Insights into Central Eastern Europe Border-Town Smuggling Economics

CIVITTA participated in a 100 million USD global initiative, proposed by Philip Morris International Impact, to fight illegal trade. The project ”Insights into CEE border-town smuggling economics,” proposed by CIVITTA Lithuania was one of 32 projects that received a grant in the first round of funding. CIVITTA conducted research to explore the size of the shadow economy generated by cigarette smuggling in Central and Eastern European border towns and other towns in the region in order to develop policy recommendations for reducing illegal trade incentives by strengthening the local economies.

Low income level or absence of economic opportunities in borderland areas are considered to be the main drivers of illegal trade. Due to significant differences in taxes and tariffs between EU and non-EU countries, tobacco smuggling is one of the most widespread illicit activities and an additional source of income among inhabitants of border municipalities. For example, in 2015 almost 20% of the cigarettes smuggled in Europe came through municipalities which share a borderline with Ukraine, Russia, Belarus, and Moldova.

In order to decrease the impact of the illegal activities, 3 ultimate goals of the project were raised: 
1. Explore the size of shadow economy generated, in part, by cigarette smuggling in border municipalities within Central and Eastern Europe; 
2. Examine factors that motivate border municipality inhabitants to smuggle;
3. Provide clear investment guidelines and action plans for governments on how to reduce the shadow economy.

The project took a detailed look at the economic situation of 48 border municipalities that are strategically situated between 8 countries: EU border countries: Estonia, Latvia, Lithuania, Romania, and Non-EU countries: Russia (incl. Kaliningrad), Belarus, Moldova, Ukraine. In order to reach the above-mentioned goals, an additional 96 inland municipalities that can be used for comparison with border municipalities and lead to further development of recommendations were involved in the project.

The project methodology was divided into 3 phases and has consisted of 3 main stages: MIMIC, quantitative and qualitative analysis.

Phase 1 has consisted of 2 major activities: MIMIC model and economic/comparative analysis. Based on the publicly available data, the aim of the MIMIC model was to explore the size of the shadow economy by calculating shadow economy indexes for each identified border and inland municipality. The model has enabled to rank country municipalities according to a prevailing level of shadow economy from lowest to highest. Moreover, it also enabled to identify the significant causal variables which influence the shadow economy as well as indicator variables, which were affected by the shadow economy the most. The ability to identify causal variables enabled to investigate motivation and hidden meanings behind these variables by raising attitudinal questions. Hence, the surveying method was chosen in order to test the assumptions raised in particular countries and it was during Phase 2. Moreover, during the 1st Phase of the Project, a comparative analysis was executed to evaluate the main differences between the border and corresponding inland municipalities. The results of the comparative analysis were used for hypothesis formulation in later project phases that led to further development of recommendations.

The main activities of Phase 2 were both formulating the questionnaire and conducting the survey. Based on the MIMIC model results, questionnaires, which consisted of attitudinal questions, were formed for each country individually. The survey was implemented in all the targeted countries and involved more than 9000 respondents. After the attitudes which required the most attention in particular municipalities were identified, the qualitative research was executed in a form of a focus group discussion. During the FGD, the initial hypothesis and observations related to the specific actions, which could possibly increase the welfare of inhabitants and at the same time decrease the overall level of the shadow economy, were tested.

During Phase 3, the qualitative research method – expert interviews -  was implemented. The qualitative research methods conducted in Phase 2 and 3 were used not only to confirm the recommendations but also to gain deeper insights of the experts as well as the examples of the best practices. The results of expert interviews were used to form the final recommendations for the governments to reduce the shadow economy in those particular border municipalities as well as strengthen local economies.  

The main outcomes of the project are: 
1. MIMIC model revealed that on average shadow economy index in all of the targeted countries is bigger in the border municipalities compared to the inland municipalities.
2. Constructed MIMIC models helped to understand, which of the variables positively or negatively influence the size of the shadow economy of the country.
3. Economic/comparative analysis revealed the main difference between the border and inland municipalities and highlighted indicators, which fluctuate the most within each of the group.
4. Performed analysis revealed the following tendency: border and inland municipalities mostly differ according to the amount of registered income, GDP per capita generated, gross investment – all of those indicators are lower in border municipalities, especially, in EU member states.
5. Quantitative surveying revealed that border municipalities across the region and within countries are different from each other and that attitude of inhabitants regarding different subjects (attitude towards municipality, tax evasion, smuggling, etc.) differs.
6. Quantitative research revealed that in most of the cases the attitude of EU border municipality inhabitants is not statistically different from the one of corresponding municipalities on the other side of the frontier.
7. The qualitative research confirmed 2 observations:
   - Each of the border municipalities has a specific profile regarding satisfaction about tax expenditures and tax evasion. 
   - The inhabitants of municipalities have different perception and scope of the shadow economy as well as distinct possible tools/solutions/measurements to fight it. 
8. Focus Group Discussions helped understand the reasoning behind each of the arising attitudes and disclose measurable, tangible and observable objects, which can be changed in order to decrease the shadow economy. 
9. The proposed recommendations encompass various forms of communication, development of local policies, changes in administrative matters and altering the education system.

Read the full report on the project here and review a set of substantiated guidelines for investment strategy for governments here.