Putin Peers Into Shadows Where 30 Million Toil on Fringes

(Bloomberg – bloomberg.com – Evgenia Pismennaya, Ilya Arkhipov – July 13, 2016)

Just about every other worker in Russia has gone missing.

Uncounted by statisticians and invisible to tax collectors, a population the size of Texas — or about 30 million people — plies its trade in the nooks and crannies of what’s become known as the “garage economy.” There, professions such as mechanics, builders, dentists and veterinarians conduct their business off-the-books and in cash. President Vladimir Putin is zeroing in on the phenomenon, said two participants in a recent Kremlin meeting on economic policy.

It’s the cops, prosecutors and taxes driving them underground, he told a gathering of ministers, advisers and regional bureaucrats, according to the people, who asked to remain unidentified because the discussion wasn’t public. Putin asked the “serious, bespectacled” lot in front of him to devise a way to ferret out the businesses and motivate them to legalize their operations, the people said.

The scale of this underworld, estimated at as much as a quarter of gross domestic product, presents Russia’s leader with a dilemma. For an economy that’s struggling to shake off a recession in an era of cheap oil, the millions of undocumented workers could prove an unrivaled resource as government finances run dry.

But by surviving and even prospering on the fringes, they’ve opened a safety valve amid Putin’s worst economic crisis as the state is increasingly forced to leave people to fend for themselves. About 30 million, or 40 percent of the economically active population of 76.5 million, are part of the “shadow” labor market at various points throughout the year, according to a survey published this month by the Russian Presidential Academy of National Economy and Public Administration.

While the estimates are inexact, the size of the workforce has been stable since the research group began tracking the data in 2001, said Andrei Pokida, a sociologist who led the study.

For that reason, dismantling the “garages” is out of the question, according to Svetlana Orlova, governor of the Vladimir region east of Moscow, who complained at the meeting with Putin of the torment inflicted on small business.

“If you tinker with the garages, there’ll be a whole revolution,” Orlova said.

Illicit Flows

The scale of underground activities is among key factors behind Russian illicit capital flows, according to Washington-based Global Financial Integrity. Crime, corruption, and tax evasion spawned at least $211.5 billion in illicit outflows between 1994 and 2011, with illegal transfers reaching $552.9 billion, it said in a report. The size of the shadow economy over the study period was estimated at 46 percent of GDP, according to the group, which researches cross-border money transfers.

Putin’s spokesman, Dmitry Peskov, didn’t reply to a request for comment on government discussions or Putin’s thinking about the underground economy.

The appeal of working off the grid is obvious for Alexander, a 36-year-old who moved to near Moscow after quitting his military career in the Far East. Doing a 30,000-ruble ($469) factory job for five years, he found that his construction work on the side, laying tiles, proved more profitable.

‘Two Kopecks’

Alexander says he quit and found a partner, another ex-military man who specializes in plumbing repairs. Their earnings may be uneven, but he now makes 80,000 rubles to 150,000 rubles a month, enough to buy a car and pay off a mortgage. Shunning advertising and relying strictly on word of mouth for referrals, their order book is full for three months ahead, he said.

For Alexander, there’s little incentive to pay into a system that returns so little in old age, with the average Russian pension near 12,000 rubles.
“To hell with it,” he said. ‘My wife’s working in a school. She’ll get two kopecks for retirement.”

Legalizing the shadow workforce alone would boost GDP by one percentage point, according to Boris Titov, the Kremlin’s business ombudsman. No longer limited to retail trade, Titov says it’s becoming a hive of small-scale manufacturing, developing into an “economy of simple things.” Businesses can be tempted into the open if the government can ensure fewer regulatory checks and a patent system catering to the self-employed, Titov said.

Regulations, Rights

The hurdles are many. While Russia has surged by 61 spots in the World Bank’s Ease of Doing Business Index since 2013 to 51st this year, dealing with construction permits still takes almost nine months Its property rights, judicial independence and the burden of government regulation were all rated below the 100th spot among 140 nations in the World Economic Forum’s 2015-2016 Global Competitiveness Report.

The government plans to adopt a law this fall freeing several categories of self-employment from taxes and easing their way to registration, leaving them to pay social levies only, First Deputy Prime Minister Igor Shuvalov said in an interview.

“We understand that only the Tax Service will lead them out of the shadows,” he said. “Now everything is being automatized, financial discipline is increasing. I think that in a couple of years, evading taxes will be extremely difficult.”

Tax Maneuvers

Among the most far-reaching ideas yet for nudging businesses out of the shadow economy is a proposal by the Finance Ministry to cut the payroll tax that employers pay on salaries, three officials familiar with the discussions said last month. If a lower levy is accompanied by an increase in the value-added tax, the measures could help authorities collect about 30 percent of the amount of salaries companies pay in cash, which the Finance Ministry has estimated is costing the government as much as 2 trillion rubles a year in lost taxes.

The need to shrink the size of the shadow economy was the subject of a meeting held at the Finance Ministry on Tuesday, which discussed fighting under-the-table salaries to increase tax collection.

By creating the conditions that would motivate entrepreneurs to come clean, Russia may pave the way for a revival of small and medium-sized businesses, whom Putin sees as a foundation for the economy. Such companies employ a fifth of the workforce, far short of the government’s goal to raise the level to at least half the total.

More Freedom

Just by clearing the regulatory roadblocks, authorities could do wonders for an economy that’s been in contraction since the start of last year. The World Bank has cited research showing that decreasing state inspections of small businesses in Russian regions brought a 12 percentage point increase in their annual sales growth.

“It’s essential to give people freedom, if there’s nothing else you can do for them,” said Sergey Dubinin, who was governor of the Russian central bank in 1998 during the government’s debt default. “It’s a great fortune that there’re people who are self-employed during a crisis period and lay no claim to getting assistance from the budget.”

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