Obstacles related to property rights, freedom of contract and equality before the law

Background

Representatives of the business community* were asked to identify six major obstacles to private sector development and name policies to overcome them in a short- to mid-term period. The experience showed that there was a need for instruction, namely: a) to avoid monetary policy area; b) to concentrate on issues that are policy driven, e.g. do not stem from market constellations, and therefore are subject to impact by different policy mixes.

Not all respondents went up to six obstacles. Besides, there were themes that reappeared throughout the discussion of obstacles. These themes were: EU accession, taxes and social welfare contributions and corruption. Neither the respondents nor the author believed that corruption is an independent variable. We attempt not to discuss the themes separately but from different angles along with the obstacles.

1. Obstacles related to property rights, freedom of contract and equality before the law FIAS

Survey of 2004 revealed that 60% of the firms find the government inefficient and that the senior managers spend 25% of their time dealing with regulations – two times worst than the second problematic country, Serbia. It is a perception, which indicates that private sector is dependent on and subject to undue intervention.

Our respondents rated enforcement of private property rights as “most important but very difficult to deal with” since they are multiplied by different regulations for different walks of life.

Property rights
In 1989-1998, the key regularity of institutional reforms has been: no regulation when using other people’s (including taxpayers’) money, but over-regulation when people use their own properties and savings.

At its roots, this is a constitutional deficiency. Article 7 of the Constitution proclaims that “the state shall be held liable for any damages” but in fact says that these should be damages “caused by illegitimate [in Bulgarian – “illegal”] (1) rulings or acts on the part of its agencies and officials”. In other words, if acts were based on a law it would be difficult to reclaim damages. This explains to some extend the legal fetishism of the Bulgaria business framework, the zeal to regulate and the legalistic opposition to reducing administrative barriers, multiple amendments to the privatization law (29 for the period 1992-2000 and three different concepts of privatization process since 2001).

Different sets of government have changed regulations as they found fit to their interpretation of “public interest”.

Series of decisions of the Constitutional Court (6/1997, 10/1999, 2/2000, 3/2000) underline that the proclaimed “free economic initiative” (Article 19.1) is limited if restrictions “are promulgated with the objective to protect public interest and are legally advisable”. At the same time there no procedure to assess how advisable is the law and what and how “public interests” are protected.

Preliminary controls hamper the entire life of the firm: its registration, commencement of activities, operations and liquidation. The government is a privilege creditor and governments appointed experts appraise the collateral in bankruptcy procedures.

Freedom of contract
There are traditional areas in which government intervenes in the freedom of contract.

1. Most important and difficult reforms is the area of labor regulations. Business associations have been more successful in reforming taxes than labor market regulations (2). Since Spring 2001 (public hearing on last major amendments of the Labor Code) legal and policy conditions that create wrong incentives deteriorate. Longer-term constellations are discussed below. Comparisons with neighboring countries are disappointing, even in relation to Serbia – a late reformer with a background of trade union ownership of enterprises (3).

Scale:
– It is not a problem at all = 1
– Insignificant problem = 2
– Do not have influence = 3
– Serious problem = 4
– Very serious problem = 5

Latest surveys (including that of FIAS) fail to identify problems because questions are not asked and because, when asked, the answers add the burden to costs of dealing with the government. Most of our respondents were on the opinion that legitimate, bigger and more competitive businesses suffer in the first place.

2. Another area is the area is banking and finance. The early 1990s lack of regulation has been converted to over-regulation. It is visible in pensions, special purpose investment vehicles (probably the most restrictive regulation in Europe), in discretionary licensing of insurance industry, etc.

Bankers and bank lawyers are divided on the issue whether a court in Bulgaria would definitely have an appropriate understanding that the rule to be applied must be the depositor and the institution. In the tradition that for a long time benefited debtors, it is possible, some say, that depositor suits a bank to refund without agreed penalties, i.e. that the court would decide that the applicable is rule is the law but not the agreement.

Equality before the law
1. Reading the law by tax authorities is different from institution to institution and from individual to individual. In some sectors, where marketing abroad uses consignation, the goods reach the buyer after a period of time; respectively the payment is executed after completion of the deals. On such situations there is an instruction on how to apply VAT procedures. But the practice is different. As one of the interviewed told us, in their case they followed thoroughly the instructions because for logistic reasons exports to EU (by road, lorries) uses 21 days payment period while the export to North America (by ship) – 35 days. Nonetheless, in contradiction to Chief Tax Directorate official prescriptions, Directorate representatives repeatedly required that the firm transaction and VAT reports (actual receipts and invoices) are submitted at the day the goods leave the country not after the goods “change hands” and the actual transaction is executed. In the experience of the firm in question so far, tax inspectors have been always acknowledging the correctness of the firms reporting.

2. Opposite to high value added exports, firms operating of the domestic market for food (in the case of our respondent – milk products) face a different challenge. First, suppliers of milk are small and not VAT registered. Second, many of them hide the values and under-report. Big payers are unequal; they are between 200 dairies (all VAT registered) and 200,000 suppliers. 40 diaries produce 80% of the milk; roughly only 20% of the market is fully accounted for. The firms that can possibly be subject to controls by tax and other authorities are 20, maximum 40 (4). As one of the respondents from another industry described the situation: “you are big and transparent, you will beaten”.

3. Similar is the situation in the furniture industry: the “backyard carpenters” use stolen timber and save almost hundred percent of taxes on labor (personal income tax, social security contributions). Since they have limited number of recorded (invoiced) sales, they are not VAT registered, and therefore charge no VAT to the consumer, thus gaining a 20% price advantage to registered companies. These competitors operate mostly in low-tech product markets, i.e. producing goods with more labor and less machinery. Such are for example basic kitchen chairs, plain tables, simple cupboards, shelves, beds, etc. The outcome is that bigger companies are slowly exiting this segment of the market by either changing the product structure entirely, or improving quality and product.

4. The lack of implementation of technical and accounting standards and other legal requirements is a typical phenomenon. The market for medical supplies is believed to be only 25% complying with the requirements. Even earmarked programs to assist people with disabilities are executed in a manner that prevents the implementation of standards (5) . Wine and liquors trading has been heavily regulated and subject to “licensing” but it is the merchant who is liable if caught with improper excise labeled stock. Veterinary service is usually after big companies. Meet product market is in a similar shape as that of milk.

Solutions and progress
The labor market rigidities have been discussed for years and private sector fails to advocate and promote reform. Liberalizing labor contracts could be conditionality to international assistance programs and loans (IMF and/or World Bank but not EU). It is unlikely that Bulgaria government or political establishment would dare to initiate reform on their own, without international backing. (Other contract enforcement issues fall into the domain of obstacle discussed below.)

The irony is that legal fetishism is to be dealt with by legal means but it is not possible to rely on concerted efforts to amend rules in these sectors. The three sub-categories of obstacles should be introduced via a regulatory change. It is relatively easy in the case of labor markets. In other areas there are no quick-fix solutions.

Other EU accession countries have established procedures that help public dialogue and participation when regulation of “public interest” is at stake. The progress to date is the adoption but not the implementation of the law on regulatory regimes.

———-

* For better orientation we present brief information on respondents in Attachment 1. The opinions expressed in this paper are strictly those of the author.

(1) Often the authorized English version of the Constitution (as it is available on the website of the National Assembly and the Constitutional Court) does not fully correspond to the original text.

(2) Some organizations, most notably Employer Association of Bulgaria (established in 2000), were focused on labor regulations (see: http://www.eabg.org/n101100.html ), which is a second topic most often highlighted in talks with the government.

(3) IME, Study of Incentives, Characteristics and Strategies of Firms Operating ‘in the Shadows’ (180 Firms Survey in Bulgaria, Romania and Serbia), Sofia, IME, p. 34, available at: http://www.ime.bg/pdf_docs/papers/_Toc71455348

(4) We check this statement by visiting sanitary inspections and labor safety inspection websites; all bigger milk producers or their branches are quoted there.

(5) See for details: People with Disabilities, CIL/IME 2003 Annual Report, at: http://www.ime.bg/pdf_docs/papers/report_2003_eng.pdf .