Download the survey in pdf. http://files.lrinka.lt/LET34/LET2014-15-1_EN.pdf
We present to you the 34th edition of the Survey of the Lithuanian Economy which was launched more than 15 years ago.
This survey covers estimates of economic indicators for 2014 and forecasts for 2015. In the first chapter we offer a special topic of this edition—why it is important to use accurate forecasts in planning public finance. The Parliament is currently debating Lithuania’s 2015 budget bill. In this study we analyse whether the budget proposal has been grounded on accurate projections. We take a closer look at public sector’s abilities to adjust to economic changes. We also discuss why it is important to draw on accurate forecasts and how to plan public finance realistically.
In the second chapter of this survey we provide estimates of the main economic indicators for 2014 and forecasts for 2015 that are based on a poll of market participants. In addition, we give an overview of the factors that might have influenced the opinions and expectations of the survey respondents.
The estimates and forecasts of economic indicators are based on the expert consensus paradigm originating from the theory of rational expectations. This theory states that economic variables can be related to observable processes in the economy, and market participants use all available information to form estimates and forecasts concerning these processes. The more information market participants possess, the more credible their estimates and forecasts are. It is assumed that individuals who are engaged in day-to-day business activities have the most information about the economy, and their successful performance reflects their ability to process this information.
Fifty-eight experts participated in this survey which was carried out in September 2014. This survey is not representative. We do not aim to have a representation of specific sectors of the economy or regions or enterprises. Rather, we interview specialists who represent prospering companies. The respondents are asked not to provide information about their own companies or industries but to estimate indicators reflecting the country’s general economic situation on the basis of all available information. Survey participants are requested to focus only on variables that they think they are competent enough to appraise. Most of the respondents in the latest survey took part in the previous stages of this survey. The list of survey participants is presented at the end of the study.
LFMI expresses its gratitude to the survey participants, donors and everybody who have provided comments and remarks on this survey.
 One of the most familiar surveys based on the expert consensus paradigm is the Livingston survey conducted in the United States since 1946. Its results are regularly published on the Philadelphia’s Federal Reserve Bank’s website (http://www.philadelphiafed.org).
The importance of accurate forecasts in planning public finances
In today’s economy, market actors have access to an ample supply of forecasts of macroeconomic indicators. Public, non-government and private organisations all produce their own projections of economic growth, inflation or unemployment for the next year.
As often as not, a single prognosis turns into a piece of news but this does not mean that economic forecasting is an end in itself. Forecasts of economic indicators serve as preconditions for better activity planning. Equipped with reliable macroeconomic projections, companies can adopt critical decisions, such as whether it’s the right time to expand their business and to what extent they should do so, or, on the contrary, whether it’s time to start shaping up for impending economic calamities.
Normally, the private sector has the ability to adjust to changing economic circumstances. For instance, when economic growth ceases, businesses react expeditiously to the altered situation: they freeze plans of development, cut down on wages and employees, and take other urgent measures. However, the swift and timely response of the business community can be stunted by a strict Labour Code and other government regulations that are applied in Lithuania.
In the public sector, the situation is much more complex. In the following section we will look at several important issues. Firstly, we will examine the forecasts that have been used in drafting Lithuania’s 2015 budget proposal. Secondly, we will determine what difficulties the legislators typically confront in cutting public spending when the forecasts they employed prove to be incorrect. And thirdly, we will assess what dangers there are if the budget law appears to have been based on inaccurate projections.
The 2015 budget bill is dangerously optimistic
Drafted by the Ministry of Finance, Lithuania’s 2015 budget bill rests on the assumption that the country’s real and nominal GDP will grow by 3.4 percent and 5.5 percent respectively, annual inflation will stand at 1.2 percent, and personal earnings will rise by 5.8 percent.
When we compare the 2015 budget proposal with the 2014 budget’s revenue plan, we can clearly observe an expected increase in revenue collections from several taxes, namely, value added tax (VAT) (8.1 percent), profit tax (8.3 percent), personal income tax (PIT) (7.6 percent), and excise duties (4.9 percent).
Compared to other institutions’ forecasts, the Ministry’s projections of economic growth seem relatively bold. The International Monetary Fund (IMF) predicts that Lithuania’s GDP will grow by 3.3 percent in 2015, and the European Commission gives the figure of 3.1 percent. Respondents to the LFMI survey expect the country’s economy to rise by 2.8 percent.
The National Audit Office has also voiced its opinion about the budget’s revenue plan as being much too optimistic. According to this institution, the growth of income from VAT, PIT, excise duties and profit tax has been planned with scant caution.
Another important fact is that Lithuania’s growth projections for 2015 have been lowered over the last six months. The IMF shaved its forecast down from 3.5 percent to 3.3 percent, the European Commission slashed it from 3.7 percent to 3.1 percent, and the LFMI survey participants marked it down from 3.4 percent to 2.8 percent.
The worsened economic outlook reflects rising concern over a new economic crisis in the eurozone and worldwide. According to the IMF, the probability of the eurozone’s economy falling into decline in the offing has doubled over the last six months, from 20 percent to 40 percent.
As we can see, the 2015 Lithuanian budget proposal has been predicated on optimistic figures of growth, with no notice of the deteriorating economic scenario for the country. In the section below, we will discuss why employing optimistic forecasts is particularly dangerous when planning a state budget.
The inflexible public sector adapts to worsening economic conditions with great difficulty
The use of optimistic projections would pose no problems if budget expenditure were trimmed, automatically, in lockstep with shrinking budget revenue. Sadly, this is not the case. The public sector finds it difficult to adjust to a deteriorating economic situation for a number of reasons:
- When politicians curtail spending—namely, public-sector pay, pensions and various social benefits—this invariably dwarfs their popularity among the ranks of public-sector employees and the recipients of social benefits involved. In 2014, Lithuania paid old-age pensions to 600,000 retirees (from the “Sodra” budget), work incapacity pensions to about 210,000 citizens, and various other social allowances to hundreds of thousands of Lithuanians. At the same time, the country’s public sector was employing 362,000 civil servants, comprising 31.6 percent of the total hired labour force in Lithuania. Because cuts in public-sector salaries and entitlements affect more than a half of the country’s electorate, such moves are always highly unpopular, meaning politicians usually attempt to give them a wide berth or at least to postpone them.
- The Constitutional Court has ruled that salaries and pensions that were reduced during the latest economic crisis must be restored. Consequently, there is always some likelihood that the Court may issue similar unfavourable decisions in the future, too. This uncertainty is diminishing politicians’ abilities to make an adequate response to the economic situation and trim the budget. The Constitutional Court’s ruling also states that the decreased old-age pensions must be compensated for when the extreme economic conditions are over. But, when such time comes, the national budget may lack a source of funds for this purpose. Thus, a fraction of politicians might be reluctant to enact cuts in the “Sodra” budget entirely because they will be obligated to offset them, one way or another, at some time in the future. As mentioned previously, the probability of similar decisions by the Constitutional Court in the future lessens politicians’ abilities to react flexibly to changes in the economic situation. As the Constitutional Court has ruled, salaries and pensions may be reduced temporarily at times of economic-financial hardship. But the problem is that decision makers do not know in advance whether a specific method of these reductions will not be acknowledged as running counter to the Constitution. For example, in the year 2009 salaries of civil servants were cut progressively, i.e. the most sizeable reductions of salary rates were applied to the highest-paid servants. At that time it was believed that this was the most appropriate way for cutting down public-sector pay. But in 2013 the Constitutional Court issued a ruling, establishing that the uneven reduction of civil servants’ salaries conflicted with the Constitution. The upshot of this ruling is the following: politicians cannot be certain that the next time they cut the public sector’s wage bill, pensions or other welfare payments, their decision is not ruled, in process of time, to be violating the Constitution, and they are not bound legally to compensate for the anti-constitutional reductions.
- Budget expenditure is never prioritized, so there is no way of knowing beforehand which areas of spending are more/less important than others. As a result, when the need for budget cuts arises, it invariably becomes a difficult task to trim spending according to priorities. As already stated, when revenue collection misses the planned target, spending is not slimmed down, automatically and accordingly. The country’s budget bill does not contain a ‘Plan B’ which would specify smaller budget allocations and be followed when budget revenue sinks. As Lithuania’s experience indicates, trimming the state budget without having spending priorities at hand turns into an unpredictable, chaotic process. This problem could be resolved by means of instituting the principle of conditional budgeting. This means that at the stage of endorsing budgetary programmes, specific levels of priority must be attached to each programme, indicating, say, ‘highly important,’ ‘important,’ ‘less important,’ or numbers from 1 to 3 (or higher). When the state budget fails to collect the planned income, the ‘less important’ programmes should be automatically frozen.
It must be admitted that if the economy contracts, the public sector is much less prepared for cutting spending at present than it was in 2008 and 2009. Like in the year 2009, spending programmes have not been prioritized but, unlike in 2009, the costs of interest on state debt have more than doubled in size. Moreover, the budget is now under pressure to reimburse the earlier cuts in the public-sector pay and old-age pensions. And on top of that, politicians are likely to be less willing to shave off spending, fearing the new cuts might be ruled as being out of tune with the Constitution.
Relying on inaccurate prognoses in budget planning is dangerous
Using inaccurate economic forecasts in the private sector takes its toll on the owners, employees and suppliers of specific companies. But when such forecasts are employed in the public sector, they exert far wider effects.
When budget revenues miss the planned target and, at the same time, spending is not cut, there is always more probability of tax hikes. This is precisely what happened in Lithuania in the period between 2008 and 2011. At that time quite a number of taxes were raised, including VAT (along with the removal of VAT exemptions), profit tax, excise duties, and social insurance contributions on income from individual activity and authorship contracts. Political talks in Lithuania often revolve around the necessity to levy a car tax, a tax on all real estate, progressive taxation and other measures. Evidently, failure to execute the budget revenue plan would constitute a bigger threat of tax increases in the country.
Yet, raising taxes may not suffice to retain the set budget deficit target (especially if tax increases were found to be boosting the shadow economy and decreasing budget revenues). That is why such a situation automatically leads to an inevitable growth of the budget deficit and, accordingly, state debt. At present Lithuania’s state debt totals LTL 50 billion, while interest on state debt will amount to LTL 2.2 billion in 2015.
For reasons outlined above, it is essential that the state budget and budgets of municipalities and non-budgetary funds are all grounded on the most accurate growth forecasts available to budget planners.
How the 2015 budget must be planned?
As discussed earlier, the 2015 budget proposal has been built following an overly optimistic scenario. Seeking to prepare for potential risks and unexpected developments that may come along, the existing 2015 budget bill should be revised to include the following recommendations:
- To plan budget revenue with more caution. As highlighted previously, income expected from certain taxes has been estimated too generously, and the National Audit Office has evaluated these projections as overly incautious. For this reason, the budget bill must be streamlined according to a more realistic projection of income growth. Budget expenditure must also be adjusted accordingly.
- To prepare for potential budget cuts through fixing the principle of conditional budgeting: when endorsing budgetary programmes, specific levels of priority must be attached to each programme, indicating, for instance, ‘highly important,’ ‘important,’ ‘less important,’ or numbers from 1 to 3 (or higher). When the state budget fails to collect the planned income, the ‘less important’ programmes should be automatically scrapped.
THE LITHUANIAN ECONOMY
GDP, price growth and unemployment: stable prices and moderately falling unemployment are advancing economic growth
In the survey of the Lithuanian Free Market Institute (LFMI), gross domestic product is understood as the total value of goods and services produced for final consumption within the country, including the shadow economy, during a given period.
In the LFMI survey changes in consumer prices are defined as changes in the average prices of goods and services intended for household consumption by comparing price levels at the end of a given period.
Unemployment is understood as the ratio of the unemployed—persons of working age who are seeking jobs but are not necessarily registered at the Labour Exchange—to the total labour force. The “labour force” then refers to all people of working age. The LFMI survey respondents are asked to evaluate the rate of unemployment at the end of the year.
According to the Survey of the Lithuanian Economy, the country’s economy will grow at a slightly lower rate in 2014 compared to 2013 but unemployment will continue to fall. The experts polled by LFMI also expect a somewhat less marked rise in prices.
The LFMI survey participants believe that economic growth in Lithuania will decelerate in 2014, mainly due to trade restrictions between the European Union (EU) and Russia, and the continued stagnation of the EU economy. The 2014 forecast of economic growth has been marked down to 2.8 percent compared to the prognosis of 3.5 percent reported early this year. But even with the diminishing expectations, Lithuania will still be among the fastest growing economies in the EU.
It is worth noting that the Ministry of Finance plans an optimistic GDP growth, 3.4 percent, in 2015, while market participants are more conservative about the economic development next year. They predict that the country’s economy will rise by the same amount as in the current year, by 2.8 percent. Such moods can be explained by the risks that market participants perceive for the near future.
According to the vast majority of the LFMI respondents (93 percent), the geopolitical situation resulting from the Russia-Ukraine conflict is the main risk source for Lithuanian businesses. The worsening economic situation in Europe is a second largest source of threat (35 percent), and 48 percent of respondents reported the latter to be only a medium-level risk. Unfavourable, hardly predictable changes in Lithuanian legislation were rated as a medium-level risk. Among the examples of such changes is an increase in the monthly minimum wage from October 2014, talk about raising taxes and plans to increase the minimum wage further. The lack of qualified labour and meagre business investments were mentioned to be among other threats to the country’s companies.
The LFMI survey participants were also asked to evaluate how the Ukrainian conflict and its after-effects will change the investment climate in Lithuania. The bulk of the LFMI respondents (63 percent) share the opinion that this conflict will work to deteriorate the country’s investment environment. This is yet another cue that the Ministry’s forecast of growth might not be realised.
Unemployment is set to decline further in spite of the lowered projection of GDP growth. According to the experts polled by LFMI, the rate of unemployment will stand at 10.7 percent and 10.1 percent at the end of 2014 and 2015 respectively. These predictions are more optimistic than the figures released by the Ministry of Finance. But looking at dynamics in the unemployment rate over the last two decades, the current rate seems still too high—double the unemployment rate, say, in 2005. On the other hand, Lithuania’s rates of unemployment look better when set side by side with the EU average (11.5 percent).
The current situation—a sluggish decline in unemployment during a spell of brisk economic growth—highlights the problem of structural unemployment that is underlying the Lithuanian labour market. One of the most popular ways to help solve it is staff training and vocational training courses. However, as the experience of EU countries demonstrates, it is a costly and ineffective tool. Considerably greater benefits would be brought by a more up-to-date, less regulated Labour Code—the instrument which would ease the recruitment of jobless and young individuals in particular.
As the LFMI survey respondents reported, the feeble economic situation (33 percent) is the main reason that a large portion of individuals are still failing in finding jobs. Nearly a quarter (23 percent) of market participants thinks that recruitment is being inhibited by the excessively high minimum wage. Evidently, the latest increase in the minimum wage (from October 2014) and plans to raise it further are typical examples of decisions that are rushed with no consideration for their effects. The lumping minimum wage is now among the most considerable barriers to labour market entry for young or unskilled people.
Roughly a half of those polled (44 percent) indicated more problems—the lack of qualifications and motivation to work—that are hindering people to get employed. Lavish welfare payments can be listed among the factors behind low work motivation.
As the LFMI survey demonstrates, consumer prices will mount by 2.1 percent in 2014 (a lower forecast compared to that provided in the previous survey). But in 2015 prices are expected to rise more significantly, by 2.6 percent. The latter forecast differs markedly from the information released by the Ministry of Finance which projects that prices will go up by barely 0.3 percent in 2014 and 1.2 percent in 2015.
Imports and exports: international turmoil is strongly affecting Lithuania’s foreign trade
The LFMI survey analyses changes in the value of exported and imported goods and services, both reported and unreported, during a given period as compared to the preceding period.
According to the LFMI survey participants, Lithuanian exports will only undergo a 4-percent growth in 2014 compared to an 8-percent increase projected in February of this year. Such a sizeable change in the export forecast can be attributed mainly to trade sanctions applied by Russia and the EU. The imposed trade barriers are having particularly negative repercussions for Lithuania which is one of major re-exporters to Russia. Flabby economies of most EU countries are not helping Lithuania to improve its economic status quo either, while finding new markets for national products is quite a lengthy process. Despite that, market participants are awaiting a pick-up already in 2015, expecting a 6-percent export growth, plus a change in the export structure.
The LFMI survey participants believe that exports to the countries of the Customs Union will see a decline by 8 percentage points, which will spread out fairly evenly across all other markets. The largest export growth is predicted to take place in the EU and other countries. However, some fraction of export-oriented production, such as dairy products, may well be sold at home.
In line with the skidding exports, the LFMI respondents have also slashed their forecast of import growth, from 9 percent to 6 percent.
The shadow economy will contract modestly; the tax burden will remain the same
The shadow economy is defined as a share in total GDP of goods produced and services rendered for final consumption within the country and unreported for the purpose of avoiding taxes and/or regulations.
In the LFMI survey the relative tax burden is understood as the ratio of total tax revenues of state and municipal budgets and funds to gross domestic product (GDP).
According to the LFMI survey, the share of the shadow economy is expected to shrink in line with the rising economy. Sadly, the pace of this reduction will remain still sluggish, with as much as a fifth (24 percent) of the 2015 GDP being generated in the underground economy. The pre-crisis level when the share of the shadow economy in GDP averaged 20 percent (in 2011 through 2008) will not be reached.
Lowering taxes on labour and streamlining the Labour Code to include more flexibility can help bring down the shadow economy. These two measures would simplify recruitment, rendering it cheaper and more flexible. As a result of the existing employment restrictions and high labour costs—both financial and time costs—companies are hesitant about creating new jobs. Meanwhile, the tremendous gap between total employer-borne labour costs and employees’ take-home pay is also goading into concealing at least an element of income from labour.
The LFMI survey participants were asked to evaluate the structure of the shadow economy. They believe that smuggling of and illegal trade in cigarettes, alcohol, fuel and other goods represent the largest share of the shadow economy. Compared to the results of the previous survey done early in 2014, the share of this type of illicit activity has increased from 32.9 percent to 34.4 percent. If the excise duties remain high, especially if they are raised further, people may easily resort to consuming more of smuggled goods in response to this move.
According to the LFMI survey participants, unofficial wages paid in ‘envelopes’ and unreported employment constitute the second largest share in the shadow economy, 25.7 percent. The underlying cause here is high taxation of labour. The experts polled think that roughly a forth of job-seeking individuals could not find employment due to strict labour market regulations and the high minimum wage. Therefore, further increases in the minimum wage may swell the ranks of those working under the table.
The remaining share of the shadow economy is comprised of the following activities: product distribution/service provision without paying taxes and hiding of business activity (20.5 percent), trade in illegal goods and services (11.2 percent), and other types of illicit activity (8.1 percent).
As the LFMI survey shows, the relative tax burden in Lithuania will remain heavy. Market participants project that the tax burden will make up 35 percent of GDP in 2014 and 36 percent of GDP in 2015. The 2015 forecast was slightly lowered in the current survey compared to February 2014 when the LFMI respondents expected the tax burden to increase to 37 percent of GDP.
Personal earnings will continue to grow
Average personal earnings refer to the average monthly reported or unreported monetary remuneration for work after tax.
Fig. Personal earnings
According to the LFMI survey, average net earnings will continue to grow steadily both in 2014 and 2015, with the growth being faster in the coming year. General economic growth in the country is an essential factor behind rising earnings. Foreign investors also play an important role in this respect. In most cases, they pay higher-than-average salaries, thus pushing the average wage level upwards. It should be noted that as the LFMI survey participants reduced the forecast of economic growth, they also lowered their 2014 forecast of average net earnings growth, from LTL 1,958 per month (reported in February) to LTL 1,888 per month.
To sum up this survey of the Lithuanian economy, even amid the Russian conflict, the prospects for economic growth in Lithuania look bright, albeit somewhat conservative. Lithuania is expected to stand as one of the fastest growing economies in the EU. Led by the rising economy, unemployment and the shadow economy are set to decrease gradually. But the two indicators will still remain high, whereas economic growth alone will not be able to amend the situation. To that end, Lithuania needs to embark on structural reforms; however, they are currently delayed.
- According to the Survey of the Lithuanian Economy, the country’s economy will rise by 2.8 percent both in 2014 and 2015. Compared to the forecast reported early in 2014 (3.5 percent), market participants’ expectations have diminished.
- Lithuania’s 2015 budget bill, drafted by the Ministry of Finance, has been grounded on more optimistic growth forecasts than those released by other institutions. Evidently, the drafters did not take into consideration a handful of potential risks for the Lithuanian economy arising from the Ukrainian conflict and the likely economic decline in the eurozone.
- When formulating a budget proposal, its authors must plan economic growth realistically, project budget revenue with more caution, and prepare for probable budget cuts by means of introducing the principle of conditional budgeting, i.e. establishing priorities for spending programmes.
- According to the absolute majority of the LFMI respondents (93 percent), the geopolitical situation resulting from the Russia-Ukraine conflict is the main risk source for Lithuanian businesses. The worsening economic situation in Europe has been reported to be a high- or medium-level risk by 83 percent of those polled.
- Market participants project that average net earnings will continue to grow steadily, amounting to LTL 2,002 (EUR 580) per month in 2015. General economic growth in the country is the key factor augmenting earnings.
- Unemployment is expected to decline further; however, its rate will still remain twice as high as in the pre-crisis period. According to the experts polled by LFMI, the rate of unemployment will stand at 10.7 percent and 10.1 percent at the end of 2014 and 2015 respectively.
- According to a third of the LFMI survey respondents (33 percent), the feeble economic situation is the main reason that a large portion of individuals are still failing in finding jobs. Nearly a quarter (23 percent) of market participants polled think that recruitment is being inhibited by an overly high minimum wage and tight employment regulations.
- Lithuanian exports will only undergo a 4-percent growth in 2014 compared to an 8-percent increase projected at the beginning of this year.
- As the LFMI survey demonstrates, consumer prices will rise by 2.6 percent in 2015.
- Market participants project that 24 percent of GDP will be generated in the underground economy in 2015.
Forecasts reported in the 34th survey of the Lithuanian economy conducted by LFMI
||Forecast for 2014 reported in September 2013
||Estimate for 2013 reported in February 2014
||Forecast for 2014 reported in February 2014
||Forecast for 2014 reported in September 2014
||Forecast for 2015 reported in September 2014
|Unemployment rate, end of period
|Changes in consumer prices, end of period
|Shadow economy, share in GDP
|Tax burden, share in GDP
|Average personal earnings (received in Litas after tax)
- Which of these risk sources are the most considerable ones for Lithuanian businesses during the next half a year?
|Geopolitical situation due to the Russia-Ukraine conflict
|Obstacles for exports resulting from a feeble economic situation in Europe
|Unfavourable, hardly predictable changes in Lithuanian legislation (e.g. an increase in the monthly minimum wage from October 1; increased taxation of capital)
|Lithuania’s accession to the eurozone (e.g. tightened price controls to prevent price rises)
- What change in Lithuania’s investment climate do you envisage to take place following the Ukrainian conflict and the ensuing measures (sanctions and the like)?
- What will be Lithuania’s export structure by region in 2015?
|EU together with Iceland, Liechtenstein, Norway and Switzerland
|Customs Union of Russia, Belarus and Kazakhstan
|CIS countries (excluding the Customs Union): Armenia, Azerbaijan, Kyrgyzstan, Moldova, Tajikistan, Turkmenistan, Ukraine, Uzbekistan
- In your opinion, what portion of individuals who were unemployed in 2014 (as a percentage of the total number of the unemployed) could not find jobs due to the following causes?
|Bad economic situation
||Overly high monthly minimum wage and strict employment regulations
- Please, evaluate the structure of the shadow economy. In your opinion, what are the shares that these constituents comprise in the total shadow economy (in percent)?
|Smuggling of and illegal trade in excise-taxed goods (cigarettes, alcohol, and fuel) and other goods
|Unofficial wages paid in ‘envelopes,’ unreported employment
|Product distribution/service provision without paying taxes, hiding of business activity
|Trade in illegal goods and services (e.g. prostitution, drug trafficking, trade in stolen goods, etc.)
|Other types of illicit activity
 Source: Sodra
 Source: Statistics Lithuania
 Source: „Faktai ir analizė. FLEXICURITY principų įgyvendinimas
darbo rinkos politikoje“ (2014, LFMI)