Factors Contributing To Business Entry Rates In Bulgaria Economics Essay

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In 2008, there were 252,682 SMEs in Bulgaria which accounted for 99.5% of all enterprises registered in the country. Micro-enterprises represented 89.2% of this in 2007 (MEE, 2008, p. 11). Between 2004 and 2006, SME growth was extremely small at 1% a year and in 2007 this jumped to 10.2% (MEE, 2008, p. 11). However, small enterprises saw a different trend (10 to 49 employees) and although their numbers were very small (22,745 in 2007) they grew by 86.7% between 2001 and 2007 with medium enterprises growing by 67% between 2001 and 2007 (MEE, 2008, p. 11). Considering that SMEs contributed 38% towards the GDP in 2007, government policy (defined by the European Commission) was to put efforts into developing this sector of the economy. All the reports indicate that the European Commission has granted funds and ideas on how to develop SMEs, be it to introduce e-government submissions (where start ups can submit their administration online and use electronic services to manage them) or to offer entrepreneurial training throughout the educational life of the citizens and to develop the public procurement services. But, "In spite of the steps taken, however, there has been no significant change in the country's business environment over the past several years" (MEE, 2008, p. 17).

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A significant improvement was noticed once Bulgaria joined the EU in 2007 as SMEs started to get easier access to external finance. In 2005, local banks were reluctant to lend money to these businesses: especially those with no credit history. "The relatively high interest rates do not encourage entrepreneurs to take long-term investment credits, which to a great extent hinders the strategic decisions making. This is usually accompanied by heavy bureaucratic procedures in combination with high tax and social security burdens" (Alexandrova, 2004, 147).

Those that did obtain credit were faced with large interest rates on the loans. "In case of default, the lesser cannot foreclose on the asset if the lessee does not agree. Repossession in cases of default requires action by the local police backed by a court order. Local courts do not always fully understand the principles of leasing that puts timely repossession at risk. This reduces the incentives for financial institutions to offer leasing" (FAO, 2005, p.13). However, after the EU accession, the 2009 ESTAT survey showed that most SMEs were relying on bank loans.

The best performing SMEs are those that focus on the export business. In 2005, the most competitive industries were apparel and textile, wood processing, handicrafts, herbs and spices, tourism and organic agriculture (FAO, 2005, 22). It is essential for SMEs to keep innovation levels high, considering the increasing competitive pressures from China and India. Bulgaria's advantage is a high quality of goods at low prices, however in the long run further competitive advantages need to be established if SMEs are to succeed.

Political Instability

Bulgaria's political framework has changed dramatically over the last three decades. Whilst the rest of Eastern Europe took on the challenge of transition and selected political parties that could take them quickly through the process (shock therapy), Bulgaria was led by the BSP party whose goal was to maintain Bulgaria under the socialist ideology (Polity IV, 2009, p. 2). A deteriorating economic situation in the country and a failure to decrease corruption has led to an overthrow of the socialist party in 1997 (by the UDF) and in 2001 when the NDST (supporters of the King) came to power. This lasted until only 2005 when the socialists won the public vote again and the country was led by a coalition between the NDST and the BST. It was not until 2009 that the GERB came to power. The GERB is a centre-right party, which is pro on European integration and the development of an open economy (Polity IV, 2009, p. 2).

These frequent changes of power in Bulgaria stopped the SMEs from opening up and developing and this has also affected the innovation levels and curbed the risk taking behaviour which naturally allows SMEs to develop. Alexandrova (2004) argues that transition is always difficult for SMEs as structural reforms affect all aspects of their businesses. As government's change then the business environment is likely to change as well, be it tax legislation, regulations that govern the businesses or administrative responsibilities. In turn, SMEs prefer to make their profits quickly without a long-term strategy for their businesses. "These entrepreneurs prefer to gain rapid returns on their capital emphasising liquidity, but they are unwilling to widely re-invest for business expansion. They actually take a waiting position expecting appropriate conditions for more risky and innovative business behaviour" (Alexandrova, 2004, p. 146). New entrants are also discouraged from running the businesses officially as long term goals can't be identified whilst the rules of the game change. This risk adverse behaviour is not healthy for the economy as the rates of new entrants would be low whilst the existing SMEs will not be growing. Also long term strategy is also affected by uncertainty around future demand and economic conditions and Bulgaria experienced this with very radical changes in power over the years, from socialism to crown supporters, back to socialism and then capitalism but in a coalition. Each of the above ideologies have a completely different target, which means that people prefer to save rather than spend due to financial uncertainties. In turn, the SMEs can't earn if there is little spending in the country.

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It can be argued that this political instability was one of the main factors affecting SME development, especially considering the 1% growth of micro enterprises from 2004 to 2006 (MEE, 2008, p. 11). Entering the EU provided Bulgaria with the necessary stability to start making long term plans, which resulted in a large increase in SME growth (10.2% in 2007). However, in 2009 the corruption levels were still the highest in the EU (News.bg, 2009). Apart from the high crime rates, the European Commission is also aware that a lot of the money that is provided as grants to help the economy goes 'missing'. "But just over a year after it joined, three streams of EU funding have been suspended because of apparent fraud, and the EU's investigating agency has 45 cases of alleged Bulgarian malpractice on its books. 'Nothing's changed,' says Yovo Nikolov, an award-winning investigative reporter for the weekly magazine Kapital."

"If there was a real fight against corruption, you would see more corruption convictions from the courts" (BBC News, 2008). More recently in 2010 this situation has not changed: "In a recent letter to the Bulgarian government, the European Commission pointed out that only 1% of EU regional aid to Bulgaria had reached the intended beneficiaries since the country joined the EU" (BBC, 2010).

Taxes

Bulgaria enjoys one of the lowest tax rates in the OECD (Figure 1). The government has introduced a 10% flat corporate tax rate in 2007 and a 10% flat income tax rate in 2008 (EBRD, 2008, p.25). It is ranked 85 out of 183 for the ease and good practice of paying taxes (DBR, 2011, p. 52). This rank was primarily influenced by the introduction of a "one-stop shop" concept in 2006 of registering a business (EBRD, 2008, p.25). The total tax rate on profits decreased from 36.7% in 2008 to 29% in 2011 (DBR, 2011, p. 54).

Figure 1: Paying Taxes in Bulgaria

Source: MEE, 2008, p. 56

However, according to the ESTAT Survey (cited by MEE, 2008), the local community sees taxation as the biggest barrier to doing business and the biggest problem seems to be with the taxes related to profit and local tax. Furthermore, the survey showed that the majority of businesses expected taxes to increase, conspiring political instability and rising budget deficits: "a possible change, even a very slight one, may reduce the business community's confidence and escalate into open discontent" (MEE, 2008, p. 57). Other taxes, such as VAT and social insurance contributions also seem to cause a problem as the business community struggles to meet the payments and this is more acute in the construction and services sectors (MEE, 2008, p. 57). The VAT rate stands at 20%, and the threshold begins at BGN 50,000 (around £22,000) (DBR, 2011,p. 12).

According to Lampe (2007), there are a number of reasons why tax rates are seen as a problem in Bulgaria. First of all, due to high crime rates the SMEs need to pay off criminals in order to stay in business which in turn adds an 'unofficial tax burden' that has to be consumed by the enterprises. Secondly, taxes feed corruption: especially in the judicial system. "While the EU remains most concerned about the courts' failings in these cases, the wider economic problem is tax evasion and related smuggling, particularly now that the VAT, already 20 percent, must add extra EU excises on alcohol and tobacco" (Lampe, 2007, p. 3).

Despite these setbacks, the economic outlook for Bulgaria in 2011 is very positive. Even with the global recession, the country has not reported a negative economy growth. The Minister of Finance (during his talk in the Heritage Foundation) announced that this success was primarily due to:

Significantly lowering the capital requirements in order to start up a business: "Bulgaria eased business start-up by reducing the minimum capital requirement from 5,000 leva ($3,250) to 2 leva ($1.30). Bulgaria reduced employer contribution rates for social security." (DBR, 2011, p. 74).

Making sure that the tax rates for businesses were the lowest in the EU.

Cutting the governments spending and its workforce (Wilterdink, 2011).

Recommendations

It can be argued, that over the years, Bulgaria has shown very little improvement in the biggest policies that act as impediments to the SME growth. Corruption is still the biggest problem that the economy is facing. The country has already lost the EU's financial support in 2010 (BBC news, 2011). France and Germany declared in 2011, that the corruption has gone so far, that it will block Bulgaria from being a part of the Schengen passport-free zone. Corruption does not allow the country to prosper, and SMEs do not want to invest their money and effort when there is no clear future ahead.

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In 2011, OECD's report on corruption has shown that law enforcement system simply does not react to the efforts put in. The legislation has changed a number of times, but if not enforced, the efforts do not lead to the positive results. In turn, the main recommendations that are provided by the OECD report (2011) are to reduce the judicial immunity that is persistent in Bulgaria.

Bulgaria needs to start rebuilding the relationship it had with the EU partners. For example, the European Progress Microfinance Facility has agreed to increase the lending to the Bulgarian SMEs in 2011. Over 8 years it is estimated that $750m will be provided in the form of loans that will allow SMEs to start up and expand. However, if this "olive branch" will be "lost" to the corruption, once again, Bulgaria will miss out on a great opportunity to help its SMEs (MicroCapital, 2011).