1998.

A key element of the World Bank’s approach to corruption is to help countries to unbundle “corruption”, a vague and menacing-sounding term for abuse of public office, into its constituent parts; to isolate the underlying causes, illuminate the agencies and organizations most affected, and to evaluate corruption in the context of the reform of political, legal, and public-sector institutions. Toward these ends, a system of diagnostic surveys focusing on corruption in the public sector was developed1 and implemented in the summer of 1998. Three surveys, targeted at households, enterprises, and public officials, sought to add specificity to the policy dialogue, to provide the hard numbers to confirm or refute popular conceptions about corruption in Latvia, and to provide a baseline against which to measure future progress in the battle against corruption.

This report presents the main findings of Latvia’s diagnostic corruption surveys. The purpose of the report is not to pass judgment on Latvia but to highlight the complexity of the corruption problem, its causes and consequences, as evidenced in responses to the surveys. Our hope is that the report be taken in the proactive way in which it was intended – looking to the future and what needs to be done, rather than dwelling on the past and what can not be undone.

The information provided by the surveys contribute to our understanding of corruption in Latvia, but the survey evidence in isolation is not definitive - it should be considered in conjunction with other views provided by analysis of the incentives and opportunities generated by the governance framework, by qualitative assessments and the opinions offered by civil society in public conferences, and by the practical views of implementing organizations. As this report is based on survey evidence, it focuses primarily on lower level corruption in the public sector. High-level corruption, including political corruption, are more difficult to detect in surveys (as discussed in Section 2), but are every bit as important as low-level corruption. It is for practical purposes only that we

1 The Latvia surveys were modeled on surveys implemented in Albania and Georgia. Although the surveys varied to some degree to account for country-specific differences, an attempt was made to keep the surveys consistent enough to allow cross-country comparisons. orient this report toward the lower-level corruption faced by households, enterprises, and public officials, rather than grand corruption.

The survey evidence suggests that corruption in public service delivery is a serious concern. 2 The trend appears to be getting worse, and more importantly, certain aspects of public sector service delivery suggest an environment that is fostering an expansion of corrupt practices. While private sector enterprises do not complain too loudly about corruption as a problem of doing business (relative to other problems), they do complain about the regulatory3 environment, particularly the excessive discretionary powers of regulators - current research on corruption suggests that excessive discretion is an important cause of corruption. The surveys also present clear evidence of certain “vicious circles” that point to increasing entrenchment of corruption, expansion of the unofficial economy, and deterioration in the quality of government services. Particularly worrying is the practice of public officials buying jobs, a corrupt activity in itself that serves to further entrench corruption within state institutions.

The surveys demonstrate clearly the powerful incentives for enterprises and households to cooperate in corrupt transactions. Households find that everyday necessities such as housing and health are not ensured unless some unofficial payments are provided, and there is considerable evidence that enterprises that engage in corruption grow faster and invest more than those that refrain.4 Honest enterprises have difficulty competing against their less-honest competitors, and honest managers must spend more of their time dealing with government officials. These empirical observations should in no way be interpreted to mean that corruption serves a useful purpose as “grease,” since the benefits to the enterprises or households do not accrue to society. The point, rather, is to illustrate the forces that perpetuate systemic corruption. Indeed, cross-country evidence suggests very strongly that in countries with more severe corruption problems, enterprise managers tend to spend more time dealing with bureaucracy, not less.

Surveys are very useful for pinpointing corruption “hot spots,” agencies and organizations in which corruption is particularly severe. To some degree corruption is pervasive across organizations, but the surveys suggest that it is particularly bad in the customs service and the road police, both of which have a large impact on enterprises and households.5 Households further expend considerable resources in bribes related to health and housing, while enterprises spend large amounts on telephone line installation, fire and sanitary inspections, and lease of state-owned office space.

2 Corruption in Latvia appears to be less of a concern than in countries further East for which comparable information is available. 3 We use terms such as “regulations” and “regulatory environment” somewhat loosely to refer to required interactions between the state and enterprises. 4 Although the relationship is clear, the direction of causality is not. This issue will be discussed in a later section. 5 While customs and the road police appear to have severe problems of corruption, the tax administration and the ordinary police come across in the surveys as relatively less corrupt (though far from “clean”).

A repeated theme emerges from the survey data: excessive discretion on the part of regulators is both a cause of current corruption and a formidable obstacle to development in itself. Latvia’s anti-corruption program wisely views anti-corruption as not just toughening standards for public servants, but dampening the underlying economic forces inspiring corruption, as well. The survey evidence demonstrates the importance of regulatory reform as an integral part of a successful long-term solution to the problem of corruption.

2. METHODOLOGY

The diagnostic corruption surveys were carried out by the World Bank and Latvia Facts in June and July of 1998. Altogether, we surveyed 1,100 households, 438 enterprises, and 218 public officials. Each of these populations provide a different perspective on the extent of corruption, its causes, and consequences.

Households are particularly knowledgeable about the widespread low-level corruption that affects them in their everyday lives, and the opinions expressed by a representative sample of households provide an indication of how society perceives the problem of corruption, its causes and consequences.

Enterprise managers are much more likely to interact with government regulatory bodies, tax and customs authorities, and the courts. They generally have deeper pockets than households, and are therefore potentially rewarding targets for corrupt public officials. At the same time, they are more likely to be informed about the modalities of corruption, when it is in the enterprise’s best interest, when it is not, and how to avoid it when it can be avoided. Enterprises provide a view of how corruption affects the business environment, competition, investment and growth.

Public officials provide the insider’s view on the causes of corruption and the organizations which have the worst reputation among civil servants. Public officials can also provide insight into a specific form of corruption that only they know about firsthand - corruption within the civil service itself and the manner in which the demand side of corruption is organized.

Individually, each of the surveys - households, enterprises, and public officials - provides information on corruption from different perspectives. The three surveys together present an even more powerful tool for understanding the overall dimensions of the problem and the specific micro-structure of corruption.

Ultimately, surveys can reflect only the information that respondents are willing to provide. For most types of surveys (e.g., public opinion research) respondents are

6 happy to give their honest views, and simple factual questions (e.g., education) are usually answered honestly. But the subject matter of corruption is particularly sensitive. Even with reassurances of confidentiality, households, enterprises and public officials may be reluctant to provide honest answers to certain direct questions about corruption. We addressed this difficulty in several ways: (1) For most of our questions, we used phrasing that lets the respondent show knowledge about corruption without admitting involvement in corrupt practices. For example, in the evaluation of corruption among various government agencies, we asked enterprises to give ratings based on their “perceptions” of corruption. We also asked questions aimed at gauging how frequently the enterprise interacts with each organization, allowing us to infer the accuracy of those perceptions. (2) For some questions, we used phrasing that casts the guilt for the corrupt activity squarely on the other party. For example, households were asked about times when they have been forced to make unofficial payments, while public officials were asked about situations when corrupt enterprises offer bribes.

The results in this report demonstrate that many respondents were not shy about discussing corruption. For obvious reasons, however, surveys are relatively better at uncovering evidence of small-scale corruption than of high-level corruption. This difficulty is unavoidable. But since the underlying societal factors that would cause small-scale corruption to grow could be linked to those that influence high-level corruption, 6 learning about the former can throw some light on the latter. It remains important to compliment the surveys with analysis of the political process and policy- making framework.

Surveys are very well suited for analyzing quantifiable interactions. This report attempts to quantify levels of corruption based on information that can be measured, such as flows of bribes. For this reason, much of the report focuses on the direct cost of bribery, rather than the less easily quantifiable dead weight loss to society from corruption. By no means does this imply that the direct cost of bribery is the only issue. Every bit as important are the other damages that society suffers: the productive activity that did not take place, the environmental or health costs when standards are evaded, and the losses stemming from reduced competition and mis-allocated resources, to name a few.

6 Paulo Mauro summarizes: “Country-specific studies and anecdotal evidence suggest that high-level and low-level corruption tend to coexist and reinforce each other.” “Corruption: Causes, Consequences, and Agenda for Further Research,” Finance and Development, March 1998, p. 13.

3. HOW BAD IS CORRUPTION IN LATVIA?

There are two challenges to answering such a broad, if frequently asked, question. First, corruption exists in varying degrees around the world - the answer to the question depends upon the benchmarks against which Latvia is evaluated. Second, “corruption” is an intentionally broad term that includes such diverse acts as theft of state assets, bid- rigging, petty bribery, and political payoffs - the answer to the question may depend on which element of corruption is being examined.

One benchmark we may consider is the overall level of corruption in Latvia relative to other countries. Several organizations generate cross-country indices of corruption based on surveys of foreign investors or corruption experts. Unfortunately, such indices are not consistent with each other, so the answer to our opening question is sensitive to the index selected. Two recent indices are the Transparency International corruption perceptions index, and the Central and East European Review (Wall Street Journal) corruption index. Among a group of eleven transition countries7 rated by both organizations, Latvia appears relatively corrupt by the TI index, and relatively uncorrupted by the CEER index. (See Figure 1.) The Latvia surveys upon which this report is based were also used in Albania and Georgia, so the surveys themselves allow a cross-country comparison among these three countries. Among these three, the surveys indicate a smaller overall level of corruption in Latvia than in the other two - in Latvia corruption is less frequent and appears to be less of a hindrance to business development - but given the widely recognized systemic corruption in those other two countries, Latvia may find little solace in this fact.

A second benchmark for evaluating the overall level of corruption is the trend - is the problem getting better, worse, or staying about the same? For this sort of question, the surveys are well-suited. (See Figures 2 and 3). When asked whether corruption has gotten better, worse or remained the same over the past four years, nearly 60 percent of households and enterprises responded that it has gotten worse, and half of those said it has become “much worse”. Only 10 percent of respondents declared that corruption has gotten better. The same response pattern applies to both “high-level corruption” and to “kukuldosana,” or low-level palm-greasing.

7 The other ten countries depicted in Figure 1 are Russia, Ukraine, Bulgaria, Romania, Yugoslavia, Belarus, Slovak Republic, Poland, Czech Republic, and Estonia.

8 Figure 1. Cross-Country Corruption Indices

8 Latvia 7

2 2 3 4 5 6 Transparency International 1998 Corruption Index

more corrupt

There are other reasons to believe that corruption threatens to become worse. Enterprises report that complex regulations and excessive discretion by bureaucrats are major obstacles to doing business. This is worrisome because those same factors are listed by enterprises as major causes of corruption, and because current international research suggests that excessive discretion in the regulatory environment is a cause of corruption. Thus, while enterprises do not rank corruption as a leading obstacle to doing business in Latvia, they do suggest that there is excessive discretion, a factor known to be a cause of corruption.

9 Figure 2. “Has the problem of 'high-level corruption' over the past four years . . .”

40 Enterprises 35 Households 30

0 - become much - become - remained about - become - become much worse somewhat worse the same somewhat better better

based on a World Bank - Latvia Facts survey of 1,075 households and 428 enterprises in June 1998.

Figure 3. "Has the problem of 'low-level corruption' over the past four years . . ." 40 Enterprises

35 Households

0 - become much - become - remained about - become - become much worse somewhat worse the same somewhat better better

based on a World Bank - Latvia Facts survey of 1,075 households and 428 enterprises in June 1998.

Notwithstanding comparisons to other countries, the survey data indicate a mixed picture of corruption in Latvia. When asked the main obstacles to doing business in Latvia, enterprises did not place corruption high on the list. However, 30 percent of enterprises expressed a willingness to pay additional taxes to wipe out corruption. These

10 responses indicate that corruption takes place on a substantial scale, though it may not be the worst obstacle to the conduct of business in Latvia.

There is further reason for worry. When asked their perceptions of how frequently specific types of corruption occur in Latvia, enterprises, households and public officials all related that corruption is very frequent. Thirty-seven percent of enterprises and 13 percent of households reported having made unofficial payments. On an organization-by- organization basis, enterprises and households that have had contact with government agencies report that unofficial payments are required a third to a half of the time from some agencies. The average enterprise spends 2.1 percent of monthly turnover on bribes and the average household spends 1.2 percent of monthly income on bribes. Time spent on negotiating bribes is also a significant cost.

4. WHICH ORGANIZATIONS HAVE THE WORST CORRUPTION PROBLEMS?

Among the strengths of data-oriented corruption diagnostics is the ability to assess the levels of corruption within particular organizations. As we discuss in the next section, corruption will be the most severe in organizations where the nature of the work facilitates corrupt behavior. Thus, the purpose of this section is to highlight the organizations facing the greatest challenges, not to pass judgment on the leadership of those organ