Part 14

Act Section 209, Consideration by Appropriate State Regulatory Authorities, "throws a bone" to the states. It requires state regulators to make an independent determination whether Board standards apply to small and mid-size non-registered accounting firms. No one can seriously doubt the outcome of these determinations. But we now pretend that we still have real state regulation of the accounting profession, just as we pretend that we have state regulation of the securities markets through "blue sky laws". The reality is that the states will be confined hence to the initial admission of persons to the accounting profession. Like the "blue sky laws", it will be a revenue source, but the states will be completely junior to the Board and the SEC.

Act Section 302, Corporate Responsibility For Financial Reports, mandates that the CEO and CFO of each issuer shall certify the "appropriateness of the financial statements and disclosures contained in the periodic report, and that those financial statements and disclosures fairly present, in all material respects, the operations and financial condition of the issuer". This may prove problematic with global companies. We have already seen resistance by Daimler-Benz of Germany.

Act Section 305: Officer And Director Bars And Penalties; Equitable Relief, will be used by the SEC to counterattack arguments arising out of the Central Bank case. As I maintained in the American Journal of Trial Advocacy, the real significance of the Supreme Court decision in Central Bank was that the remedial sanctions of the federal securities laws should be narrowly construed.

Well, now the SEC has a Congressional mandate. Federal courts are authorized to "grant any equitable relief that may be appropriate or necessary for the benefit of investors". That is an incredibly broad delegation of rights, and is an end run around Central Bank. I was surprised that this received no publicity.

Lastly, Act Section 402, Prohibition on Personal Loans to Executives, shows how low this generation of US leadership has sunk. President Bush has signed a law that makes illegal the type of loans from which he and his extended family have previously benefited.

Tacitly, the Act admits that some practices of Enron were not illegal inter se. Act Section 401, Study and Report on Special Purpose Entities, provides that the SEC should study off-balance sheet disclosures to determine their extent and whether they are reported in a sufficiently transparent fashion. The answer will almost certainly be no, and the Board will change GAAP accordingly.

Q. Does the SEC collaborate with other financial regulators and law enforcement agencies internationally? Does it share information with other US law enforcement agencies? Is there interagency rivalry and does it hamper investigations? Can you give us an example? A. The SEC and other regulators - as well as two House subcommittees - have only very recently begun considering information sharing between financial regulators.

This comes too late for the victims of Martin Frankel, who, having been barred for life from the securities industry by the SEC and NASD in 1992, simply moved over to the insurance industry to perpetrate a scam where investors have lost an estimated $200 million dollars.

Had the state insurance regulators known this person's background, he would have been unable to set up multiple insurance companies. Failure to share information is a genuine problem, but "turf" considerations generally trump any joint efforts.

XXV. Trading from a Suitcase. The Case of Shuttle Trade

They all sport the same shabby clothes, haggard looks, and bulging suitcases bound with frayed ropes. These are the shuttle traders. You can find them in Mongolia and Russia, China and Ukraine, Bulgaria and Kosovo, the West Bank and Turkey. They cross the border as "tourists", sometimes as often as 10 times a year, and come back with as much merchandise as they can carry in their enormous luggage. Some of them resort to freight forwarding their "personal belongings".

They distort trade figures, smuggle goods across ill- guarded borders, ignore international treaties and conventions and, in short, revive moribund economies.

They are the life-blood and the only manifestation of true entrepreneurship in swathes of economic wastelands.

They meet demands for consumer goods unmet by domestic manufacturers or by officially-sanctioned importers.

In recognition of their vital role, the worried Kyrgyz government held a round table discussion last summer about the precarious state of Kyrgyzstan's shuttle trade.

Many former Soviet republics have tightened up their border controls. In May last year, Russian officials seized half a million dollars worth of shuttle goods belonging to 1500 traders. When two million dollars worth of goods were confiscated in a similar incident in fall 2001, eight Kyrgyz traders committed suicide.

The number of Kyrgyz shuttle traders dropped in 2002 to 300,000 (from 500,000 in 1996). The majority of those who remain are insolvent. Many of them emigrated to other countries. The shuttle traders asked the government to legalize and regulate their vanishing trade and thus to save them from avaricious and minacious customs officials.

Even prim international financial institutions recognize the survival-value of shuttle trade to the economies of developing and transition countries. It employs millions, boosts investments in transport and infrastructure, and encourages grassroots capitalism. The IMF - in the 11th meeting of its Committee on Balance of Payments Statistics in 1998 - officially recognized shuttle trade as a business activity to be recorded under "goods".

But there is a seedier and seamier side to shuttle trade where it interfaces with organized crime and official corruption. Shuttle trade also constitutes unfair competition to legitimate, tax and customs duties paying enterprises - the manufacturers of textiles, shoes, cigarettes, alcoholic drinks, and food products. Shuttled goods are not subject to health and safety inspections, or quality control.

According to the March 27th 2002 issue of East West Institute's "Russian Regional Report", the value of Chinese goods shuttled into the borderlands of the Russian Far East is a whopping $50 million a month.

China benefits from the serendipitous proceeds of these informal exports - but is unhappy at the lost tax revenues.

EWI claims that Russian banks in the region (such as DalOVK, Primsotsbank, and Regiobank) are already offering money transfer services to China. DalOVK alone transfers $1 million a month - a fortune in local terms. But even these figures may be a serious under-estimate. The trade between Khabarovsk Territory in Russia and Heilongjiang Province in China - most of it in shuttle form - was $1.5 billion in 2001. The bulk of it was one way, from China to Russia.

Shuttle trade is even more prominent between Iraq and Turkey. The Anatolia News Agency expected it to increase to $2 billion in 2002. By comparison, the official exports of Turkey to Iraq amount to $800 million. The then prime minister Bulent Ecevit himself stated to the Ankara Anatolia news agency: "We have provided necessary support to increase shuttle trade".

"The Economist" reports about the flourishing "petty trade" between China and Vietnam. Western and counterfeit goods are smuggled to bazaars in Vietnam, owned and operated by Chinese nationals. The border between these two erstwhile enemies opened in 1990.

This led to the rise of criminal networks which involve border guards and policemen.

Another hot spot is the Balkan. In a report dated July 2001, the Balkan Information Exchange describes the "Tulip Market" in Istanbul. Vendors are fluent in Russian, Bulgarian and Romanian and most of the clients are East European. They buy wholesale and use special vans and buses to transport the goods - mainly textiles - northwards, frequently to destinations in the Balkan. This kind of trade is estimated to be worth $8 billion a year - more than one quarter of Turkey's official exports.

Bulgarian customs officials, border patrols, and policemen form part of these efficient rings - as do their Macedonian and, to a lesser extent, Greek counterparts. The Sofia- based Center for the Study of Democracy thinks that a third of the Bulgarian workforce (i.e., c. 1 million people) may be involved. Many of the traders maintain mom-and- pop establishments or stalls in public bazaars, where members of their family sell the goods.

Some of the merchandise ends up in Serbia, which was subjected to UN sanctions until lately. Fuel smuggling on bikes and other forms of sanctions busting have largely ended but they have been replaced by cigarettes, alcohol, firearms, stolen cars, and mobile phones.

The Serbian authorities often round up and deport Bulgarian shuttle traders, provoking furious resentment in Bulgaria. Headlines like "(Serbian) Policemen take away our countrymen's money" and "Serbs searching (Bulgarian) women's genitals for money" are pretty common. The Bulgarians are embittered. They used to smuggle medicines and fuel into embargoed Serbia - only to be abused by Serb officials now, that the embargo has been lifted.

East European buyers used to reach as far as India where they shopped wholesale in winter. Russians used to buy readymade clothes, leather goods, and cheap jewelry in New Delhi and elsewhere and sell the goods in the numerous flea markets back home.

To finance their purchases, they used to sell in India Russian cosmetics and consumer goods such as watches, cameras, or hair dryers. But the 1998 financial crisis and sub-standard wares offered by unscrupulous Indian traders put a stop to this particular venue.

Governments are trying to stem the shuttle trade. The Russian news agency, ITAR-TASS, reports that Sergei Stepashin, the dynamic chairman of the Russian Audit Chamber (and a former short-lived prime minister of Russia) is bent on tightening the cooperation between member states of the Shanghai Cooperation Organization.

The audit agencies of China, Russia, Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan will exchange information and strive to control the thriving shuttle trade across their porous borders. China and Russia are poised to sign a bilateral accord regarding these issues in October.

The WPS Monitoring Agency reported last November that the Economic Development and Trade Ministry of Russia intends to treat cargos of more than 50 kilos as a consignment of commercial goods, subject to import tariffs (on top of the current tax of 30 percent).

The Ministry claimed that shuttle trade accounts for up to 90 percent of all imported goods "in certain spheres" (e.g., furs). As late as 1994, Russians were allowed to import up to $5000 of duty-free goods in their accompanied baggage - a relic of communist days when only the privileged few were allowed to travel.

Up to 2 million Russian citizens may be engaged in shuttle trade and the value of "gray" goods may be as high as $10 billion annually. Goods from Turkey alone amounted in 2002 to $1.5-2 billion, according to then vice-premier Viktor Khristenko, but shuttle traders also operate in the United Arab Emirates, Syria, Israel, Pakistan, India, China, Poland, Hungary, and Italy.

A set of figures published for the first quarter of 2001 shows that shuttle trade amounted to $2.6 billion, or 8 percent of Russia's total foreign trade. Shuttle traded goods made up 1.5 percent of exports - but a full quarter of imports.

But the shuttle trade's coup de grace may well be EU enlargement. Already a new "iron curtain", comprised of visas and regulations, is rising between EU candidates and other East European and Balkan countries.

Consider the EU's eastern boundary. More than a million people cross the busy Ukrainian-Polish border every month. Enhanced regulation on the Polish side and new, IMF-inspired, tax laws on the Ukrainian side - led to a massive increase in corruption and smuggling. Truck owners now bribe customs officials to the tune of $300 per vehicle, according to a January 2001 report by CEPS.

The results are grave. Following the introduction of these new measures, cross border traffic fell by 50 percent and unemployment in the Polish border zones jumped by 40 percent in 2002 alone. It has since doubled. The IMF and the EU are much decried by the Polish minority now trapped in Western Ukraine.

The situation is likely to be further exacerbated with the introduction of a reciprocal visa regime between the two countries. Shuttle trade may be decimated by the resulting bureaucratic bottlenecks.

Still, it may no longer be needed now that Poland acceded to the EU. Shuttle trade thrives on poverty. It arbitrates between inefficient markets. It satisfies unrequited demand for goods. The single market ought to rid Europe of all these distortions - and, thus, most probably of this makeshift though resilient solution, the shuttle trader.

XXVI. The Blessings of the Black Economy

Some call it the "unofficial" or "informal" economy, others call it the "grey economy" but the old name fits it best: the "black economy". In the USA "black" means "profitable, healthy" and this is what the black economy is. Macedonia should count its blessings for having had a black economy so strong and thriving to see it through the transition. If Macedonia had to rely only on its official economy it would have gone bankrupt long ago.

The black economy is made up of two constituent activities: 1. Legal activities that are not reported to the tax authorities and the income from which goes untaxed and unreported. For instance: it is not illegal to clean someone's house, to feed people or to drive them. It is, however, illegal to hide the income generated by these activities and not to pay tax on it. In most countries of the world, this is a criminal offence, punishable by years in prison. 2. Illegal activities which, needless to say, are also not reported to the state (and, therefore, not taxed).

These two types of activities together are thought to comprise between 15% (USA, Germany) to 60% (Russia) of the economic activity (as measured by the GDP), depending on the country. It would probably be an underestimate to say that 40% of the GDP in Macedonia is "black". This equals 1.2 billion USD per annum. The money generated by these activities is largely held in foreign exchange outside the banking system or smuggled abroad (even through the local banking system).

Experience in other countries shows that circa 15% of the money "floats" in the recipient country and is used to finance consumption. This should translate to 1 billion free floating dollars in the hands of the 2 million citizens of Macedonia. Billions are transferred to the outside world (mostly to finance additional transactions, some of it to be saved in foreign banks away from the long hand of the state). A trickle of money comes back and is "laundered" through the opening of small legal businesses.

These are excellent news for Macedonia. It means that when the macro-economic, geopolitical and (especially) the micro-economic climates will change - billions of USD will flow back to Macedonia. People will bring their money back to open businesses, to support family members and just to consume it. It all depends on the mood and on the atmosphere and on how much these people feel that they can rely on the political stability and rational management. Such enormous flows of capital happened before: in Argentina after the Generals and their corrupt regime were ousted by civilians, in Israel when the peace process started and in Mexico following the signature of NAFTA, to mention but three cases. These reserves can be lured back and transform the economy.

But the black economy has many more important functions.

The black economy is a cash economy. It is liquid and fast. It increases the velocity of money. It injects much needed foreign exchange to the economy and inadvertently increases the effective money supply and the resulting money aggregates. In this sense, it defies the dictates of "we know better" institutions such as the IMF.

It fosters economic activity and employs people. It encourages labour mobility and international trade. Black economy, in short, is very positive. With the exception of illegal activities, it does everything that the official economy does - and, usually, more efficiently.

So, what is morally wrong with the black economy? The answer, in brief: it is exploitative. Other parts of the economy, which are not hidden (though would have liked to be), are penalized for their visibility. They pay taxes.

Workers in a factory owned by the state or in the government service cannot avoid paying taxes. The money that the state collects from them is invested, for instance, in infrastructure (roads, phones, electricity) or used to pay for public services (education, defence, policing). The operators of the black economy enjoy these services without paying for them, without bearing the costs and worse: while others bear the costs. These encourages them, in theory to use these resources less efficiently.

And all this might be true in a highly efficient, almost ideal market economy. The emphasis is on the word "market". Unfortunately, we all live in societies which are regulated by bureaucracies which are controlled (in theory, rarely in practice) by politicians. These elites have a tendency to misuse and to abuse resources and to allocate them in an inefficient manner. Even economic theory admits that any dollar left in the hands of the private sector is much more efficiently used than the same dollar in the hands of the most honest and well meaning and well planning civil servant. Governments all over the world distort economic decisions and misallocate scarce economic resources.

Thus, if the goals are to encourage employment and economic growth - the black economy should be welcomed. This is precisely what it does and, by definition, it does so more efficiently than the government. The less tax dollars a government has - the less damage it does. This is an opinion shares by most economists in the world today. Lower tax rates are an admission of this fact and a legalization of parts of the black economy.

The black economy is especially important in times of economic hardships. Countries in transition are a private case of emerging economies which are a private case of developing countries which used to be called (in less politically correct times) "Third World Countries". They suffer from all manner of acute economic illnesses. They lost their export markets, they are technologically backward, their unemployment skyrockets, their plant and machinery are dilapidated, their infrastructure decrepit and dysfunctional, they are lethally illiquid, they become immoral societies (obligations not honoured, crime flourishes), their trade deficits and budget deficits balloon and they are conditioned to be dependent on handouts and dictates from various international financial institutions and donor countries.

Read this list again: isn't the black economy a perfect solution until the dust settles? It enhances exports (and competitiveness through imports), it encourages technology transfers, it employs people, it invests in legitimate businesses (or is practised by them), it adds to the wealth of the nation (black marketeers are big spenders, good consumers and build real estate), it injects liquidity to an otherwise dehydrated market. Mercifully, the black economy is out of the reach of zealous missionaries such as the IMF. It goes its own way, unnoticed, unreported, unbeknownst, untamed. It doesn't pay attention to money supply targets (it is much bigger than the official money supply figure), or to macroeconomic stability goals. It plods on: doing business and helping the country to survive the double scourges of transition and Western piousness and patronizing. As long as it is there, Macedonia has a real safety net. The government is advised to turn a blind eye to it for it is a blessing in disguise.

There is one sure medicine: eliminate the population and both unemployment and inflation will be eliminated.

Without the black economy, the population of Macedonia would not have survived. This lesson must be remembered as the government prepares to crack down on the only sector of the economy which is still alive and kicking.

Operational Recommendations The implementation of these recommendations and reforms should be obliged to be GRADUAL. The informal economy is an important pressure valve for the release of social pressures, it ameliorates the social costs inherent to the period of transition and it constitutes an important part of the private sector.

As we said in the body of our report, these are the reasons for the existence of an informal economy and they should be obliged to all be tackled: ? High taxation level (in Macedonia, high payroll taxes); ? Onerous labour market regulations; ? Red tape and bureaucracy (which often leads to corruption); ? Complexity and unpredictability of the tax system.

Reporting Requirements and Transparency ? All banks should be obliged to report foreign exchange transactions of more than 10,000 DM (whether in one transaction or cumulatively by the same legal entity). The daily report should be submitted to the Central Bank. In extreme cases, the transactions should be investigated. ? All the ZPP account numbers of all the firms in Macedonia should be publicly available through the Internet and in printed form. ? Firms should be obliged by law to make a list of all their bank accounts available to the ZPP, to the courts and to plaintiffs in lawsuits. ? All citizens should be obliged to file annual, personal tax returns (universal tax returns, like in the USA). This way, discrepancies between personal tax returns and other information can lead to investigations and discoveries of tax evasion and criminal activities. ? All citizens should be obliged to file bi-annual declarations of personal wealth and assets (including real estate, vehicles, movables, inventory of business owned or controlled by the individual, financial assets, income from all sources, shares in companies, etc.). ? All retail outlets and places of business should be required to install - over a period of 3 years - cash registers with "fiscal brains". These are cash registers with an embedded chip. The chips are built to save a trail (detailed list) of all the transactions in the place of business. Tax inspectors can pick the chip at random, download its contents to the tax computers and use it to issue tax assessments. The information thus gathered can also be crossed with and compared to information from other sources (see: "Databases and Information Gathering"). This can be done only after the full implementation of the recommendations in the section titled "Databases and Information Gathering". I do not regard it as an effective measure. While it increases business costs - it is not likely to prevent cash or otherwise unreported transactions. ? All taxis should be equipped with taximeters, which include a printer. This should be a licencing condition. ? Industrial norms (for instance, the amount of sugar needed to manufacture a weight unit of chocolate, or juice) should be revamped. Norms should NOT be determined according to statements provided by the factory - but by a panel of experts. Each norm should be signed by three people, of which at least one is an expert engineer or another expert in the relevant field. Thought should be dedicated to the possibility of employing independent laboratories to determine norms and supervise them. ? Payments in wholesale markets should be done through a ZPP counter or branch in the wholesale market itself. Release of the goods and exiting the physical location of the wholesale market should be allowed only against presentation of a ZPP payment slip.