pages 409 to 600 .

Transcription

pages 409 to 600 .

New Challenges of Economic
and Business Development – 2013
May 9 - 11, 2013, Riga, University of Latvia
INTEREST RATE IMPLIED VOLATILITY AND CONSUMER SENTIMENT
Raquel López, University of Castilla-La Mancha, Spain;
María Isabel Martínez, University of Mucia, Spain;
Eliseo Navarro, University of Alcalá, Spain1
Abstract. In this paper we examine the information content of interest rate volatility
for explaining the economic agents’ expectations on the business cycle as measured by
consumer confidence indicators. The volatility measure is the one-year implied
volatility of caps and floors. We find that implied volatility adds significantly to the
yield spread and the change in the short-term interest rate in explaining consumer
sentiment before and during the current financial crisis in the U.S. and Germany.
Moreover, implied volatility outperforms realized volatility in all of the cases.
Key words: consumer sentiment; expectations; term structure of interest rates; implied interest rate
volatility
JEL code: E32, E43
Introduction
There is a lot of literature concerning the ability of financial variables to predict business cycle. Kessel
(1965) showed evidence, for the first time, on the procyclical behaviour of the yield spreads between nine-to
twelve-month government securities and Treasury bills in the U.S. for the period from 1942 to 1953. Since
the late eighties, consistent empirical evidence on the predictive power of the yield spread can be found for
different countries and time periods.2 See, for instance, Estrella and Hardouvelis (1991) for evidence in the
U.S. over the period 1955-1988; Davis and Fagan (1997) for the E.U. countries from various 1970s up to
1992; Estrella and Mishkin (1997) for the U.S., the U.K., Germany, France, and Italy, covering the period
from 1973 to 1995; Kozicki (1997) for the G-7, Australia, Sweden, and Switzerland from 1970 up to 1996;
or, more recently, Duarte et al. (2005) for the Euro area over the period 1970-2000.3
Harvey (1988) provides a theoretical model based on the CCAPM that establishes a positive linear
relationship between expected real yield spreads and expected consumption growth. The underlying idea
behind this model can be described as follows. If investors expect an economic downturn, they will tend
to reduce current consumption in order to invest in long-term bonds that will provide an extra income in
the bad times. This practice then will raise the price of long-term bonds and reduce the corresponding
long rate, whereas the sale of short-term bonds will push short rates up. As a result, the yield curve will
flatten.
1
2
3
Corresponding author – e-mail address: [email protected], telephone: +349 18854295
The most commonly used spread in the literature is the one computed as the difference between the yield on a tenyear government security and the yield on a three-month security.
See also Wheelock and Wohar (2009) for a review of the most recent research on the usefulness of the term spread
for predicting changes in economic activity. According to the authors, many studies find that the spread predicts
output growth and recessions up to one year in advance, although several also find that its usefulness varies across
countries and over time.
Raquel López, María Isabel Martínez, Eliseo Navarro
409
Harvey (1988) tests this model on U.S. data from 1953-1987 and finds that the short end of the real
term structure of interest rates is significant for predicting consumption growth from quarter t+1 to
quarters t+3 and t+4, mainly since 1972. Furthermore, he finds that the model outperforms both in sample
and out-of-sample alternative models based on lagged consumption growth or lagged real stock returns as
explanatory variables.
Results in Harvey (1988) show that the short-term expected real rate does not contribute significantly
to the explanatory power of the model, thus Harvey (1989) extends the analysis in Harvey (1988) by
using a simplified version of his model in which the only explanatory variable is the spread, with the
expected real short-term rate contained in the intercept. In addition, some other changes are introduced
into the model. In particular, the U.S. real GNP annualized growth from quarter t+1 to quarter t+5 is used
as a proxy of expected consumption, and the real yield spread is also replaced by the nominal spread,
where the long-term rates are the five- and ten-year yields instead of the yield of a bond with five quarters
to maturity. He finds that the spread alone is able to explain more than 30 per cent of the variation in
economic growth. The simplified version of the model is also tested for the G-7 countries over the period
1970-1989 by Harvey (1991), where the most favorable empirical evidence on the predictive power of the
yield spread is reported for Canada, Germany, and Italy, in addition to the U.S.
Another branch of the literature (see Davis and Henry, 1994; Davis and Fagan, 1997; Dueker, 1997;
Dotsey, 1998; and Hamilton and Kim, 2002, among others) attributes the ability of the yield spread to
forecast economic activity to monetary policy actions. The argument runs as follows. A contraction of
monetary policy causes short-term interest rates to rise; however, market participants will probably expect
future short-term rates to be lower than current short-term rates once economic growth slows or inflation
decreases. As a result, according to the expectations theory of the term structure, long-term rates will rise
less than short-term rates and, hence, the slope of the yield curve will drop. Monetary policy tightening
will bring about a future decline in investment and, consequently, an economic deceleration. Thus, the
yield spread falls in advance of an economic slowdown and vice versa. 4
The monetary policy explanation has been repeatedly tested in the literature by regressing real
economic growth from time t to time t+N , on both the yield spread observed at time t and a new variable
representing the current stance of monetary policy. That is,
Based on this regression equation, Estrella and Hardouvelis (1991) find that the yield spread
(computed as the difference between yields on ten- and three-month Treasury securities) alone is able to
explain more than 30 percent of the cumulative change in real GNP from three- to eight-quarter horizons,
and that it continues to be statistically significant when the real (nominal) federal funds rate or the threemonth Treasury bill rate are also significantly included into the equation as explanatory variables. That is,
the spread appears to contain information for future economic growth over and above that provided by
variables that reflect the stance of monetary policy. 5 Plosser and Rouwenhorst (1994), Estrella and
Mishkin (1997), Moersch (1996), Kozicki (1997), Dotsey (1998), and Hamilton and Kim (2002) confirm
these results and extend the evidence to other countries.
Thus, the joint forecasting ability of the yield spread and short-term interest rates on economic growth
has been consistently tested in the financial literature for different countries. Concerning interest rate
volatility, we are aware of only a few studies that address the information content of interest rate volatility
for predicting economic activity.
Andreou et al. (2000) analyze the behavior of certain financial variables and their volatilities over the
business cycle in the U.S., the U.K., and Germany from 1970 up to 1998. Volatilities are calculated as the
square of the first difference of the series. They find that the volatility in the term structure appears to be
4
5
Nevertheless, according to Wheelock and Wohar (2009), this argument has been usually stated with little
underlying theory.
According to Beranke and Blinder (1992), short-term rates can be considered good indicators of monetary policy
actions.
410
procyclical and to lead industrial production growth in the U.K., whereas the volatility of real short- and
long-term rates appears to have countercyclical and leading indicator properties in Germany. 6 However,
interest rate volatility does not seem to lead economic activity in the U.S.
Annaert et al. (2001) analyze the extra information content of short-term interest rate and stock return
volatility over two traditional leading indicators of the business cycle: the yield spread and stock returns.
Volatility estimates of short-term interest rates as constructed as mean absolute deviations, over a onemonth interval, of daily changes in three-month interest rates. Results in this study show that interest rate
volatility adds significantly to the yield spread and real stock returns to forecast the probability of future
recessions up to twelve months in advance in the U.S., Germany, and Japan for a sample starting at
different 1960s and ending at 2000. As expected, higher interest rate volatility increases the probability of
entering a recession. However, the sign and the statistical significance of stock return volatility differ
between countries.
More recently, Fornari and Mele (2009) analyze the single and in blocks forecasting power on
industrial production growth of a wide set of macroeconomic and financial variables and their volatilities
(including the yield spread) in the U.S. for the period 1957-2008. They obtain that in-sample forecasts of
up to two-year growth in industrial production based on the volatility of the spread between the ten-year
government bond yield and the three-month Treasury bill rate outperform forecasts based on stock market
volatility. Volatility is defined as a moving average of past absolute returns.
As stressed, all these studies use volatility estimates based on historical data. So far, we are not aware
of any study that analyzes the forecasting performance of, according to Annaert et al. (2001), the most
forward-looking volatility estimate: the volatility implied from interest rate options. We build on this
issue by analyzing the information content of interest rate volatility for explaining economic agents’
expectations regarding the future state of economy.
Data
The study is performed on U.S. and Germany data from January 1995 to July 2011. Next we describe
the four variables involved in our empirical model: the consumer confidence index (CCI), the yield
spread, the change in the three-month interest rate, and the one-year implied volatility. Then we analyze
the statistical properties of the series.
In order to measure expectations about future economic activity, we employ the Conference Board
CCI for the U.S. and the Icon CCI for Germany. Data have been obtained from Reuters.
The link between consumer confidence and spending can be found in the work by Katona (1968). The
author states that consumer spending is a function both of ability to buy and willingness to buy. While the
ability to buy is mainly a function of disposable income, the willingness to buy depends primarily on
attitudes and expectations about personal finances and the economy as a whole. And this is specifically
what questions included in these two indices cover.
In addition, according to Curtis (2007), consumer spending accounts for one-half to two-thirds of all
spending in market-based economies, and hence even small changes in household spending can have a
major impact on the economy. Empirical evidence in this study for an extensive group of countries shows
that consumer confidence in Germany and the U.S. (based on the same questionnaires that we use in this
paper) Granger causes changes in more than 50% of the economic variables included in the analysis. 7
6
7
See also Sun (2005) and Gerlach et al. (2006) for further evidence on the countercyclical properties of the volatility
of short-term interest rates (Treasury bill rates and interbank rates) and bond returns, respectively.
These variables are the unemployment rate, inflation rate, interest rates, personal income, GDP, total personal
consumption, retail sales, expenditures for durables, and vehicle registrations.
411
The Conference Board CCI is closely followed by financial markets and business community and so it
is treated by financial press as an important piece of economic information. It is constructed on the basis
of a monthly household survey of consumers’ perceptions of current business and employment
conditions, and their expectations over the next six months concerning business situation, employment, as
well as their total family income. 8 The index is benchmarked to 1985 = 100. Thus, values greater than 100
indicate above-average consumer confidence and vice-versa.
Questionnaires used to obtain the monthly value of the index are mailed to sample households at the
end of the previous month, and responses flow in throughout the survey month. Responses received up to
approximately the eighteenth of the month are used for the preliminary estimates of the index, which the
Conference Board releases on the last Tuesday of the survey month. Final estimates for the month based
on all the responses received are released with the next month’s preliminary figures and are not subject to
further revision. So we use final estimates of the index in our study.
The Icon CCI is based on the German consumers’ responses to the E.U. harmonized consumer survey
elaborated by the European Commission. 9 However, we prefer this index instead of the one published by
the European Commission since the former is scaled to have a long-term mean of 100. In this way, values
above 100 indicate that optimistic consumer estimates outweigh the pessimistic ones, while values below
100 indicate the opposite.
Specifically, consumers are asked about their expectations of change in the financial position of their
households, the general economic situation and employment, as well as their saving possibilities over the
next 12 months.10
Surveys responses are normally collected in the first half of the month and transmitted to the European
Commission services around one week before the end of the month. Based on the results of the surveys,
the Icon CCI is then released in the first calendar week after the end of the month that is reported about.
A usual dilemma that academics have to face when working with indicators of consumer sentiment is
whether to focus on index-level or monthly changes. The decision must depend basically on the time
frame of the questions included into the consumer surveys. In this case, both consumer confidence indices
ask about changes in the near-future, suggesting that the indices are measures of change in sentiment (see
Matsusaka and Sbordone (1995)). Given this and the fact that both indices are scaled to have a long-term
mean of 100, we use data in levels.
As for interest rates, we collect daily data on three- and 12-month yields on U.S. Treasury securities,
and three- and 12-month interbank interest rates from the Bundesbank. Given that the Conference Board
CCI and the Icon CCI cover expectations over the next six and 12 months, respectively, the 12-month
interest rate is selected to represent the long-term rate.11
In order to obtain the monthly data on interest rates, we proceed in two different ways depending on
the collection period of the survey responses used to estimate the values of the consumer confidence
indices. This way, since the final monthly data of the Conference Board CCI are based on responses
received during the whole month, the monthly interest rate data for the U.S. are the average of the daily
data corresponding to the month of reference. However, in regard to German interest rates, given that
surveys responses used to estimate the Icon CCI are collected in the first half of the month the index is
8
See technical notes on the consumer confidence survey available at the website of the Conference Board for further
details.
9
See “Joint Harmonised E.U. Programme of Business and Consumer Surveys (12.10.2006)” and “The Joint
Harmonised E.U. Programme of Business and Consumer Surveys. User Guide 2007” for a complete description of
the survey (questionnaires, timetable, use of information…). Further information about the Icon CCI can be found
at http://icon-added-value-source.com/.
10
Thus, it must be highlighted that consumers are not surveyed on the future development of any financial market
variable in any case.
11
This is in accordance to Plosser and Rouwenhorst (1994), who match the maturity of long-term rates to the forecast
horizon of growth rates of industrial production.
412
reported about, the monthly data on interest rates are the average of daily data collected from the second
fortnight of the prior month up to the first fortnight of the month of reference.
The yield spreads for both countries are then just obtained as the difference between the monthly
continuously compounded annualized 12- and three-month interest rates. As usual in the literature on the
predictive power of the yield spread, we also use a monetary policy variable: the monthly change in the
three-month interest rate.12
So, the first monthly average data on interest rates for Germany is computed from daily data
corresponding to the period from the second fortnight of January 1995 up to the first fortnight of February
1995. Thus, the first data on the change in the three-month interest rate for Germany is obtained as the
difference between the monthly average data corresponding to the period from the second fortnight of
February 1995 up to the first fortnight of March 1995 and the monthly average data corresponding to the
period from the second fortnight of January 1995 up to the first fortnight of February 1995. Thus, the first
data on CCI in our study is March 1995 for both countries.
With respect to interest rate volatility, most papers first need to deal with the problem of its estimation
since it is a non-observable variable. However, in this study we use implied volatilities from the cap
(floor) market with a twofold purpose. First, data can be directly obtained from the market, and second,
this is a forward-looking measure of interest rate volatility.
In particular, we collect daily volatility (bid close) quotes of at-the-money (ATM) one-year caps and
floors for the U.S. and the Euro area from Reuters. 13 It is important to point out that these implied
volatilities are used to obtain the prices of caps and floors by applying the well-known Black pricing
formula. According to the Libor Market Model (LMM), the use of this pricing formula can be justified
under the assumption that forward interest rates follow a lognormal stochastic process. Then, volatilities
implied from caps and floors can be considered some sort of average of the instantaneous volatility of the
logarithm of the forward rates up to me maturity of the contracts.14 So these volatilities are forwardlooking. This way, the one-year implied volatility represents the market estimation of the volatility of
three-month forward interest rates over the next year. 15
With respect to the estimation of the monthly average data on volatility from daily data, we proceed in
a similar way as for interest rates for the U.S. and Germany. Thus, we use interest rate and volatility data
that are available around one month before the CCI is published in the case of the U.S., and around three
months before in the case of Germany.
In the U.S., the average level of consumer confidence remained just below the neutral 100 mark over
the whole period. However, as suggested by the standard deviation, it was remarkably variable not only
across the entire sample but also within the two subperiods. Thus, the differences in the index level before
and during the crisis are noticeable: the mean of the index values dropped from 110.16 to 58.66. It is not
the case for Germany, where consumer confidence stayed on average around 92 over the two subperiods.
The yield spread between the 12- and the three-month interest rates was three times higher during the
crisis period than before in Germany, and nearly 50 percent higher in the U.S. Statistics also show that the
monthly difference in the three-month interest rate series was more stable in both countries before the
crisis burst out. The average implied volatility level and its standard deviation were greater in the U.S.
than in the Eurozone throughout the sample period and in both subperiods. Moreover, as expected,
interest rate volatility was noticeably higher during the crisis period than before in the U.S. and Germany:
more than 3.5 and two times higher, respectively. The autocorrelations show that consumer confidence
indices and implied volatilities are the most persistent series in both countries.
12
Dotsey (1998) and Hamilton and Kim (2002), for instance, use the change in the Federal funds rate as a measure of
changes in monetary policy.
13
Quotations for countries that belong to the Euro area are just provided for the whole of the Eurozone.
14
See, for instance, Brigo and Mercurio (2001) for a comprehensive overview of caps (floors) valuation within the
LMM framework.
15
Caps and floors with terms to maturity of one year from the U.S. and Euro area markets have a three-month tenor.
413
In order to obtain an appropriate specification of our regression equations, that will be tested over the
pre-crisis and the crisis periods, we further investigate the stationarity of the series over both subperiods
by conducting the KPSS (Kwiatkowski-Phillips-Schmidt-Shin) stationarity test (specified with and
without a time trend).16 The null hypothesis of stationarity is accepted at the 1% level for both
specifications of the test for the four series in both countries over the first period. From the KPSS test
performed over the second period, the null hypothesis is also accepted in all the cases, with the possible
exception of the implied volatility for the U.S. where the evidence is mixed. Nonetheless, results from the
test should again be considered with caution due to the well-known limited power of stationarity and unit
root tests when conducted on small size samples.
The information content of interest rate volatility on economic agents’ expectations
160.00
0.01
0.008
0.006
0.004
0.002
-2E-18
-0.002
-0.004
-0.006
140.00
CCI_US
120.00
100.00
80.00
60.00
40.00
20.00
CCI_US
Spread_US
Figures 1 through 6 show CCI against the yield spread (spread), the change in the three-month
interest rate (ΔR), and the one-year implied volatility (ivol) for the U.S. and Germany, respectively,
for the overall period. In addition, Table 1 shows the linear correlation coefficients between CCI and
the explanatory variables the index will be regressed on, for both countries and for the two
subperiods we divide the sample into. Results show that there exists a positive relationship between
the German CCI and the yield spread, but this is weaker since the beginning of the crisis.
Unexpectedly, we obtain the opposite sign for the U.S. before and during the crisis, where the linear
fitting releases a correlation coefficient of -0.54. CCI and the change in the three-month interest rate
are positively correlated in Germany. In addition, the relationship is particularly strong during the
crisis period: the correlation coefficient is 0.61. In the case of the U.S., we observe that after the
burst of the crisis, the relationship between these two variables has inverted. Unlike correlation
coefficients between CCI and the previous two variables, linear fitting results obtained for the one year implied volatility are robust between countries: there exists a strong negative correlation
between consumer confidence and volatility during the pre-crisis and crisis periods.
Spread12M3M_US
Fig. 1. The Conference Board CCI for the U.S. (line) and the yield spread
between the 12- and three-month interest rates (dash)
16
Results will be provided upon request.
414
120.00
110.00
100.00
90.00
80.00
70.00
60.00
0.008
0.006
0.004
0.002
0
-0.002
-0.004
Spread_GERMANY
CCI_GERMANY
0.006
0.004
0.002
0
-0.002
-0.004
-0.006
-0.008
-0.01
-0.012
ΔR_US
160.00
140.00
120.00
100.00
80.00
60.00
40.00
20.00
0.006
0.004
0.002
0
-0.002
-0.004
-0.006
-0.008
-0.01
-0.012
ΔR_GERMANY
CCI_US
Fig. 2. The Icon CCI for Germany (line) and the yield spread
between the 12- and three-month interest rates (dash)
CCI_GERMANY
Fig. 3. The Conference Board CCI for the U.S. (line) and the change
in the three-month interest rate (dash)
120.00
110.00
100.00
90.00
80.00
70.00
60.00
Fig. 4. The Icon CCI for Germany (line) and the change
in the three-month interest rate (dash)
415
1.2
1
0.8
0.6
0.4
0.2
0
ivol_US
160.00
140.00
120.00
100.00
80.00
60.00
40.00
20.00
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
ivol_GERMANY
CCI_US
Fig. 5. The Conference Board CCI for the U.S. (line)
and the one-year implied volatility (dash)
CCI_GERMANY
120.00
110.00
100.00
90.00
80.00
70.00
60.00
Fig. 6. The Icon CCI for Germany (line)
and the one-year implied volatility (dash)
Table 1
Linear correlation coefficients between CCI and the explanatory variables
spread
a
ΔR
ivol
United States
Pre-crisis period
(1995:03-2007:07)
Crisis period
(2007:08-2011:07)
-0.15
0.14
-0.69
-0.54
-0.26
-0.53
Pre-crisis period
(1995:03-2007:07)
Crisis period
(2007:08-2011:07)
0.26
0.25
-0.59
0.11
0.61
-0.48
Germany
a
Spread is the difference between the 12-and three-month interest rates; ΔR represents the change in the three-month interest rate;
and ivol stands for the one-year implied volatility.
416
Next, we estimate the first basic regression equation:
CCI t / 100   0  1 ( Rt(12)  Rt(3) )   2 Rt(3)   t ,
(1)
where CCIt is the Consumer Confidence Index for month t; Rt(12) and Rt(3) are the monthly average data
on the 12- and three-month interest rates, respectively, obtained as described in the previous section; and
Rt(3) represents the monthly change in the three-month interest rate.
Table 2
OLS regression results based on Equation [3]
a
CCI t / 100   0  1 ( Rt(12)  Rt(3) )   2 Rt(3)   t
1
0
a
Pre-crisis period
(1995:03-2007:07)
Crisis period
(2007:08-2011:07)
1.11**
(0.12)
0.71**
(0.02)
Pre-crisis period
(1995:03-2007:07)
Crisis period
(2007:08-2011:07)
0.90**
(0.05)
0.90**
(0.05)
United States
-9.93
(10.78)
-51.25**
(7.29)
Germany
9.77
(6.25)
6.04**
(0.48)
2
R2
22.64
(14.34)
-20.35**
(6.66)
0.04
8.32
(5.38)
31.49**
(0.11)
0.07
0.45
0.34
Inside the parentheses are standard errors computed using the Newey and West (1987) correction for autocorrelation and
heteroskedasticity. One asterisk denotes statistical significance at the 5% significance level. Two asterisks denote statistical
significance at the 1% significance level. R2 is the adjusted coefficient of determination.
OLS regressions results based on Equation [3] for the U.S. and Germany over the pre-crisis and crisis
periods are depicted in Table 2. Given the possible correlation between the explanatory variables, the change
in the short-term interest rate is orthogonalized. In addition, since the Conference Board CCI measures
expectations over the next six months and the Icon CCI does over the next 12 months, we consider that there
exists overlap in the dependent variables of five and 11 months, respectively. Overlapping does not affect
the consistency of the OLS regressions coefficients but does affect the consistency of the OLS standard
errors. Thus, standard errors are corrected by using the Newey and West (1987) method of adjustment,
including five lags in regressions for the U.S. and 11 lags in the case of Germany.
We find that the coefficients on the yield spread and the monetary policy variable are not different from
zero at usual levels of significance during the pre-crisis period in both countries. Thus, the explanatory power
of these regressions is low. However, the yield spread and the change in the three-month interest rate
significantly help explain CCI during the crisis period. Particularly, both variables jointly are able to explain a
striking 45 percent of the variation in CCI in the U.S., and more than 30 percent in Germany. In addition, as
expected from the linear correlation analysis, we obtain that the coefficients on the yield spread and the shortterm interest rate have opposite signs in these two countries: negative in the U.S. and positive in Germany.
Thus, two conclusions can be drawn from this analysis. One the one hand, we find that the yield
spread coefficient remains significant for explaining consumer confidence when a monetary policy
measure is also included in the regression. This suggests that information contained in the spread is not
only a consequence of its link with monetary policy, but that it also reflects general economic conditions
independent of monetary policy actions. This in line with previous empirical evidence provided in
different papers in which the dependent variable is some measure of output growth. On the other hand,
417
results in this study suggest that these two variables significantly help capture consumer expectations only
during the crisis period, although the sign of the coefficients is not robust between countries.
In the second basic regression equation we regress CCI for month t, CCIt, on the monthly average data
of one-year implied volatility, ivolt,:
CCI t / 100   0   1ivolt   t ,
(2)
Regression results on the information content of implied volatility for explaining consumer confidence
are provided in Table 3.
Table 3
OLS regression results based on Equation [4]a
CCI t / 100   0   1ivolt   t
1
0
Pre-crisis period
(1995:03-2007:07)
Crisis period
(2007:08-2011:07)
Pre-crisis period
(1995:03-2007:07)
Crisis period
(2007:08-2011:07)
a
United States
1.31**
(0.20)
0.81**
(0.06)
Germany
1.06**
(0.03)
1.07**
(0.01)
R2
-0.99*
(0.49)
-0.31**
(0.06)
0.48
-0.83**
(0.15)
-0.39**
(0.05)
0.35
0.26
0.22
significance at the 1% significance level. R2 is the adjusted coefficient of determination.
In this case, we find that the coefficients on the implied interest rate volatility are negative and
significant before and during the crisis in the two countries. That is, results suggest that volatility is a robust
variable in explaining economic agents’ expectations on the future state of the economy. In particular,
implied volatility alone helps explain 35 percent of the variation in CCI before the crisis, and 22 percent
during the crisis period in Germany. Results are more favorable for the U.S., especially before the crisis,
where implied volatility alone is able to explain nearly an outstanding 50 percent of the variation in CCI.
At this point, we have obtained that the yield spread and the change in the three-month interest rate are
useful for explaining consumer confidence after July 2007, and that implied volatility contains significant
information on consumers’ expectations during the two subperiods considered. Thus, we expect that volatility
adds significantly to the yield spread and the change in the three-month interest rate for explaining consumer
sentiment before the crisis. The most interest point that we want to check is whether uncertainty on the
future development of interest rates also provides significant additional information beyond that contained in
the previous two variables during the crisis periods. In addition, we want to investigate further whether
implied volatility significantly outperforms a volatility measure based on historical data of interest rates.
Thus, the basic regression model depicted in Equation [3] is augmented by including the one-year
implied volatility. That is, we estimate the following equation:
CCI t / 100   0  1 ( Rt(12)  Rt(3) )   2 Rt(3)   3ivolt   t ,
(3)
where CCIt, R , R , R , and ivolt are defined as before. In this case, in addition to the three-month
interest rate, the implied volatility variable is also orthogonalized.
(12)
t
418
( 3)
t
( 3)
t
Results for the augmented regression equation in [5] are depicted in Table 4. As expected, implied
volatility noticeably increases the in-sample forecasting accuracy obtained from Equation [3] before the
crisis in both countries, but the adjusted R 2 s are the same obtained when CCI is regressed only on
implied volatility. The second part of the sample offers the most appealing results. They show that
implied interest rate volatility lets enhance the explanatory power of the model including only the spread
and the change in the short-term interest rate as explanatory variables in a 42 percent and a 58 percent for
the U.S. and Germany, respectively. Particularly, the augmented model is able to explain a remarkable 64
percent of the variation in CCI for the U.S., and a 54 percent in the case of Germany.
Table 4
OLS regression results based on Equation [5].
a
CCI t / 100   0  1 ( Rt(12)  Rt(3) )   2 Rt(3)   3ivolt   t
0
a
Pre-crisis period
(1995:03-2007:07)
Crisis period
(2007:08-2011:07)
1.11**
(0.09)
0.71**
(0.02)
Pre-crisis period
(1995:03-2007:07)
Crisis period
(2007:08-2011:07)
0.90**
(0.02)
0.90**
(0.02)
1
2
United States
-9.93
22.64
(9.83)
(24.45)
-51.25**
-20.35**
(3.67)
(4.55)
Germany
9.77**
8.32**
(2.91)
(2.67)
6.04*
31.49**
(8.47)
(7.90)
3
R2
R2
[ 5]
/ R2
-1.01**
(0.34)
-0.26**
(0.03)
0.47
11.75
0.64
1.42
-0.80**
(0.18)
-0.52*
(0.20)
0.34
4.85
0.54
1.58
[ 3]
[ 5]
[ 3]
significance at the 1% significance level. R2 is the adjusted coefficient of determination; and R 2 / R 2 stands for the quotient
between the adjusted coefficients of determination obtained from regressions based on Equation [5] and the adjusted coefficients
of determination obtained from regressions based on Equation [3].
Finally, in order to compare the explanatory ability of implied interest rate volatility to that of the
realized volatility, we also estimate the following model:
CCI t / 100   0  1 ( Rt(12)  Rt(3) )   2 Rt(3)   3 hvolt   t ,
(4)
where CCIt, Rt(12) , Rt(3) , Rt(3) are defined as in Equations [3] and [4]; and hvolt stands for the historical
volatility constructed as mean absolute deviations, over a one month interval, of daily logarithmic
changes in the one-year interest rate17. Similar to Equation [5], the change in the three-month interest rate
and the historical volatility are orthogonalized.
Table 5 reports the results. We find that historical volatility is negative and significant at usual levels of
significance, except for the crisis period in Germany. Favorable to our expectations, we obtain that the insample forecasting ability of the model including the implied volatility outperforms the model including
the historical volatility measure in all the cases. The explanatory power of the model including the
implied volatility within the pre-crisis period is 42 percent higher than that of the model including the
17
This is also the volatility measure employed in the work by Annaert et al. (2001). Poon and Granger (2003) provide
an extensive review on the forecasting performance of various volatility measures and find that after implied
volatility, the historical volatility provides the second best forecasting.
419
historical volatility for the U.S., and 36 percent higher in the case of Germany. For the crisis period,
adjusted R 2 s from regressions based on Equation [5] for Germany and the U.S. are 63 and 33 percent,
respectively, greater than those based on Equation [6].
Table 5
OLS regression results based on Equation [6]
a
CCI t / 100   0  1 ( Rt(12)  Rt(3) )   2 Rt(3)   3 hvolt   t
0
a
Pre-crisis period
(1995:03-2007:07)
Crisis period
(2007:08-2011:07)
1.11**
(0.10)
0.71**
(0.03)
Pre-crisis period
(1995:03-2007:07)
Crisis period
(2007:08-2011:07)
0.90**
(0.00)
0.90**
(0.03)
1
2
United States
-9.93
22.64
(10.48)
(18.16)
-51.25**
-20.35**
(6.81)
(3.28)
Germany
9.77**
8.32
(2.60)
(4.79)
6.04
31.49**
(30.50)
(9.37)
3
R2
R2
[ 5]
/ R2
-14.33**
(4.93)
-2.74*
(1.09)
0.33
1.42
0.48
1.33
-11.83**
(1.92)
2.06
(9.63)
0.25
1.36
0.33
1.63
[ 6]
[ 5]
[ 6]
significance at the 1% significance level. R2 is the adjusted coefficient of determination; and R 2 / R 2 stands for the quotient
between the adjusted coefficients of determination obtained from regressions based on Equation [5] and the adjusted coefficients
of determination obtained from regressions based on Equation [6].
Thus, overall, results from this study suggest that implied volatility contains extra information for capturing
consumer sentiment not already embodied in two traditional leading economic indicators of the business cycle:
the yield spread and a variable that reflects the stance of monetary policy. In addition, these results are robust to
the inclusion of the period associated to the current financial crisis. Given that we use interest rate and volatility
data that are available at least three months before the consumer confidence indices are published, we are able
to explain in advance an important percentage of the variability of the indices. Concerning the most suitable
volatility measure for capturing uncertainty on interest rates, the results we obtain are quite concluding. As
expected, a forward-looking measure of volatility is able to explain a greater percentage of the variation in CCI
than a volatility measure based on historical data of interest rates.
Conclusions
Since the late eighties, many papers have shown consistent empirical evidence on the usefulness of the
slope of the term structure of interest rates (the yield spread) for predicting economic growth. Moreover,
expectations are the foundation of the most widespread explanations on this forecasting ability. In this
paper we want to implicitly check the hypothesis on the information content of financial variables for
explaining economic agents’ expectations by using another variable in addition to the yield spread: the
interest rate variable. In particular, we analyze the ability of interest rate volatility to capture economic
agents’ expectations regarding future economic activity, and whether it provides extra information
content over the yield spread.
420
For this purpose we must decide how to measure expectations and volatility. For the first issue we
employ consumer confidence indicators which contain consumers’ expectations over the near-future (six
or twelve months) concerning micro- and macro-economic aspects over which they have no control.
Concerning the second non-observable variable, we suggest using a forward-looking measure of volatility
not based on historical data of interest rates. This is the volatility implied from the market prices of caps
and floors according to the Black-pricing formula. Thus, it can be understood as an estimation of the
average future volatilities of a set of forward interest rates with consecutive terms to maturity up to the
expiration date of the contracts. That is, it reflects the market consensus on the uncertainty regarding the
future development of one of the most important financial variables: interest rates.
Outcomes from this study suggest that implied volatility is a robust variable for explaining consumer
sentiment before and during the crisis both in Germany and the U.S. As expected, there exists a
significant negative relationship between consumer sentiment and interest rate volatility. In addition, we
find that implied volatility can add significant explanatory power to the yield spread in order to explain
economic agents’ expectations of future economic growth. Moreover, the in-sample forecasting accuracy
of the model including the implied volatility as the volatility measure is always greater than that obtained
when a realized volatility measure is used instead. Thus, it seems to support the extra information content
of a forward-looking measure of volatility on economic agents’ expectations.
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422
PROFESSIONAL EDUCATION IN RUSSIA: LEGAL AND FINANCIAL
ASPECTS OF TRANSFORMATION
Tatiana Maidan, Saint-Petersburg State University
of Service and Economics, Russia1;
Lada Podolyanets, Saint-Petersburg State University
of Service and Economics, Russia;
Anastasiya Porokhova, Saint-Petersburg State University
of Service and Economics, Russia
Abstract. Purpose. In the situation of long and officially latent crisis there is a change of
financing organization in the country. It includes a change in Federal budget expenditures
on education, organizational changes in the quantity and structure of higher education
institutions, the introduction of efficiency standards for activity of institutes and universities.
So the main purpose of the paper is to analyze problems and prospects of higher
education system transformation in Russia and develop proposals for the removal of
problems identified.
Methodology. Positive and normative analyses are used. The concept of state
regulation of economy is a foundation of the investigation.
Results: Solution of the reforming of higher education should be sought not on the way
a significant reduction the number of higher education institutions. The high level of the
population education – it is not only an investment to lift the domestic economy, but it is
also a necessary condition for human potential development, so – for the country welfare.
Reformation of the education system of the Russian Federation is carried out without
considering the needs of society, which is manifested in the absence of a positive effect.
However, comparison of the reform program with the changes of consumer preferences,
market demands, as well as indicators and characteristics of educational institutions,
will help to achieve a positive result.
It is necessary to create of common educational websites, which will contain information
actual at present on all courses of the higher school. Besides, much attention has to is paid
to creation of the imitating models working as in real time, and in limited temporary terms
in the various directions of training. Such approach will allow students to form necessary
practical and professional skills which aren’t fully formed at existing education system and
practically are not realized in the traditional distance learning system.
Keywords: professional education, financing, higher educational institutions, education reform, distance
learning
JEL code: I122
1
Corresponding author – e-mail address: [email protected], telephone: +7(812) 650 65 63
Tatiana Maidan, Lada Podolyanets, Anastasiya Porokhova
423
Introduction
At the present time there are two types of education standards in the system of special and higher
education of the Russian Federation - diploma and two-level system of higher education (bachelor and
master). The transition to the two-level system legislatively carried out just under the impact of the
economic crisis.
Current trends of special and higher education financing in the Russian Federation are reviewed in the
paper. At the present time there are two types of education standards in the system of special and higher
education of the Russian Federation – diploma and a two-level system of higher education (bachelor and
master). Just under the impact of the world economic crisis legislatively carried out the transition to the
two-level system. In this work problems and prospects of such transformation are analyzed. Financing of
higher school in the Russian Federation is exacerbated by the demographic problems of the country.
In the conditions of long and officially latent crisis there is a change of financing organization in the
country. It includes a change in Federal budget expenditures on education, organizational changes in the
quantity and structure of higher education institutions, the introduction of efficiency standards for activity
of institutes and universities. As a result the state differentiation of educational institutions takes place
instead of market-public differentiation.
According to the results of such differentiation various conditions are provided to various educational
institutions. It concerns both the preparation of students, and scientific and educational-methodical
activity of teachers and scientific staff. This approach fixes the position of the educational institution in
their group, not allowing to develop the competition in the service sector, which includes an education.
The main purpose of the research is to analyze problems and prospects of higher education system
transformation in Russia and develop proposals for the removal of problems identified.
Tasks of the research are following:
 to review current trends of special and higher education financing in the Russian,
 to analyze problems and prospects of higher education transformation in a two-level system,
 to identify the features of the competency-based approach in the implementation of the new
education standards,
 to develop offers on elimination of problems identified.
Positive and normative analyses are used in this research and also the concept of state regulation of
economy is a foundation of the investigation.
The authors reveal the features of the competency-based approach in the implementation of the new
education standards. Authors believe that the offered state approach of the maximal transition to distance
learning for economy of means in the higher and vocational school is ambiguous and doesn’t allow the
student to get the required volume of knowledge and especially practical skills. The authors propose to
make changes to this paradigm of education, having added it, and at the same time having limited it
widespread.
The article deals with the proposals for the creation of common educational web sites, which will
contain information actual at present on all courses of the higher school. Besides, much attention has to is
paid to creation of the imitating models working as in real time, and in limited temporary terms in the
various directions of training. On authors’ opinion, such approach will allow the listener to form
necessary practical and professional skills which aren’t fully formed at existing education system and
practically are not realized in the traditional distance learning system.
Education reform requires changing the order of modernization. Practical implications of the research
are that the authors propose to establish normative regulation categories of education quality, because at
the present time educational institutions do not have information on demands placed on them. The above
requirements should represent a concept of characteristics totality that reflects to the level of the
educational institution. For example, such characteristics include the demand for graduates.
424
Legal and Financial Aspects
Russian society, changing economic, political and state structure, has felt the necessity to make
changes in the well-established education system. This necessity is dictated by the new demands of the
society for citizens who possess a certain volume of knowledge that is important in the modern
professions and able to reach certain purpose of the state. Reforming of the national system of higher
education is caused by demands of the general (note: general, and not only economic) development of the
country. It is necessary to bring the country on the frontiers of post-industrial or information society,
ensuring its people a decent life in compliance with the modern standards of scientific, technical, socioeconomic, spiritual and cultural progress.
For the preparation of highly trained and qualified personnel are required systematic and significant
investments in education.
Realizing the important role of education, the countries with a developed market economics
implemented serious investment in the development of this sphere in the last 15-20 years. We have, in
accordance with the Education Act, the money allocated to this sphere in two times less than in the West.
Public and private expenditures on education in Russia, according to the authors of the report of the
OECD “Education at a Glance – 2011” account for only 4.7 per cent of GDP, while in the OECD
countries – 6.1 [1].
For instance, public expenditure on education in the EU-27 in 2009 was equivalent to 5.4% of GDP,
while the expenditure of both public and private sources of funds on educational institutions amounted to
6.2% of GDP (see Table 1).
The highest public spending on education relative to GDP was observed in Denmark (8.7% of GDP), while
Cyprus (8.0%), Sweden (7.3%), Finland (6.8%), Belgium (6.6%) and Ireland (6.5%) also recorded relatively
high proportions. Most Member States reported that public expenditure on education accounted for between
4% and 6% of their GDP (note that the data for Luxembourg excludes the tertiary education sector). Between
2004 and 2009 the combined public and private expenditure on education as a share of GDP rose by 1.9
percentage points in Ireland, 1.6 percentage points in Malta and by 1.5 percentage points in the United
Kingdom; the only Member States to record a decrease in their relative expenditure were Slovenia, Slovakia
and Poland, all down by either 0.1 or 0.2 percentage points. It should be noted that changes in GDP (growth or
decline) can mask significant increases or decreases made in terms of education spending. [2].
Meanwhile, the state support of education is a long-term investment in the future economic and social
stability.
Expenditure on education may help foster economic growth, enhance productivity, contribute to
people’s personal and social development, and help reduce social inequalities. The proportion of total
financial resources devoted to education is one of the key choices made by governments in each country
of the European Union (EU). In a similar vein, enterprises, students and their families also make decisions
on the financial resources that they will set aside for education.
The Federal budget expenditures on education will amount in 2012 year 603.5 billion rbl., in 2013 –
558.9 billion rbl., in 2014 – 499.5 billion rubles[3]. In the total expenditures of the Federal budget these
costs will amount respectively 4.6%, 3.9% and 3.3%.
The education reform includes two directions: a qualitative transformation of the system and the
reorganization of its financial provision. Legal reform of the qualitative component of the education
system provides for implementation of a number of measures aimed at selection of educational
institutions. To a large extent, this selection affects higher education. Employment of graduates reflects to
the market demand for the services of a particular educational institution. In case if the quality of the
education graduates do not meet the requirements of the economy, the demand for graduates of this
higher educational institution decreases, which makes the latter correspond to the needs of the society.
Consequently take place the market regulation of the educational institutions quality.
425
Table 1
Expenditure on educational institutions, 2004 and 2009 (1)
EU-27
Belgium
Bulgaria
Czech Republic
Denmark
Germany
Estonia (2)
Ireland
Greece
Spain
France
Italy
Cyprus
Latvia
Lithuania
Luxembourg (3)
Hungary
Malta (4)
Netherlands
Austria
Poland
Portugal
Romania (2)
Slovenia
Slovakia
Finland
Sweden
United Kingdom
Iceland
Liechtenstein (5)
Norway
Switzerland
Croatia (6)
Turkey
Japan
United States
Public expenditure
(% of GDP)
Private expenditure
(% of GDP)
2004
5.06
5.95
4.40
4.20
8.43
4.62
4.92
4.65
3.83
4.25
5.80
4.56
6.77
5.08
5.17
3.87
5.44
4.79
5.46
5.48
5.41
5.10
3.28
5.74
4.19
6.42
7.09
5.16
7.47
2.43
7.42
5.72
3.87
3.07
3.59
5.32
2004
0.65
0.34
0.62
0.58
0.32
0.92
0.38
0.32
0.19
0.61
0.55
0.42
1.18
0.82
0.47
:
0.52
0.44
0.97
0.39
0.59
0.13
0.40
0.83
0.75
0.13
0.19
0.93
0.74
:
0.05
0.58
0.28
0.08
1.21
2.33
2009
5.41
6.57
4.58
4.38
8.72
5.06
6.09
6.50
:
5.01
5.89
4.70
7.98
5.64
5.64
3.15
5.12
5.46
5.94
6.01
5.10
5.79
4.24
5.70
4.09
6.81
7.26
5.67
7.82
2.05
7.32
5.55
4.33
:
3.61
5.47
2009
0.79
0.38
0.66
0.58
0.33
0.80
0.36
0.37
:
0.72
0.61
0.45
1.53
0.58
0.66
:
:
1.36
1.01
0.51
0.77
0.38
0.11
0.68
0.72
0.16
0.18
1.87
0.74
:
0.11
0.60
0.36
:
1.60
2.03
Expenditure on public &
private educational
institutions per
pupil/student (PPS for
full-time equivalents)
2004
2009
5487
6504
6251
7659
1810
2874
3664
4621
7645
9114
6184
7299
2823
4172
5723
:
4148
:
5258
6953
6121
6988
5916
6275
5960
8590
2403
3722
2356
3509
:
:
3642
:
4076
6836
7016
8359
7804
8945
2723
3928
4233
5298
1437
2386
5527
6610
2594
3965
6242
7085
7130
7950
6046
7847
7375
7702
:
:
8629
10179
:
:
:
4103
:
:
6820
7484
9948
11370
(1) Refer to the internet metadata file (http://epp.eurostat.ec.europa.eu/cache/ITY_SDDS/en/educ_esms.htm).
(2) Data for 2005 instead of 2004 other than for public expenditure.
(3) Excluded tertiary education; data for 2007 instead of 2009.
(4) Break in series between 2004 and 2009.
(5) Data for 2008 instead of 2009.
(6) Data for 2005 instead of 2004 for private expenditure.
Source: Eurostat (online data codes: educ_figdp, tps00068, and tps00067), UNESCO, OECD
426
However, the Russian Federation chose a faster (revolutionary) way to improve the system, based on
the statistical data about the needs in qualified specialists. Such approach has a number of drawbacks. So,
the government’s view of a qualifying level of a specialist is different from the real needs of the economic
environment in the staffing. The Bologna process, to which Russia joined in 2003, is implemented in the
form of the adoption of the Federal state standard for the preparation of specialists, bachelors and masters.
However, the useful effect of the adoption of these standards level out the uneven distribution of the total
load on each teacher, the lack of a common system of funding for higher education institutions, as well as
the unified requirements the higher educational institutions. Furthermore, analysis of the effectiveness
and relevance of trained professionals points to reduce the overall level of their training.
Currently, the legislation establishes requirements to the teaching staff of the University, to the
volume and procedure of teaching in each subject of the curriculum, but there are no requirements
directly to the educational institution. Moreover, the educational institution is deprived a possibility
independently to estimate own efficiency, a demand of graduates on a labor market in connection with
absence, difficulty of reception or closeness of the given information. Given these facts, we can conclude
that it is impossible to evaluate the quality of education provided by the specific higher education
Institution. Consequently, it is impossible to draw a conclusion about the effectiveness of the reform of
the system.
Nevertheless, the Ministry of Education in year 2012, monitored the activities of the federal
educational institutions of higher professional education. To determine the effectiveness of universities
were elected the following indicators:
 Educational activities: the Average score of the Unified State Examination (USE) of students
admitted to the USE results.
 Research and development: the volume of R & D per science teachers (NDP).
 International activities: the share of foreign students completed their education, in the total output
of the students.
 Financial and economic activities: income of universities from all sources per NDP.
 Infrastructure: the total area of the educational-laboratory buildings of the University on the right
of ownership and assigned to the University on the right of operational management, per student.
It should be noted that these indicators have not been approved regulations, have not been tested, and
are not objective. Earlier similar requirements to the educational institutions of higher professional
education are not presented. But the monitoring of higher education institutions on the basis of these
indicators has revealed a number of so-called “inefficient institutions of higher education”. Moreover, the
consequences of classifying establishments to “inefficient” seem fatal, because a way of increasing the
effectiveness determined as the reorganization of the institution.
Today there are 3 thousand universities and branches in Russia, including:
 Global Research Universities – 2 (Moscow and St. Petersburg State Universities);
 Federal universities – 8: North-East (Krasnoyarsk), Kazan (Volga), Ural (Yekaterinburg),
Northern (Arctic), Far-East (Vladivostok), Southern (Rostov-on-Don), Baltic universities;
 National – research – about 30 universities [4].
The Ministry of Education and Science of Russia in the next three years plans to reduce the number of
higher educational institutions by 20%, and the number of their branches by 30%. Thus, the reform of the
higher education system by increasing the quality component is currently not given the positive results.
The second element of the reform of the education system is the financial aspect. This issue is painful
for consumers of educational services, and for educational institutions. One of the tasks of the education
change’s system is the reduction of the volume of state financing into this sphere at the expense of
reduction of the budget subsidies. Another task – to provide educational institutions an opportunity to
independently carry out activities, aimed at making profit.
427
Up to 2010, the educational institutions had the organizational-legal form of the unitary enterprise
based on the right of operative management or institution, and therefore were deprived of the opportunity
to dispose of their property, to render additional educational services and receive profit.
In May 2010, the Federal Law was adopted; it allows to carry out the reorganization of the educational
institutions in the preferred form a state-owned institution, budgetary organization, an Autonomous
institution. However, lately gaps were identified of this type of transformations. For example, insufficient
written the procedures of the reorganization of institutions, that led to the bureaucratization of the process
and legal errors. In addition, a significant number of shortcomings were revealed in the field of the
financial sphere rights of the activities of educational institutions. These features of modernization noted
also by other authors [5].
Such shortcomings complicate the activities of educational institutions, including those aimed at
making a profit. Nevertheless, the objective to reduce the volume of state financing is achieved. The
volume of financing has significantly reduced. However, the planned incomes sufficient for selfsufficiency, educational institutions do not currently receive. Insufficient financing of higher education
institutions is an additional reason for the reorganization.
Distance learning as a way to save money in higher education
Currently, the following types of information technologies used in the educational process in a
reduction of financing are selected:
1. Distance learning. This area of the Russian practice is quite new and not fully worked off. Let’s
mark the problems, which associate with this type of training.
 It is assumed that in such system of training students are present in person only at the final
certification: state interdisciplinary examination, the defense and protection of the graduation
thesis. In Because of it, there is reasonable doubt in student’s self-study. (Unfortunately, we are
often faced with a dependent work.). There could be a situation when the student will not be
certified and selected out, which naturally have a negative impact for the university. We obviously
need to produce highly skilled professionals. But at the time the government finances the
universities according with the number of students enrolled in it. If one student is not certified
graduate – is a high possibility for the universities to loss the budgetary funds.
 There also could be problems of legal order. If in the process of training a student receives positive
grades, but what do they mean, if the final assessment of students – is not satisfactory? It should be
noted that institutions with a strong position find the ways how to fight with such problems. As for
private institutions – they have more serious problems. Payment by students of their education – is
the main source of income for the institution, and it is difficult to deduct students. In normal form
of study problems with such students are identified in the early courses, which allow to use various
methods to improve the situation.
 In our opinion, Distance learning needs more for time students, and in this group there are less
strong students than in other forms of education, and they should have the greater constant and
personalized control. For these students the motor memory is important. A practice shows that the
form of lectures with the video camera was not effective. The teachers do not see the feedback, if
they read for the audience. And probably it will be quite difficult to make classes for students on
an individual basis.
 It should also be noted some distrust for such form of study from the part of students and their
parents.
 Electronic textbooks. The main problem in this case due to the inability to see before buying a
textbook with its contents – “look through” like a book. As a result, buy “a cat in a poke”. The
428
reason for the purchase is often the presence of different vultures on the basic subjects of the
specialty and expertise. The experience has shown that even in this case, often shows a lag of 6-8
years in changes of legal basis of the items in the content material of electronic textbooks. Also,
traditionally, each electronic textbook has shorter course than other forms of training. Also some
inconvenience due to the fact that during the installation of the data required textbooks utilities are
higher than it’s available in student’s computers, especially not in big cities. This disadvantage is
pretty much due to the need to protect the electronic books from unauthorized copying, what often
try to do by buying a copy, and trying to install it on a computer class, or by passing to a group of
students, usually external students.
2. Full-length electronic courses with tutors. For such a system also used the name “E-teaching
materials” (EUMK). Its purpose is to improve the quality of education on the basis of information support
of the educational process, the application of automatic knowledge control, learning and management
self-study of students. In EUMK it’s supposed to provide a systematic approach based on
interdisciplinary and inter navigation links, based on the structural logic schemes of disciplines in
specialties and areas of training, compliance with all the training materials standardization. If we
approach the solution of these problems is complex, it is necessary to consider the personnel component,
technical support and implementation.
Personnel component is divided into two parts:
 Teachers, who receive the advanced training, and as a result they can work in information space,
 Specialists with specialty number 230202 – “Information Technology in Education”. This
specialty takes place since year 2003, and its volume is quite small in a number of universities.
The main personnel problem is that at the time of using some standardized software products that
are in demand on the market and, therefore, the training work that is carried out in universities; there is
a deficit of qualified teachers of their own, capable to teach at a high as the methodological and
specific professional level. In such cases it is necessary to involve the specialists for teaching process
from outside [6].
The next problem is related to the overall resource base of universities and public purchase of
necessary equipment for the educational process. In this procedure, there are usually two extremes:
University buys or “all the best”, non-optimal using their financial resources or purchases made on a
residual principal.
The process of agreement the equipment purchased with public purchase usually is time-consuming
and makes quite large distortions into the process of passing on services. Initially the specialist makes a
request, who generally can’t determine the optimum configuration for the equipment, which will to be
used in the classroom. Moreover, such computer can be used by students of different specialties to solve
completely different problems – from simple mathematical calculations, which do not require more
resources to work in complex design and graphics packages and distributed DBMS which significantly
critical to the configuration.
The equipment, which is written in the request, includes into a set of requests, accepts in different
departments and then certain lot-batch is formed. Such form of work usually allows to get the best
possible price during the trading, but has a negative impact on the quality (in terms of the future use in the
learning process) of purchased equipment.
And of course, problems as incorrect complex of practical implementation of information technology
in the educational process couldn’t be ignored. For example, a major theme reported by EUNIS member
universities is the change from “choosing” to “using” e-learning platforms [7].
The fact that the process of implementation supposes a simultaneous attack of several events: the
construction of a network, installation the required software, user training of elementary work in the
system, and the support of all training complex in up-to-date and operational conditions. In this case a lot
of programs are installed in the same network, each of them needs its own system requirements, and not
429
at the level of the workstations, but at the server level. For some of installable network products
specialized knowledge is required, which the university administrators often do not have.
Another problem is the lack of possibilities for the students to get practical skills, because in most
companies there is a system of information security and information security management system, which
make up a system of information security together. This way of technology organization greatly limits the
possibilities of cooperation between the higher education and the practical scope of activities in
improving the students’ skills, because it’s not possible to use the technologies in the learning process, as
full so trial versions [8].
However, the search for solutions to these problems is ongoing.
In our opinion, integrated learning systems based on the simulation can be created in the universities
for getting a large number of competences in their profile. Part of the universities solves such tasks on
different levels of credibility, authenticity and specification. In the integrated model of the economy
should be included:
 Enterprise. In a system are modeled as a manufacturing process so servicing units (including
accounting, finance, sales, marketing, logistics, warehouse, R&D departments, technological
department, etc.);
 Commercial bank. The system is modeling with the following departments: credit, foreign
exchange, front office, processing, client, securities, deposit, asset management, financial
management at the bank, the credit committee, legal, internal audit, etc.
 Exchange;
 The insurance company;
 Customs;
 Federal Treasury;
 Investment Company and / or the Fund and / or depositary;
 The Central Bank;
Mechanism for constructing goes ascending Product – from simple to complex. An enterprise may
produce a single product and has the simplest organization system. It may be an enterprise with a more
complicated functional, divisional or other management system, and also to have a more number of
departments. A small amount of accounting records and simple, not sophisticated conductings, with the
corresponding list of primary, settlement, payment and analytical documents can be used. The same
applies to the list of departments – from the minimum to the more complex structures, including the
departments of tax planning, foreign economic activity, the development department and innovation.
Number of institutions may also be minimal, and much larger than presented in the list.
The model is constructed in such manner as to there were modularly expandable opportunities for
work of students as under the reduced temporary scheme, and, for example, in real-time. Students also
have to have the opportunity to work as individually, and in various groups. Other than that, the group can
be divided into various departments within of one institution (businesses, banks, etc.), or among all
institutions between which is carried out economic cooperation. The process can develop indefinitely.
The unconditional requirement is the constant updatability information in connection with significant
fluctuations of the Russian legislation.
Conclusions
Solution of the reforming of higher education should be sought, in our opinion, not on the way a
significant reduction the number of higher education institutions. The high level of the population
education – it is not only an investment to lift the domestic economy, but it is also a necessary condition
for human potential development, so – for the country welfare.
430
Reform of the education system of the Russian Federation is carried out without considering the needs
of society, which is manifested in the absence of a positive effect. However, comparison of the reform
program with the changes of consumer preferences, market demands, as well as indicators and
characteristics of educational institutions, will help to achieve a positive result.
Education reform requires changing the order of modernization. The authors propose to establish
normative regulation categories of education quality, because at the present time educational institutions do
not have information on demands placed on them. The above requirements should represent a concept of
characteristics totality that reflects to the level of the educational institution. For example, such
characteristics include the demand for graduates. Thus, the goal is reached – equal competition in the
education market, where the most effective educational institution will prepare specialists needed by society.
The proposed imitating model will allow to participate in its work students of different economic
specialties which will better understand the related professions and the interaction between them. The
problem is the high cost of such models and a long period of their drafting, that not on forces for small
universities, or higher technical education institutions, having only the one economics faculty.
Nevertheless, on our opinion, such way of learning is more effective. It allows speaking about the need
for its introduction and financing, if not in the one higher education institution that in several higher
education institutions of the city on the basis of solidarity.
Bibliography
Пылина Н. Бюджет 2012. Образование// Аккредитация в образовании. [Электронный ресурс].
URL: http://www.akvobr.ru/budget_2012_obrazovanie.html (дата обращения 17.12.2012).
Educational expenditure statistics September 2012. [Electronic resource]. URL: http://epp.eurostat.ec.
europa.eu/statistics_explained/index.php/Educational_expenditure_statistics (the date of circulation
20.04.2013).
Федеральный закон ‟О федеральном бюджете на 2012 год и на плановый период 2013 и 2014
годов”. [Электронный ресурс]. URL: http://asozd.duma.gov.ru/main.nsf/%28Spravka%29?
OpenAgent&RN=607158-5 (дата обращения 07.12.2012).
Сколько же вузов требуется России, чтобы быть на уровне века? // Вестник высшей школы . 02
февраля 2012. [Электронный ресурс]. URL: http://www.almavest.ru/ru/favorite/2012/02/02/279/
(дата обращения 20.12.2012).
Серых В.В. Совершенствование законодательства субъектов Российской Федерации об
образовании на современном этапе: теоретико-методологические подходы. Ежегодник
Российского образовательного законодательства, 2009, выпуск 4, c. 132-140.
Подолянец Л.А. Проблемы информационного обеспечения экономического образования//
Экономика. Налоги. Право, 2010, № 6, с. 115-120.
Bell V., Rothery A. E-Learning in Europe: moving forward. [Electron resource]. URL:
http://yandex.ru/yandsearch?text=e-learning%20in%20europe&lr=2 (the date of circulation
20.04.2013).
Подолянец Л.А., Подолянец Д.В. Алгоритмизация построения корпоративных информационных
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Acknowledgements
The study was supported by The Ministry of education and science of Russian Federation, project
14.В37.21.1995.
431
THE COMPARISON OF THE ACCOUNTING LEGISLATION OF THE
REPUBLIC OF LATVIA WITH THE INTERNATIONAL REQUIREMENTS
CONCERNING THE COMPONENTS OF THE ANNUAL REPORTS
DEVELOPED BY COMMERCIAL COMPANIES
Inta Millere, University of Latvia, Latvia1
Abstract. The annual report is a significant document of commercial companies and
according to Latvian Republic “Annual Accounts Law”: “the annual accounts shall
provide a true and fair view of the assets and liabilities, financial position, profit or loss
and cash flow of the company” (Supreme Council, 1992 with amendment). Annual
report is used by external users (investors, creditors, customers, competitors,
governmental institutions etc.) and by owners of companies, administration and
employees. Annual report components, its structure, form, and other requirements are
regulated by legislation acts of each country and by international normative documents.
Unfortunately these requirements are frequently different. In nowadays globalization
circumstances when international cooperation is widely spread it is important for
commercial companies annual reports to be comparable and understandable.
The aim of the article is to research and compare requirements of the Latvian
Republic commercial company annual reports contents with European Union normative
regulations as well as international accounting standards and offer suggestions for LR
commercial company annual reports components.
In the paper there are applied the methods of general scientific research in
economics: economic analysis and synthesis, logically-constructive, qualitative methods
including the methods of the analysis of normative acts. The theoretical and
methodological grounds of the article are the normative acts regulating accounting,
works produced both by Latvian and foreign scientists as well as the Internet sources.
The author describes and analyses Latvian Republic commercial companies annual
report components and compares LR “Annual Accounts Law” and international
legislation requirements, which determine annual report content, there are assessed
common trends and differences, claimed problems and there are also offered some
suggestions for performing LR commercial companies annual reports.
Key words: annual report, financial report, accounting legislation requirements
JEL code: M41
1
432
Inta Millere
Introduction
An annual report developed by commercial companies provides information on the financial
standing, profit or loss, cash flow, as well as any other information that is relevant to its users to make
a variety of important decisions. The composition and the drawing up requirements of an annual report
are set in the Latvian Republic (LR) regulatory framework. An annual report consists of individual
statements, and during the last twenty years the composition of an annual report of the LR commercial
companies has changed several times. The preparation of an annual reports is a labour consuming
process, so it is necessary to examine the composition of an annual report, to investigate, what are the
international trends in the components of corporate annual reports and find answers to the following
question: what LR companies and what statements shall be included into an annual report in order to
provide the necessary information about the company, but at the same time to avoid creating an
additional administrative burden?
The author principally explores the composition of an annual report only of those commercial
companies, which are bound by the LR “Annual Accounts Law”. To the extent it is necessary to research
the topic, the author reviews also the requirements for the composition of annual reports of those
companies, which shall draw up consolidated annual reports, credit institutions, insurance companies,
investment and other companies, which shall comply with the legislative acts regulating their activities.
The aim of the article is to research and compare requirements of the Latvian Republic commercial
company annual reports contents with European Union normative regulations as well as international
accounting standards and offer suggestions for LR commercial company annual reports components.
In the paper there are applied the methods of general scientific research in economics: economic
analysis and synthesis, logically-constructive, qualitative methods including the methods of the
analysis of normative acts. The theoretical and methodological grounds of the article are the normative
acts regulating accounting, works produced both by Latvian and foreign scientists as well as the
Internet sources.
The article consists of 3 parts:
1. The components of annual reports of the LR commercial companies and the development of their
application,
2. The International framework for the components of annual reports and its assessment,
3. The proposals for the amendments to the LR regulatory framework concerning the components of
annual reports of the commercial companies.
To finalize the article there are provided conclusions, proposals and recommendations, including
proposals for significant amendments to the regulatory framework concerning the LR commercial
companies.
Research results and discussion
1. The components of annual reports of the LR commercial companies and the
development of their application
Law of the Latvian Republic “Annual Accounts Law” definite that “the annual accounts, as a unified
whole, shall consist of a financial report and the report of the company management regarding the
development of the company during the accounting year” for one’s part “the financial report is a unified
whole, which consists of a balance sheet, a profit or loss account, a cash flow statement, a statement of
changes in equity and an annex” (Supreme Council, 1992 with amendment). As it is currently defined in
Inta Millere
433
the LR “Annual Accounts Law”, an annual report includes six reports altogether and the Law “refers to
the companies, cooperative societies incorporated in Latvia, economic interest groups registered in
Latvia, the European co-operative societies and European commercial companies as well as individual
companies, farmers and fishing companies, whose turnover (revenue) from business transactions during
the previous year exceeds 200 000 lats” (Supreme Council, 1992 with amendment).
In 1992 there was passed the Law “On Enterprises Annual Accounts”, which title was changed on
October 19, 2006 and on November 22, 2006, the presently known title the “Annual Accounts Law”
entered into force. The composition of the annual report specified in this law has undergone several
changes since Latvia regained its independence. In the law “On Enterprises Annual Accounts” in the first
version, which came into force on January 1, 1993, it was stated that “the annual report as a single
package consisting of a balance sheet, profit and loss, attachment, and the report” (Supreme Council,
1992 with amendment) – which meant – four statements.
While researching the history of application of components of annual report in Latvia, the author
concludes that the balance sheet as a statement to submit had been already defined in the article 678 of the
Russian Empire Trading Regulations (Свод законов Российской империи, 1913), which had to be
applied by companies also in Latvia even before there was established the independent Republic of
Latvia. After the establishment of the LR in 1918 there were passed several normative acts that provided
for the balance sheet and other reports to be drawn and submitted (Millere I., 2011). In 1937, the LR
Cabinet of Ministers passed the Law “On Joint-Stock and Share companies”, which provided for the
following to be included into the annual report:
 balance sheet;
 profit and loss account;
 review of turnovers by the General ledger accounts;
 a written report by the Board on the past year and the current standing of the company (Cabinet of
Ministers, 1937).
Comparing the composition of annual report set in the “Law on Joint-Stock and Share Companies” of
1937 with the first passed since the regaining of independence edition of the “Annual Accounts Law” of
1992, the author believes that the composition of annual report prescribed in 1992 was similar to the
annual report composition established by the 1937 Act.
The new accounts, which previously were not included into the annual report in LR, were: the
statement of cash flow, which for the first time in Latvia was established by the Regulation No.292
“Amendments to the Law “On Enterprises Annual Accounts” of the Cabinet of Ministers, on July 30,
1996, which entered into force on August 7, 1996 (Cabinet of Ministers, 1996). In other countries, the
cash flow statement in the application appeared also relatively recently – the first application was set in
1985 in Canada, then in the United States – in 1987, in 1988 in France and in the United Kingdom – in
1991 (Stolowy H., Lebas M., 2006).
The a statement of changes in equity as a compulsory part of the financial statements and hence of the
annual report was set on December 16, 1999 by the passed by the Parliament “Amendments to the Law
“On Enterprises Annual Accounts”. The author points out that similar information had to be submitted
also during the first independence of the Republic of Latvia until 1940 – basic, reserves and other capital
(Millere I., 2011).
Table 1 shows the annual report content set by the “Annual Accounts Law”, as well as the date, when
the specified in the table component of the annual report came into force. Table 1 also shows the potential
reliefs concerning the composition of the annual report, which allows not to submit some report.
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Inta Millere
Table 1
The annual report content in the “Annual Accounts Law”, the applicable
reliefs referable thereto and the effective date of the regulations*
The effective date
of the regulations
From 01.01.1993.
(Supreme Council,
14.10.1992.)
From 07.08.1996.
(Cabinet
Regulations No.292
30.07.1996.)
From 19.01.2000.
(Amendments to
law “On Enterprises
Annual Accounts”
16.12.1999.)
From 20.04.2001.
(Amendments to
law “On Enterprises
Annual Accounts”
22.03.2001.)
From 01.01.2010.
(Amendments to
law “Annual
Accounts Law”
01.12.2009.)
From 01.01.2013.
(Amendments to
law “Annual
Accounts Law”
29.11.2012.)
Annual Report Content
Article 4, Paragraph 1: “The annual
accounts, as a unified whole, shall consist of
a balance sheet, a profit and loss account, an
annex and the report”.
Article 4, Paragraph 1: “The annual accounts,
as a unified whole, shall consist of a balance
sheet, a profit and loss account, a cash flow
statement, an annex and the report”.
a balance sheet, a profit or loss account, the
statement of changes in equity, a cash flow
statement and an annex, as well as the report
of the company management regarding the
development of the company during the
accounting year”.
a financial report and the report of the
management regarding the development of
the company during the accounting year.”
Terminology used in this law:
“The financial report is a unified whole,
which consists of a balance sheet, a profit or
loss account, a cash flow statement, a
statement of changes in equity and an annex”.
The Reliefs Relating to the Annual
Report Components
Article 66, Paragraph 2: “The companies to
which the provisions of Article 54 of this
Law are applicable to not have to send a
report”.
Article 54, Paragraph 1: “Companies, which
on the balance sheet date do not exceed two
of the criteria referred to in Paragraph two
of this Article, are permitted not to prepare a
cash flow statement and a statement of
changes in equity”.
Article 54, Paragraph 1: “Companies, which
on the balance sheet date do not exceed two of
the criteria referred to in Paragraph two of this
Article, are permitted not to prepare the report
of the management, a cash flow statement and
a statement of changes in equity”.
Article 541 Paragraph 1: “Companies, which
on the balance sheet date do not exceed two
of the criteria referred to in Paragraph two
of this Article, in addition to the reliefs
which are mentioned in Paragraph one of
this Law Article 54 are permitted:
1) to prepare an abridged balance sheet,
2) not to prepare an annex”.
* the major changes in the composition of the annual report, which entered into force on the date specified in the table, are underlined
Inta Millere
435
As it can be seen from Table 1, in the Article 66 of already the first edition of the “Annual Accounts
Law” of 1992, there were included reliefs in respect on the composition of the annual report: “the
companies covered by the Article 54 of this Law, can omit sending the report” (Supreme Council, 1992).
In its turn in the Article 54 of the Law stated: “the companies, which on the date the balance sheet is
drawn do not exceed two criteria of those specified in the second part of the present article ...” (Supreme
Council, 1992). It means that, if companies did not exceed two of the criteria set out in Article 54 of the
Law, then the annual report consisted only of the balance sheet, profit and loss statement and an annex – a
total of three reports, but as it has been already mentioned – since 1996 the composition of the annual
report was supplemented with the cash flow statement, but since 2000 – with the statement of changes in
equity that companies also had to draw. It should be noted that in the following years, the criteria of the
Article 54 were repeatedly changed in various versions of the Law, and if companies wanted to apply the
reliefs, they had to meet the existing criteria.
From January 1, 2010, the “Annual Accounts Law” allows not to make a cash flow statement and
a statement of changes in equity, if the company does not exceed two of the criteria set out in the
Article 54, which in 2010 and 2013 are as follows:
 Balance sheet total – 250 000 Ls,
 Net turnover – 500 000 Ls,
 Average number of employees during the year of account – 25.
The “Annual Accounts Law” stated that if a company does not exceed two of the above criteria for
two consecutive years, they may omit the drawing of the cash flow statement and statement of changes in
equity, while preparing the report for 2009 (Saeima, 2009).
On November 29, 2012 there were adopted and entered into force on January 1, 2013 substantial
amendments to the “Annual Accounts Law”, which provide also for other reliefs for the composition of
the annual report. In the new version of the “Annual Accounts Law” there was adjusted the Article 54 and
now it includes all the reports that companies using the reliefs may omit drawing: “the companies, which
on the balance sheet date do not exceed two of the criteria specified in the second part of the present
article, may refrain from drawing up the management report, cash flow statement and statement of
changes in equity” (Saeima, 2012). Into the “Annual Accounts Law” additionally there is included the
Article 541, which provides for that companies which on the balance sheet date do not exceed two of the
criteria specified in the second part of the present article (balance sheet total – 35 000 lats, net turnover –
70 000 lats and the average number of employees during the year – 5) in addition to the relives listed in
the Article 54 of this Law may:
1) to prepare an abridged balance;
2) not to prepare an annex (Saeima, 2012).
So the companies covered by the criteria of the Article 541, which are basically the criteria to apply
micro-enterprise tax, must include into the annual report only the bridged balance sheet and profit or loss
statement.
Summarizing the previously studied, the author concludes that for the LR companies covered by the
“Annual Accounts Law”, the composition of the annual report in periods is as follows:
01.01.1993 – 06.08.1996 – four statements: balance sheet, profit and loss statement, an annex and the
report,
07.08.1996 – 18.01.2000 – five statements: balance sheet, profit and loss statement, cash flow
statement, an annex and the report,
19.01.2000 – present time – six statements: balance sheet, profit or loss statement, cash flow
statement, statement of changes in equity, an annex and the management report.
Throughout the period of effect of the “Annual Accounts Law” – from 1993 to early 2013, the
companies, which were able to apply the some reliefs did not have to submit the management report, but
since 2010 – also the cash flow statement and statement of changes in equity. Since 2013, the companies
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Inta Millere
which meet the criteria of the Article 541 may additionally omit submitting the annex. While summarizing
the gathered information, the author points out that the companies applying the reliefs set in the “Annual
Accounts Law” had as a minimum annual report the below listed statements within the specified period:
01.01.1993 – 06.08.1996 – three statements: balance sheet, profit and loss statement and an annex;
07.08.1996 – 18.01.2000 – four statements: balance sheet, profit and loss statement, cash flow
statement and an annex;
19.01.2000 – 31.12.2009 – five statements: balance sheet, profit or loss statement, cash flow
statement, statement of changes in equity and an annex;
01.01.2010. – the present moment – three statements: balance sheet, profit or loss statement and an
annex;
Since the 01.01.2013 – the companies, subject to the criteria of the Article 541 – two statements: an
abridged balance sheet and profit or loss statement.
Further the author will explore the international requirements that determine the composition of the
annual report, as well as the application of the requirements for the LR.
2. The International framework for the components of annual reports and its assessment
The composition of the annual report and particularly the financial statement is determined by
international organizations such as the International Accounting Standards Board, which issues the
International Financial Reporting Standards, the European Parliament and the Council, which adopt
regulations and directives.
The International Accounting Standard Board is the independent standard-setting body of the
International Federation of Accountants Foundation. Its members (currently 15 full-time members) are
responsible for the development and publication of International Financial Reporting Standards (IFRS)
(IFRS Foundation, 2012). International Accounting Standard (IAS) No 1 “Presentation of Financial
Statements” determine: “a complete set of financial statements comprises:
(a) a statement of financial position as at the end of the period;
(b) a statement of profit and loss and other comprehensive income for the period;
(c) a statement of changes in equity for the period;
(d) a statement of cash flows for the period;
(e) notes, comprising a summary of significant accounting policies and other explanatory
information; and
(f) a statement of financial position as at the beginning of the earliest comparative period when an
entity applies an accounting policy retrospectively or makes a retrospective restatement of items
in its financial statements, or when it reclassifies items in its financial statements.” (IASB, 2012).
In 2010, the International Accounting Standard Board issued a “practice statement” on the subject of
“Management Commentary”. A practice statement is guidance rather than being a mandatory standard.
(Nobes C., Parker R., 2012).
Summarizing the IFRS requirements pertaining to the annual report, the author points out that into the
financial statement there shall be included the five statements listed in the above paragraphs a) to e) and,
where appropriate, “a statement of financial position as at the beginning” as well as in the annual report
there must be included a management report.
The companies shall apply the IFRS in accordance with legislative requirements. Further the author
studies, which companies in the LR shall apply the IFRS.
In 2002 The European Parliament and the Council issued “Regulation (EC) No 1606/2002 of the
European Parliament and of the Council of 19 July 2002 on the Application of International Accounting
Standards”. Article 4 of this Regulation provides: “for each financial year starting on or after 1 January
2005, companies governed by the law of a Member State shall prepare their consolidated accounts in
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437
conformity with the international accounting standards … if, at their balance sheet date, their securities
are admitted to trading on a regulated market of any Member State” (European Parliament and the
Council, 2002). This above mentioned Regulation should be used by every EU member country,
including LR.
In Latvia IFRS can be used by companies which prepared consolidated accounts, but whose securities
are not admitted to trading on a regulated market. Section 16 of the “Law On Consolidated Annual
Accounts” provide: “on the basis of Article 5 of Regulation (EC) No 1606/2002 of the European
Parliament and of the Council of 19 July 2002 on the application of international accounting standards, a
parent company of a group of companies may prepare consolidated annual accounts in accordance with
international accounting standards.” (Saeima, 2006).
A reference to the application of the IFRS in the LR is also included in the Article 56, Part 2 of the
“Financial Instruments Market Law”, which provides for: “if a corporation, which transferable securities
are listed on a regulated market shall prepare a consolidated annual report, the consolidated financial
statements shall be drawn in accordance with the Regulation (EC) No. 1606/2002 of the European
Parliament and Council, dated July 19, 2002 on the application of the international accounting standards,
but the financial statements – according to the legislative act requirements of the Member State of origin”
and the Part 3 provides for: “if transferable securities of a commercial company are included into the
official list in the Republic of Latvia, it draws its financial statements in accordance with the international
accounting standards approved by the European Commission and the international financial reporting
standards, as published in the official publication of the “Official Journal of the European Union.” It
should be noted that in the Article 56 of the “Financial Instrument Market Law” the composition of the
report is interpreted differently than in the IFRS: “The annual report consists of:
1) the audited financial statements;
2) the management report;
3) statement of management’s responsibility;
4) the statement of corporate governance, if the commercial company draws his statement as a
separate part of the annual report.” (Saeima, 2003).
In the “Financial Instruments Market Law” there are neither presented in details, what actually stands
for the “audited financial statements”.
Beside the above requirements in the LR the IFRS must be applied by banks, brokerage firms and
investment authorities, as provided for by the “Law on Credit Institutions”, the “Financial Instruments
Market Law” and the “Investment Companies Act”, the “Regulations on developing the annual report and
the consolidated annual report for Banks, brokerage firms and investment management companies” issued
by the Financial and Capital Market Commission, where in the clause 4 the composition of the financial
statement (Financial and Capital Market Commission, 2006) is set out in analogy to the estimated in the
1st IAS.
To sum up the above reviewed provisions of the EU Regulation, LR laws and other legislative acts,
the author concludes that the annual report in accordance with the IFRS requirements, including therein
the financial statements set in the 1st IAS shall be drawn up:
 by the companies that prepare consolidated reports, if on the balance sheet date the securities are
listed on a regulated market of any Member State,
 by banks, brokerage firms and investment authorities, but
parent companies may prepare the consolidated annual reports in accordance with the IFRS.
The “Annual Accounts Law” doesn’t provide for the application of the IFRS, but the requirements of
this law are binding for all limited liability companies (LLC), as well as other law subjects. In compliance
with the data of the LR Commercial Register in January 2013, there are more than 133.5 thousand of only
Ltd. and they are almost 90% of all the active merchants registered in the LR Commercial Register (total
of 149.5 thousand). (Register of Enterprises, 2013). Taking into account the previously written, the author
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Inta Millere
believes that the UK professors Nobes, C. and Parker, R. in their book “Comparative International
Accounting”, falsely claim that, “the three Baltic states ... require IFRS for all financial statements,
perhaps because they are small economies lacking their own well-development national rules” (Nobes C.,
Parker R., 2012).
The “Annual Accounts Law” is prepared in accordance with the directives of the European Council
and Parliament – including in particular the requirements of the Fourth Council Directive pertaining to the
annual reports of certain types of companies, so the author will explore the requirements of this Directive
on the composition of the annual reports and compare them with those set in the “Annual Accounts Law”.
In the Article 2 of the Fourth Council Directive, which was adopted on July 25, 1978, it was stated
that: “the annual accounts shall comprise the balance sheet, the profit and loss account and the notes on
the accounts. These documents shall constitute a composite whole”, but the Article 46 of the Directive
stated that in the report there should be included also in the report. In the Directive it was also stated that
Member States may allow the companies to draw up abridged balance sheets (Article 11), and notes
(Article 44) (Council of the European Communities, 1978).
In 2012 the European Parliament and the Council of the European Union issued Directive 2012/6/EU
of the European Parliament and of the Council of 14 March 2012 Amending Council Directive
78/660/EEC on the Annual Accounts of Certain Types of Companies as Regards Micro-entities. “The
European Council underlined that reducing administrative burdens is important for boosting Europe’s
economy and Accounting has been identified as one of the key areas in which administrative burdens for
companies within the Union may be reduced” ( European Parliament and the Council of the European
Union, 2012). For that reason Directive 2012/6/EU contains facilitations for contents of the micro-entities
annual report. Directive 2012/6/EU determines a new sub-group of micro-enterprises, so-called “microentities”. These are companies which on their balance sheet dates do not exceed the limits of two of the
three following criteria:
a) balance sheet total: EUR 350 000;
b) net turnover: EUR 700 000;
c) average number of employees during the financial year: 10 (European Parliament and the Council
of the European Union, 2012).
If the company on the balance sheet dates of the current and previous year does not exceed two of the
following criteria, as provided for in the Directive 2012/6/EU, then it can apply the reliefs pertaining to
the composition of the annual report and include therein only an abridged balance sheet and profit and
loss statement. Since January 2013, these and other provisions of the Directive 2012/6/EU have been
included in the “Annual Accounts Law”, and the “micro-enterprise” criteria set out in the Article 541 of
this law, however, are several times smaller than the required by the Directive, namely: the net amount of
turnover and the balance sheet total is 7 times smaller, but the number of employees – two times smaller.
It means that the LR “Annual Accounts Law” projects to apply for relief under the Directive to a
significantly smaller number of companies, but the fact remains that, as the Ministry of Finance points
out, the reliefs of the Article 541 may be applied by more than 58 thousand, or approximately 73% of the
subjects of the “Annual Accounts Law” (Ministry of Finance, 2012). However, the provisions of the
Article 54 of the “Annual Accounts Law” allowing not to include a management report, cash flow
statement and statement of changes in equity into the annual report “refers to more than 73 thousand, or
about 93% of all the entities, who shall prepare an annual report in accordance with the requirements of
the “Annual Accounts Law”. Therefore, now the obligation to prepare a full annual report and audit it at a
certified auditor shall be performed by only 7% of the subjects of the “Annual Accounts Law” (Ministry
of Finance, 2012). Here the author wishes to draw attention to the differences in the data on the subjects
of the “Annual Accounts Law”. In compliance with the data of the LR Commercial Register in January
2013 there are registered and are active more than 133.5 thousand Ltd., in its turn, while performing the
calculations on the basis of the data presented in the “Initial Impact Assessment Report (Summary) of the
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439
Draft Law “Amendments to the Annual Accounts Law” of the Ministry of Finance it is possible to
estimate, that the total number of the subjects of the “Annual Accounts Law” (they are: limited liability
companies, joint stock companies, cooperative societies and individual businesses, farms and fish farms)
is only 80 thousand. It can be concluded from the above that the Ministry of Finance does not include into
the number of law subjects due to inexplicable reasons, about 50 thousand Ltd., as well as other
companies, which are required to conform to the requirements of this Law. Do these companies not
prepare their annual reports? This issue should be clarified and resolved by the national institutions.
Comparing the requirements of the above-mentioned Fourth Council Directive in respect to the
composition of the annual report with the set by the “Annual Accounts Law”, the author concludes that in
addition to the requirements of the Directive the LR law included another two statements: from 1996 –
the cash flow statement and from 2000 – the statement of changes in equity, which greatly increased the
administrative burden of the companies, as only since 2010 the companies, which could apply for reliefs
were allowed to omit the submitting of these statements. So for eleven years all the subjects of the Law,
regardless of their size, were required to draw up and submit these two statements, the inclusion of which
into the financial statements projects the IFRS. The author also wishes to note that the preparation of the
cash flow statement requires special additional knowledge and drawing of this statement is considerably
time-consuming.
To summarize the above studied, the question arises, why there is necessary the “Annual Accounts
Law” in such version, if only 7% of the subjects of the Law, as it is indicated by the Ministry of Finance,
without applying the reliefs shall comply with requirements of this Law (Ministry of Finance, 2012).
In the following part of the article the author suggests possible solutions for the future regulatory
framework on the composition of annual reports of the LR commercial companies.
3. The proposals for the amendments to the LR regulatory framework concerning the
components of annual reports of the commercial companies
To be able to recommend what should be the optimal regulatory framework defining the composition
of the annual report, first of all the author would like to point out that in fact the Latvian accounting
corresponds the accounting traditions of the continental Europe. Historically, in the world there were
formed two major accounting traditions: Anglo-Saxon and continental European accounting tradition.
The United States, the United Kingdom, Australia, Canada, New Zealand and other countries where there
was the common law system observed in accounting the Anglo-Saxon accounting tradition. The Common
law system was established in England and adopted rules aiming at providing an answer to some specific
case, not to establish the further guiding rules. This effect resulted in adoption of the Commercial laws,
which traditionally did not include detailed regulatory provisions (Nobes C. and Parker R., 2012). It
contributed to the development of the accounting profession and professional organizations, consequently
the professional organizations worked out and adopted the rules and standards which were voluntarily
applied in accounting by society. A different practice is in the countries that follow the continental
European accounting traditions that occurred much earlier than the Anglo-Saxon accounting tradition. It
was based on the Roman law, which in the 6th century was compiled by Justinian, and which became the
doctrine (Nobes C. and Parker R. 2012). The continental European accounting system was based on the
French Commercial Code, as adopted in 1673 and known as the Code Savary. This Code and the
Commercial Code of 1807 of Napoleon was taken over by other countries – notably Belgium, Spain,
Germany and Italy, and in the continental Europe there developed a tradition that all the accounting
activities have been defined in the legislation (Walton P., Aerts W., 2006). As it has been studied and
found in the monograph by I. Millere “The Accounting Development in Latvia” the accounting
development within the Latvian territory in previous centuries was established by the German, Swedish,
Danish and other national requirements. Before founding the LR the accounting requirements in Latvia
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were imposed by the legislative acts of the Tsarist Russia, which also continued to affect the LR
accounting framework after the foundation of the LR in 1918. While establishing the LR accounting
framework to 1940 there were used as the basis as the legislative acts of the former Tsarist Russia, so
particularly the German Commercial Code (Handelsgesetzbuch). During the socialist period, until the
restoration of the independence of the LR, the accounting in Latvia was regulated by the detailed
regulatory framework of the USSR (Millere I., 2011).
The author believes that the Latvian accounting systems, historical development and belonging to the
continental European accounting tradition shall certainly be taken into account, when developing and
adopting the LR accounting regulatory framework, which unfortunately, was not always previously
observed. It is testified by the repeated attempt to apply the national accounting standards, which
essentially failed. In the development and adoption of the Latvian Accounting Standards (LAS), for many
years there was invested much work, but as the result in 2011, again in accordance with the “Annual
Accounts Law” there were passed the CM Regulations No. 488 “The Regulations on the Application of
the Annual Accounts Law” and the CM Regulations No. 481 “The Regulations on the content and the
development order of the cash flow statement and statement of changes in equity,” which contain the
requirements of the LAS and thus the developed and adopted standards were no longer relevant. It should
be noted that, unlike other Anglo-Saxon countries, the application of standards in Latvia was not
voluntary, but established by the regulations of the Cabinet of Ministers. It could be concluded that by
means of immature regulatory framework in the LR following the regaining of independence there was an
attempt to implement the Anglo-Saxon accounting tradition, but the result was again the adopted
regulatory framework that complied with the continental European accounting traditions. The author also
points out that neither the existing laws, nor the binding regulations of the Cabinet of Ministers include all
the accounting and reporting requirements, but at the same time provide for the additional administrative
burdens on businesses, for instance, as on the subject of the composition of the annual report, as it was
previously explained.
The author positively evaluates the amendments of 2012 to the “Annual Accounts Law”, which have
reduced the number of components of the annual report, however, the regulatory framework pertaining
thereto is irrelevant. As it is recognized by the Ministry of Finance currently in Latvia in compliance with
the EU view, the criteria of small business would be met by more than 99% of the Latvian companies
(Ministry of Finance, 2012), but the composition of the annual report estimated in the “Annual Accounts
Law” corresponds the IFRS, including the cash flow statement and statement of changes in equity, which
should not be drawn by small, and even more micro-enterprises. For the corporate accounting and report
drawing and submission, applying the least administrative burden, to provide the necessary outcome in
the LR economics, there shall be taken into account the Latvian accounting traditions and developed the
sustainable accounting concept, which would also include the requirements to draw the annual report.
On the subject of the composition and the framework of corporate annual report, the author
recommends the Ministry of Finance to develop and implement the national policies on accounting issues,
considering the following possible solution:
 the IFRS should be applied: by the companies that prepare consolidated reports, if on the balance
sheet date their securities are admitted to trading on a regulated market of any Member State, as
required by the EU regulations, banks, brokerage firms and investment authorities, as it is required
by the LR normative acts. There could also be established requirements for the LR parent
companies to prepare consolidated annual reports only in accordance with the IFRS. In the law
regulating the activities of some companies it should be specified that the company’s annual report
shall be drawn up in accordance with the IFRS, but in the regulatory framework it is not necessary
to include the composition of the annual report and other requirements on preparing, as those are
covered by the EU Regulations;
Inta Millere
441
 to develop and adopt a separate law for companies that are not micro-enterprises and which annual
reports shall not be drawn up in accordance with the IFRS. It could be the corrected edition of the
“Annual Accounts Law”. This law shall provide for the composition of the annual report for the
subjects of this law in compliance with the one set in the Fourth Council Directive, including
therein four statements: the balance sheet, profit or loss statement, annex and the management
report;
 to develop and adopt a separate regulatory framework for micro-enterprises to draw up their
annual reports. The annual reports of micro-enterprises can include only a balance sheet and profit
or loss statement, in abridged form, to provide information about the financial standing of the
companies as well as the profit of the accounting that is taken into account when calculating the
corporate income tax. The framework should also include the bookkeeping requirements, the
criteria to recognize and evaluate the items, term definitions and the requirements on the scheme
and drawing up of statements.
Conclusions, proposals, recommendations
The author of the article has studied the LR regulatory framework requirements for the composition of
the corporate annual reports, as well as described the requirements of the Fourth Council Directive and
the IFRS that determine the composition of the annual report. The author has compared those with the
requirements set in the “Annual Accounts Law” and other legislative acts, and consequently the author
draws the following conclusions and recommendations:
 the composition of the annual report in the LR “Annual Accounts Law”, which name from the
moment it was adopted in 1992 by November 22, 2006 was the law “On Enterprises Annual
Accounts”, underwent several changes and increased from four in 1992 to six statements in 2000
and include: balance sheet, profit and loss statement, cash flow statement, statement of changes in
equity, the annex and the management report. The above composition of the annual report is
provided for in the IFRS, but the “Annual Accounts Law” does not determine the application of
the IFRS;
 the EC Regulation No.1606/2002 on the application of the international accounting standards
states that the IFRS shall be applied by the companies that prepare consolidated annual reports and
the securities of which are admitted to trading on a regulated market of any Member State. Beside
the above companies, according to the LR regulatory framework, the annual reports in accordance
with the IFRS must be prepared by banks, brokerage firms and investment authorities, while
corporate parent companies can prepare consolidated annual reports in accordance with the IFRS;
 the Fourth Council Directive pertaining to the annual reports of certain types of companies,
provides for the four statements to be included into the annual report: the balance sheet, profit and
loss statement, notes and report, still the LR “Annual Accounts Law” in addition to the set by the
Directive since 1996 has included the cash flow statement and since 2000 – the statement of
changes in equity, which greatly increased the administrative burden;
 while applying the reliefs provided for by the Article 54 of the “Annual Accounts Law”, which
companies may be exploit since January 1, 2010, into the annual report there must be included
three statements: balance sheet, profit or loss statement and annex. These reliefs could be applied
in 2012 by more than 73 thousand, or approximately 93% of all the subjects of the law. So the task
of drawing up a full annual report shall be executed by only 7% of the subjects of the “Annual
Accounts Law”;
 the LR “Annual Accounts Law” provides for a significantly smaller number of companies to apply
for the reliefs set in the Directive 2012/6/EU for the composition of the annual reports of micro442
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enterprises, including therein only an abridged balance sheet and profit or loss statement. Although
by law the amount of the net turnover and balance sheet total is 7 times smaller, but the number of
employees - two times smaller than in the provisions of the Directive, still, these reliefs set in the
Article 541 of the Law could be applied by more than 58 thousand, or approximately 73% of all the
subjects of the “Annual Accounts Law”;
 the Latvian accounting meets the continental European accounting tradition and it must be taken
into account, when developing and adopting the LR accounting regulatory framework;
 in order to determine the optimal composition of the annual report and adopt an appropriate
regulatory framework, the Ministry of Finance could evaluate the proposals:
− to develop and adopt a separate regulatory framework for the preparation of annual reports by
micro-enterprises, stating that the annual report of micro-enterprises shall contain an abridged
balance sheet and profit or loss statement;
− to develop and adopt a separate law for companies that are not micro-enterprises and which
annual reports shall not be drawn up in accordance with the IFRS. In the annual reports of
these companies, in compliance with the requirements of the Fourth Council Directive, there
shall be included four reports: the balance sheet, profit or loss statement, the annex and the
management report;
− in addition to the set in the LR regulations, to provide for the IFRS to be applied by all the
parent companies, while preparing the consolidated annual reports.
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laws and regulations by the Cabinet of Ministers, book 40. Riga: the edition of the Codification
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[Accessed 08 January 2013].
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to the Annual Accounts Law”. Riga: Ministry of Finance of the Republic of Latvia [Online] Available
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Inta Millere
THE FACTORS AFFECTING LATVIAN PUBLIC ADMINISTRATION
DECISION TO OUTSOURCE INFORMATION TECHNOLOGY FUNCTION
Larisa Naumova, University of Latvia, Latvia1
Abstract. Outsourcing has been widely discussed in the context of advantages and
disadvantages, potential risks and problems, but very little discussed about the factors
that determine public administration decision to outsource. Outsourcing now is
widespread, but the main question still existed: how can we identified activities or
services that must not be contracted out? More and more public administration is
questioning whether is necessary to provide all services by themselves or it is possible
to guarantee high quality and cost-effective results with contracting out.
This article reviews how general, public administration-specific and information
technology-specific factors influence decision to outsource. All these factors separately
and jointly influence public administration decision to outsource information
technology function. Examining these factors therefore helps in understanding the
outsourcing decision-making process.
The aim of this article is to find factor that can be used in decision making process
about public administration function outsourcing in the field of information
technologies. Unified comparative factors allow make the decision, taking into account
short term and long term goals.
Key words: decision system, information and communication technology, outsourcing, public administration
JEL code: H8, H830
Introduction
Outsourcing has been widely discussed in the context of advantages and disadvantages, potential risks
and problems, but very little discussed about the factors that determine public administration decision to
outsource. The decision-making system about outsourcing is a complex set of factors that covering full
outsourcing life cycle (the decision making process of usage of outsourcing, defining of criteria in
connection with amount and quality, choosing process of outsourcing provider, as well as work control of
service provider) and different aspects of entrepreneurship (economical, social, technical, political,
juridical and organizational). However the economical factors are the main important in decision making
process (Holcomb and Hitt, 2006).
All factors can be divided into two groups – strategical factors (for example, accession of specific
abilities/ competence, competitive expenses, risk minimization) and tactical factors (for example,
compliance with standard quality, the lack of competence within the company, lack of capital) (Lok et
al., 2012).
1
Larisa Naumova
445
The outsourcing influencing factors in the field of information technologies can be divided into the
followings groups (under the analysis of scientific literature, listed in alphabetical order):
 General factors – is not under the influence of pattern and sphere of outsourcing (company size,
costs reduction, demand fluctuations, innovation, intellectual property rights, language and culture
and resources of company);
 Specific factors of public administration – are influencing the outsourcing in public administration
field (inherently governmental function and political drivers);
 Specific factors of information technology – are influencing the usage of outsourcing in the field
of information technology (data security and technical competence).
This article reviews how general, public administration-specific and information technology-specific
factors influence decision to outsource. Examining these factors therefore helps in understanding the
decision-making process.
In the scientific literature exists also other influencing factors (listed in alphabetical order) – critical
operations risk (Downey, 1995), expenses of labour (Abraham and Taylor, 1996), level of competition
(Smith, 2004), necessity of twenty-four hours working schedule (Djavanshir, 2005), organization of
working process (Kalleberg, 2001), possibilities of export (Görg et al., 2008), quality of service
(Dabholkar, 1995), the location place of service provider (Grover and Teng, 1993), the strategy of
company (Currie and Wilcox, 1998), as well as uncertainty of technology (Ang and Cummings, 1997).
Part of the listed factors characterizes service provider selection conditions, but others can be distributed
as a subset of the other factors; therefore these factors will not be discussed in-depth article.
The aim of this article is to find factor that can be used in decision making process about public
administration function outsourcing in the field of information technologies. The research methods used
include a scientific literature review and a survey of Latvian public administration employees (high,
medium, and low-level managers and experts who have experience in usage of information and
communication technology outsourcing). Factors were evaluated using a 6-point scale, where 1 indicated
a strong disagreement and 6 indicated a strong agreement.
1. Company size
The usage of outsourcing depending on the company size is the most commonly researched issue in
scientific literature; because the company size closely influences the company’s production or service facilities.
The company size in the context of outsourcing is measured by the number of staff employed by the company.
The proponents of negative influence points out that small companies tend to focus their limited
resources on the core business processes, but outsource the secondary processes (Abraham and Taylor,
1996). The negative influence in following years is also supported by the side of Ang and Straub (Ang
and Straub, 1998). In order to provide IT services the company necessary specific kind of competence
that is not available to the small companies. By contrast, the large companies have sufficient financial
resources and facilities to provide the specific resources (Delone, 1981).
The promoters of positive influence points out that large companies use outsourcing in order to
decrease the expenses (Kimura, 2002). In a result of bargaining the large company can lead to lower
prices (Grossman and Helpman, 2002). Also the choice of outsourcing provider for the large company
costs less (Grossman and Helpman, 2002).
Merino and Rodriguguez believe that there is no linear influence between the company size the usage
of outsourcing, but inverted–U relationship (Merino and Rodriguguez, 2007). Using the curvilinear it is
possible to determine the optimal level of outsourcing in company.
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Larisa Naumova
2. Costs reduction
Cost reduction is the most important and the most frequently researched topic of outsourcing, but its
economic importance is dependent on the quality, therefore it is essential to evaluate combination of the
cost savings and quality.
There are many reviews about the costs reduction. Some researches have shown that outsourcing can
reduce costs (Bowers, 1990; McFarlan), especially labour costs (Abraham and Taylor, 1996).
Furthermore the cost reduction in the amount of 20%, not significantly influence the quality of service
(Domberger et al., 1987). Also research made in public administration shows that it is possible to get cost
savings of about 20%, especially with open procurement (Vining and Goberman, 1999). But researches
made in following years indicate less positive results (Hodge, 1999). The end of the 90s shows that only
54% of the outsourcing agreement is reached the expected cost savings (Lacity and Willcocks, 1998).
Hodge indicates that in a result of outsourcing the expenses can even increased (Hodge, 1996). But the
evidences of efficiency of outsourcing are still infrequently (Leiblein et al., 2002).
Using outsourcing the companies cost savings can be obtained only under the condition that
outsourcing provider work efficiently and are able to provide a lower cost (Bers, 1992).
Expenses of outsourcing are not constant throughout the duration of the contract, because initially
have difficulty in clearly defining the quality of service criteria, the technologies are changing during the
time, as well as the outsourcing provider and receiver are cooperating and improve cooperation (Chopra
and Sohdi, 2004).
3. Data security
One of core principles in sensitive and confidential data processing is an accepted level of data
security. Particularly important is medical personal data (Huston, 2001) and financial information security,
because misuse of these kind of data can cause significant damage to a person’s life, reputation,
professional activities as well as financial prosperity.
Data security problem are described as the lack of outsourcing and non-use reason, while the most
important security and data privacy risks are mentioned company’s corporate policy, audit and control
procedures, as well as state laws and regulations (Tafti, 2005). Data security is dependent on technical
and subjective safety (Shin, 2009).
The safety factor significantly influences outsourcing. The higher is the accepted level of safety, the higher
are the expenses (and vice verse). Even a little change in the level of safety can make great influence to the
expenses of outsourcing, even more the companies are ready to pay more for the provided additional safety
(Piazza, 2006), because safety risk is considered as one of the greatest company’s priorities (Buzzard, 1999).
In the scientific literature there are considered different viewpoints, if data security risk depends on
the type of outsourcing (onshore or offshore). Colwill and Gray believe that legislations of national law in
some countries are not complete in the question of data security; therefore the data security risk is higher
in offshore (Colwill and Gray, 2007).
Security risks can be divided into two categories – the company’s internal and external risk (Loch et
al., 1992) and four subcategories – the human, non-human, intentional and unintentional (Bojanc and
Jerman – Blazic, 2008). In order to reduce security risks are used complex measures, which covers the
technical, legislative and administrative issues.
4. Demand fluctuations
In the decision making process it is important to take into account demand value, uncertainty and
fluctuation (Hsiao, 2009, p. 49-50). The uncertainty creates difficulties for planning and control process
Larisa Naumova
447
(Fisher, 1997); therefore demand uncertainty significantly increases the company’s reliance on
outsourcing benefits (Kouvelis and Milner, 2002).
The uncertainty of demand is defined by two dimensions (Grover and Malhotra, 2003)  environmental uncertainty and behavioural uncertainty. However, some another uncertainties exists  performance ambiguity, technical uncertainty, complexity and unpredictability (Krickx, 2000). It is useful to
use internal resources, if they are used on a regular basis and work with a full load, while outsource
resources with low or irregular demand (Carlton, 1979).
If demand is very volatile then providing services with the company’s internal resources, the company
must invest significant financial resources, because resources must be provided in full amount even in
period when particular service is not necessary or it is necessary under limited conditions. Under these
circumstances it is more advisable for company to use outsourcing (Abraham and Taylor, 1996).
Company’s request for flexibility can influence the internal (low component commonality) and
external factors (seasonality), therefore outsourcing is advisable for companies with seasonal work (Fill
and Visser, 2000).
5. Inherently governmental function
The usage of outsourcing can be excellent tool in achieving the goals of public administration, but it is
important to keep the monitoring functions in order to control the service providers and outcomes, as well
as determinations of political and regulatory rights (OECD, 2011).
Although the usage of outsourcing in public administration have increased in recent years, specially in
the fields in national security, intelligence, warfare, development of state infrastructure and military
(Freeman and Minow, 2009, p. 2), there is still a belief that some functions is not appropriate to
outsourcing  functions that are critical for existence of the state or that are in basis of the creation of public
administration (for example, military operations, working of police and fire safety department, as well as tax
collection) called as inherently governmental function. Each company has its own central functions that are
in great importance for existence of the company and not be outsourced. However if company’s goals are
changing, then core functions or priorities can change (Cohen and Cohen, 2008, p. 99).
In nowadays the outsourcing are being used also for realization of very important (sensitive) functions of
the public administration that some time ago were considered as exclusive functions for public
administration, for example, military target selection, interrogation of prisoners, border control, security
training, monitoring system design, intelligence service management, classified or confidential information
gathering and use, military support in warfare zone (Freeman and Minow, 2009, p. 2). Another researches
shows following the fields in public administration where usage of outsourcing is possible – public building
maintenance and management; personnel management; services of public transport; parks and gardens
management; prison supervision; road maintenance; public health services; tax assessment; maternity salary
administration; welfare program implementation; state auto-parks maintenance and information technologies
services (Washington Roundtable and Washington Research Council, 2010, p. 6).
6. Innovation
If the company does not have the required competence to create innovation, or the creation of an internal
innovation process is too slow and expensive, the company can use the outsourcing (Barney and Lee, 2002).
Different classifications for innovations can be met that are divided into pairs – innovations of
products/ processes, competence lowering/ innovation-enhancing, radical/ incremental innovations,
administrative/ technical innovations (Schilling, 2006, p. 43-45). According to Glass and Saggi
innovations gives positive impact on outsourcing  innovation provides additional income, that later can
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Larisa Naumova
be used for the purpose of development of the company (Glass and Saggi, 2001). Bardhan points out that
outsourcing is appropriate when innovation becomes as a mainstream subject, when competence of the
company is freely available and it can be repeated by the competitors (Bardhan, 2006).
Decision making process about outsourcing innovation can be influenced by some characteristics,
arising from the nature of innovation or in comparison with other goods or services (Howell, 2006).
Company access to the external service provider competence and technological capabilities, including
innovation is one of the advantages of outsourcing (Lacity et al., 2009), but the main setback for usage of
innovation outsourcing is investors’ uncertainty about the return on investment (Hall, 2002). The data
from research shows that only a third of companies are satisfied with their innovation results obtained
from the use of outsourcing (Robinson et al., 2008).
Innovation can be described as an unclear, uncertain and at the same time a complex process (Pich et
at., 2002), which in the high-tech age can cause significant damage to the company or to provide a
competitive advantage.
7. Intellectual property rights
Intellectual property rights are related to data security, but it is discussed as a separate factor. One of
the most importance assets of company are the intellectual property rights that cover copyrights, patents,
trademarks, business processes and business plans (Hinkelman, 2007, 15). Leakage of the intellectual
property risk has historically been mentioned as one of the most important risks and outsourcing non-use
reasons (Teece, 1986).
The protection of intellectual property rights is under the basis of legitimacy of each country, in this
manner influencing the relationship within parties of contract if they are located in different countries (Pai
and Basu, 2007). The main attention must be paid to outsourcing provider that is operating in country
without strong protection.
Using the advantages of outsourcing companies are important to maintain its intellectual property
rights, as well as getting the appropriate ownership of outsourcing results (Pai and Basu, 2007). In
contracts of outsourcing typically the protection of intellectual property rights are being enclosed in three
degrees – in the moment of signing the contract, during the contract period and after the termination of
the agreement (Corley et al., 2005).
Merges and Nelson believes that the protection of intellectual property is difficult to implement in some
fields, for example, in information technology (Merges and Nelson, 1990), however, over time the legislation is
improved and in nowadays the company knowledge base is dependent on efficiency of the protection
system of intellectual property rights in the company itself (Martinez-Noya and Garcia-Canal, 2001).
8. Language and culture
In decision making process about outsourcing, the culture and linguistic factors play an important role,
especially in customer relationship management, however in the scientific literature can be found
conflicting assessments about necessity to know official state language in outsourcing, because there is
belief that knowledge of English language can fully replace the knowledge of official state language
(Herbsleb and Moitra, 2001).
Other researchers indicate that the number of people who speak in several languages is more then
people who speaks only in one language (Graddol, 1998). However the majority part of English speaking
people, English uses it only as the second, third or forth language. There are differences in level of
knowledge and used dialects (Fishman, 1998); therefore the knowledge of national state language is one
of the core factors in outsourcing.
Larisa Naumova
449
Cultural differences can create significant and systematic misunderstandings in process of cooperation
(Herbsleb and Moitra, 2001), for example, the differences in perception of life, values, beliefs and
behaviour, working habits, as well as incompatible working hours; therefore the cultural differences
between parties must be taken into account (St. Amant, 2002). Due to the time zone differences,
communication can be distorted and service response time can increase (Qureshi et al., 2006). The
cultural differences influence the decision-making process. In order to reduce outsourcing risks,
outsourcing is mainly used in nearshore – in the regions with the same or similar culture.
As important reason for nearshoring can mention lower expenses (especially when talking about
labour), cultural similarities, similarities in legislations and language, lower travelling and communication
expenses (Gartner, 2002, 4).
9. Political drivers
There are three drivers of outsourcing  costs, strategy and policy. If the first drivers characterized the
decisions made in private company, then decisions that are being made within the usage of outsourcing in
public administration are closely influenced also by political drivers, however the political drivers can be
hidden (Ni and Bretschneider, 2007). In every decision can be used one, several or even all the drivers
together (Kakabadse and Kakabadse, 2000).
In public administration decision making process about outsourcing is often determined by political criteria
rather than efficiency and effectiveness indicators (Vintar and Stanimirovic, 2011), that is why the decision
makers have to find an effective balance between efficiency and political direction (Reddick, 2011, p. 173).
It must be mentioned that in the decision making process about IT outsourcing in the public
administration one of the most important aspects that must be taken into account is the “bandwagon effect”
and the public administration wish work under the principles of entrepreneurship (Willcocks et al., 1995).
It is accepted to think that outsourcing in the public administration is based only on economical and
political decisions (Hirsch, 1995), despite the evidence about politically aspect is met very rare (Brudney
et al., 2005).
Rising the frequency of outsourcing the companies are meeting with the advantages of outsourcing and the
influence of political and costs drivers are getting lower, because in nowadays decision-making strategy
involves a set of aspects  economic, technical, political, strategical and organizational (Baldwin et al., 2001).
10. Resources of company
Company resources include all assets, capabilities, business processes, characteristics, information and
knowledge that are available for the company in order to fulfil its strategy (Daft, 1983).
In conditions of limited resources company is forced to regularly review the company’s limited
resources (Drtina, 1994), because only with effective administration of resources, being aware of their
benefits and losses the company can gain competitive advantages in the market and succeed (Fahy and
Smithee, 1999, p. 1). The typical resources are districted to the fields which creates the most value added,
usually on the company’s core business processes.
The human capital resources are one of the most important factors that affecting the company’s basic
functions and opportunities (Bresnahan et al., 2002), including the decision making process about
outsourcing. Companies with high level employees with competitive salary in core process can reduce the
cost with outsourcing in secondary process (Cusmano et al., 2009). Usually companies increasingly use
outsourcing when companies have their internal lack of the human resource (Green, 2000). But the lack
of resources in the public administration is with increased influence, due to the restrictions on the
recruitment, the employment termination processes and procedures, as well as the existing limitations in
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the number of officials (Kremic et al., 2006). However, both public administration and private companies
may have difficulty finding particular human-specific knowledge.
11. Technical competence
Technical competence is particularly important in the technology-intensive sectors, where technology
diversification is becoming more and more required (Granstand, 1998). The competence includes the
appropriate qualifications and experience, necessary specialized skills, specializations in the industry and
technological knowledge (Carey et al., 2006).
One of the most important advantages of outsourcing is company access to high-quality technological
services (Baldwin et al., 2001), which are too expensive for company to provide with internal resources
(Gilley and Rasheed, 2000). However, the outsourcing does not in itself mean that the company will have
access to the latest technology, because the deals are being regulated by the contract signed between
provider and receiver (Lacity et al., 1994).
It must be taken into account that the usage of outsourcing reduces the company’s internal
technological competence (Coombs, 1996) and critical knowledge, creating the risk of dependence on
service provider (Hoecht and Trott, 2006).
There is a believed that companies with high technological competence is more competitive and they
do not need to seek additional external resources. On the other hand, companies with high technological
competence are better protected against outsourcing failures, due to the fact that company with
competence can choose the most appropriate provider for outsourcing, as well as better control the work
(Mayer and Salmon, 2006).
12. Results of empirical research
The study was conducted among 68 employees in Latvian public administration  high, medium, and
low-level managers and experts who have experience in usage of the information and communication
technology outsourcing. The questionnaire was distributed to the respondent by web form during January,
2013. Distribution of responses for factors influencing the decision making process about outsourcing is
shown below (see Table 1 and Table 2).
Table 1
Distribution of responses for factors influencing the outsourcing decision
in the public administration (part 1)
Company
size
1
2
3
4
5
6
Total
n
11
7
25
6
18
1
68
%
16.2
10.3
36.8
8.8
26.5
1.5
100.0
Costs
reduction
n
7
1
7
14
28
11
68
%
10.3
1.5
10.3
20.6
41.2
16.2
100.0
Data
security
n
7
1
4
7
7
42
68
%
10.3
1.5
5.9
10.3
10.3
61.8
100.0
Demand
fluctuations
n
1
17
22
14
7
7
68
%
1.5
25.0
32.4
20.6
10.3
10.3
100.0
Inherently
governmental
function
n
%
10
14.7
1
1.5
17
25.0
7
10.3
22
32.4
11
16.2
68
100.0
Innovation
n
3
3
15
25
19
3
68
%
4.4
4.4
22.1
36.8
27.9
4.4
100.0
Source: author’s research results, January, 2013 (n=68). Scale: 1  strongly disagree; 2  disagree; 3  slightly disagree;
4  slightly agree; 5  agree and 6  strongly agree
Larisa Naumova
451
Table 2
Distribution of responses for factors influencing the outsourcing decision
in the public administration (part 2)
1
2
3
4
5
6
Total
Intellectual
property rights
n
%
3
4.4
3
4.4
22
32.4
18
26.5
14
20.6
8
11.8
68
100.0
Language and
culture
n
%
11
16.2
11
16.2
22
32.4
18
26.5
3
4.4
3
4.4
68
100.0
Political
drivers
n
%
7
10.3
14
20.6
11
16.2
18
26.5
11
16.2
7
10.3
68
100.0
Resources
of company
n
%
3
4.4
3
4.4
1
1.5
22
32.4
25
36.8
14
20.6
68
100.0
Technical
competence
n
%
3
4.4
3
4.4
1
1.5
22
32.4
25
36.8
14
20.6
68
100.0
Source: author’s research results, January, 2013 (n=68). Scale: 1  strongly disagree; 2  disagree; 3  slightly disagree;
4  slightly agree; 5  agree and 6  strongly agree
The data displayed in table 1 and table 2 indicated that:
 Most of the respondents gave an evaluation of 5 and 6 to the factor of data security (72.1%), but
the next important factors were found costs reduction (57.4%), resources of company (57.4%),
technical competence (57.4%) and inherently governmental function (48.5%);
 Only 32.4% of respondents gave an evaluation of 5 and 6 to the factor of innovation, while 69.1%
of respondents in general are agreed that innovation is important factor in decision making process
about outsourcing (gave an evaluation of 4 or more);
 Most of the respondents disagree that language and culture (64.7%), company size (63.2%) and
demand fluctuations (58.8%) are important factors in decision making process (gave an evaluation
of 3 or less);
 Respondents’ views on the importance of political driver factor are not homogeneous  52.9%
respondents in general are agreed that this factor is important in decision making process about
outsourcing (gave an evaluation of 4 or more), while 47.1% respondents in general disagreed
(gave an evaluation of 3 or less).
Conclusions
Based on the scientific literature analysis and the results of survey can be drawn the following key
conclusions, proposals and recommendations:
1. Outsourcing has been widely discussed in the context of advantages and disadvantages, potential
risks and problems, but very little discussed about the factors that determine public administration
decision to outsource.
2. Public administration decision to outsource is influenced mainly by three groups of factors 
general, public administration-specific and information technology-specific factors.
3. Under the analysis of scientific literature was identified the following key factors (listed in
alphabetical order)  company size, costs reduction, data security, demand fluctuations, inherently
governmental function, innovation, intellectual property rights, language and culture, political
drivers, resources of company and technical competence. Examining these factors therefore helps
in understanding the outsourcing decision-making process, assumptions and limitations.
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Larisa Naumova
4. In scientific literature exists also other less important factors (listed in alphabetical order) – critical
operations risk, expenses of labour, level of competition, necessity of twenty-four hours working
schedule, organization of working process, possibilities of export, quality of service, the location
place of service provider, the strategy of company, as well as uncertainty of technology. Due the
fact that part of the listed factors characterizes service provider selection conditions, but others can
be distributed as a subset of the key factors; these factors not discussed in-depth in this article.
5. In Latvian public administration the main factors that influence decision making process about
information and communication technology outsourcing are data security, costs reduction,
resources of company, technical competence and inherently governmental function, while factors
as language and culture, company size and demand fluctuations are undervalued.
6. In Latvian public administration the factor of political driver can not be assessed unambiguously,
but in practice is usually overestimated. However in the case of changes in political directions, the
previous made decisions, priorities and even targets may become outdated. In context of
outsourcing contracts are typically closed to the long period of time, therefore contracts must
respond to changing requirements.
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Larisa Naumova
HUMAN DEVELOPMENT AND GENDER ISSUES:
A CASE OF UZBEKISTAN AND LATVIA
Shoirakhon Nurdinova, Tashkent State Technical University, Uzbekistan /
University of Latvia, Latvia1
Abstract. Gender inequality is one of the most topical global problems nowadays.
The purpose of human development is to increase people’s opportunities for a healthy,
long and happy life. The main aim of this paper was to investigate the relationship
between the human development concept and gender problems in the last decade. The
link between human development and gender is less studied, particularly in case of
former Soviet Union countries. The case study was based on a comparative analysis of
the situation and problems in Latvia and Uzbekistan, and it aimed at studying the
relationship between human development and gender issues: gender norms, inequality,
difference in education, working hours, earnings, and life expectancy in both countries.
Gender and human development analysis aims at contributing to understanding
implications of interventions and potential outcomes for women and men in particular
countries: Latvia and Uzbekistan. It has been concluded that creating opportunities for
women, encouraging women’s education may be brought positively to sustainable
human development. It is expected that the results of the research will help to determine
and solve the human development problems as causes of discrimination against women
and men encountered by women in Latvia and Uzbekistan.
Key words: human development, gender, case studies, Latvia, Uzbekistan
JEL code: O15, J16, O57
Introduction
The objective of this paper is to develop more effective gender mainstreaming tools and
methodologies that will facilitate favourable gender environment. The paper is based on comparative
analysis of the socio-economic situation, gender equality status, gender aspects of development priorities
and a number of other important factors.
The theoretical literature suggests that human development is a theory and methodology of ecological,
economic and social complex development. According to the definition of United Nations Development
Programme, human development is a process of providing people with more choice, empowerment and
ability.
The founding from the first report of Human Development was “The real wealth of the nation is its
people” in 1990, and this phrase was mentioned again as the main idea of Human Development report in
2010. The purpose of development is to create good opportunities for a long, healthy and creative life.
1
Shoirakhon Nurdinova
457
This simple, but important “truth too often gets forgotten in the pursuit of material and financial” wellbeing. Mahbub ul-Haq’s (the Nobel prize holder) seminal work laid the foundations for the field of
human development. Mahbub ul-Haq’s and Amartya Sen’s ideas were set out in their books “Reflections
on Human Development” and “Development as enlarging opportunities” in 1996. “The basic purpose of
development is to enlarge people’s choices. In principle, these choices can be infinite and can change
over time. People often value achievements that do not show up at all, or not immediately, in income or
growth figures: greater access to knowledge, better nutrition and health services, more secure livelihoods,
security against crime and physical violence, satisfying leisure hours, political and cultural freedoms and
sense of participation in community activities. The objective of development is to create an enabling
environment for people to enjoy long, healthy and creative lives.” (Mahbub ul Haq, 1990).
The first Human Development Report was published in 1990 and since then it has been released every
year to demonstrate countries’ annual social-economic development tendencies.
The basic concept of human development is noted in the following:
 human development reflects both the expansion of the human choice, and the current level of wellbeing;
 welfare measured in terms of the ability of people to lead a decent life;
 human development critically depends on the satisfaction of three basic needs, such indicators
characterizing human development as longevity, education and material well-being;
 income is a tool that extends the human choice;
 people do not need an infinitely high income to lead a decent life; the positive impact of higher
income on human development decreases, as their income rises. (The Human Development
Report, 1996).
Human development index consists of the index of literacy, index of life expectancy and GDP per
capita in PPS in US dollars. The Human development index is renewed yearly by other indicators and
indexes:
 The index of human freedom (1991);
 The index of political freedom (1992);
 Development Index according to gender (1994);
 The display of the empowerment of women (1994);
 Poverty Index  1 (1997);
 Poverty Index  2 (1998);
 The index of technological advances (2001);
 Attempts to “green” index (2003).
In 2010, the human development report was enriched by three indexes: Human Development Index
for inequality, the Gender Inequality Index and the Multidimensional Poverty Index.
Gender is one of the universal biological differences between men and women; it is the anatomical
and physiological reality, that is, a set of biological characteristics which are a prerequisite for the
inclusion of the individual to the biological sex, male or female. Evidently, gender is manifested in the
relationship between men and women and the authority of one over another. The concept of gender has
been used to differentiate the socially constructed roles which are ascribed by society to men and women.
More importantly, it helps us identify how differently men and women benefit from social and economic
development. Gender examines how cultural, social and economic differences affect the roles of men and
women in the family, the work place and in society at large.
In the international scientific practice, special attention has been paid to gender studies, as this
research area has strategic and practical significance for social development, in particular, it is important
for structural reforms in the transition countries leading to a democratic, economically prosperous society.
458
The use of gender approach in addressing the participation of different groups in development
activities in accordance with their social roles and specific needs has allowed the development of a gender
strategy which includes the following components:
 Priority consideration and the needs and requirements of women (especially when cultural norms
and values set limits for equal participation in the activity);
 Definition and status of women in society relation to men;
 Awareness of women’s situation, needs and requirements;
 Identification of barriers to the advancement of women;
 Expanding the scope of women, the development of traditional male roles and occupation;
 Elimination of direct or indirect results of discrimination. (D.Alimjanova, 2007).
Gender Aspects of Human Development
Over the last thirty years the term “gender” has become common in the discussions to describe the
whole field. The development of science has provided a way to pass these difficulties. Gender is a matter
of social relations within which individuals and groups act. Gender equality means that the rights,
possibilities, responsibilities, obligations, the treatment of both sexes, as well as their access to resources
should be equal. However, in practice it is not always so, due to various social, economic, cultural and
historical circumstances, e.g., stereotyped views on the role of women and men in society called the “boy
problem” in some countries, the rights of girls to education continues to be inhibited in many developing
countries in important respects.
Hilary Lips, American professor studied gender issues and proposed some conclusions about sex and
gender studies. In 1984 John Archer suggested a model of gender roles as developmental pathways. He
offered women’s and men’s roles, the same method can be separate pathways of development. In other
words, the acquirement of gender roles, and not just the content of these roles may be different for males
and females. His discussion concentrated on 4 related dimensions of gender-role acquisition, which he
argues may be fundamentally different for two sexes:
 Rigidity or flexibility (extent to which cross-gender-typed behaviour is permitted);
 Simplicity or complexity (how elaborate the content of the gender role is);
 Internal consistency or inconsistency of the role requirements;
 The degree of continuity or discontinuity in role development.
Archer’s theory alerts us to the possibility, suggested by much of current literature on gender
socialization, that the females and males may not travel along completely parallel tracks in the
development of their gender roles. Furthermore, his approach illustrates the usefulness of life-span
approach to gender-role development (H.M. Lips, 2007).
In other literature, we can face the two most popular stereotypes – “woman as a domestic slave” and
“man as a breadwinner” in the present day situation:
1. Constraints with families. In many developing countries girls take on domestic responsibilities,
including the care of younger siblings, and, depending on the country and the culture, boys often
receive preferences when choices have to be made regarding education. Since it is commonly
expected that girls should be married off at an early age, parents consider educating their daughters
a waste of time and money in Uzbekistan. The girls are aware of their parents’ perceptions
regarding their education. They do not find it necessary to work hard because they assume that
they will probably drop out of school early.
2. Constraints within society. These include pressure for early marriage, sexual harassment and violence in
and out of educational settings, religious constraints and vulnerability to HIV and AIDS.
459
3. Policies of school system and educational practices. School systems in countries of all kinds are
not always empowering for girls, nor are they sensitive to their needs through curricula, guidance
and counselling services, teaching methods and the presence of appropriate female role models.
4. Benefits of education. Even when girls achieve parity in access to education or academic
performance, this parity does not always lead to equal benefits of education, especially in the job
market of developed countries.
In short, gender disparities and inequalities are prevalent within the schooling process in both developing
and developed countries. Virtually all countries must address the gender disparities and inequalities that
shape the ways in which boys and girls progress through the education system (L. Kim, 2007).
In 2010, the United Nations (UN) General Assembly organized some branches as UN Women, the
United Nations Entity for Gender Equality and the Empowerment of Women. Thereby, UN Member
States put a historic step in accelerating the Organization’s goals on gender equality and the
empowerment of women.
The United Nations Millennium Development Goals and associated target are to eliminate gender
disparity in primary and secondary education, and in all levels of education by 2015.
The United Nations defines situation in gender equality in societies:
 In some regions, education remains elusive for girls;
 Poverty is a major barrier to education, especially among older girls in every developing region,
except the CIS, men outnumber women in paid employment;
 Women are largely relegated to more vulnerable forms of employment;
 Women are over-represented in informal employment, with its lack of benefits and security;
 Top-level jobs still go to men — to an overwhelming degree;
 Women are slowly rising to political power, but mainly when boosted by quotas and other special
measures.
American economist Bernard Walters (University of Manchester) conducted a research on gender and
development and suggested the following model the link of economic development and gender equality
(Bernard Walters, 2008).
Equality in the household, in employment, in the society
(access to finance, resources, decision-making)
Women’s improved
access to market
Improved education and
health of women
Increased participation women labour-force,
increased productivity and income
Increased income / expenses
Decrease in poverty and improved
economic development
Magnitude in savings
Increased influence of women
decision-making in household
Improved the health of children
Better health and education =
increased productivity
in adulthood
Further poverty reduction
and economic development
Fig. 1. The relationship between economic development and gender equality
460
It is clear that issues should be considered in the gender-based approach that would eliminate gender
gaps in the analysis of the welfare state. In accordance with the principle of gender equality, economic,
political, and social resources must be allocated between men and women on an equal basis. In general,
these suggest policies to increase educational provision to girls, raise certain forms of infrastructural
spending, and release a range of institutional constraints will support socio-economic development.
Latvia and Uzbekistan: gender issues and tracks
The Government of Uzbekistan has adopted a number of laws and national programs, including the
National Platform of Action (1998-2005), which outline the strategy and priority areas for improving the
status of women in Uzbekistan. The National Program has been recently developed based on the
President’s decree on “Additional measures to support the Women’s committee of Uzbekistan”. It focuses
on improving women’s economic situation by increasing employment of women and promoting their
entrepreneurial activities. Year 2012 was declared the “Year of the Family”. The government of
Uzbekistan has developed the State program “Year of the Family”.
Since 1997, in Uzbekistan on the initiative of the state each year is titled and devoted to a specific
social programme. Year 1998 was proclaimed the Year of the Family, year 1999 was the Year of
Women, year 2000 was the Year for healthy generation, year 2001 was Year of Mother and Child, year
2005 was the Year of Health, year 2007 – the Year of Social Protection, year 2010 – the Year of
harmoniously developed generation. Each year the Government prepares a social-oriented programme to
improve living standards and empower women.
The Committee on the Elimination of Discrimination against Women (CEDAW) has prepared
recommendations to Uzbekistan’s CEDAW implementation report. As a follow-up, the Government
adopted the National Action Plan and established a national working group to coordinate and monitor its
implementation. The Government of Uzbekistan supports a number of activities to raise women’s
awareness of their rights and to improve women’s status in society. The public information campaign in
Uzbekistan was implemented according to the “Public Information Strategy on Gender Equality Issues”
centring around six problem areas:
1) gender discrimination in the labour market;
2) gender roles in the family;
3) providing the possibility to harmonise work and family life;
4) gender discrimination problems in the mass media;
5) issues of gender equality in education;
6) domestic violence.
As European member, Latvian government has adopted laws and legislations concerning gender
discrimination. In 2003, CEDAW Committee submitted Consideration of parties under article 18 of the
Convention on the Elimination of All Forms of Discrimination against Women initial, second and third
periodic report for Latvia. Despite of the fact that in some of the existing legislation, there are some
gender equality arrangements, but these are insufficient. Several provisions of the new labour law demand
the execution of equality in different areas such as employment, salary, paternity regulations. whereby
national labour legislation is to be brought in line with EU directives. The new Labour Code, which
entered into force in 2002, includes a general provision prohibiting direct and indirect discrimination on
women. Consequently, the relevant EC Directives on equal opportunities are transposed into the new
Labour Code and the Law on Labour Protection since 2002. According to Article 172 of Labour Code of
Latvia stipulates that women with children under the age of three should be awarded full wages while
working only 30 hours per week, instead of 40. (Gender and Human Development in Latvia, 1999)
461
In 1999, the Department on Social Policy Development was submitted as the responsible agency for
challenge of gender equality in Latvia. Women need to become a more powerful force in the political
parties and in business by increasing the number of women in various government, thus achieving a faster
pace of gender equality policy.
According to the international criteria, one of measurements of gender equality in country is women’s
participating in policy-making. Women’s seats in national parliaments are shown in Figure 2.
35
30
25
20
15
10
5
0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Latvia
Uzbekistan
Source: developed by the author from the data of State Committee of Uzbekistan and World Economic Forum.
Fig. 2. Seats held by women in parliaments (in numbers)
In this statistical data analysis on women’s seats in parliaments of Latvia an Uzbekistan is shown.
1999-2007 was the first woman to hold presidential post in Latvia. The analysis of gender inequality in
national parliaments by taking into account unequal population size of each country shows that there is a
level of inequality in particular countries. In Latvia women don’t try to get position in parliaments, but
women are getting more active in decision-making and policy in Uzbekistan.
Gender Roles in Labour Market
Women and men are engaged in different areas of activities indicating that the traditional patterns of
men’s and women’s jobs are still prevailing based on the predominant gendered division labour, in
particular, women’s obligations towards to unpaid household work. Analysing the education system in
Western Europe, researchers have come to the conclusion that the school education helps to perpetuate
and reproduce traditional gender roles and stereotypes. Myra McDonald wrote on the subject in her book
that the child’s behaviour in schools is assessed according to expectations imposed on the floor: the
behaviour of girls should comply with generally accepted model of femininity, and the boys –
masculinity. The school system is making its “contribution” to impart gender roles, in accordance with
the boys need to be prepared for their future professional activities, and girls – for domestic duties. In
school boys attributed the so-called “Male” subjects and classes, and girls – to “female” ones. This is
especially seen in lessons and occupational orientation on which in fact traditional gender roles are rigidly
fixed: girls are oriented to women’s employment and occupation (housekeeping, secretary, seamstress,
etc.), and the boys – to men (carpenter, mechanic, driver, buzzer, etc.). Teachers often encourage the
462
activities and view of boys. Existing school tacit division of objects into “male” (technical and accurate)
and “female” (liberal) shows that boys are encouraged to engage in more complex science, and, therefore,
ability to weigh more. And since the training complex items are a priority, therefore, according to
teachers, the existing system of education is positively tuned to the boys and “hostile” to the girls. Similar
conclusions are representatives of feminist pedagogy contributed to the fact that the view that boys are
preferred sex and that the school inhibits girls prevailed in American education for a long time.
(MacDonald M, 2009). This point is also sustained by the work of B.Orser and J.Leck, suggested gender
concept is modified in two ways. First, gender is incorporated as a moderating variable and the
interactions of gender with other determinants of success are examined. Second, their research adds to the
model attributes that are potentially relevant to women’s career outcomes (e.g. domestic responsibilities).
The gender-interaction model of executive career success is shown in Figure 3. The influences of gender
on career outcomes are described in the model. Orser B., Leck J., 2010)
Source: adapted from Judge et al. (1995)
Fig. 3. The gender-interaction model of executive career success
Therefore, the employment rate is a suitable indicator for the quantity of labour supplied. Beside the
employment rate, the activity rate is used to account for unemployment. Overall, the discrepancies in the
job status are substantial between men and women as well as between countries. (Kaiser L., 2007)
463
Table 1
Labour force participation rate (percentage), 2011
No.
1.
2.
Country
Uzbekistan
Latvia
Female
58.4
94.8
Male
71.0
96.2
Source: author’s calculations based on Human Development Report indicators 2011.
According to Table 1, it is easy to notice that the rate of women in labour market is too low in
Uzbekistan in comparison with Latvia. There are more reasons to the absence of women’s participation as
a labour force despite religious, cultural and traditional causes. According to the statistical data, 68.2% of
students of the higher educational institutions in Latvia are female. This is likely to be even more correct
for girls because of the impact of girls’ education and labour market engagement on fertility, infant
mortality and the future health and well-being of the population.
The Gender Parity Index (GPI) is a socioeconomic index usually used to measure the relative access
to education of males and females. It is calculated as the quotient of the number of females by the number
of males enrolled in a given stage of education. The following formula is commonly used to calculate
GPI:
GPI = value of indicator for girls/ value of indicator for boys
A value of less than one indicates differences in favour of boys, whereas a value near one indicates
that parity has been more or less achieved. International organizations describe attempts to eliminate
gender disparities in primary and secondary education and emphasizes the plight of girls in unequal
access in developing countries. (Koronkiewicz, M., 2008). In Figure 4 Gender Parity index in Latvia and
Uzbekistan is described:
3
Coefficents
2.5
2
Latvia
1.5
Uzbekistan
1
0.5
0
1991 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: calculated and created by the author using UNSD data
Fig. 4. Gender Parity Index in tertiary level enrolment (coefficients)
In public opinion, the stereotypes associated with the nature of male and female differences in labour
are reflected in the gender segregation in employment. They are derived from the first two groups of
gender stereotypes. Traditional roles of men and women in society are influenced by both professional
464
preferences of employees, as well as the requirements of employers to employees. At the same time, the
stereotypes of femininity and masculinity influence when making a choice in favour of a particular
employee, male or female candidates, according to which calls are advantages and disadvantages to both
male and female occupations. In Uzbekistan women marry in early, they cannot continue their studies,
during their maternity leave they lose professional skills and qualifications. Ultimately women command
competitiveness than men and face more difficulties in labour market as white collars. As a rule, women
prefer such branches as education and public health, while men go for industry, agriculture, building and
communication.
Gender challenges do not only depend on women’s rights, problems, issues, but also on men’s
possibilities. Women can expect to live longer than men, and they also tend to have less serious health
problems than man (Harris D., 2007). In general, men live on average less than women worldwide, in
Uzbekistan the difference is about 5 years. The society has a concept of the stereotype that men should be
stronger physically and mentally than women, and thereby men can not cry or show their negative and
unfavourable feelings. All these reasons cause hypertonic disease and other diseases of heart and nervous
system. According to data provided by the World Health Organization, men are more likely to die in
accidents and from cardio-vascular diseases in more cases. So men work more (retire later) and then live
less. Life expectancy for male in Uzbekistan is 66 (in Figure 5) and retirement age for men is 60.
According to Figure 5, life expectancy in Uzbekistan for men is by 6 years (in 1990) or 5 years (in 20002009years) lower than for women. This indicator in Latvia is more significant: the differences of life
expectancy for women and men are 9 years (in 1990-2000 years) and 10 years in 2009.
160
140
1990
2000
2009
120
100
75
69
76
68
77
71
Female
80
Male
60
40
64
63
65
63
67
66
Latvia
Uzbekistan
Latvia
Uzbekistan
Latvia
Uzbekistan
20
0
Source: developed by the author using the data of World Health Organization, 2011.
Fig. 5. Life expectancy at birth for men and women (in years)
Practically it is admitted the existence of gender marked spheres of labour and occupations. The
differences between male and female labour are conditioned by physiological and psychological
differences between sexes. In social opinion, that the male labour requires “brute physical power” or
“analytical mind”, therefore a number of specialties from industrial, technical, building, military,
465
agricultural and other spheres are included into male labour, as for science, men are considered to
dominate reasonably in technical and natural sciences. The above-mentioned labour distributions sectors
for men are well-paid spheres. Women are considered to fit the professions in education, medicine, public
service that require particular “female” qualities, i.e. ability to empathize, industriousness, etc. In the
fields of science women are considered to take the niche in humanitarian disciplines. Unconditionally,
females consider jobs of librarian, teacher in kindergarten, secretary, and archives employee, housemaid,
nurses, cashiers and others. The male professions are those of a driver, servant in military, engineer,
sanitary engineer, electrician, engineer, surgeon, etc. Besides, the “male” positions are those of the
directors and managers in firms and enterprises. However, in comparison with other countries, the share
of women in the total number of scientists in Latvia is rather high – 52.4% (32.9% on average the EU).
Moreover, in future this ratio may increase, as the share of women in the total number of doctorates
awarded every year is high in Latvia and other EU Member States. In 2011 in Latvia 193 females and 104
males received a doctoral degree (65% and 35%, respectively). But the same indicator is decreasing year
by year in Uzbekistan.
60
50
40
30
Latvia
Uzbekistan
20
10
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
0
Source: calculated and developed by the author using the data from the United Nations
Fig. 6. Share of women in the non-agricultural sector (in per cent)
The tendencies of number of women in non-agricultural sector are described in Figure 6. In
Uzbekistan 60% population live in rural areas, and most women are engaged to agricultural works. The
government of Uzbekistan prepares the programme for rural women’s support: rural women can get
preferential credits, grants and loans to begin their own business or enlarge their activities.
While the government programmes are directed to improve economic opportunities for women, the
labor market is sex-segregated, and women are usually paid lower wages. Unskilled workers are actually
non-productive sphere consisting completely of women. Considering employment in different branches of
economy, we can see the following distribution. The women are engaged mainly in public health services
and social security, as well as in education, culture, art and science (more than 70 %). As for the other
branches, the men’s share is higher. This is especially true in construction, transportation and
management, where the share on male participation is more than 80%. Besides, having a rather high
466
proportion in terms of higher education (the share of the women here is 18%, and the men – 17.3%), the
women are less represented in the economic management. (Azizova N., 2007)
In the statistical edition “The men and the women of Uzbekistan” it is noted about this, “the choice of
specialties in educational institutions differs considerably among women and men. The distribution in
professional specialization between men and women goes by existing stereotypes, i.e. dividing the labor
on “female” and “male”, family traditions and also economic factors.
The World Economic Forum publish annual report framework for measuring Equality the Gender Gap
Index as an attempt to assess the size of the gender gap using economic, educational, health and political
criteria. According to WEF’s Global Gender Gap Report 2012, GGI is 0.757 in Latvia (15 th place) among
the 130 investigated world countries in 2012. Undoubtedly, the situation of women from the Baltic States,
especially in Latvia, is not as bad as for women from the Uzbekistan (58 th place). In Figure 7, Latvian
Index is increasing year by year and the Gender Gap Index shows that the gender inequality and women
discrimination level is low in this country.
0.77
0.76
0.75
GGI
0.74
0.73
Latvia
0.72
Uzbekistan
0.71
0.7
0.69
0.68
2004
2006
2008
2010
2012
2014
year
Source: developed by the author using the data from The Global Gender Gap Report
Fig. 7. The Gender Gap Index and tendencies in Latvia and Uzbekistan
The Gender Equity Index (GEI) was introduced to measure inequities in different areas of women’s
and men’s everyday lives around the world. The GEI is based on information available that can be
compared internationally, and it makes it possible to classify countries and rank them in accordance with
a selection of gender inequity indicators in three dimensions, education, economic participation and
empowerment. According to GEI ranks 157 countries in 2009 GEI score is 75 in Latvia (17 th place) and
Uzbekistan’s score is 57 (100th place). The means to achieve equality is gender equity, understood as
fairness in the treatment of women and men according to their needs. Human Development Index
rankings in Latvia (0.805 is very high HDI) is greater than Uzbekistan (0.643 is medium HDI).
467
Conclusions
1. The data analysis on the cases of Uzbekistan and Latvia shows that each country has their own
advantage to improve gender equality.
2. The data presented above shows that Latvian people perceive gender discrimination in line below In
Uzbekistan. We can say that Latvia is more democratic or less patriarchal in relation to women’s
issues than Uzbekistan.
3. The movements of less gender equalities countries in Human Development Index rankings are greater
than the movements of more developing countries. Thus the countries with higher gender equality
index are stable in their positions and are strong in their ability to develop.
4. Gender equality implies the possibility of differential treatment to correct inequalities of departure
measures are not necessarily equal, but conducive to equality in terms of rights, benefits, obligations
and opportunities.
5. In general, social policy to improve women’s status in societies in countries determines the certain
country development level.
The study concludes the following recommendations for Uzbekistan:
 empowering of women and achievement of equality between women and men as partners and
beneficiaries of development;
 supporting NGO activities to enhance economic and social status of rural women;
 mobilizing efforts of rural communities in addressing economic and social challenges for ensuring
rights based and gender responsive development;
 organizing law and physiologic centers to help and supporting for increasing in living standards of
women;
 ensuring access to economic and financial resources for women to begin and encourage their
business;
 improving of the role of women for gender equality and the rights and interests of rural women;
 strengthening women’s rights and possibilities fostering increase of women’s social and economic
activity.
It could also be said that, Latvian women are more active than men in participating in social life,
labour market, education and so on. It can be seen from the above analysis that, even Latvia is more
liberal in gender cases, it will reach to sustainable human development by encouraging to improve both
women and men possibilities for active participation in public and economic fields.
Bibliography
Azizova N. & others, 2007. Introduction to theory and practice of gender relations, Tashkent, UNDP
Uzbekistan.
Chris Beasley, 2007. What is feminist? SAGE.
Gender and Human Development in Latvia, 1999. Riga, UNDP.
Gender Equality in Uzbekistan, Facts and Figures 2000-2004, Uzbeksitan.
Golubeva M. &Havons D., 2002. Women in Baltic societies: present and past, Riga, N.I.M.S.
Harris Diana, 2007. The sociology of aging, UK.
Hilary M.Lips, 2001. Sex and Gender, California.
Human Development report 2011. UNDP Tashkent, Uzbekistan.
Koronkiewicz, M., 2008. Gender Parity Index. UNESCO Bangkok.
Labour Migration in Uzbekistan: Social, Legal and Gender Aspects, 2007. Tashkent.
MacDonald M, 2009. Representing Women, Bloomsbury USA.
468
Novikova I., 2008. Gender Matters in the Baltics Latvia.
Orser B., Leck J., 2010. Gender influences on career success outcomes, Gender in Management: An
International Journal, Vol. 25, Iss: 5.
Social Report for 2006, 2007, Riga.
The Global Gender Gap Report, 2012. World Economic Forum.
World Atlas of Gender Equality in Education, 2012. United Nations Educational, Scientific and Cultural
Organization, France.
Kaiser L., 2007. Gender-job satisfaction differences across Europe: An indicator for labour market
modernization, International Journal of Manpower, Vol. 28, Iss: 1.
469
ANALYSIS OF GINI COEFICIENT (INDEX) IN HOUSEHOLDS OF LATVIA
Rita Ozolina, University of Latvia, Latvia1
Abstract. The author continues researching the theme of the correlation of
demographic, social and economic factors in regions of Latvia, studying the Latvian
households in aspect of Gini coefficient. Aim of the studies is, based on the on
information available in databases, to evaluate changes in Gini coefficient in Latvia,
and, based on calculations of the author (with example being Latvia) to prove the
disadvantages of using it – it’s systematically reducing in bigger territories.
Gini coefficient (index) is generally statistical indicator. In year 2012 it was 100
years since for the first time (in 1912) the formula of Gini coefficient was published,
together with its Italian authors Corrado Gini’s ideas about usage of it. It can be
calculated for different indicators wherever it is needed to numerically compare the
inequality of distribution. Most commonly it is used in statistics of measuring quality of
life. It is relative indicator, derived from average level of income. It describes the
relative, not aboslute risk of poverty within population. Gini coefficient is 0, if all of
population is having same level of income. The more this indicator is closing to 1, the
bigger is inequality of income. Gini coefficient is expressed also as percentage.
The newest comparable data for EU countries are available for year 2010. Within EU
countries the average Gini index was 30.7 pct. The highest value of Gini was for Latvia
(35.2), but the lowest – for Ireland (23.6). (EUROSTAT Database)
In Latvia the Gini index is being measured since 2004 (36.1). The biggest inequality
was in year 2005 – 39.2, but the lowest one in 2006 – 35.2 (it can be explained by
increase of social tax transfers). Since 2007 the Gini coefficient has been decreasing,
from 37.7 till 35.2 in year 2010.
When comparing statistical data in regions of Latvia, it can be concluded that in year
2010 the most unequal distribution of income was in Riga – 35.2 and Pieriga – 34.7, but
the most equal distribution of income was in Kurzeme –32.2. (CSB Database)
Income of whole household is dependant on the income of most profitable member –
is he/she working wage work, has retired, self-employed or has other status. In 2010,
56% of households were working in hired jobs, 29% – households of retired people,
7% – self-employed. Approximately 7% of households consisted of unemployed, where
most of income.
Main results and findings of paper are: even if Gini coefficient in Latvia has a
tendency of reducing, it is still a relative indicator which does not reflect how real
consumption expenditure on one household member has lowered over this period of
time in all types of households.
1
470
Rita Ozolina
Key words: Gini coefficient (index), Quintile share ration (S80/S20), households, regions
JEL code: J170
Introduction
In 2001, European council of Laeken accepted using indicators to be able to monitor and analyze
progress of its member countries in regards of reducing social exclusion. Poverty risk index, Gini
coefficient and others were one of these indicators.
During the last years, in analysis of social stratification in Latvia both in public and scientific
literature, the Gini coefficient is broadly used. Gini index is varying from 0 to 100. Gini index is 0, if
absolute equality of income exists, i.e., all the population is receiving same income. The closer this
coefficient is to 100, the more inequality of income there is. Gini coefficient – the same, with an
amplitude from 0 to 1.
Another indicator that measures inequality of income is index of quintile proportion S80/S20, which is
relation between the amount of income received by wealthiest 20% of the population (higher quintile),
compared against amount of income received by 20% of population receiving lowest income (lowest quintile).
In this paper, subject of the research is one of the indicators of monetary poverty and income
inequality – the Gini coefficient.
The essence, calculations and interpretations of Gini coefficient in 2003 were researched by Dr. habil.
oec. Olgerts Krastins and Dr. oec. Inta Ciemina of University of Latvia, in their scientific papers “Issue of
statistics and administration”, in article “Gini coefficient: its content, calculation, interpretation”. Both
authors have many other papers about this topic, which are named in the Bibliography and which were
explored by the author of this paper.
The goal of this research is to evaluate changes of Gini coefficient in Latvia, its households and its
regions, based on the information available in various databases, and to prove the disadvantages of using
it – it’s systematically reducing in bigger territories, based on example of Latvia.
1. Indicators of income inequality in Latvia
The newest comparable data about EU member countries are available for year 2010. Gini coefficient
in this year in EU countries was at 30.7 pct. average. Highest value between EU member countries was in
Latvia (35.2), but the lowest one – in Ireland (23.6). Comparing to our neighbour countries, in Estonia
Gini coefficient was 31.9, but in Lithuania – 32.9.
Table 1
Income inequality indicators in Latvia (in percentage)
No.
1.
2.
Indicator
S80/S20
Gini coefficient
2004
6.7
36.1
2005
7.9
39.2
2006
6.3
35.4
2007
7.3
37.7
2008
7.3
37.4
2009
6.9
36.1
2010
6.6
35.2
2011
6.5
35.9
Source: CSB Database
Indicators of income inequality (one of them – also Gini coefficient and quintile proportion index
S80/S20) in Latvia are being calculated since year 2004, when they were 36.1 for Gini coefficient, and 6.7
for S80/S20, respectively. The highest inequality of income was in year 2005 – 39.2 and 7.9 respectively,
but the lowest one – in year 2006, when it was 35.2 and 6.3 (in year 2006 there were parliament elections –
Rita Ozolina
471
social transfers like child birth and alimentation allowances, were increased, as well as various allowances
from self-governments. Since year 2007, Gini coefficient and S80/S20 index decreased – from 37.7 and 7.3,
to 35.2 and 6.6 respectively. Dynamics of these indicators were driven mainly by better financial situation
for pensioners compared to wage reduction for employees, as well as increase of EU direct payments to
agriculture sector, which decreased inequality of income between urban and rural citizens. However, in year
2011 Gini coefficient has increased compared to year 2010 (increase of 0.7% pts.), but quintile proportion
index S80/S20 decreased by 0.1 % pt. in the same period of time.
There is very high correlation between Gini coefficient and quintile proportion index S80/S20. Based
on calculations of the author, from year 2004 to 2011, Pearsons correlation coefficient of both of these
indicators are 96.6 pct.
2. Indicators of income inequality in statistical regions of Latvia
When comparing inequality of income between statistical regions of Latvia, we can conclude that
from period of 2004 to 2010, the most unequal distribution of income was within population of Rīga and
Pierīga regions. (Gini coefficient was 35.4 and 35 pct. respectively), but the most equal distribution was
within population of Zemgale region – 33.5, and Vidzeme region – 34.1.
Table 2
Gini coefficient in statistical reģions of Latvia (in percentage)
No.
1.
2.
3.
4.
5.
6.
Region
Riga
Pierīga
Vidzeme
Kurzeme
Zemgale
Latgale
2004
35.1
32.4
33.8
34.6
31.7
35.2
2005
38.3
31.8
36.7
38.1
32.8
36.0
2006
33.1
33.1
32.4
33.5
33.8
32.1
2007
35.6
38.6
33.2
34.7
33.6
36.4
2008
35.5
38.0
35.9
36.8
32.8
34.7
2009
34.9
36.3
33.3
33.3
36.4
34.5
2010
35.2
34.7
33.2
32.2
33.6
33.3
The regional average
35.4
35.0
34.1
34.7
33.5
34.6
Source: CSB Database and author’s calculations based on CSB Database
S80/S20 quintile proportion indexes of income in regions of Latvia are showing different results than
Gini coefficient: the most unequal distribution of index is in Latgale region (this index was average 6.9 in
these years, which was 0.4 % pts. higher than Riga region, 0.6 % pts. higher than Pierīgas, Vidzemes and
Kurzemes regions and 0.8% pts higher than Zemgales region). The average of S80/S20 index in Zemgales
region, same as for Gini coefficient, is showing that it has relatively most equal distribution of income
compared to other statistical regions of Latvia.
Table 3
S80/S20 quintile index of income in statistical regions of Latvia
No.
1.
2.
3.
4.
5.
6.
Region
Riga
Pierīga
Vidzeme
Kurzeme
Zemgale
Latgale
2004
5.8
5.7
6.9
6.6
5.4
7.1
2005
7.4
5.6
6.9
7.1
5.8
8.2
2006
6.0
5.3
5.4
5.7
5.7
6.0
2007
6.8
7.7
6.1
6.0
6.1
7.2
2008
6.7
7.3
6.7
6.8
5.9
6.8
2009
6.5
6.5
6.1
6.3
7.2
7.0
2010
6.4
5.9
6.0
5.7
6.7
6.2
The regional average
6.5
6.3
6.3
6.3
6.1
6.9
472
Rita Ozolina
In Table 2 displayed above (for 2004- 2010) it can be noticed that at some regions Gini coefficient is
lower than the total coefficient in Latvia (Table 1). Indicator of Rigas region hasn’t significantly changed
in 6 year period. Gini coefficient in Kurzeme has decreased from 34.6 to 32.2, the same for Pierigas
region from 34.7 in year 2004 reached its maximum at 2007 (38.6). In Zemgales region Gini coefficient
increased from 31.7 in year 2004 to 33.3 in year 2007.
Also within statistical regions of Latvia there is high correlation between both income inequality
indicators, but not as high than in Latvia overall.
Table 4
Pearson’s correlation coefficient in statistical regions of Latvia
Indicator
Correlation coefficient
Riga
0.834
Pieriga
0.947
Vidzeme
0.797
Kurzeme
0.880
Zemgale
0.866
Latgale
0.863
3. Differences between indicators that are published and the ones calculated from
weighted average Gini coefficients in statistical regions
Table 5
Differences between indicators that are published and the ones calculated from weighted average
Gini coefficients in statistical regions
Indicators
Gini (published)
Gini (weighted average from regions)
2004
36.1
34.1
2005
39.2
36.0
2006
35.4
33.0
2007
37.7
35.6
2008
37.4
35.7
2009
36.1
34.9
2010
35.2
34.0
The data of table 5 is displayed in graphical figure as follows:
Fig. 1. Differences between indicators that are published and the ones calculated from weighted
average Gini coefficients in statistical regions
Rita Ozolina
473
One of the disadvantages of Gini coefficient is, that in bigger territory this coefficient can be higher
than separately measured in each of its regions. It is illustrated by data of Latvia, where Gini coefficient
of Latvia in most of the years is higher than in any of its regions.
The average Gini coefficient of EUROSTAT ES27 countries is being calculated by separate
coefficients of its member countries, by weightening them with number of population in each country. It
means that Gini coefficient in all of EU is getting systematically downgraded and is not displaying real
situation of inequality.
4. Average disposable income per one equivalent consumer
The amount of expenditures of the population is mostly dependant of the household’s income and
social status, meaning what source of income is received by the most profitable member of each
household. Source of income can be salary of the person working in wage work, pension, income of the
self-employed, etc. If we compare households of Latvia using this criteria, we can conclude that in year
2010, about 56.1% of the households were the ones working wage work, 29.5% - the ones consisting of
pensioner. Comparing this data from year 2008, it can be concluded that the number of households
consisting of member working waged work has decreased by 9.4 % pts., but number of households lead
by pensioner has increased by 5 % pts. When unemployment increased from 2.65 to 7.1%, the proportion
of households where the most profitable member was one receiving allowances, scholarships and support
from relatives, friends and family members, saw an increase. The proportion of self-employed households
before the crisis was 7.4%, and it remained at the same level also after the crisis. (Bicevska A., 2012)
Table 6
Average disposable income per one equivalent consumer in Latvia from 2004- 2010
Measurement
Lats per year
Growth rate, times
2004
1817.8
…
2005
2248.8
1.2
2006
2845.3
1.3
2007
4160.2
1.5
2008
4655.6
1.1
2009
3894.0
0.8
2010
3638.0
0.9
Sourse: CSB Database and author’s calculations based on CSB Database
Households disposable income divided by its “equivalent size”, which is calculated using so-called
“modified OECD” equivalence scale. This scale gives a weight of 1.0 to the first adult, 0.5 to any other
household member aged 14 and over, and 0.3 to each child aged less than 14.
As it can be seen from table 5 (CSB Database), the average disposable income on one equivalent
household consumer during a year from 2004 to 2010 is increased significantly until 2008, but decreased
afterwards. The reason for decrease of expenditures was a decrease of received income. Based on the
survey carried by CSB regarding welfare of households of Latvia, approximately 4/5 of households admit
that they dont hold savings in amount that would be enough to live at least 1 month without receiving any
income. Also, this situation has worsened in year 2011. (Bicevska A., 2012)
Indicators of inequality of income- Gini coefficient (index) and index of quintile proportion S80/S20 are
relative indicators, and decrease of them have been creating illusory impression of improving financial
situation of households. In the same time other indicators, for example, average disposable income on one
equivalent household member, which was analyzed in this research, are showing different tendency which is
474
Rita Ozolina
not so optimistic. In order to analyze the situation of income inequality of households of Latvia, it is useful
to avoid using just few indicators of inequality of income, but instead to use broader range on indicators.
The average Gini coefficient of EUROSTAT ES27 countries is being calculated by separate
coefficients of its member countries, by weightening them with number of population in each country. It
means that Gini coefficient in all of EU is getting systematically downgraded and is not displaying real
situation of inequality.
When analyzing Gini coefficient for inequality of income within one country (in Latvia – by regions)
for a shot period of time, it is recommended to analyze also indicators of level of income in the same
time. The most simplest one – median of income (this indicator is not good for using it in dynamics
analysis (its affected by inflation) and for comparison between countries (comparison issues of currency
exchange and purchasing power).
Bibliography
Bicevska, A., 2012. How crisis has affected purchasing power of different groups of population [Online]
Available at: http://webcache.googleusercontent.com/search?q=cache:Sr3M1SKroBQJ:www.makro
ekonomika.lv/ka-krize-ietekmeja-dazadu-iedzivotaju-grupu-pirktspeju+d%C5%BEini+koeficients&cd
=4&hl=lv&ct=clnk&gl=lv [Accessed 18 December 2012].
Gini coefficient (Source: SILC) [Online] Available at: http://webcache.googleusercontent.com/search?q=
cache:Ush4XOW5PooJ:epp.eurostat.ec.europa.eu/tgm/table.do%3Ftab%3Dtable%26plugin%3D1%2
6language%3Den%26pcode%3Dtessi190+gini+index+eu&cd=1&hl=lv&ct=clnk&gl=lv [Accessed 16
December 2012].
Gini coefficient in statistical regions of Latvia. [Online] Available at: http://data.csb.gov.lv/DATABASE/
Iedzsoc/Ikgad%C4%93jie%20statistikas%20dati/Monet%C4%81r%C4%81s%20nabadz%C4%ABbas
%20un%20ien%C4%81kumu%20nevienl%C4%ABdz%C4%ABbas%20indikatori/Monet%C4%81r
%C4%81s%20nabadz%C4%ABbas%20un%20ien%C4%81kumu%20nevienl%C4%ABdz%C4%AB
bas%20indikatori.asp [Accessed 16 December 2012]
On household disposable income in 2011. [Online] Available at: http://www.csb.gov.lv/en/notikumi/
household-disposable-income-2011-36958.html [Accessed 21 January 2013].
Ciemina, I., Krastins, O., 2004. Data about the population’s welfare: possibilities of comparison,
evaluation. Issue of statistics and administration, Riga, pp. 70-81.
Ciemina, I., Krastins, O., 2005. The stratification of general and different groups of Latvia’s households.
Issue of statistics and administration, Riga, pp. 99-109.
Cowell, F. A., 2011. UK Wealth Inequality in international Context. Sticerd, London School of
Economics.
Krastins, O., 2002. About political integration and social stratification. – Statistics about problems, Riga,
pp. 81-86.
Krastins, O., 2002. About stratification of our society and its depth, root causes and tendencies. –
Statistics about problems, Riga, pp. 87-93.
Krastins, O., Ciemina, I., 2003. Gini coefficient: its content, calculation, interpretation. – Issue of
statistics and administration, Riga, pp. 78-89.
Krastins, O., Jansone, I., 2004. How (in)equal is distribution of income. – Evaluations and reflections,
Riga, pp. 76-81.
Luebker, M., 2010. Inequality, income shares and poverty: The practical meaning of Gini coefficient.
Travail Policy Brief, No. 3.
Rita Ozolina
475
COLLABORATIVE DIMENSION IN CONFLICT MANAGEMENT
WITHIN PRE-UNIVERSITY EDUCATION SYSTEM REGARDING
HUMAN RESOURCE
Constanta Popescu, Valahia University from Târgoviste, Romania1
Ana-Maria Tudorache (Stăncescu), Valahia University from Târgoviste, Romania
Liviu Vasilescu, Valahia University from Târgoviste, Romania
Abstract. In a society directed towards globalization, kneaded by crises on multiple
plans, the educational conflict management is a complex and continuous process, its
features being given not only by the amazing speed with which the society transcends
space and time boundaries, but also by changes of impact on thought, conscience,
attitudes and modes of action of human resources involved in the educational process. A
critical view into the diachronism of conflict management theories reveals that on this
plan the perspective has also changed; from the traditional conflict essentially negative,
destructive to the positive, beneficial model.
For these reasons, the purpose of this research is to identify and analyse conflict
situations in the pre-university education in Romania (particularly in Dambovita
County) and also to highlight the main motivators, respectively de-motivators regarding
teachers’ work in pre-university education.
The collection of information was done by means of direct observation methods and
documents study, the findings of this research indicating that currently, Romanian preuniversity education undergoes a tense period. As a result, the teaching profession is
characterized by many conflicts and low levels of motivation.
In conclusion, it is extremely important for us to realize the depth and nature of
conflicts that education is facing. And in the process of trying to diminish or to solve
the problems and challenges we face, we should ensure that we do not destroy
teachers’ motivation because this will have a negative impact on all stakeholders in
the education field.
Key words: human resources, conflict, pre-university education, motivation, communication
JEL code: I21, J 52
Introduction
Every day we face conflicts with our family members, colleagues or simply strangers. But how many
times do we really resolve a conflict and how many times are we satisfied to get rid of the problem? (Kim
S.H., 2012, p.105) And at the same time, given that teachers form the backbone of education, what impact
1
476
Constanța Popescu, Ana-Maria Tudorache (Stăncescu), Liviu Vasilescu
do conflicts have at work on their motivation? Answering these questions will benefit teachers
themselves, students, administrators and educational system in general (Kocabaș. I., 2009, p.725-726).
Considering that conflict case studies contribute to the enrichment and refinement of theoretical
knowledge, but especially to the development of the applied side of educational management, this article
aims to analyze the situation and the impact of conflict in educational organization dynamics from
Dambovita County, using for this purpose a wide variety of methods for collecting and processing data
(direct observation, document analysis).
Thus, we can say that this article has as fundamental coordinates: education, human resources and
conflict in pre-university education, which are also permanent elements of human existence in everyday
social life.
1. Theoretical framework
1.1. Conflict – a reality in any organization
Once Romania joined the European Union, the educational system crosses a profound transformation
period in all its levels, the current socio-economic context threatening though the national capacity to
achieve common European goals to expand and improve education. Under these conditions, the large
number of conflicts represents a warning for the managerial behavior in the educational system where the
specific line, drawn on prevalent human value losses on financial ones, requires close monitoring of
conflicting tensions since the first signs of their occurrence.
An imperative requirement of modern conflict management necessary for the opportunity to settle it,
but not sufficient, is to create a communication channel between conflicting parties: students, parents,
representatives of authorities at different levels, managers of pre-school teams and pupils, managers of
the school or educational authority departments such as inspectorates; in this context we add motivating
the parties to communicate and not to escalate conflict by avoiding patterns of constraints and threats,
considered to be wrong reflexes.
In a modern analysis, avoiding conflict appears as an “expensive option” (http://www.capital.ro.
Interviu cu Daniel Dana, 2003) because the modern world is built on a complicated system of
interdependence, and continuing professional responsibilities excludes such drastic measure to terminate
the relationships within the organization. Alternative reflex of the coercive force, although it may appear
useful on short term, is generating negative feelings and attitudes including humiliation, anger, revenge.
Recession and intimidation, even disguised as modern, sophisticated forms, are approaches of the conflict
designed to increase stress within the organization and exacerbate the tense especially in times of
economic recession.
Conflicts arise in educational organizations regardless of their type: kindergarten, elementary schools,
high schools and school groups, children’s clubs and sports and so on, their size, their level: standard
schools, European schools, national colleges, special schools, their age, but conflicts are influenced by
organizational culture and tradition in reverse proportion.
Conflict management in educational space refers to the specific planning process of management
activity meaning the probability of avoiding conflicts, of organization in order to reduce and/or resolve
conflict emerged “in a quite quickly and correct way” (http://www.etu.org.za/toolbox – Conflict
Management) and implementing positivity ways of its impact in the learning organization.
If the conflict management phrase is generally accepted, that of conflict resolution is under
discussion, ranging between the concepts of non-resolving problems and no conflict without resolution.
Therefore, solutions can be located at different points on the scale from positive to negative, including
recession and coercion options, as well as solving type “avoiding the boulder out of the way”
477
(http://www.capital.ro.Interviu cu Daniel Dana, 2003), although it is desirable for any conflict to find a
“win-win” solution for all parties involved. Even if this is not happening, the result should not be
considered in terms of gain and loss of each of the parties, but at the educational level of life as an
improvement for all, focused on the things which there should be an agreement on, common values, the
development of specific skills, the accumulation of experience.
Under these conditions, cooperation between all components of management is vital ; by
conjugating actions is recognized the importance of the work to develop and maintain the interrela tionship system to a level that would prevent and minimize dimensional transformation of a dispute
in destructive conflict.
Cooperation requires from this angle a professional behavior based on the communion of values,
priorities and interests. Both within the management team and outside it, the educational organization, in
partner and associated institutions may occur complaints, quarrels, mutual accusations, attempts to avoid
responsibility, confrontation which must be prevented, monitored and resolved using methods and
techniques designed to redress the impact on foundations that can provide adequate functionality of the
institution providing education services; references are made in this regard, on the one hand towards the
identification of negative effects on mechanisms of institution gears and the supervision of generating
factors, on the other hand towards the mediation, conciliation, arbitration of human resources affected to
return to a work environment favorable to achieve envisaged objectives.
1.2. Impact of conflict on teachers’ motivation
The literature states that “the conflict is not a problem, but the poor quality of conflict management”
(http://managementhelp. Org/interpersonal/conflict – Carter McNamara – Clarifying Confusion About
Conflict) in case they obstruct the educational process in any of its components (teaching, consolidation,
evaluation etc.), human resources involved are de-motivated and cause numerous escalations leading to
improper conduct of high standards of a learning environment dedicated to his mission.
Although the employees’ motivation is a critical element in terms of its influence on individual
performance and capacity of the education system to achieve its objectives (Müller, K., Alliata, R.,
Benninghoff, F., 2009, p. 595), conflicting moods of the school, specifically intellectual labor
consumption associated with reduced possibilities of promotion compared to the private sector, growing
number of job tasks and a more hectic workday, misbehavior of directors and inspectors, have resulted in
a major decline of teachers’ motivation at work (Skaalvik, E.M., Skaalvik, S., 2011, p. 1031).
Also, teachers’ dismissal due to budget constraints, low wages in education, discipline problems or
disruptive behavior of students ( Skaalvik, E.M., Skaalvik, S., 2011, p.1035), evaluation grids without
objectivity, egalitarian motivation achieved not by employee performance, but according to the terms of
service affects negatively teachers’ motivation.
Under these conditions, a low motivation of teachers is reflected in a deterioration of standards of
professional conduct, in major frustrations evidenced by negligence, carelessness, “avoiding
responsibility” (http://managementhelp. Org/interpersonal/conflict – Carter McNamara – Clarifying
Confusion About Conflict), absenteeism, misuse of teaching equipment, non-purchase or information
distortion that do nothing but to perpetuate conflicts and determine sharper conflict cost share, thus
creating a conflict spiral where motivation and conflicts are cause and effect, fueling each other (Bennell,
P., 2004, pp. 8-9).
Considering that an efficient educational system cannot exist without a competent, well trained and
dedicated teaching staff (Cicea, C., 2004, p. 102), and the formation of students’ desired behavior is
closely linked to teachers’ motivation levels and also teachers’ attitude and behavior, it is necessary to
realize the depth and nature of conflicts in education and to limit their impact on the motivation of human
resources involved in the educational process.
478
2. Findings and discussion
Analyzing the situation of Dambovita County pre-university education, in 2009-2012 we have noticed
a restriction of the school network, due in part to the current socio-economic context and various
demographic factors. Under these conditions, the total number of schools decreased from 654 to 614
educational institutions. Also, the number of students enrolled in school decreased from 81766 to 77296
students.
All these changes have imposed a downward trend on the number of teachers in Dambovita County,
recording a decline of 6.61%. Thus, out of 5943 teachers in the school year 2009-2010 only 5550 teachers
have continued in subsequent school years.
Performing an analysis of teachers in Dambovita County schools, we have seen that in the school year
2011-2012 is kept the same age structure as in previous years, teachers aged between 30 and 45 years
being the most numerous (2519 teachers), and the opposite still hovering teachers under the age of 30
years (910 teachers). Also, the analysis of teachers depending on their teaching grades obtained show a
predominance of 1st grade teachers (2265 teachers), while debutants and PhD teachers are the least
numerous (only 548, respectively 35 teachers).
Analyzing the situation of petitions/complaints/intimations in the past two school years, there has
been a reduction in the number of petitions (in 2009-2010 school year were 60 petitions and in 2010-2011
there were 57, with less than 3 petitions which represents a decrease of 5.3% of petitions/intimations).
Also, for the first semester of school year 2011-2012 was monitored the settlement activity of a total of 23
petitions – 2 fewer than the first semester of the previous school year – which reported a series of failures
in the pre-university educational system in Dambovita County.
Analyzed by the domain of activity the situation is as follows:
Table 1
Educational conflict situation in Dambovita County according to the domain of activity
Crt.
no.
1.
2.
3.
4.
5.
Contents
Managerial activity of principals
Teaching, auxiliary and nonteaching staffing (restraints,
transfers, detachments,
competition) and labor rights
complaints
Relationship teacher –
student/parent
Complaints of local community
Other issues
Total
Addressed to
I.S.J
Addressed to
M.E.C.T.S.
–
2
3
2
Addressed to
County Council/
Prefecture
1
2
9
2
–
1
12
1
8
23
–
3
Source: Report on education, available on the website of Dambovita County School Inspectorate – http://isj-db.ro/
Following an operative analysis of progress and dysfunctions occurred in order to stimulate, revaluate,
resolve and eliminate them in time with effectiveness and objectivity we can draw the following ideas:
 Issues claimed by petitioners who addressed to the School Inspectorate are related to employment,
job continuity, detachment, recognition of seniority within the department, misconduct of some
principals and teachers, cases of violence between pupils or verbal and physical aggression on
479
pupils by teachers, school minibuses request, compulsory class attendance by students of foreign
nationality, establishment of new groups of kindergarten, poor condition of school building.
 Petitioners who addressed to Dambovita County Council signaled issues regarding social grants,
misconduct of some principals and teachers, compulsory class attendance by students of foreign
citizenship, poor condition of school building.
 The resolution of complaints and petitions by Damboviţa County School Inspectorate was made
promptly. Progress/dysfunction occurred to stimulate, revaluate, resolve and eliminate them in
time with effectiveness and objectivity was operative analyzed.
By cumulating the analysis results of human resources situation in the educational system with the
results of conflict situation analysis in the pre-university education in Dambovita County we can highlight
the main positive aspects and those that need to be improved in terms of conflict situations management.
Table 2
The main positive aspects and aspects that need to be improved in terms of human resources
and conflict situations in pre-university education in Dambovita County
Pozitive aspects
 Existence and observance of the procedure for
resolving complaints;
 Professional training of people responsible for
resolving complaints;
 Proper functioning of collective management
bodies;
 Effective communication;
 Tenure teachers are the majority of all teachers
in Damboviţa County (about 83.74%) being
distributed approximately equally between
urban and rural areas;
 Unqualified or ongoing qualification substitute
teachers are less than 1% of all substitute
teachers;
 Educational programs and partnerships on
conflict prevention among students and nonviolence education prove to be not only
frequent in schools but also in centers of
interest for many school organizations and for
organizations of polarization of community
attitudes towards transformations of thought,
attitude and action, oriented towards strength
in dealing with the wave of verbal and
physical aggression, differences and conflicts
in the school.
Aspects that need to be improved
 Due to the socio-economic context, the
number of teachers in schools in Dambovita
County decreased with 6.61% (from 5943 in
2010-2011 school year to 5550 in 2011) –
drop that can have serious consequences on
their motivation;
 More careful management of potential
conflicts;
 High number of dropouts which can be a
major source of de-motivation for teachers in
the county – thus, only in the 2010-2011
school year were recorded 204 dropout cases;
 Teachers aged 30-45 years represent the
majority of pre-university teachers in
Dambovita County (45.38% of total teachers),
while teachers aged under 30 years are the
least numerous (16.39%) which can be a
warning sign for young people willingness to
choose the pre-university education as a
profession;
 Also, teachers with less than 5 years of service
represent the largest category of teachers
(about 18.66% of the total 8 stages of
seniority) which brings into focus the retention
capacity of teachers in the education system.
Source: authors’ contribution based on documents research
Also, as a result of direct observation of a sample of fifteen high schools in Dambovita County, we
can highlight a number of motivational and de-motivational factors in relation to the work of teachers in
pre-university education.
480
Table 3
The main motivational and de-motivational factors in relation to the work
of teachers in pre-university education
Motivational factors
 Relationship of respect and collaboration
between teachers;
 Positive results at examinations, seminars,
competitions and school Olympiads;
 Teachers participation in training courses;
 Positive relationships with parents;
 Pleasant atmosphere at the work;
 Obtaining teaching degrees;
 Participation in international exchanges;
 Teacher involvement (as member or coordinator) in POSDRU projects, Comenius, etc;
 Students interest in extracurricular activities;
 Positive influence that teachers may have on
students;
 Partnerships with other educational establishments in the country or in other countries;
 Recognition of teachers’ credit from managers
of some educational establishments;
 Opportunity of using modern means of
teaching – in some educational
establishments;
 Pleasure of working with students;
 Modernization of some laboratories,
classrooms;
 Having a position of teaching committee
responsible;
 Positive results in school inspections.
Motivational factors
De-motivational factors
 Misbehavior and disinterest from students;
 Poor performance of students in national
examinations;
 Overload curriculum;
 Multiple reforms of the national education
system;
 High frequency of inspections of CSI and the
Ministry of Education;
 Poor working conditions (cold in classrooms);
 Giving gradations of merit and leadership
positions on political criteria;
 Not settling transportation;
 High absenteeism of students, especially
commuter students;
 Differential treatment of some teachers from
school management;
 Lack of teaching support by local authorities;
 Wage cuts;
 Salary inequity to the effort – many teachers
believe to be more motivated professionally if
the salary would be higher in order to reflect
the real efforts of teachers;
 Feeling of powerlessness to change/improve
teaching, the educational system;
 Too many administrative tasks – to the
detriment of effective teaching;
 Damaging the image and social status of teachers.
De-motivational factors
 Lack of resources needed for developing the
activity under optimum conditions;
 Inconsistent disciplinary measures in some
schools;
 Professional promotion on criteria other than
performance;
 Involvement of political factor in preuniversity education system;
 Negative impact of media on students;
 Disinterest of some parents of the pupils;
 Lack of long-term safety of the job;
 Insufficient involvement of teachers in
decision-making.
Source: authors’ contribution based on documents research
481
Synthesizing the results of the analyses conducted, it may reveal the negative trend regarding the
school network and human resources in pre-university education, which is a warning for their motivation
to engage in an educational quality process.
At the same time, these analyses bring into question the issue of conflicts in school institutions,
various, complex and sometimes complicated issues which pleads for a careful attitude of managers
providing constant care for environment (at the organization level as well as within each category of
human resources), efficient communication and collaboration ( Jinga, I., 2009, p.110). However,
decreased number of conflicts is a first step towards an efficient pre-university education system in
Dambovita County.
Conclusion and proposals
The situation analysis of human resources and conflicts in Dambovita County educational
environment can provide a clear picture of the importance of teacher motivation. Thus, teacher motivation
is the central element of their own performance and also of their students, the achievement of
organizational goals and educational reforms and solving conflict situations and reducing conflict spiral.
Given the negative impact that the current socio-economic context exercises over the education
system, school success depends – now more than ever – on the motivation of human resources working in
these institutions.
Differences in attitudes, values, priorities, lifestyles, perceptions and interests arise in any important
relationship at work, in family or in the community and generates many times conflicts affecting not only
the employees of the educational institution, but also the one positioned in the core of the educational
process – the student.
Issues raised in letters, complaints, appeals and intimations laid down at hearings were resolved in
compliance with the applicable law and jurisdiction by inspectors appointed by the management of
Dambovita County School Inspectorate.
It is a fact that not all conflicts can be resolved in a positive manner, but those where the intention of
cooperation through negotiation, mediation, arbitration are present bring benefits to the educational
organization. Argumentative and persuasive speech provides efficiency to the communication –
fundamental element of the educational process with bipolar function: communication is repeatedly
generating conflicts but also solving conflicts.
Considering the profound implications that conflict situations have on human resources involved in
the educational process, each participant in a conflict learn or should learn something: to prevent, avoid,
face, solve such a social “asymmetry”; mutually, members of any organization providing education,
whether educated or educators, learn or should learn, both theoretical and practical, what conflict means
and what are the benefits of cooperative solutions.
After analyzing the motivational situation of teachers in Dambovita County, it may reveal a
predominance of demotivating factors (as identified 24 major demotivating factors) to the detriment of
motivating factors (the research conducted revealing only 17 primary motivating factors). This situation
may be explained in part by the many budgetary restrictions (restrictions due to the global financial crisis
which, since late 2010, has made its effects felt in a steady pace in the economic, political and social
Romanian environment) that the education system had to cross in recent years, and also by the sharp
deterioration of social image of teachers in Romania.
The main motivating factors identified in this research were the positive results that students have
acquired in competitions and examinations, the good atmosphere at work and also the teachers merit
recognition by the head of school units.
482
Teachers surveyed appreciate that their professional motivation recorded a declining trend in
particular due to the inappropriate behaviour and the apathy of some of the students, inadequate
conditions of work in some schools units, the sense of not being able to improve the education system, as
well as administrative tasks too numerous.
Quick changes in teaching activity and those determined by the educational reform represent a major
demotivating factor and thus a potential source of conflict.
Most teachers members of the target group of this research states that are professionally demotivated
and that only professional ethics, commitment and dedication to this profession and also the pleasure of
working with students still motivates them to continue their work at educational standards imposed at
national and European level.
Considering the socio-economic reality, school managers should place special emphasis on moral
motivation of teachers (teacher merit recognition, participation in personal and professional training and
so on) in an attempt to compensate, even partially, the salary situation unfair to them and their effort in
order to avoid possible conflict situations.
In conclusion, managers of pre-university education institutions in Dambovita County must create a
motivating learning environment in which the baseline to be the resolution and not the elimination,
suppression or avoidance of problems because, essentially, a conflict is a difference of opinions or ideas
and not an insurmountable obstacle (Kim S.H., 2012, p.106).
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învăţământ, Economia. Seria Management, 1, pp. 102-105.
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483
DUAL-CAREER SUPPORT FOR EXPATRIATE SPOUSES
Katharina Priesner, University of Latvia, Latvia /
University of Applied Sciences Kufstein, Austria1
Abstract. International assignments are a phenomenon that affect a lot of companies
throughout the world. As a result of low employee mobility, one recent research topic is the
influence of expatriate spouses on relocation willingness. Seeing that more and more people
live in dual-career relationships, the author would like to take a look at the specific situation
that dual-career couples face when they go abroad. It is the objective of this paper to
evaluate the reasons for on-assignment career support both on the employer and
employee/spouse part. This paper should help to clarify why it is in a company’s and
expatriate’s interest to spend resources on such family-friendly policies. The author
conducts a literature review using books as well as articles from academic journals. Based
on the research questions, the author comes to the following conclusions:
1. The main challenge for dual-career couples apart from the work-family conflict is
to find adequate work in the host country.
2. Accompanying partners prefer to do further training compared to actual
employment in the host country because of restrictions such as work permit
requirements.
3. Dual-career support is beneficial for the trailing spouse, the expatriate and the
employer.
The author sees that the majority of accompanying spouses are faced with troubles
when looking for a job in a new location. The author concludes that dual-career support
is beneficial for all involved parties, especially in terms of increased employee mobility.
This paper provides further insight into the situation of accompanying spouses. It is the
aim to highlight the situation of dual-career couples on international assignments for
future management decisions.
Keywords: dual-career, expatriates, international assignments
JEL code: O15
Introduction
Delegating employees from one branch office to another has become an indispensable part of
everyday business for many international corporations. Driven by globalization, also an increasing
number of small and medium sized enterprises are faced with global transfers. Although international
assignments have already become more standardized over time, the end of the single breadwinner turns
1
Corresponding author – e-mail address: [email protected], telephone: +43 664 2305849
484
Katharina Priesner
out to influence the selection process of potential expatriates as well as the general outcome of
international assignments. Dual-career couples – meaning that both partners pursue careers – represent a
threat to the mobility of the work force today. Studies, e.g. [1], have shown that the occupation of the
expatriate’s partner plays a major role when it comes to the success of an international assignment.
Consequently, companies have tried to implement different kinds of measures to prevent the failure of
assignments due to dual-career issues. However, the outcome of these policies remains unclear. Few
studies have considered the expatriate adjustment process from the spouse’s point of view. In light of
increasing numbers of dual-career couples, this is a research gap that still needs to be covered.
First, dual-career couples are described from a more general point of view and the major challenges
are presented. Then the author focuses on the different kinds and benefits of dual-career support. Finally,
the summary of the main findings gives an answer to the stated research questions.
Research Questions and Methods
It is the objective of this paper to evaluate the situation of dual-career couples during international
assignments. In addition, the consequences of dual-career support should be disclosed from different
perspectives. Based on a literature review this paper should help to clarify why it is in a company’s and
expatriate’s interest to spend resources on family-friendly policies. In order to test the presented
relationships, the following research questions are proposed:
1. What is the main challenge for dual-career couples during international assignments?
2. What is the preferred kind of dual-career support on the part of the trailing spouse?
3. Who benefits from dual-career support?
Based on the research questions, the author identifies the following hypotheses as the foundation for
the paper:
1. The main challenge for dual-career couples is to find adequate work in the host country.
2. Accompanying partners prefer to do further training compared to actual employment in the host
country.
3. Dual-career support is beneficial for the trailing spouse, the expatriate and the employer.
Based on the literature review, the findings should lead to a better understanding of the need of onassignment dual-career support.
Dual-Career Couples
Krause-Nicolai [1] identifies higher education for women, new employment patterns, changes in
family structure (fewer children), lower fertility rates and changed gender roles as the main factors that
have led to the development of dual-career couples. Whereas most authors only use the general term dualcareer couples, there are also researchers who distinguish between different forms of couples. Duxbury et
al. [2] describe four different family types in modern families where both partners are in the labour force:
 the dual-career couple, in which both partners are engaged in managerial or professional work;
 the dual-earner couple, in which both partners have “jobs” rather than careers;
 the status-reversal couple, in which the female partner is engaged in managerial or professional
work, whereas the male partner has a “job”; and
 the new-traditional couple, in which the male partner is engaged in managerial or professional
work, whereas the female partner has a “job.”
Katharina Priesner
485
Looking at the modern family types, it is apparent that the occupation of the spouse is important, at
least in financial terms if not in regard to career planning. The type of couple could also change because
of an international assignment. Van der Zee et al. [3] observed that expatriate spouses turn into more
traditional partners as caregivers and housekeepers after giving up their career. However, this change of
the family structure could easily lead to lower well-being and decreased self-esteem.
Halbesleben and Rotondo [4] focus on a special kind of dual-career couple, the so-called same-career
couple. They argue that same-career couples have certain advantages because they have more social
support resources and might even improve organizational support systems. If one partner has a supportive
supervisor, this could positively reflect on the partner’s job as well. This means providing resources to
one partner in a same-career couple could result in double benefits.
Harvey [5] identifies three different theoretical models that are frequently used to analyse family
migration in regard to organizational relocations:
 Neoclassical market model (maximizing family well-being; each spouse’s potential gain or loss
is weighted equally),
 relative resources and couples’ decision making (concept of power through which decisions are
made; the partner with greater earning capacity is likely to determine the outcome of a relocation
decision) and
 gender-role and provider-role ideology (the potential trailing spouse has the right to exercise
power in a given area and his/her relative resources).
This means regardless of the family type prior to an international assignment, couples have different
strategies how to decide about an international relocation. Eventually, there is not only a change from
single- to dual-earners but there are plenty of new structures such as single-parent families, stepfamilies,
blended families and gay and lesbian families that question the conventional thinking about work and
family [6].
Challenges for Dual-Career Couples on International Assignments
One of the challenges for dual-career couples is the situation when family responsibilities interfere
with the professional life, no matter if they are on an international assignment or not. This is generally
referred to as the work-family conflict. Hein [7] identifies different origins of the work-family conflict.
She mentions the separation of home and workplace, the increasing labour force participation of women,
the declining availability of family assistance, the increasing care needs of the elderly, pressure of work
and long working hours, longer travel time to and from the office and stress. Ruhm [8] refers to higher
employment rates of mothers and an increase in single-parent households which makes it more
demanding to balance conflicts between family and work responsibilities. Van der Zee et al. [3] point out
that for expatriate couples the interrole and intrarole stress levels may be higher in comparison to noninternational couples because the spouse has often given up a career to go abroad which results in a
stronger pressure for the expatriate.
Hein [7] explains that the tradition that companies do not feel responsible for families is based on the
male breadwinner model where the employee could not risk losing his job because the family was
dependent on one income. Today’s two-income couples present a new situation which puts the family on
the company’s agenda.
The Brookfield Survey Report [9] shows that 50% of the interviewed spouses were employed prior to
the foreign assignment. Not surprisingly, only a small number – namely 9% – were employed both before
and during the assignment. Even if this figure might not be the same for every position and location – for
other figures see, for example, the Permits Foundation Survey [10] – it still shows that the employment
rates considerably decrease for trailing spouses.
486
Katharina Priesner
Solomon [11] names the following challenges accompanying partners are faced with when they try to
find work:
 Immigration regulations that forbid foreigners to work,
 language barriers,
 skills cannot be used in the host country,
 lack of volunteer opportunities,
 cultural barriers that don’t allow women to perform certain jobs and
 lack of knowledge about educational opportunities.
It is even more difficult for male partners to follow their spouses on an assignment. Anderson [12]
points out that male partner have greater difficulty to adjust to a foreign environment because they are
additionally faced with social exclusion, loss of identity, isolation and change of status. One of the issues
particularly important for female expatriates is the loss of income of the partner. In such situations, paid
employment for the accompanying partner would help to compensate for this loss and would make
international assignments financially more attractive.
Thornton and Thornton [13] observed that when it comes to short-term assignments which do not exceed a
duration of 6 months, expatriate spouses are not confronted with career issues. For this period the assignment is
considered as a long vacation and the spouses will get back to their jobs. This means if companies think about
offering short-term assignments, the difficulties for dual-career couples could be reduced.
Kinds of Dual-Career Support
The ways in which companies offer organizational support differ widely. Saxena and Bhatnagar [14]
note that corporate policies are still mainly built around the outdated belief that the (male) employees
have a support system at home and they can exclusively focus on their professional lives. However,
companies have identified several family-friendly policies such as part-time work, flexible schedules, jobsharing, alternative work locations, workplace nursery and support groups, e.g. [15]. Dual-career support
represents a specific area in the field of family-friendly policies.
Hein [7] points out that only few industries have considered family support in the past (e.g. only in
remote locations such as plantations or mines). Enterprises have rather separated work and family not
perceiving family matters as their responsibilities but believing that family is the sole responsibility of the
employee, who has to make sure that there is no interference with work.
Research data implies that smaller companies are less likely to offer family-friendly benefits than
large firms [8]. Hein [7] adds that family-friendly programs are most popular in high-skilled industries
and sectors where the costs of losing and replacing an employee are high and the benefits of familyfriendly practices are easier to quantify. Hein [7] also argues that many organizations still restrict familyfriendly programs to women-friendly childcare support. Companies only now realize that work-family
programs need to have a broader perspective. Dowling and Welch [16] point out that there are several
methods of supporting the expatriate’s spouse professional career:
 Inter-company networking (the employer supports the spouse to find a job in the same location but
at a different company),
 job hunting assistance (e.g. employment agency fees, career counseling, work permit assistance),
 intra-company employment (the spouse is offered a job in the same branch office) and
 on-assignment career support (e.g. lump sum payments for education expenses, professional
association fees, seminar attendance, language training, employment agency fees, career
development activities).
Katharina Priesner
487
Konopaske et al. [17] mention the same career support methods but add the introduction to decision
makers in other multinational companies in the host country as a possible form of overseas career support
for spouses. They also highlight the importance of intercultural training and introducing spouses to
repatriated spouses of former expatriates. According to the Brookfield Survey Report [9], companies most
frequently assist the expatriate spouse with language training (85%), educational assistance (38%) and
company-sponsored work permits (34%). Expatriates often wish to get a reimbursement of spouse
educational costs and help with arranging work permits for the partner [18]. Bauer and Taylor [19] also
advise companies to offer language courses and intercultural training for spouses and to support them
with building social networks, e.g. by arranging social events, providing cultural counsellors and prerelocation training which will lead to more successful assignments. Suutari and Tornikoski [18] report
spouse-related disadvantages such as the loss of salary and pension contributions of the spouse during the
international assignments. The expatriates also ask for a compensation for the second income because the
household income is lower during the assignment. It is also important to say that the financial position of
a dual-career couple makes a difference when it comes to work-family interference. Wealthier couples
could afford to hire some help which reduces household responsibilities [20].
Harvey [5] summarizes spouse support from different assignment policies: job-related assistance
(counselling and preparation for overseas career opportunities, job support within MNC or with international
counterparts, professional international placement assistance, support for advanced education opportunities,
creating tasks for spouses) and operational support (realistic ‘preview’ of international relocation/Look &
See trip, flexible housing solutions/commuting options, short-term assignments) and other support from case
to case. However, even if family-friendly policies exist, availability is still subject to supervisory discretion
which means they might not be equally accessible [21].
Punnett [22] highlights that the spouse should be considered in the entire assignment life cycle,
meaning pre-assignment, early assignment, late assignment and post assignment. Pre-assignment
measures typically include Look & See trips, language training and intercultural training. The early
assignment phase is usually more informal with support groups consisting of local managers and spouses.
If the expatriates survive the culture shock, they enter the late assignment stage where the most important
thing is to keep in touch with the home company/country. The post-assignment stage usually also
contains a culture shock and difficulties with adjustment.
Even though companies have started to introduce such measures, they have not assessed and
compared costs that result from adopting family-friendly arrangements [7]. Although literature supports
the idea of dual-career programs, reality seems to lack behind, as reported by Anderson [12]. KrauseNicolai [1] found in her study that preparation, on-assignment support and reintegration of dual-career
couples are insufficient in German companies. Her empirical results show that usually the solutions for
the expatriate couples were not employer-initiated but based on private commitment. She argues that
companies could achieve considerably higher satisfaction among dual-career couples by providing some
customized support. Higher satisfaction also goes along with less stress and increased productivity. Even
though the possibility of work for the spouse in the host country is an important factor, Krause-Nicolai [1]
mentions that this is not determining the decision for or against an international assignment. However,
many dual-career couples want some sort of career counselling.
Harvey [5] mentions that the level and quality of support for the dual-career couple will be influenced
by the family background (quality of the marriage), the social network in the new environment, the
similarity between the home and host support systems and the individual characteristics of the couple
(willingness to seek and provide support). Bauer and Taylor [19] emphasize that in view of the increasing
numbers of dual-career couples being sent abroad, the differences in the adjustment process between male
and female spouses need to be understood. Punnett [22] argues that there is also a need to consider the
three different groups of spouses because they need different treatment:
488
Katharina Priesner
 Female spouses who do not expect to work abroad (“traditional expatriate spouses”): major
concern is cultural adjustment;
 Female spouses who do expect to work abroad: major concern is job/educational opportunities;
 Male spouses who predominantly expect to work abroad: major concern is job opportunities
and emotional support;
As already mentioned, paid employment for accompanying spouses usually improves the dual-career
dilemma, however, only few companies provide spouse employment opportunities [13]. Some companies
might argue that including the spouse in the assignment process is discriminating against other
employees. Brummelhuis and van der Lippe [23] note that single expatriates might have a feeling of envy
or exclusion when they are confronted with a family-supportive culture. However, if the policies are
transparent and clear for everybody and the spouses are willing to participate, this problem can be solved
[22]. Companies who think about offering the accompanying partner a job in the company should also
think about possible risks. Considering that the spouse does not have to go through a demanding
recruiting process, other candidates could feel discriminated against and might even sue the company
[20]. Nevertheless, companies could mention in their job ads that they encourage couples for applications
which could attract candidates who might not have applied otherwise [20].
Some companies have introduced dual-career policies. Still, these should be reviewed in regard to the
individual needs of the couples. Harvey [5] mentions the following aspects that need to be considered in
terms of support infrastructure:
 emotional needs of the dual-career couple;
 instrumental needs, i.e. time, resources and skills provided by the company to provide assistance in
adjustment to dual-career couples;
 infrastructural support on the provision of facts, opinions, and advice while on the expatriation
assignment; and
 appraisal support which supplies the dual-career couple with feedback on performance as well as
adjustment overseas (following House, 1981 and Granrose et al, 1992).
Overall, there are plenty of possibilities to support dual-career couples. Companies should review
which ones best fit their employees and corporate strategies.
Beneficiaries of Dual-Career Support
The benefits of dual-career support are most evident for the expatriate spouses. They are directly
affected by most of the policies and can benefit from them. Of course, a prerequisite is that they are made
aware of the company-provided support systems. The measures can either help them on an emotional
level, like improved adjustment to the new culture, on a professional level, e.g. cost coverage for
educational expenses, on an operational level, e.g. paid child care facilities, or in financial terms, for
example a compensation for lost income.
At the same time, the policies usually do not directly involve the expatriate. Nevertheless, there are
spillover effects in relationships. Van der Zee et al. [3] identify spillover effects in terms of subjective
well-being meaning that emotional stress is transferred from one partner to the other. This means if the
partner feels bad, the expatriate will also suffer. Black and Stephens [24] highlight the importance of
spouse adjustment for the international assignment:
 Spouse opinion about accepting the international assignment is related to spouse adjustment,
 spouse adjustment is positively related to expatriate adjustment and expatriate intentions to stay or
leave.
Katharina Priesner
489
Expatriates, in general, appreciate it when the company cares about their families. Allen [25] found
out that staff who felt that the organization was less family-supportive experienced more work-family
conflict, less job satisfaction, less organizational commitment, and greater turnover intentions
compared to employees who perceived the organization as more family-supportive. This goes along
with the findings of Allard et al. [26] who say that a family-supportive organizational culture is
associated with experiences of less work-to-family conflict and family-to-work conflict, even if there is
little reported work-family support from top managers and superiors. This means because of different
perceptions it is not enough that benefits are available. The employee perceptions about the family supportiveness of a workplace environment has a strong influence on job attitudes and experiences
[25]. Not surprisingly, superiors play a major role when it comes to the perception of the work
environment as they have the power to allow employees to benefit from support measures. All the
more, it is important for supervisors to receive training in regard to work-family balance issues [25].
Major et al. [27] explored that a supportive workplace relationships leads to decreased work
interference with family. In general, employees who have troubles with their work-family balance feel
less satisfied with their job and show smaller organizational commitment [7].
There are several reasons why it is in a company’s interest to spend resources on dual-career support.
In cases where the situation at home reduces the general well-being of an employee, the productivity at
work is usually negatively affected. In order to improve the performance of expatriate managers
companies must consider trailing spouses in their assignment policies [5]. Companies need to think about
solutions how to retain talent as the increasing number of dual-career couples demand organizational
support to manage the work and family fronts [14]. Barnett [6] mentions that helping men as well as
women better integrate their work and non-work lives helps in attracting and retaining outstanding
workers and optimizing their productivity. Overall, the biggest danger is a premature return to the home
country which is linked to high costs for the company.
Main Findings and Limitations
There are several challenges for dual-career couples which include the general work-family conflict
every dual-career couple has to face. In regard to international assignments, specifics of the foreign labour
market make it even more difficult to find an appropriate job (constraints due to immigration, language,
cultural barriers and/or different labour market demands). Typical dual-career actions include job or
educational support, emotional help, cultural preparation, operational/infrastructure assistance and
financial compensation for losses. Expatriate spouses directly benefit from dual-career support on
different levels. At the same time, the expatriate is influenced by the well-being of the spouse. The main
reasons why companies should consider on-assignment support are spillover effects from the spouse to
the expatriate (if the spouse feels bad the expatriate will be affected as well) leading to decreased
productivity and low employee mobility if the company does not care about the spouses.
In regard to limitations, it is evident that further empirical research should follow to confirm the findings
derived from this theoretical work as this paper is merely based on a literature review. Another limitation
might be that the outcome is on a general level, e.g. not mentioning the different cultures that expatriate
couples face. Surveys with a different cultural background could help to understand the situation.
Conclusion and Further Research
This paper gives further insight into the situation of dual-career couples. Work-family issues are
definitely an issue in the modern working environment. The author presents several points emphasizing
490
Katharina Priesner
that the personal situation for dual-career couples and expatriates is even more challenging compared to
single earner households who stay in their home countries. These findings lead to the following results:
The main challenge for dual-career couples is the work-family conflict. In addition, an international
assignment creates the problem for the spouse to find adequate work in the host country. Differences in
the labour market requirements sometimes make it impossible to pursue a career abroad. This is why
accompanying partners prefer to do further training compared to actual employment in the host country.
Finally, dual-career support is not only beneficial for the trailing spouse, but also for the expatriate and
the employer due to spillover effects.
There are several aspects that could be covered through possible further research. The question of the
age of the expatriate/spouse and the duration of an international assignment were not considered in this
conference paper. However, age and duration could make a difference in regard to the necessity or
effectiveness of dual-career support. Further research could also focus on family size. Many expatriates
are accompanied by children. However, the number of children has not been analysed so far. Further
studies could also investigate the influence of dual-career support in the long run, e.g. long-term
consequences on the career of trailing spouses. Another research question could be if members of a
certain profession are more open for dual-career support than spouses with a different job profile.
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Katharina Priesner
APPLICATION OF PROJECT MANAGEMENT PROCESS
IN PUBLIC PROJECTS
Emils Pulmanis, State Regional Development Agency, Latvia1;
Silvija Bruna, University of Latvia, Latvia
Abstract. The modern-day project management is unimaginable without the application
of project management process. On the changing economic scene, one of the tools for
growth of the new European Union member states is the available funding for improvement
and construction projects of the public infrastructure. In the 2007-2013 planning period
Latvia has 4.5 billion EUR available for the implementation of various projects.
The purpose of this article is to analyse the polycentric development infrastructure
project initialization, planning and introduction processes through analysis of their
compliance with the project management process.
The subject of the study refers to municipality infrastructure and construction projects.
The methodological basis for the article is made up of the laws, regulations, and guidelines of the Republic of Latvia as well as works of foreign authors, and research carried out
by the authors. Comparative analysis was used for assessment of the results of expert surveys (Delphi method) and their coordination with the risk analysis provided by project submitters. Having analysed the municipality public infrastructure and construction projects, it
was concluded that their adopted project planning is incomplete, and its significance is not
always understood on the municipality level. To justify the necessity for the project, it is
best to start by describing the issue in question or the problem topicality. Municipalities are
forced in their work to solve problem situations involving various target groups.
Having analysed municipality project submissions, the authors concluded that the
particular problem solution approach, i.e. the alternative analysis, is of particular
importance in program and project planning.
To analyse 73 of the approved municipality infrastructure projects in the polycentric
development priority, the authors carried out assessment of a cost-benefit (CBA)
analysis application.
Key words: project management process, construction projects
JEL code: O22, L74
Introduction
The Baltic countries are currently in the stage of recession, and every European Union member state
has to make reasonable decisions with respect to its investment policies. Undoubtedly, various financial
instruments can serve as a means of economic recovery following the economic crisis. The biggest input
1
Corresponding author – e-mail address: [email protected], telephone +371 26896748
Emils Pulmanis, Silvija Bruna
493
in economy is of course provided by implementations of various kinds of infrastructure projects, as they
create both added value for state and municipality owned assets and jobs, and also improve the services to
project target groups. Unfortunately, the available resources bring about doubts about what is efficient
administration of the funds and how project management principles should be applied in implementation
of municipal infrastructure projects.
The financing available to the National and Regional Scale Development Center Growth Promotion
for Balanced State Development activity of the event Support for Sustainable Urban Environment and
Urban Region Development of the supplemental priority Polycentric Development of the program
Infrastructure and Services in the 2007–2013 planning period makes up LVL 209,216,720, including
ERAF co-financing of LVL 177,834,211 and national public co-financing of LVL 31,382,509 (Draft
National Strategic Reference Framework 2007-2013, 2007), and as a consequence the reception and
efficient administration of financial resources have become topical issues.
The aim of this article is to analyse the polycentric development infrastructure project initialization,
planning and introduction processes through analysis of their compliance with the project management process.
The subject of the study refers to municipality infrastructure and construction projects.
The methodological basis for the article is made up of the laws, regulations, and guidelines of the
Republic of Latvia as well as works of foreign authors, and research carried out by the authors.
Comparative analysis was used for assessment of the results of expert surveys (Delphi method) and their
coordination with the risk analysis provided by project submitters.
The listing of literature provides references to works of both foreign authors, and sources of publicly
available information.
Project management process
As the 1990s approached, project management began to mature in virtually all types of organizations,
including those firms that were project-driven, those that were non–project-driven, and hybrids. Knowledge
concerning the benefits project management offered now permeated all levels of management. Project
management came to be recognized as a process that would increase shareholder value (Kerzner, 2001).
A construction project begins with an idea, a perceived need, a desire to improve or add to productive
capacity or the wish for more efficient provision of some public service (Bennett, 2003).
A process is a defined sequence of tasks, that requires the cooperation of several roles from one or
several organizations. Elements of processes are tasks, decisions, interrelationships between the tasks and
decisions, and organizational responsibilities. A process is not an organization itself, but a sequence of
tasks which runs horizontally through one or several organizations (Gareis, 2008).
The project management process is defined on the basis of a process description and enables the
determination of measurable outputs. This improves the quality of project management (Gareis, 2008).
Research methodology and results
The authors based their research on an assessment of the public infrastructure project planning process
implemented by municipalities and a more detailed analysis by the following project initialization stages
in polycentric development projects:
 problem definition;
 alternative analysis;
 costs – benefit analysis;
 risk analysis.
494
Problem solving is a mental process which is the concluding part of the larger problem process that
includes problem finding and problem shaping where problem is defined as a state of desire for the
reaching of a definite goal from a present condition that either is not directly moving toward the goal, is
far from it or needs more complex logic for finding a missing description of conditions or steps toward
the goal (Altshuller, 1973).
Justification of a problem situation should make sure it describes a controversy, not just lists a number
of various facts. A typical mistake is to indicate in the project submission the desired situation, not
describing the existing. In such a case the problem justifying the need for the project is not demonstrated.
Therefore, the problem results from the problem situation. Whereas a problem situation is one that
encourages formulating and solving the problem. If a problem situation is not analysed in sufficient detail,
the solution, too, can be incomplete. To justify the necessity for the project, it is best to start by describing
the issue in question or the problem topicality. Municipalities are forced in their work to solve problem
situations involving various target groups.
Having analysed municipality project submissions, the authors concluded that the particular problem
solution approach, i.e. the alternative analysis, is of particular importance in program and project
planning.
80
73
70
60
50
40
100%
30
31
20
42 %
10
0
Accepted projects
Retrospective projects and
CBA
Source: Author’s construction based on empirical research
Fig. 1. A formal application of CBA
To analyse 73 of the approved municipality infrastructure projects in the polycentric development
priority, the authors carried out assessment of a cost-benefit (CBA) analysis application. A
municipality project management specialist survey revealed that the need for the municipalities and
56% of the 136 respondents do not understand a cost-benefit analysis believed the CBA to be an
unnecessary and cumbersome process. At the same time, the authors analysed the public
procurement procedures for projects and found that in limited project bid selection 42% of the cases
feature a formal cost-benefit analysis that is only done after announcing the construction
procurement and even after beginning the construction (Figure 1). Considering that in the case of
limited selection costs are eligible after the approval of the idea by the Coordination Board, project
proposal, and a CBA must be presented for the evaluation of projects when the project
implementation begins, there is a well-grounded suspicion that the project ideas are often politicized.
Such a situation preconditions the perception of CBA as a formal requirement rather than a means of
495
assessing projects’ efficiency and usefulness. Retrospective projects (ones assessed and approved
only when the planned project activity has already begun) cause the municipalities to skip a detailed
project planning and rely only on the decision-making power’s assumptions as to the necessity of the
projects, and respectively making not more than a formal evaluation of all benef its and costs when
the construction or reconstruction work has practically already begun.
A selective analysis of the technical and economic justification of the projects found several negative
aspects and non-conformance to the project management theory.
Project analysis considers two factors, i.e. the situation with the project and without the project,
making the corresponding calculations for the alternatives. A characteristic of such selection is that the
project ideas in limited selection bids are approved by the Coordination Board meeting, where each
region or municipality is assigned its specific financing quota. The authors did not find in the selected
projects any alternative analysis methods where the municipality would perform a preliminary detailed
assessment of not only the situations with or without the project, but also with a greater extent of detail,
for instance analysing specific approaches and solutions. When developing project bids, municipalities
should perform such solution analysis for infrastructure reconstruction projects, analysing the possibility
to implement the project using various solutions – construction solutions, financing models, and other
alternatives (Campbell, 2003).
Hence, in absence of such a detailed analysis it is impossible to objectively assess the existing
technical and economic justification, since only two alternatives are considered, i.e. with or without the
project.
Analysis of the solutions defined in the projects lead to conclude that the cheapest alternative is not
always justified, but it can explained by the fact that the cheapest solution is not always the best. In such
case definition of the potential benefits serves as the justification. It must be ensured that the net benefit is
greater than the planned expenses (net benefit = benefit-costs).
Non-eligible cost
Lack of competencies
Inaccuracies in public
procurement
Inflation
3
2.5
2
1.5
1
0.5
0
Lack of pre-finance
Lack of information
Changes of legal acts
Fig. 2. Expert main risk evaluation summary
496
The financial instrument administration institution given methodology requires the project applicant
to define and evaluate all possible project risks (including cost increases risk etc.), to which the project
applicant may face during the implementation of the project and which could adversely affect, impair
or impede the project implementation. For example: the potential cost increases, construction of service
availability and quality of human resource availability and professionalism (the project management
team’s risk), service time link with the project deadlines, juridical risks, etc. Imple menters should
provide information on planned measures for identified risk, defined prevention or mitigation
activities, as well as state and will be overseen by a risk-prevention measures and take new potential
risk identification. Although the methodology and regulations of Cabinet of Ministers clearly define
the need for project risk analysis, the practice shows that the public sector project risk analysis is
comprehensive and not always defined as the risk analysis in the content of the standard risk
management theory. Project submissions presented in the risk analysis and prerequisites are given as
generalized forms, and often not defined as a risk.
To demonstrate the experts and project applicants’ different approach for risk analysis the author used
comparative analysis method to examine project applicants (Figure 3) and field experts risk assessments
(Figure 2). Comparative analysis shows that experts have defined financial risks (non-eligible costs, lack
of pre-financing, inflation impact etc.) as important.
Meanwhile, analysis shows that project applicants have defined risks regarding human resources
and project management as well as project implementation risks at the highest rate. It means that
applicants consider themselves incompetent in the project management field. It could also be explained as
fear of the administrative institution decisions with regard to the project acceptance process. In the
international project management standards (PMBOK, IPMA ICB baseline, PRINCE2 etc.) the human
resource and management risks have been defined as important, but not as important as the financial and
implementation risks. Meanwhile the leading authority on project management K.Herzner says that risk
analysis is reasonably well defined for schedule and cost risks and does not emphasize the risks of human
resources (Kerzner, 2001).
Inflation
3
Non-eligible costs
2
Lack of prefinance
1
Lack of
competencies
Inaccuracies in
public
procurement
0
Lack of
information
Changes of legal
acts
Fig. 3. Project applicants risk evaluation summary
497
There are two essential conditions that must be taken into account when carrying out risk analysis, i.e.,
whether the project is implemented in pure project organization form or mixed form of organization in the
risk analysis of the widely prevalent definition of risk management and a variety of prevention measures.
Clearly, the human factor is key to the success of the project, but the risk analysis shows that local
governments often justify them with the risks that employees amateurism, improper implementation of
actions, ignorance, inaptitude, incorrect application of law rules, etc. It should be remembered that these
defined conditions cannot be considered a risk. If a person applied improperly, or unprofessional, then the
project manager simply builds a team which is professional and knowledgeable in project management.
The definition of risk by itself has already determined that it is an unexpected event or activity that might
affect the achievement of project results, so the incorrect application of risk analysis is unacceptable
because it just proves the incompetence of the project developer, if you can afford to believe that the same
employee is incompetent (Pulmanis, 2011).
From the 234,336,206 EUR handed out in contracts to the polycentric development priority, the found
non-conformances amounted to 2,304,836 EUR, i.e. 0.98 % of the approved financing. The proportion of
non-conformances having financial consequences exceeding 2% in terms of material impact is assumed
as a point of reference in evaluation, seeing that it is the level established for the EU funds in accordance
with the European Commission regulation No. 1828/2006, annex No. 4. A non-conformance
(Commission regulation, 2006) is any violation of the community legislation resulting from actions or
lack of action by the subject of operational activity and causing or threatening to cause damage to the
general budget of the EU by demanding the general budget to cover an unjustified part of costs. Nonconformant expenses arise where they cannot be withheld from the current payment.
Non-conformance without financial consequences are violations where no non-conformant expenses
are found and the expenses need not be recovered, since the recipients of the financing have not been
financed, for instance when a contract is cancelled before any payments are made.
Non-conformant expenses are ones that cannot be withheld from the current payment. In other words,
these expenses are paid to the recipient of the financing and respectively the non-conformant expenses are
taken from the next payment, or recovered otherwise.
Losses to the state budget by non-conformant expenses and non-conformances found in the projects of
direct or indirect state administration institutions, derived public entities, or other state institutions, are
recovered by withholding them from the current/next payment, by writing them off, recovering and
reporting the Cabinet of Ministers. Additional losses to the state budget are caused by non-conformant
expenses found in the projects implemented by businesses and non-governmental organizations, and these
cannot be recovered.
All in all, it can be concluded that the most significant reasons for non-conformance continue to be
violations in the public procurement procedures, lack of operational activity by the recipients of the
financing, and failure to implement the activities or comply with project conditions, which includes the
indicators planned in a project being practically out of reach or impossible to measure.
Municipality project management experts have indicated the poor project implementation and control
system in municipalities as the flaw, rather than the project planning process, emphasising in particular
the issues in construction project implementation because:
 municipalities are incapable of providing for a construction board in its own territory –the
institution necessary for the construction process – which leads to a situation where several regions
share a single construction inspector, who cannot ensure a sufficient quality construction control in
his/her municipality,
 lack independence for the inspector, which is especially pronounced in construction of the projects
co-financed by the municipality; in some cases the construction inspectors do not have any legal
support,
498
 insufficiently optimal construction project implementation control system and relatively low level
of competence among the construction inspectors,
 the level of project specialists’ competence and professional knowledge in technical processes,
especially in implementation of large scale infrastructure projects.
Conclusions
Having analyzed the municipality public infrastructure and construction projects implemented in
Latvia, it was concluded that their adopted project planning is incomplete, and its significance is not
always understood on the municipality level. When studying the polycentric development priority project
planning, an important deficiency is the fact that projects are approved in limited selection procedures and
the project approval is done in retrospect, when the project ideas have been approved formally, and the
project implementation begins before detailed project submissions are developed, which includes proper
problem definition, cost-benefit analysis and a justified risk analysis.
The project budget will only function effectively on the three levels if decision making and project
management systems and processes are performance-oriented. Weaknesses that undermine public sector
performance include:
 Poor project planning;
 No links between policy making, planning and budgeting (political influence);
 Poor expenditure control at municipality level;
 Lack of professional and skilled project managers;
 Poor construction quality.
Authors conclude that research object was public sector implemented projects financed by the
European Union funds. The study shows the existing problems of public sector project management
problems, which could affect the efficiency of public expenditures in Latvia. The further research and
study should be done to evaluate problems why the public sector project management practice is poor and
lack of project management tools and instruments.
Bibliography
Altshuller, Genrich, 1973. Innovation Algorithm. Worcester, MA: Technical Innovation Centre. 311 p.
Bennett, F.L., 2003. The Management of Construction: A project Life Cycle Approach. Great Britain,
Butterworth-Heinemann, 333.p.
Campbell, H., Brown, R., 2003. Benefit-Cost Analysis, Cambridge, UK: Cambridge University Press,
361. p.
Commission Regulation (EC) No 1828/2006 of 8 December 2006 setting out rules for the implementation
of Council Regulation (EC) No 1083/2006, European Commission, 2006, 126.p.
Draft National Strategic Reference Framework 2007-2013, 2007. Ministry of Finance of Republic of
Latvia. 116 p.
Gareis, R., 2005. Happy Projects!. Manz Crossmedia, 1051 Vienna, 624 p.
Gareis, R., Stummer M., 2008. Processes & Projects, Manz Crossmedia, 1051 Vienna, 323 p.
Kerzner, H., 2001. Strategic planning for project management using a project management maturity
model, John Wiley & Sons Inc., 270 p.
Pulmanis, E., 2011. Risk assessment in the project initialization process as part of the cost – benefit
analysis, International scientific conference “Current Issues in Economic and Management Sciences”,
University of Latvia, November 10-12, ISBN 978-9984-45-417-7, pp. 512-523.
499
FINANCIAL MARKETS IN THE BALTIC STATES
IN THE CHANGING ENVIRONMENT
Ramona Rupeika-Apoga, University of Latvia, Latvia1
Abstract. Many agreed that in recent years the economic environment has changed
very quickly, dramatically, and thus, creating new challenges for financial market
development. But behind this too often scanned claim, almost everything else about this
phenomenon is the subject of intense debate.
The object of this paper is the Baltic financial markets.
The purpose of this research is by analysing Baltic financial markets from
international competiveness perspective to find how Latvia’s financial market can
benefit under changing environment.
To achieve the purpose the following tasks were conducted:
1) to identify the main characteristics of financial market soundness in the changing
environment;
2) to assess Baltic financial markets from international competition prism;
3) to analyse access to finance through loans in the Baltic states financial markets;
4) on the basis of the author’s findings to put forward offers, how Latvia’s financial
market can to benefit in the changing environment.
The study results highlight the need to recognize that countries require sound and
well-functioning at the same time financial markets. Only in that case financial markets
can provide recourses for investments as sound banking loans, properly regulated
securities exchanges, venture capital, and other sources.
During development of the paper the generally accepted qualitative and quantitative
methods of economic research were used including comparative analysis and
synthesis, graphical illustration methods.
Key words: financial markets, competiveness, Baltic States
JEL code: G10
Introduction
Changing global economic environment has made it more important than ever to identify and
contribute the qualitative as well as the quantitative aspects of financial markets growth, integrating such
concepts as social and environmental sustainability to provide a fuller picture of what is needed and what
works.
1
500
Ramona Rupeika-Apoga
Financial markets all over the world face a number of significant and interrelated challenges that
could prevent a real growth after an economic crisis as in the most advanced economies as in the
developing markets as well. The remaining financial difficulties in the euro zone have led to a longlasting sovereign debt crisis that has now reached the highest point. Scientists together with governments
are looking for cooperation and management of the current economic challenges while preparing their
economies to perform well in an increasingly difficult and changing environment. Financial markets
activities mostly focused on the short-term crisis management, remain critical for countries to establish
the fundamentals that contribute to economic growth and development in the long run.
The object of this paper is the Baltic financial markets.
The purpose of this research is by analysing Baltic financial markets from international
competiveness perspective to find how Latvia’s financial market can benefit under changing environment.
To achieve the purpose the following tasks were conducted:
1. to identify the main characteristics of financial market soundness in the changing environment;
2. to assess Baltic financial markets from international competition prism;
3. to analyse access to finance through loans in the Baltic states financial markets;
4. on the basis of the author’s findings to put forward offers, how Latvia’s financial market can to
benefit in the changing environment.
The structure of the paper is as follows. Chapter 1 explores the main characteristics of financial
market soundness in the changing environment, by emphasizing in what directions we need to work to
improve financial market efficiency: macroeconomic policy and data transparency; supervision and
regulation of financial intermediaries and institutional and market infrastructure. Chapter 2 assesses Baltic
financial markets from international competiveness perspective, paying attention to access to finance and
trustworthiness and confidence of financial markets. Finally, in Chapter 3 the author looks for solutions
how Latvia’s financial market can to benefit in the changing environment taking into account our
neighbour countries achievements, by analysing the main recourses of finances: loans.
The study results highlight the need to recognize that countries require sound and at the same time
well-functioning financial markets. Only in this case financial markets can provide resources for
investments as sound banking loans, properly regulated securities exchanges, venture capital, and other
sources.
To analyse access to finance is a multifaceted task, the authors of the paper in this research have
mostly concentrated on the main sources of finance- loans, as one of the main characteristics of financial
market soundness.
During development of the paper the generally accepted qualitative and quantitative methods of
economic research were used including comparative analysis and synthesis, graphical illustration
methods.
1. Characteristics of financial market soundness
The recent economic crisis has emphasized the need of efficient financial markets. Efficient financial
markets that are sound and well-functioning play the vital role for countries development. A characteristic
of efficient financial market is that it channels funds from the ultimate lenders to the ultimate borrowers
in a way that the funds are used in the most socially useful manner.
In the 1970s Eugene Fama defined an efficient financial market as “one in which prices always fully
reflect available information” (Fama E., 1970). Financial markets allocate the resources saved by as local
as foreign citizens to their most productive uses. Financial markets are more profit oriented than
politically, that is why they transfer resources to those projects with the highest expected rates of return
rather than to the politically connected. In the analysis of financial markets the examination of efficiency
501
assumes an informational dimension, the existence of which may well be related to that of Pareto or
productive efficiency, but the meaning of which is quite distinct (Leighton, 2005).
While most scientists believe the markets are neither fully efficient, nor fully inefficient, many
disagree where on the efficiency line the world's markets fall. In reality a financial markets can’t be
considered to be extremely efficient, or completely inefficient and are a mixture of both, sometimes
providing fair returns on the investment for everyone, while at other times certain investors will generate
above average returns on their investment. In this research the author of the paper are not arguing about
the market efficiency in general terms, but looking for key factors how Latvia’s financial market can to
benefit taking into account turmoil financial markets development in recent years.
Backed by solid empirical evidence, development practitioners are becoming increasingly convinced
that efficient, well-functioning financial systems are crucial in channelling funds to the most productive
uses and in allocating risks to those who can best bear them, thus boosting economic growth, improving
opportunities and income distribution, and reducing poverty.(Fama E., 1991; Mankiw G., Phelps E. and
Romer P., 1995; Clas W., 1990; Berger Allen N., Hunter William C., Timme Stephen G., 1993; Aghion
P., Howitt P. and Mayer-Foulkes D., 2005).
To improve financial market efficiency we have to work in three directions: macroeconomic policy
and data transparency; supervision and regulation of financial intermediaries and institutional and market
infrastructure.
1. First of all on macroeconomic policy and data transparency: macroeconomic policy divides to
monetary and financial policies and fiscal policy.
To achieve transparency on monetary and financial policies we need to identify and develop:
 what are the main responsibilities and targets of central banks and financial agencies, and their
role in the market;
 how to formulate and report monetary policy decisions by the central bank and of financial
policies by financial agencies;
 public access to information on monetary and financial policies;
 responsibility and assurances of integrity by the central bank and financial agencies.
IMF in the Code of Good Practices on Transparency in Monetary and Financial policies (MFP)
identifies desirable transparency practices for central banks in their conduct of monetary policy and for
central banks and other financial agencies in their conduct of financial policies. For purposes of the MFP,
transparency refers to an environment in which the objectives of policy, its legal, institutional, and
economic framework, policy decisions and their rationale, data and information related to monetary and
financial policies, and the terms of agencies' accountability, are provided to the public on an
understandable, accessible and timely basis. The code is currently under review (IMF (a)).
To achieve transparency on fiscal policy we need to identify and develop:
 clearness of government structure and functions to the public;
 fiscal policy intentions;
 public sector accounts;
 fiscal projections.
Fiscal transparency by strengthening responsibility and increasing the political risk can therefore
enhance credibility. As a result companies will receive access to finance with lower borrowing costs and
in general stronger support for sound macroeconomic policies by a well-informed public.
IMF have been designed the Code of Good Practices on Fiscal Transparency. The code contains
transparency requirements to provide assurances to the public and to capital markets that a sufficiently
complete picture of the structure and finances of government is available so as to allow the soundness of
fiscal policy to be reliably assessed. Code is currently under review in line with the recent IMF Board
502
paper on Fiscal Transparency, Accountability, and Risk, which proposed a set of revisions to existing
international fiscal transparency standards and monitoring arrangements (IMF (b)).
2. Secondly, supervision and regulation of financial intermediaries, emphasising the banking and
insurance sector supervision and securities regulation. Last year problems in banking sector activities
have highlighted the necessity of structural reforms in banking sector regulation and supervision all over
the world. That is why the Basel Committee on Banking Supervision revised Core principles for effective
banking supervision, underling the difference between what supervisors do and what they expect banks to
do. New revised principles address supervisory powers, responsibilities and functions, focusing on
effective risk-based supervision, and the need for early intervention and timely supervisory actions. The
principles cover supervisory expectations of banks, emphasising the importance of good corporate
governance and risk management, as well as compliance with supervisory standards.
In addition, the review has taken account of several key trends and developments that emerged during the
last few years of market turmoil:
 the need for greater supervisory intensity and adequate resources to deal effectively with
systemically important banks;
 the importance of applying a system-wide, macro perspective to the microprudential supervision of
banks to assist in identifying, analysing and taking pre-emptive action to address systemic risk; and
 the increasing focus on effective crisis management, recovery and resolution measures in reducing
both the probability and impact of a bank failure. (BIS, 2012)
The regulatory and supervisory system must address the increasing presence in the market of
insurance groups and financial conglomerates, as well as financial convergence. The importance of the
insurance sector for financial stability matters has been increasing which has implications for insurance
supervision as it requires more focus on a broad set of risks. Supervisors at a jurisdictional and
international level must collaborate to ensure that these entities are effectively supervised so that
policyholders are protected and financial markets remain stable; to minimise the risk of contagion from
one sector or jurisdiction to another; and to reduce supervisory gaps and avoid unnecessary supervisory
duplication. The Insurance Core Principles (ICPs) are the highest level in the hierarchy of IAIS
supervisory material and prescribe the essential elements that must be present in the supervisory regime in
order to promote a financially sound insurance sector and provide an adequate level of consumer
protection. (IAIS, 2011)
Efficient security market requires:
 investors protections;
 ensuring that markets are fair, efficient and transparent;
 reducing systemic risk.
The International Organization of Securities Commissions (IOSCO) has published its revised
Objectives and Principles of Securities Regulation (Principles) to incorporate eight new principles, based
on the lessons learned from the recent financial crisis and subsequent changes in the regulatory
environment, which are designed to strengthen the global regulatory system against future crises.
(IOSCO, 2010)
3. Thirdly, institutional and market infrastructure. Managing institutional and market infrastructure to
ensure financial markets efficiency we need to concentrate on:
 Crisis resolution and deposit insurance;
 Insolvency and creditor rights;
 Corporate governance;
 Accounting and auditing;
 Payment, clearing and settlement;
 Market integrity.
503
A well-considered and proper assessment of macroeconomic policy and data transparency; financial
regulation and supervision; institutional and market infrastructure as well are the key ingredients of a
sound financial market. As a result countries require sophisticated and well-functioning at the same time
financial markets. Only at that case financial markets can provide recourses for investments as sound
banking loans, properly regulated securities exchanges, venture capital, and other sources. To accomplish
all those functions, financial markets regulation has to be sustainable and well-functioning. Financial
regulation and supervision has to be confident and reliable, available to protect market participants from
external and internal shocks.
In the next chapter the author assesses the Baltic States financial markets through the prism of
international competiveness, by emphasising availability and affordability of financial services.
2. Baltic financial markets analysis through the prism of international competiveness
The authors of the paper relied on “The Global Competitiveness Report” of the World Economic
Forum, by assessing development of the financial markets of the Baltic States from international
competiveness perspective.
This forum has, for more than thirty years, provided detailed assessments of the productive potential
of nations worldwide. The Report contributes to an understanding of the key factors that determine
economic growth, helps to explain why some countries are more successful than others in raising income
levels and opportunities for their respective populations, and offers policymakers and business leaders an
important tool in the formulation of improved economic policies and institutional reforms.
Fig. 1. Global Competiveness Index 2012-13 of financial market development for the Baltic States,
World Economic forum’ report (Rank/144 countries) (World Economic Forum, 2012)
504
In accordance with World Economic forum’s report financial market efficiency can be characterised
by following factors:
 Availability of financial services;
 Affordability of financial services;
 Financing through local equity market;
 Ease of access to loans;
 Venture capital availability.
Factors characterising trustworthiness and confidence are following:
 Soundness of banks;
 Regulation of securities exchanges;
 Legal rights index
In figure 1 are reflected the main determinants of financial market development in the Baltic States in
accordance with World Economic forum’s report. As we can see all efficiency determinants correlate
with access to finance. In recent years access to finance has been considered one of the main obstacles to
successful financial market development (Peachey S. and Roe A., 2004; Beck T. and Demirguc-Kunt A.
2006; ECB, 2012).
The results from the Feasibility study on new forms of EU support to Member States and Regions to
foster SMEs Innovation Capacity report have highlighted the shortage of financial resources and access to
finance as one of the main barriers to SMEs innovation capacity (Pro Inno Europe, 2011).
This same conclusion has been reached by European Central Bank survey results:
 European Central Bank Consultation: among 7,532 firms, of which 6,941 had less than 250
employees:
 Access to finance was second ranked most pressing problem faced by SMEs in the Euro Area.
(ECB, 2011)
 Public Consultation on the effectiveness of innovation support in Europe:
 1,000 companies (of which a large majority were innovative micro and small enterprises) and
430 innovation intermediaries found that:
 Lack of access to finance is viewed by enterprises as the main factor hampering innovation
activities.
 Lack of access to finance is considered by institutional stakeholders as the principal barrier
hampering enterprises bringing innovations to the market. (EC, 2009)
Access to finance can be analysed from different aspects:
 How available are financial services for companies and individuals in general?
 Who can afford financial services in general?
 What are the main recourses of financing: loans, securities and venture capital?
Analysing availability of financial services in the Baltic States in general, the authors concluded that in
Estonia companies and individuals have better access than in Latvia and Lithuania, ranking Estonia in 43rd
place (2012), within 45 best countries, at the same level as Slovak Republic and Czech Republic, and not far
from Japan’s and Israel’s levels. Whereas Latvia’s and Lithuania’s positions are 65 and 74 respectively,
placing Latvia at the same level as Jamaica and Colombia, and for Lithuania - Uganda and Zambia.
Whereas access to finance is significantly better in Estonia, the affordability of financial services is
rather similar in the all Baltic countries, placing Latvia and Estonia in 58 and 59 places out of 144
countries, and Lithuania in 73rd place. By evaluating the positions of the Baltic States in the world
countries ranks, Latvia shows an improved affordability of financial services when compared with access
to services, whereas in Estonia the situation is opposite, as for Lithuania in both determinants situation is
the same.
505
3. Main recourses of finances: case of the Baltic states
To better understand why in Estonia access to finance is easier, lets analyse the main recourse of
finances: loans.
In figure 2 we can see two different approaches to loan access in the Baltic States: the first in Latvia
and Lithuania, and the second in Estonia. The period from 2004 to 2007 was marked by buoyant growth
of the Baltic States economies and banking sector, characterised by investment inflows, lending boom
and a very low exposure to non-performing loans in the loan portfolios. In 2006-2007 all three Baltic
States were actively working on the introduction of the euro and were trying to reduce too high inflation,
for example Latvian government was forced into action to set up a working group on inflation which
published an anti-inflation plan in early March 2007. As a result if in the beginning of 2006 access to
loans in Lithuania and Estonia was at the same level and significantly better than in Latvia, after
government reforms Latvia and Lithuania worsened their positions equally. Whereas Estonia continued to
strengthen financing possibilities for companies and individuals till 2008.
Starting from the third quarter of 2008, the first signs of growing stress became apparent mainly as a
result of the shrinking economic activity, drying-up lending and an ever accelerating fall in real estate
prices. In the second half of the year, access to loans worsened against the background of the collapse of
Lehman Brothers and the subsequent liquidity squeeze and deterioration of the external economic
environment. In Latvia situation was complicated with the take-over of JSC Parex banka in 2008 and the
government turning to international donors for assistance. Despite the fact that Lithuania didn’t use
international aid, the problems in the country were very similar to Latvia’s, as a result Lithuania’s access
to credits was only slightly better than the Latvia’s. Only starting from 2010, the situation can be assumed
to normalise, yet the high provisions ratio, significant losses of the banking sector and shrinking loans
still suggest that the availability of loans remains problematic.
After 2010 Latvia showed significant improvements in crediting and almost reached the level of
Estonia, at the same time in Lithuania the improvement of credit availability was moderately stable.
Fig. 2. Ease of access to loans from 2006-2013 in the Baltic States: 1-7 (best)
(World economic forum data base)
506
The crisis affected Latvia’s market more severely than others, as during 2 crisis years the drop of
availabilities of loans was 41% compared with 38% and 35% in Lithuania and Estonia respectively.
Fig. 3. Ease of access to loans from 2006-2013 in EU economic groups: 1-7 (best)
(World economic forum data base)
Fig. 4. Loans to resident financial institutions, non-financial corporations and households
in the Baltic States (author calculations based on central banks statistics)
It is interesting to compare the performance of the Baltic States as a group with other EU groups. The
crisis had similar effect on all economic groups, but the effect was stronger in the Baltic region, when
507
during 2 years the availability of loans decreased by 38%, whereas in EU-12 (Accession) and EU-15
only by 25%. The author positively values that after the crisis recovery was more dynamic in the Baltic
region, when access to loans improved by 10%; at the same time in EU-12 and EU-15 it decreased by 3%
and 6% respectively.
Comparing the Baltic financial markets with EU-12 and EU-15 the author concluded that our
markets were not as stable, as fluctuations in the access to financing are significantly higher than
average for the EU.
The differences in government and central bank -implemented credit policies can be observed in
figure 4. Estonia started to implement restrictive crediting policy more actively, more aggressively than
Latvia and Lithuania, as a result the Estonian financial market was more prepared for crisis, and recovery
in Estonian market started from 2009, whereas in Latvia we still see negative credit growth.
By analysing availability and affordability of financial services in the Baltic States the author
concluded that the best access to finance is in Estonia, the most problematic in Lithuania, while situation
in Latvia is average.
1. Backed by solid empirical evidence, development practitioners are becoming increasingly convinced
that efficient, well-functioning financial systems are crucial in channeling funds to the most
productive uses and in allocating risks to those who can best bear them, thus boosting economic
growth, improving opportunities and income distribution, and reducing poverty.
2. Improvement of financial market efficiency needs the revaluation of:
 macroeconomic policy and data transparency;
 supervision and regulation of financial intermediaries;
 institutional and market infrastructure.
3. Macroeconomic policy and data transparency by strengthening responsibility and increasing the
political risk can therefore enhance credibility. As a result companies will receive access to finance
with lower borrowing costs and in general stronger support for sound macroeconomic policies by a
well-informed public.
4. In recent years the problems in financial intermediaries’ sector activities have highlighted the
necessity of structural reforms in this sector regulation and supervision all over the world :
 the need for greater supervisory intensity and adequate resources to deal effectively with
systemically important system participants;
 the importance of applying a system-wide, macro perspective to the microprudential supervision
of financial intermediaries to assist in identifying, analysing and taking pre-emptive action to
address systemic risk;
 the increasing focus on effective crisis management, recovery and resolution measures in reducing
both the probability and impact of the intermediaries failures.
5. In recent years access to finance has been considered as one of the main obstacles to successful
financial market development; as a result availability and affordability of loans, as loans are the main
resource of financing within the Baltic States.
6. In Estonia companies and individuals have better access than in Latvia and in Lithuania, placing
Estonia in 43rd place (2012), within 45 best countries, at the same level as Slovak Republic and Czech
Republic, not far from Japan’s and Israel’s levels. Whereas Latvia’s and Lithuania’s positions are 65
and 74 respectively, placing Latvia at the same level as Jamaica and Colombia, and for Lithuania Uganda and Zambia.
508
7. In assessment of loans availability the author divides data to before and after the crises:
 in the begging of 2006 access to loans in Lithuania and Estonia was at the same level and
significantly better than in Latvia, than after government reforms in 2007-2008 Latvia and
Lithuania worsened their positions equally. Whereas Estonia continued to strengthen financing
possibilities for companies and individuals till 2008.
 the crisis had similar effect on all economic groups, but the effect was stronger in the Baltic
region, when during 2 years the availability of loans decreased by 38%, whereas in EU-12
(Accession) and EU-15 only by 25%. The author positively values that after the crisis recovery
was more dynamic in the Baltic region, when access to loans improved by 10%; at the same time
in EU-12 and EU-15 it decreased by 3% and 6% respectively
 Estonia started to realised restrictive crediting policy in 2005 more actively, more aggressively
than Latvia and Lithuania, as a result the Estonian financial market was more prepared to the
crisis, and recovery in Estonian financial market started from 2009, whereas in Latvia we still see
negative credit growth.
 Taking into account that loans are only one part of the finance recourses, in the future researches,
will be necessary to analyse security market, venture capital and other resources availabilities in
the Baltic States.
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HANDLING OF MERGERS AND ACQUISITIONS RISK WITH DUE
DILIGENCE IN EMERGING MARKETS – COMPARISON OF SCIENTIFIC
STATE OF RESEARCH AND PRACTICAL POINT OF VIEW
Alen Sacek, University of Applied Sciences Kufstein, Austria1
Abstract. The obviously ever increasing number of corporate mergers and
acquisitions (M&As) in recent decades has widened and improved the general
knowledge and awareness of due diligence for both the industry and research. In the
current financial crisis, M&A transactions face higher degree of risk profiles, especially
in the emerging markets. The greater the uncertainty, the more diligence is due. A
number of globally active consulting companies performed surveys and got results
which differ from the state of the scientific economic research to this topic. Companies
investing in firms in those markets believe the risk assessment they do before investing
in the lesser-known environment of emerging markets, needs to be enhanced. The
problem is that common risk assessment approaches consider financial, legal,
commercial, and other issues – but they are not discrete areas in emerging markets,
because there is overlap between the public and private sector in these regions,
information is unreliable and regulation unpredictable. As the surveys show, e.g. state
intervention, political instability and litigation history are both commercial and
reputational issues in emerging markets. Thus more integrated approach to due
diligence is required in these regions than in developed markets. This paper focuses on a
practitioner’s experience with M&A due diligence and how the current state of research
efforts in M&As due diligence fits to this experience. The comparison calls for a
different, more integrated system of due diligence and shows the research deficit.
Key words: due diligence, emerging markets, mergers and acquisitions, risk, investment
JEL code: G 34
Introduction
Global mergers and acquisitions (M&As) activity in 2012 is down on last year, with volume falling
12% compared to 2011, while the total value of deals fell by 8% as macro-economic concerns, including
the ongoing Eurozone crisis and the impending “fiscal cliff” in the US, restricted corporates in the
developed markets from committing to acquisitions (Rodwell/Parker, 2013). The M&As in Central and
Eastern Europe decreased merely by 40%. M&A activity is predicted to remain low in 2013, with the
intention to acquire among large global corporate’s falling. A growing number of global executives
looking to make an acquisition see the gap between their valuation of potential assets and the prices
sought by sellers as the main reason not to do a deal in 2013 (Rodwell, H., Parker, 2013). Historically,
1
Corresponding author – e-mail address: [email protected]
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M&A activity levels have tracked equity prices in many developed markets – such as the US and UK –
but in recent years there is a gap in those prices and M&A activity (Rothenbuecher/Hoyningen-Huene,
2007). According to this observations of the practitioners, in such an environment, the quality of
assessing the potential risks in M&As prior to concluding the transactions becomes crucial. In a broad
based survey at the Annual Due Diligence Conference, the symposium said weak due diligence was the
main reason that many mergers collapsed within few years (Morrison et al, 2008). In an effort to examine
the current state of due diligence this paper reviews the traditional approach conducting due diligence
M&As in Emerging Markets, especially in the Central and Eastern Europe region. In the second step
author researches the understanding of due diligence proceeds in current publications and surveys of
M&A practitioners and figures out the gap between the traditional and practitioners’ approach. The
literature review considers all, at my best knowledge, current scientific papers about risk assessment via
due diligence and deals with M&As, even if they do not concentrate on due diligence as the risk
assessment tool.
Due Diligence
Due diligence is generally accepted method of risk assessment in the M&A world. The nature of due
diligence is that it is used across all industries and business activities such as M&As but also in case of
initial public offerings, real estate transactions, venturing technology firms, HR topics, supplier
identification etc.. Due diligence is also known as “due care”, and used essentially to prevent damages
and/or possible harm to either party involved in transaction or business decision (Angwin, 2001, Belian,
2011, Meier, 2011). In general, the core point of due diligence is to provide an acquirer with enough basic
information about a target to pave the way for an informed decision about whether to pursue the M&As
transaction and to at what price and other terms. The acquirer can make a better risk assessment about the
economic benefits of a potential M&A, when there are more precise private information. "The basic
function of M&A due diligence is to assess the benefits and the liabilities of a proposed acquisition by
inquiring into all relevant aspects of the past, present, and predictable future of the business to be
purchased. Those making this assessment should focus on risk" (Lajoux/Reed, 2011). In a M&A
transaction, due diligence means carrying out an investigation or audit of a potential investment serving
as a confirmation of all material circumstances related to a transaction. The final purpose is to give
confidence to the acquirer that they fully understand the value and risks of associated with the target
company (Angwin, 2001, Belian, 2011, Meier, 2010).
Since the 1980s, a lot of research has been done on due diligence methods covering mostly the factors
of the realm of the economy and finance (Firstbrook, 2007) and the number of factors to be addressed
increases steadily. Due diligence practices are not uniformed around the world, but they are roughly
categorized in two forms in the literature. Rosenbloom (2002) differs between “Anglo-Saxon” and the
“Non-Western” due diligence. The Anglo-Saxon practice involve legal and financial due diligence and
significant disclosure prior to signing the acquisition agreement. The Non-Western approach involves
broad preliminary legal and financial due diligence procedures with more limited disclosure. The areas
examined are the targets company’s (Angwin, 2001):
 industry and how it is affected by macroeconomic factors,
 the current competitor analysis in terms how the target company competes against current and
potential competitors,
 historical picture and development,
 commercial situation in terms of products and services and their position in the market,
 management and personnel quality and capabilities,
 financial performance over time,
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 asset valuations,
 accounts and the accounting policy and
 information systems.
The main challenge for the acquiring firm is not obtaining adequate information about the target
company’s business. This problem is known in the business as the information risk problem (Wangerin,
2011). In line with the literature, I use the term information risk to describe the uncertainty surrounding
information relevant to the acquirers valuations and expectations for future economic development
(Wangerin, 2011). Information risk also arises due to uncertainty about how the combined entity will
generate future cash flows after the acquisition is completed. Other common and more general risks relate
to the existence and valuation of the assets and liabilities in the financial statement and litigation and
claims against the target company. Table 1 summarizes these risk assessment factors relevant for the
acquirer that are addressed within the due diligence inquiry (Lajoux/Elson, 2000).
Table 1
Summary of due diligence inquiry areas and mergers and acquisitions risk factors
Risk Type
Area of Inquiry
Risk factors related to the acquisition
Information Risk
Financial Statement
Review






compliance of financial statements with GAAP
existence and valuation of assets/liabilities
identification of undisclosed contingencies and liabilities
assessment of internal accounting policies
taxation issues
effectiveness of internal control and accounting
information systems
Operating Risk
Operations review





operational performance and efficiency
condition of the productive assets and infrastructure
post-acquisition integration strategies
evaluation of management control systems
key customer and supplier relationships
Litigation Risk
Litigation review









compliance with relevant laws and regulations
contractual rights and obligations
exposure to antitrust litigation
intellectual property protection and litigation risk
assess risk under consumer protection law
assess risk under environmental law
assess risk under employment law
negligence
improper disclosure
Source: Authors table, based on Lajoux/Elson 2000
The cross-border M&As include as greatest risks cultural, regulatory or risks in the competitive
environment in the target market (Firstbrook, 2007), but concrete scientific research on this issue, with
exception of the cultural aspects, is still rare.
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The traditional approach
In general, the traditional due diligence approach considers legal, financial and commercial issues and
is carried out by legal and accounting advisors (Angwin, 2001, Belian, 2011, Meier, 2011). There is an
interconnecting idea between these three issues graphically visualized in Fig. 1 (Blayney, 2007).
Source: Blayney, 2007
Fig. 1. Traditional Approach Due Diligence
Berens/Brauner/Strauch (2011) also theoretically consider further topics than the traditional approach
but the additional areas are all combined with the financial and legal outcome without considering the
critical areas which often led to failure of the M&As.
The traditional due diligence process has been primarily focused on tangible assets or documents
relative to the operations of the company (Harvey/Lusch, 1995). Harvey/Lusch (1995) divide the due
diligence proceedings in risk assessment separated in intangible and tangible assets as they consider the
traditional due diligence approach as a “mechanical verfication” of legal, accounting, and tax matters.
Their research includes the secondary consideration of intangible assets resulting from a survey of
members of due diligence practitioners. Especially beyond the tangible matters, they recommend to
include audits of macro-environment, production, management, marketing, and information systems in
due diligence proceedings as shown in Figure 2 and 3.
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Internal Environment
Tangible
 cash
 plant equipment
 accounts receivable
 patents/trademarks
 technology
 inventory
Intangible
 quality of leadership
 training of personnel
 corporate culture
 quality of infor./analysis operating system
 loyalty of personnel
 trade secrets
 data bases
 personal/professional networks
External Environment
Tangible
 share of market
 supplier/distributor contracts
 physical location
Intangible
 brand product awareness
 customer loyalty
 competitive positioning
Source: Harvey/Lusch 1995
Fig. 1. Tangible und Intangible assets approach by Harvey/Lusch (1995)
(1) Macro-Environment Audit
(2) Legal/
Environment
Audit
Target Acquisition
(3) Marketing
Audit
4 P’s
$
Plant/Equip.
(4) Production
Audit
(7) Financial Audit
(5 yr. Historical)
Computers
(5) Management
Audit
(6) Information/System
Audit
Internal field
Internal & external field
Source: Harvey/Lusch 1995
Fig. 3. Due Diligence Requirements
In the past four years there have been few theoretical research articles about operational due diligence.
This kind of risk assessment concentrates mainly on the target company’s operational elements. Namely, the
operational complexity in companies increased – such as the need for integrated supply chain management
systems, logistics operations which must work real-time and across the borders, the extensive use of
subcontracting and manufacturing, etc. (Knecht & Calenbuhr 2007). Other authors, e.g. McGrady (2005),
name merely the same area of “typical due diligence considerations” and argues that the guidelines and best
practice vary but that they appear to be comprehensive. As long time the approach consisted exclusively of
financial and legal issues, the newer scientific work includes employees, benefits, environment and
intellectual property are signs of a broadening of scope in the due diligence process (Mcgrady, 2005).
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There seems to be a pattern emerging from both research and experience that intangible issues such as
culture and change are critical to success. Some research even identifies “irrational” influences on postmerger integration. However, the predominant focus of due diligence remains financial and legal although
the track record of M&A deals points to shortcomings in the traditional due-diligence approach (Morrison
et al., 2008 and McGrady, 2005).
Practical point of view
In general, the potential rewards from acquiring in emerging markets are undeniable, but the risk
profile of such M&As is higher than in domestic transactions. One of the difference is the information
risk on a higher level than in developed countries, as the acquirer does not get reliable information about
the target company. The M&A practitioners still search for the best practice standards. This research
paper considers three market surveys that were carried out by renowned advisors of multinational
companies when they acquire M&A targets in the emerging markets: Kroll Advisors, AT Kearney
(Emerging Markets), Deloitte (Emerging Markets, Central and Eastern Europe). Kroll Advisors
interviewed 50 practitioners with broad experience in M&As in emerging markets (Glapion 2012).
Deloitte surveys also consist of numerous expert interviews.
Kroll Advisors – Due Diligence in Emerging Markets (2012)
Source: Kroll Advisors, Glapion, 2012
Fig. 4. Due Diligence in developed markets
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The study concludes that conducting due diligence on targets in emerging markets requires a different
approach and that the acquirers have adapted their approach to emerging & frontier markets, opting
instead to increase the traditional approach with concentrating on legal and tax issues. The main hurdle
identified is the connectivity and overlaps between commercial and reputational dynamics, as illustrated
in the Fig. 4 and 5. when addressing the risk assessment challenges in the pre-acquisition phase (Glapion,
2012). In the focus of the Kroll’s survey stands the inter-play between commercial and reputational issues
and their implications on the M&As in emerging markets. This is especially the case in jurisdictions and
sectors where the government involvement in its role as a regulator, undisclosed ultimate beneficial
owner in the target company, a client or a supplier, a provider of infrastructure or a competitor.
Source: Kroll Advisors, Glapion 2012
Fig. 5. Due Diligence in Emerging Markets
Deloitte Study – Emerging Markets (2012) and Central and Eastern Europe (2009)
The survey from Deloitte also investigated that managing compliance and integrity-related risks in
emerging markets is a major concern for many companies as over 70 per cent of the executives are
extremely concerned about this fact and over 70 per cent of the executives believed compliance and
integrity-related risks in emerging markets had increased over the last two years (Deloitte 2012). Their
most concerned topic is commercial bribery and kickback-payments. The survey participants report of the
need to more thoroughly analyze to gain real insight into the political and regulatory environment, as well
as its impact on to operation’s and financial issues. A special topic are related with corruption, bribery
and fraud, changeable regulatory situation as well as the implications of interaction with state-owned or
state-controlled entities. As the most promising emerging markets are the countries of CEE (Glapion,
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2012). However, the challenge remains because of the fact that emerging market countries are often found
in the upper level of the Transparency International Corruption Perceptions index, which ranks countries
based on how corrupt their public sector is perceived to be (van Dijk/Griek/Jensen, 2012). This implicates
a different investigation questions than those found in the traditional due diligence approach:
 impact of the regulatory changes on commercial success of the business,
 level of government interference or influence on the business,
 conflict of interests in the supply chain,
 steering board and their political career or exposure,
 appetite for bribery in this region/sector and the compliance issues with prevailing legislation and
the acquirers reputation.
More than a half of the survey participants’ companies reported conducting extremely or very
extensive due diligence before conducting M&As in emerging markets (Deloitte 2012). Furthermore, the
political uncertainty is named as important factor to be considered, as the politics are associated with
adverse changes in market policies, uncontrollable inflation and changing laws regarding labor and
resource utilization (Glapion, 2012). This implicates further investigation needs than those found in the
traditional view and these uncertainties demand a thorough approach to scenario planning and the
acquisition needs to be stress-tested for i.e. changes in political leadership, or the withdrawal of
government subsidies. Further issue is the weak discipline in documentation and creating reliable
financial statement. This implicates the that an thorough examination of a company’s financial and
operational state are difficult to perform and often only within a longer time period feasible.
Compared to the traditional view of conducting due diligence, the survey from the M&A practitioners
points to the fact that the due diligence approach needs to be suited to the dynamics of the markets.
Summarized, for example (Glapion, 2012):
 overlap between public and private sector requires combined commercial and reputational due
diligence in order to uncover potential implications of the interconnections,
 questionable information quality need to be supplemented with “on-the-ground” research,
 ambiguous regulatory environment or lack of legal framework require plan scenarios for
unforeseen events.
Source: Deloitte, 2009
Fig. 6. Top Five Risks in M&As in the emerging markets 2009
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In the survey from Kroll (2012) participants have pointed out that the most important issue to be
examined are the relationships. Especially the relationships in the supply chain, i.e. to customers and
suppliers, third party agents, are seen crucial in the examination (Deloitte 2012), but only 30 per cent of
the of the acquiring companies do really conduct due diligence on this matter. Also important relationship
are the ties to the political community. The concerns about transparency are widespread as target
company’s in emerging markets lack transparency in sense of corporate governance. Thus, considering
studying all stakeholders of the target and internal controls must be tested to a greater extent in order to
mitigate risk and/or fraud (Glapion, 2012).
Deloitte study proved the level of due diligence when conducting mergers and acquisitions in
emerging markets and found out that due diligence into specific risks is often not extensive. Despite the
fact that bribery of government officials and commercial bribery or kickbacks were ranked as the top
risks, only little more than a half of executives said their company conducts an extremely assessment of
those issues when considering M&As. The typical risks in M&As in the emerging markets, regionally
focused on the Central and Eastern European market, show the currency and financing concerns as well
as worries about political stability as the top five risks as shown in Figure 6.
Only about the half of the executives conducts an extensive assessment during due diligence of
bribery, kickbacks and other violations of economic and trade sanctions. This risk assessment might be
challenging but the avoidance to do so when engaging with third parties in emerging markets leaves the
company vulnerable to significant reputational risks (Deloitte 2012).
A.T. Kearney Study
In the study of the A.T. Kearney points out that M&As involving companies from emerging markets
at different stages of economic development bear unique challenges for acquirers, and require “redesign
and expansion of their M&A skills” (Rothenbucher/Hoyningen-Huene, 2011). There are specific success
factors in terms of target selection, due diligence, closing and integration. I. e. the data and information
collection is weak and these markets lack transparency in relational aspects. Thus, the acquirer must
spend more time and money in assessing the risk profiles of target companies. Among the practitioners,
there also due diligence professionals who are still pinned to the traditional view of risk assessment. One
of the biggest legal M&A advising companies in the world, Clifford Chance points out in their
publication on cross-border M&As, that the due diligence process comprises of “thorough picture of
historic financial accounts and cash flows and challenge of the financial forecasting…” and “legal due
diligence as the most critical cornerstone in risk assessment of M&A valuation issues” (Layton, M., 2013).
Digesting the study results
Summing up, the surveys show a gap between due diligence scope in the practical and scientific
approach. The gap arises from historical experiences in the M&A, new risk potentials arising from the
regulatory field and from the political risks. Further aspect is the assessment of economic and political
framework of the host country and the probability of changes in that environment. As the political
institutions tend to be weak in emerging markets, and power often lies in the hands of an elite. thus, the
acquirer may face a changeable and unpredictable operating environment. All these aspects are intangible
and mostly difficult to measure but were named by the practitioners as unavoidable to assess in the preacquisition phase.
The reputational risk is also not a topic at all in the traditional view of due diligence (Morrison et
al., 2008). But in the newer literature about this topic we find research of reputational issues within
integrity due diligence that assesses critical integrity risks arising from money laundering, hidden
interests, conflict of interest or business relationships. By identifying such kind of risks which could
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negatively impact the overall evaluation, the acquirer can manage the risk and mitigate it’s overall
impact (Hanley-Giersch, 2011).
The level of due diligence is being impacted by variety of issues conducted during the acquisition
process. Harvey/Lusch (1995) categorize the issues in as time restrictions, cost constraints, and situational
factors. Under time restriction it is often the case that the effective examination of the target acquisition –
beyond the major financial, legal, tax and future sales projections – does not occur. An further aspect of
not performing an full scope due diligence are the cost constraints as it is been viewed as to expensive to
bring in experts in each functional area. Finally, situational factors for performing a limited due diligence
is most notably with cross-border acquisitions and hostile takeovers because the competitive nature of
bidding for a company has required or has not allowed full scope due diligence.
Conclusion
Due diligence is the cornerstone of successfully executing M&A transaction, either in developed or
emerging markets. When such a transaction is being contemplated, a whole new range of decisions must
be made that do not have a domestic or developed markets equivalent. At that point, the traditional, in the
literature mostly researched due diligence approach falls short as it concentrates largely on very tangible
risks i.e. as the financial, legal or operational issues. The traditional due diligence approach found in the
current literature shows partial insufficiency in covering the current necessary pre-acquisition needs of the
acquirer, as the risk profile of target company in emerging market differs from the target company in
developed markets, however, requires awareness of additional points.
As the considered surveys show, acquirer need to consider using consistent and scalable process for
assessing such typical risks across acquiring in the emerging markets. That means placing the same
importance to reputational due diligence as on legal, financial, operational, and other traditional due
diligence. The move to the next level of performing due diligence requires more enhancing than replacing
traditional due diligence activities. The due diligence scope will be longer but they will be forwardlooking and more post merger oriented. On the other side, the “new” risk fields are almost all nonquantifiable and the more they have been assessed, the more difficult is to determine the quantitative
impact. However, each M&A has own “personality” and thus, the applicability of the expanded due
diligence process may wary from one situation to the next. In phase of competitive bidding process there
is a lack of time to institute full blown due diligence proceedings. The same is applicable for small
volume M&As as an expanded due diligence is very costly.
According to the scientific matter, the transfer from the best practice to the scientific work seems to be
an area where a need for further scientific research exists. As it is often difficult to ensure the transfer
from the practical to theoretical knowledge and vice versa, an integrated approach is likely to develop
with a growing amount of experience in growing frequency of M&As in the emerging markets. An
important factor for proving the hypothesis is the input from experienced executives from acquirers and
their advisers in M&As in emerging markets. In brief, the nature and scope of the due diligence process
need to be examined in light of these new trends. This will help to ensure that the M&As deal intelligence
gets wider scope of the risk assessment methods and finally improve the success rates in M&As either in
developed or emerging markets.
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DEVELOPMENT OF LONG-TERM SAVINGS SYSTEM IN LATVIA
Svetlana Saksonova, University of Latvia, Latvia1;
Svetlana Orlova, University of Latvia, Latvia
Abstract. This paper documents that in Latvia long-term savings are not particularly
widespread both in the form of bank deposits as well as investment assets. Indirectly, this
contributed to the 2009 balance of payments crisis, because it encouraged overreliance on
foreign financing sources. Low levels of financial literacy may be one of the contributing
factors to the low level of long-term savings along with low levels of disposable income
and the demographic situation. The paper suggests some proposals and recommendations
to further facilitate the development of the system of long-term savings.
Key words: long-term savings, deposits, pension plan assets
JEL code: E21
Introduction
Savings and their dynamics are concepts of fundamental macroeconomic significance. In countries
with a sustainable market economy accumulated savings are invested and therefore become the driver of
economic growth. Sustainable economic growth further increases a country’s level of wealth, which
enables economic agents to save more, establishing a positive feedback loop. Furthermore, imbalances
between savings and investment levels in open economies are associated with current account deficits,
which played a definitive role in the run-up to the 2008-2009 crisis in Latvia. If investment levels exceed
the levels of saving, the gap is closed by foreign capital inflows, which can stop or reverse suddenly.
Historically, such reversals have had a negative effect on growth that goes beyond their direct effect on
investments (Edwards, 2004).
The link between the processes of saving and investment is established by financial markets. Financial
markets and relationships not only underpin the majority of economic transactions, but also aspire to a
leading role in the modern economy. Beck et. al. (2010) document that financial markets have generally
deepened over time measured by increases in market development indicators (especially in high income
countries) and became more globalized measured by the volume of cross-border transactions. The level of
development of financial markets is a key indicator of the social and economic development, while the
level of the financial literacy of the population determines whether the potential of financial market to
execute their man function of facilitating productive investment can be unlocked.
A high level of the financial literacy enables a person to manage his money savings more efficiently,
contributing to the formation of active saving and investment behaviour (Lusardi and Mitchell, 2011a).
All of this, in turn, facilitates financial market development and provides the basis for the growth in
prosperity of the population and of the country. A positive link between financial market development
and growth has been shown, for example, by Enisan and Olufisayo (2009), as well as Guiliano and RuizArranz (2009).
1
Corresponding author – e-mail address: [email protected], telephone: +37129653287
522
Svetlana Saksonova, Svetlana Orlova
The problem of promoting financial literacy and encouraging responsible saving by the population has
been highlighted by Lusardi and Mitchell (2011b), who show that financial illiteracy is widespread when
financial markets are well developed as in Germany, the Netherlands, Sweden, Japan, Italy, New Zealand,
and the United States, or when they are changing rapidly as in Russia. They also argue that financial
literacy is critical to retirement security.
Only a proper level of the financial literacy of the population leads to the rise in the standard of living
of citizens, development of economics and improvement of social welfare. A sufficiently high level of the
financial literacy facilitates the inflow of cash into the economy thereby strengthening its financial
stability. As globalization encourages faster and more uniform processes of economic development across
many emerging markets, the problems of improving financial literacy acquire particular relevance.
In this paper the authors document the trends in the development of long-term savings system in Latvia,
by highlighting the dynamics of its main forms – term bank deposits and pension plans. The authors propose
a theoretical framework for classifying savings based on different incentives to save and consider the
reasons for rising importance of financial literacy and how they apply to Latvia, as well as certain other
considerations, such as demographic trends. Finally, the authors conclude with recommendations on
improving financial literacy and the operation of the long-term saving system overall.
Long-Term Savings in Latvia
The long-term savings system in Latvia offers several venues for savers: long-term bank deposits,
contributions to pension funds, and life insurance being the primary ones. Immediately, certain
idiosyncratic circumstances become apparent.
Source: Authors’ calculations based on Financial Capital and Markets Commission data2.
Fig. 1. The term structure of deposits in the Latvian commercial banks in 2011-2012 (billions LVL)
For example, the share of deposits made by the population is comparatively small. According to the
respective national banks’ data, in 2012 total deposits of residents in the banking system amounted to around
37% of GDP, whereas in neighbouring Estonia they were around 60% of GDP. One possible explanation could
be that the average disposable income in Latvia is low relative to the EU average, and lower than in Estonia.
2
See http://www.fktk.lv/lv/statistika/kreditiestades/ceturksna_parskati/2013-02-07_banku_darbiba_latvija_20/
523
Recent evidence shows that low levels of disposable income can be especially damaging to the likelihood of
saving – having income below the household reference level decreases the likelihood of saving, while having
income above the household’s reference level does not have a significant effect on the likelihood of saving
(Fisher and Montalto, 2011). Another explanation could be the lack of saving habits.
The analysis of the Latvian banks data on long-term savings also shows that in the 3rd quarter of 2012
only 2% of the general savings fall to the share of long-term savings in the banks (deposits for a term
exceeding five years and more), long-term savings if compared to 2011 decreased by 68%. The
proportion of medium-term (1-5 years) and short-term savings (up to 1 year) has decreased as well by
34.2% and 6.2% respectively. The changes occurred not only in the term structure of deposits, but also
the level of deposits in the banking system has decreased by 4.48%.
The decrease in the amount of long-term savings in the form of bank deposits can be explained by
lowering of bank interest rates on fixed-term deposits and by the growing popularity of alternative
deposits in private pension schemes, which can be considered investment savings.
Having analyzed the trends shaped up in 2010-2012, one can conclude that decrease in the volumes of
bank long-term and short-term deposits was partially compensated by the growth of assets in private
pension schemes (Figure 2), which can be explained both by their average profitability (Table 1), and by a
possibility to get additional profitability through recovery of personal income tax from the contribution
amount not exceeding 10% of gross income.
In 2012 in Latvia there were 7 private pension schemes – 6 open and 1 closed pension scheme.
Source: Pensiju fondu apskats, No. 4, 2012, http://www.bankasoc.lv/lv/pdf/Apskats_2012_gads.pdf
Fig. 2. Pension plan assets in Latvian private pension schemes in 2010 - 2012 (million LVL)
In 2012 the pension plans in private pension schemes had a 142.4 million lats in assets, up 19%
compared to 2011.
Fig. 3. Number of members in Latvian private pension funds in 2010-2012, pers.
524
In general, in Latvia 207501 members participate in the third level of pension plans, or 17 percent of
the number of members of the 2nd level participants (Fig. 3). In 2012 the number of members increased by
4 percent, the average age of the members is 45 years, confirming that the members are of the active
working age.
Table 1
Average return of private pension plan as at 31.12.2012, in percentage terms
Balanced Plans
Average Return
1 year
2 years*
3 years*
5 years*
Since Inception
8.23%
3.29%
4.84%
4.08%
4.72%
Active Plans
1 year
2 years*
3 years*
5 years*
Since Inception
Average Return
9.19%
2.84%
4.59%
1.62%
4.88%
Average Return of All Plans
8.80%
3.02%
4.69%
2.62%
4.82%
* Average annualized return
The main advantages of these types of savings are that it is possible to change the amount and timing
of contributions easily. In addition, according to the current tax legislation contributions to the third pillar
of the pension system are tax deductible, allowing the saver to recover part of the income tax paid each
year. In addition, Table 1 shows that the profitability of these pension plans has been higher than the
average deposit interest rates, which can explain their rising popularity on account of declining popularity
of long-term deposits.
Another form of long-term saving is a form of life insurance, which simultaneously combines both the
life insurance function as well as accumulation of capital. Insurance becomes current with the first
contribution, which means that if the saver dies, the designated beneficiary will receive the full amount of
the insurance policy together with the accumulated premiums and income on those. Otherwise, the policy
will expire and the saver will receive all of the premiums paid, together with interest. Current tax
legislation makes contributions to these life insurance policies tax deductible as well.
Theoretical Classification of Savings
It is well-known that the presence of certain incentives or lack thereof contributes to the economic
agent’s decision on whether to save and, if yes, then to what extent. Based on the incentives for saving,
the following types of household savings can be distinguished:
 current savings – for the purchase of durable goods (typically in the form of bank deposits);
 contingency savings and savings for old age (often in the form of bank deposits);
 investment savings (including investment in private pension schemes).
Current savings are replenished regularly by diverting some of the income to that purpose. When the
income is used for current consumption purposes current savings are depleted. Such savings are usually
short-term and are accumulated in highly liquid forms, including physical cash.
Savings for the purchase of durable goods are built-up when the price of a planned purchase
exceeds the current income of a potential buyer. In order to make the purchase the consumer must
accumulate the necessary amount, unless he or she is willing to take a loan. In fact, the durable
525
goods itself may serve as collateral for a loan. Fernández-Villaverde and Krueger (2011) show that
in a model with interaction of consumer durables and endogenous borrowing constraints durables
accumulation is predicted early in life and higher consumption of nondurables and accumulation of
financial assets is predicted later in the life cycle. Accumulation of the said amount implies the delay
of consumption in time, whereas the longer delay the more time is required to accumulate the
amount necessary for the purchase.
Contingency savings and savings for old age are by nature long-term savings. The decision to spend
the funds saved in this category implies the occurrence of a special case: disease, disablement, old age
etc. Such savings might be less liquid until completion of the process of their accumulation.
Investment savings refer to a special type of savings, which is not simply deferred consumption. The
main objective of such funds is investment in assets that generate returns. The volume of such savings
depends upon the general living standards of the society and upon the level of income of individuals. The
majority of savings of this type is invested in different investment tools. The funds from which
investment savings are formed can be short-term and long-term.
The long-term savings manifest the source of financial assets on the capital markets or long-term
assets. The short-term savings come on the money market or commercial paper market. The degree of
liquidity of investment savings depends upon the liquidity and return on assets, in which the funds were
invested.
The level of savings can depend upon many factors, reflecting the presence of different social
and economic reasons of building-up thereof in different people, manifested as certain saving
motivations. These factors are considered by the family economics, as well as personal finance,
which refers to a special area of scientific study and cognition. Historically, it has been identified as
moral economics or humanitarian finance, where the defining role is played by a subjective factor,
i.e., human psychology. Humanitarian finance is a cross-disciplinary line formed at the junction of
economics, psychology, financial science and sociology. The problems, related to the household
finances and management thereof, have not been researched substantially by the Latvian financial
science. The savings initially stand for the result from the decision of households as regards the use
of monetary income, at the same time they represent one of the components of the economic
relationship system. For the society the availability of savings means development opportunities in
the future.
The Concept and Impact of Financial Literacy
Having reviewed the dynamics of long-term savings system in Latvia and the theoretical classification
of savings, one can now turn to the concept of financial literacy. The OECD offers the following
definition of financial literacy: “knowledge and understanding of financial concepts and risks, and the
skills, motivation and confidence to apply such knowledge and understanding in order to make effective
decisions across a range of financial contexts to improve the financial well-being of individuals and
society and to enable participation in economic life” (OECD, 2012).
Thus, one of the ways in which the impact of the low level of financial literacy can manifest itself, is
the lack of knowledge about financial services on offer, as well as the lack of trust in the offered financial
instruments for saving – universal life insurance and investment in private pension schemes. These
explanations may be as important in accounting for the dynamics previously described as the scarcity of
funds available for saving.
Economic agents may need incentives to save. The large levels of debt accumulated by variously both
private and public sectors in most of the advanced countries testify to lower incentives to save in those
countries and higher incentives to consume. In many countries there are incentives for building up
526
savings and there are mechanisms enabling to accumulate and efficiently apply savings in economic
activity. At the moment, the culture of savings in Latvia is in its incipient stage, and economic agents may
not have enough knowledge of the offered avenues for saving.
On the other hand, the development of lending industry and lighter terms of borrowing, driven by the
temporary influx of resources from abroad, resulted in the considerable widening of the circle of
consumers of credit products, as well as in the emergence of borrowers, incapable to evaluate objectively
their capacity to meet the assumed obligations. 3 In crisis situations this problem becomes aggravated and
occasionally requires interference of government institutions, with potentially high overall social costs.
Loans taken without due consideration and problems with their repayment, another possible manifestation
of low levels of financial literacy, adversely affect the disposition of the population to make savings or
exclude such possibility at all.
However, even economic agents free of debt may not necessarily concern themselves with building up
savings. The polling of one thousand individuals taken by the SEB bank in cooperation with the SKDS
Public Opinion Research Centre in 2012 showed that one person out of six saves up cash, while only one
out of ten has savings in a bank. A mere one percent of the respondents invest in securities or jewellery,
while four percent of respondents chose another type of accumulation of money or tangible resources.
Only three percent of the respondents invest in pension or insurance saving funds, while the
overwhelming majority (69 percent) declared that they did not have any savings at all. Thus,
approximately two – thirds of the country population does not have any savings for the future, for
education, for improvement of their living conditions. These facts support the notion that a more
sustainable long-term savings system needs incentives, which can, in part, be supplied by improvement in
financial literacy.
Demographics
Another area of concern for the sustainability of the long-term savings system is the demographic
situation. In Latvia one can observe a trend of reduction of employable population and of population in
general (Table 2).
Table 2
Latvian population and natural growth in 2011-2012
Population (at the beginning of the period), thousand
I
II
III
IV
V
VI
VII
VIII
IX
X
XI
XII
2011 2074.6 2072.3 2070.4 2066.8 2062.7 2059.3 2056.0 2052.9 2049.8 2047.9 2045.0 2043.4
2012 2041.8 2040.4 2038.7 2036.9 2035.4 2034.4 2033.6 2033.0 2032.4 2031.7 2030.6 2029.4
Population natural growth, pers.
I
II
III
IV
V
VI
VII
-982
VIII
IX
X
XI
XII
2011
-1179
-940
-990
-848
-531
-442
-523
-589
-856
-839
-996
2012
-1090 -1320 -1110
-800
-680
-490
-320
-280
-490
-830
-880
n/a
Source: http://www.csb.gov.lv/dati/iedzivotaju-skaits-un-dabiskas-kustibas-galvenie-raditaji-30070.html
3
This was matched by imperfections in asset management on the part of the banking system.
527
Reduction of employable population and the potential increase in the size of the shadow economy
increase the risk of poverty for people of the older generation and jeopardize the long-term viability of the
pension system, as well as the system of long-term savings. In addition, poor demographic prospects
mean that population is likely to become older and older generations as a rule tend to spend what was
saved previously rather than save themselves. Implementation of structural reforms in the field of
stimulation of savings and of the pension system can help to ease these trends and mitigate their adverse
economic affect.
The problem of ageing and reduction of population can weaken the creation of business environment
aimed at vigorous and long-term growth, sophisticated and realistic regional planning, support of
childbirth and realistic approach to the immigration policy. For mitigation of negative demographic trends
it is necessary to stimulate not only childbirth, repatriation of immigrants, skill-based migration, but also
increase in employment of population and rise in labour productivity.
Conclusion
This paper had considered the dynamics of the long-term saving system in Latvia, offered a
theoretical classification of savings based on the underlying incentives and suggested that one of the
reasons for the lack of sustainable domestic savings may lie in the low levels of financial literacy of
the population. Lack of financial literacy is by no means the problem unique to Latvia; high levels of
financial illiteracy have also been documented by Lusardi (2008) in the U.S. and Van Rooij et. al.
(2011) in the Netherlands. However, in Latvia the problem is complicated by poor demographics and
low level of population trust in the institutions in general. This makes the task of improv ing financial
literacy even more urgent.
Because low levels of financial literacy may be a concern, the government and the financial industry
should more actively facilitate encouragement of responsible financial behaviour and literacy of the
population. The financially literate part of the population, who respond to incentives such as higher
profitability of pension plans, will save more once the macroeconomic situation in the country is
improved. To that end the government must take steps to preserve macroeconomic stability and create a
tax environment that is conducive for saving and investment. Finally, the demographic trends highlighted
in the paper should be reversed by stimulating the return of migrant workers and adopting pro-natal
policies. This will result in growth of the number of economically active population, who will create more
long-term savings in the future.
Bibliography
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and over Time: The Updated Financial Development and Structure Database, The World Bank
Economic Review, 24 (1), pp. 77-92.
Edwards, S., 2004. Thirty Years of Current Account Imbalances, Current Account Reversals, and Sudden
Stops, IMF Staff Papers, 51.
Enisan, A. A., Olufisayo, A.O., 2009. Stock Market Development and Economic Growth, Evidence from
seven sub-Sahara African countries, Journal of Economics and Business, 61(2), pp. 162-171.
Fernández-Villaverde, J., Krueger, D., 2011. Consumption and Saving Over the Life Cycle: How
Important are Consumer Durables?, Macroeconomic Dynamics 15(5), pp. 725-770.
Fisher, P.J, Montalto, C.P., 2011. Loss Aversion and Saving Behaviour: Evidence from the 2007 U.S.
Survey of Consumer Finances, Journal of Family and Economic Issues 32 (1), pp. 4-14.
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Giuliano, P., and Ruiz-Arranz, M., 2009. Remittances, financial development and growth, Journal of
Development Economics, 90, pp. 144-152.
Lusardi, A., 2008. Household Saving Behaviour: The Role of Financial Literacy, Information, and
Financial Education Programs, NBER Working Paper 13824.
Lusardi, A., Mitchell, O. S., 2011a. Financial Literary and Planning: Implications for Retirement
Wellbeing, NBER Working Paper 17078.
Lusardi, A., Mitchell, O. S., 2011b. Financial literacy around the world: an overview”, Journal of Pension
Economics and Finance, 10(4), pp. 497-508.
OECD, 2012. PISA 2012 Assessment and Analytical Framework: Mathematics, Reading, Science,
Problem Solving and Financial Literacy.
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Journal of Financial Economics 101 (2), pp. 449-472.
529
DOES THE LEADER METHOD PRODUCE INNOVATION
IN RURAL TOURISM DEVELOPMENT?
Günter Salchner, University of Latvia, Latvia /
University of Applied Sciences Kufstein, Austria1
Abstract. At the beginning of the 1990ies the European Commission (EC)
introduced the Community Initiative (CI) LEADER (Liaison Entre Actions de
Développement de l’Économie Rurale). Linked to a specific method and equipped with
public funds LEADER should open up a laboratory for finding and testing new
solutions for development problems in rural areas. The added value of LEADER in
comparison to traditional regional and rural development instruments is often associated
with strengthening governance and innovation. However, in 2010 the European Court of
Auditors comes to the conclusion that LEADER produces innovation or interaction
between different sectors only to a very limited extent. Ambiguous and even
contradicting appraisals of LEADER raise questions on how to transfer the LEADER
method into effective practice and how to evaluate intended outcomes. Departing from
the basic proposition that the LEADER method, when properly applied, produces
innovation the paper aims to uncover empirical patterns of innovation. The empirical
analysis is based on the case study of an Austria LEADER territory covering six years
of programme implementation (2007-2012). The subject of analysis is less the single
projects but more strategic linkages of activities and interactions of the players
involved. Thereby the focus is on tourism as one of the major drivers for employment
and growth in rural areas. The main findings are that innovation in a rural tourism
context occurs in smaller steps, concerns rather traditional competences and need often
years to reach market entry. Municipalities and destination management organisations
play a dominant role in project implementation whereas deficits occur in the integration
of private businesses. This is particularly true for lagging areas. In stronger destinations
innovation is more pushed by private companies.
Keywords: regional governance, rural development, innovation, LEADER method, tourism development
JEL code: R11
Introduction
Taking into account the specific development challenges for rural areas the European Commission
(EC) launched at the beginning of the 1990ies the Community Initiative (CI) LEADER (Liaison Entre
Actions de Développement de l’Économie Rurale / links between actions of rural development).
1
Corresponding author – e-mail address: [email protected], telephone: +43 676 5926577
530
Günter Salchner
Connected to a specific method and equipped with public funds for projects LEADER should open up a
laboratory for building local capabilities and testing out new solutions for development problems in rural
areas (EC 2006). As programme evaluations indicate LEADER worked well in different situations and
types of rural areas. The methodological approach is particularly recognised as driver for innovation in
rural areas. However, in 2010 the European Court of Auditors comes to the conclusion that LEADER
produces innovation or interaction between different sectors only to a very limited extent (2010).
These contradicting appraisals result at least partly from a rather vague understanding of innovation in
rural development and an inappropriate evaluation approach. In their study on LEADER and innovation
Dargan and Shucksmith observed that local actors regarded their action indeed new but not innovative
due to an overrated conceptual understanding of innovation. In spite of its key position within the
LEADER method innovation was hardly discussed and conceptualised at local level (2008).
Programme evaluations focus primarily either on single projects or aggregated quantitative monitoring
data. Neither the summing up of projects, anyhow subjectively qualified as innovative, nor aggregated
monitoring data based on rather general indicators (e.g. number of jobs created, etc.) provide a consistent
picture of the innovative development of an areas as such.
1. Basic proposition and research aim
The paper at hand is an account of a qualitative study of the LEADER method in regard to innovation.
The basic proposition of the paper is that LEADER produces innovation in rural development in general
and in particular in tourism as one of the major drivers for employment and growth in rural areas.
Thereby innovation takes place in the form a chain of interlinked projects making up a development path.
The empirical database comprises more than 80 tourism-related projects implemented in an Austrian
LEADER territory in the period 2007 to 2012. Closely link to the basic proposition the paper address the
following questions: How can innovation get captured for a LEADER territory beyond single projects
and, in further consequence, which innovation patterns can be observed? What are favourable conditions
for an innovative development? To answer these questions the logic model of the innovation spiral is used
to uncover patterns in the context of LEADER implementation (European Observatory LEADER 1997).
This model is derived from a rich empirical basis dating back to a relatively early stage of LEADER
implementation. However, this model has so far not been applied in systematic evaluations. The results
should help LEADER actors in the design and implementation of development strategies as well as of
self-evaluation instruments.
In the following the LEADER approach is outlined and put into the context of background literature
on regional innovation systems. Next, the research method and the case study area are described.
2. The LEADER method
The basic idea of LEADER is grounded on seven key features that are (1) area based approach;
(2) bottom-up approach; (3) local private-public partnership; (4) multi-sectoral approach; (5) innovation;
(6) cooperation; and (7) and networking (EC 2006). These features should complement each other and
make up a holistic/consistent toolkit for rural development. The cooperative and integrative nature of
LEADER is often subsumed under the concept of governance.
The area based approach encourages local actors to define a common territory comprising more than one
rural municipality and at the same time safeguarding a critical mass in terms of human, financial and
economic resources. The territory should represent a rather small, homogenous and socially cohesive entity
that does not need to be equal to a pre-defined administrative unit. Based on an analysis of the territory’s
Günter Salchner
531
strengths and weaknesses, major needs and endogenous potentials a Local Development Strategy (LDS) has
to be elaborated. The strategy is to be implemented by projects supported by the European Agriculture Fund
for Rural Development (EAFRD) complemented by national funds of the Member States.
The second feature, the bottom-up approach, highlights the participative process of strategic planning
and decision making in terms of priorities to be pursued and actions to be chosen to deliver the strategy. The
involvement of local actors should comprise economic and social interest groups as well as representative
public and private institutions. The first two features become institutionalised by the third, the Local Action
Group (LAG), a private-public partnership model. The LAG forms a legal body that takes over the formal
responsibility of strategy elaboration and implementation. The decision making body in particular regarding
project selection must consist of private partners at a minimum of 50%. The LAG mostly runs an operating
unit, the LAG management, which has an important support function regarding animation of local actors,
project development and funding procedures. Before a LAG can work with LEADER funding it must
submit its LDS at the MA for approval and demonstrate beforehand its governance and management
capacity in terms of human and financial resources. Therefore the MA launches a tendering process at the
beginning of each programme period after the respective RDPs have been approved by the EC. The LAG
plays a very crucial role for a well-functioning LEADER process. It should bring together the relevant
groups and act as an open platform for their balancing interests. LDS must have a multi-sectoral and
integrative rational. That means that projects should be coordinated in the course of strategy implementation.
Thereby clusters of projects can make up strategic initiatives within one sector or forge links between related
sectors such as tourism and agriculture and so forth. LEADER is particularly recognised as driver for
innovative approaches to the development of rural areas. Innovation can concern new products and services,
new processes, new forms of organisation or the exploring of new markets. The networking feature aims in
particular at overcoming innovation barriers and the remoteness of many rural areas as such. It encourages
LAGs and other players involved in rural development to mutually exchange achievements, experiences and
know-how. Networking should not least lead to joint projects involving two or more LAGs. These
cooperation projects can have an inter-territorial (cooperating LAGs within one member state) or
transnational scope bringing together LAGs from different member states.
In the current programme period 2007-2013 the 25 Member States have until 2012 selected more than
2,300 LAGs. By then Romania and Bulgaria have not yet completed the tendering process. Since the
launch of LEADER in 1991 the number of LAGs has therefore increased ten-fold, the EU contribution
twelve-fold which underlines the importance LEADER gained in the last 20 years.
3. Literature review
A good deal of recent literature on innovation draws on the fundamental work of the Austrian
economist Joseph A. Schumpeter. In a general approach he defines innovation as a new combination of
factors (1997). In a broader understanding innovation comprises also imitations of an innovation firstly
introduced elsewhere. In regard to economic impacts Fritsch recommends to use a broader definition
(2012). Weak forms of innovation such as smaller product improvements or even imitations can have
considerable effects on economic success.
Such a broader approach is particularly useful when innovation is discussed in the context of rural
development. Taking into account the uniqueness of rural areas the Rural Observatory LEADER regards
innovation as an “initiative of the local actors who bring a new solution to the specific challenges facing
the area” (1997).
In a very simple approach the innovation process is described as a linear model with the following
consecutive phases: research, development, production, marketing/diffusion, application. However, in
reality innovation follows a much more dynamic, complex and often unpredictable process. All phases
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Günter Salchner
can be a starting point, some are leapfrogged others have to be repeated. Research can be irrelevant at all
or play an important role in each phase. The outcome can be intended new solutions but also unexpected
or even – and quiet often – useless or of no result at all. In any case the innovation process goes always
along with a considerable economic risk (Fritsch 2012).
The innovation process is to a large part characterized by a high degree of cooperation and work
sharing. Many actors such as private businesses, R&D institutions, etc. contribute in one or the other way
to new solutions. A collective learning process consequently relies on the flow of knowledge among all
the actors involved. Knowledge can be of codified or of tacit nature whereas the latter is linked to
individuals. The exchange of tacit knowledge consequently requires face-to-face contacts.
The literature on regional innovation capacity refers mainly to five rather complementing than
contradictory theories that are regional innovation systems, network theory, innovative milieu, concept of
learning regions and the triple-helix-approach. All of these theories come more or less to similar
conclusions. Thereafter cooperation among regional actors in the course of the innovation process is an
important facilitator. Internal networks are not per se a guarantor for innovation. Such cooperative
settings can just as well be responsible for conserving traditional power relations (Fritsch 2012).
Much of these theoretical considerations are incorporated in the LEADER method. Already in the
second programme period (1994-1999) the European Observatory LEADER translated the innovation
feature into practical terms. Based on 80 case studies the Observatory outlined a general framework for
innovation in rural development (1997). Referring to the 80 case studies the Observatory conceptualised
an idealistic innovation process typical for LEADER projects. The first stage comprises the clarifying the
context. Very often a new local leader, that can be an individual or a small group, enters the stage and
reads the context with new eyes and spots new development opportunities. These initiators must be
willing to share their ideas with other actors concerned by the issue and so raise collective awareness. A
new idea gets perceived from different angles and becomes consolidated. In a next step a group of
initiators emerges whereby the start is much easier when a group is already set up and used to work
together. The process from an idea to a project goes often along with a transformation of an initiators’
group into project promoters often with a higher number of people or institutions involved. A project is
finally held by an organisational structure. Implementation rests on close cooperation of involved actors
that act from conviction of a project’s advantages. The implementation process is often facilitated by
further analysis of potential markets and risks as well as of further financial and human resources needed.
Finally, a project’s viability in form of new products or services relies much on a permanent adaptation to
market changes and a further professional management.
This innovation pattern shows a strong emphasis on social processes and particularly on cooperation. The
cooperation feature according to the LEADER method, however, aims for inter-regional or transnational
cooperation projects involving different LAGs. Given the collective nature of innovation in general and in a
regional context in particular such a cooperation approach falls simply short and distracts from the actual
processes within a LEADER territory. Anyway, also the concept “project” must be conceptualised wider than a
single EU funded LEADER project. The complex social processes cannot be captured by single projects.
Innovative initiatives comprise often of several interlinked projects, some of them supported by LEADER,
others not. Hence evaluations based on single projects seem not to be an appropriate approach.
Besides this analytical view on social dimensions the Observatory also proposes a tool to capture the
result of innovation. Thereby three different types of innovative actions are distinguished. First,
coordinating actions help to animate local actors and mobilise resources and potentials. Such actions
include area analyses, participation and strategy processes or measures for strengthening regional identity.
Second, innovative structuring actions concentrate on improving and developing infrastructure and
immaterial assets of an area. Third innovative consolidating actions comprise economic activities. They
simply make use of the potentials created by coordinating and structuring activities.
These tree types of innovative actions are interlinked and complement each other. Their consistent
combination constitutes a step forward along a so called development spiral. The innovation spiral shows
Günter Salchner
533
some analogies to evolutionary concepts. According to Beinhocker the creation of wealth follows a
simple three step logic (2007): differentiation, selection and amplification. Thus, evolution is the basic
formula for innovation. Trial and error produces constantly new business concepts. Markets constitute
selection criteria for these new concepts. If they find acceptance by markets they will survive and
consequently amplify. The innovation spiral follows a similar logic though on a smaller scale. It starts
with coordinating actions that corresponds to differentiation processes. If new ideas that emerge from
coordinating actions find enough followers they become structured in terms of new or improved material
and immaterial assets. So, this stage implies also a selection of ideas. Consolidating actions, then, have an
amplification impact by stimulating further economic activities.
A lack of creative milieu, risk avoidance attitudes and concentration of power in the hands of
government actors turned out to be major hindrances for innovation. In many areas there was simply no
tradition of cooperation. Actors worked atomistically rather than collectively. Anyway, in the extent to
which LEADER gained importance in terms of budget Dargan and Shucksmith observed a reassertion of
top-down control over LAGs. In the last years the critique about a curtailed autonomy of LAGs increased. In
its report facilitating the national dialog on strategic RDP orientation for 2014-2020 the Austrian MA comes
to the conclusion that in 2007-2013 integrated regional development was in fact not of high priority.
Referring to the LEADER implementation in Germany Schroedter criticises the dominating role of
programme authorities at the expenses of a real bottom-up approach and civil society participation. Lacking
a real tradition of private-public cooperation political and administrative decision makers are apparently not
willing to share responsibilities with private actors in the sense of regional governance (Schroedter 2009).
However, certain top-down dominance seems not to be a completely new phenomenon. In his study
on EU multi-level governance reflecting the CI LEADER+ (period 2000-2006) in Finland and Germany
Kull sums up: “managing authorities were the most powerful actors in LEADER+” (2009).
However, the decision making at LAG level seems to be not only heavily influenced by programme
authorities, also the composition of boards reflects often an area’s traditional power relations. A survey in
Denmark on 55 LAGs revealed that board members are mostly well-educated older men who hold many
other posts in society (Thusen 2010). If steering groups are primarily composed of actors representing the
traditional power relations innovation aspirations will rather have the quality of lip services (Hahne
2002). So, deficiencies in regard to innovation can not only be reduced to external factors. In the context
of the Austrian midterm evaluation of LEADER in the period 2007-2013 almost two thirds of Austrian
LAGs assessed the local actors’ readiness for innovation rather low.
4. Methods
The purpose of the case study is to show how the LEADER approach produces innovation in rural
tourism development. So, at first it is necessary to define rural tourism. There is no general definition the
study can relate to (for a critical discussion of definitions see Rein and Schuler 2012). However,
LEADER territories, designated according to the Austrian selection criteria, are considered as
representative for rural areas as such. In further consequence rural tourism is defined as industry-related
economic activities within the LEADER territory. Thereby the conceptual understanding goes far beyond
farm holidays. Of course, rural tourism is not limited to LEADER activities. In fact LEADER might
concern only a certain aspect of tourism. The tourism system as such, anyway, constitutes an important
scope of reference for the discussion of empirical patterns.
Second, the innovation phenomenon has to be transferred into operational terms. The most visible
expressions of tourism development in the context of LEADER are tourism-related projects. So they form
the basic elements of analysis. The period of reference is 2007-2012. The main attention is drawn to their
specific nature, content and strategic linkages to other projects. Projects are defined as tourism-related
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Günter Salchner
when their ultimate objective is to attract tourists, either directly via new or improved infrastructure, new
products or marketing or indirectly via strategy processes, education and training.
In order to uncover innovation patterns in the course of LDS implementation the case study draws on
the logic model of the so called innovation spiral outlined in the European Observatory Dossier on
Innovation and Rural development (1997). Thereafter three different kinds of innovative actions are
distinguished. They are interlinked, complement each other and make up an evolutionary path of
innovation expressed as a spiral. The technique of logic models is frequently used for case study
programme evaluations (Yin 2009).
As described in the previous chapter, coordinating actions come at beginning of an innovative
initiative because of their animating and mobilising effect. The next step on the innovation spiral
constitutes structuring actions. They address the improvement of material and immaterial assets of an
area. Coordinating and structuring actions both form a fruitful ground for further economic activities - the
consolidating actions embedded in an entrepreneurial or institutional context. Hence, the logic model
implies an ideal-typical chain of events. Coordinating actions become the independent variable for the
next stage, the structuring actions. These in turn cause consolidating actions. However, in reality
innovation emerges not necessarily in a linear specific cause-effect-cause-effect pattern (Fritsch 2012). It
can in fact evolve from any point on the spiral.
In order to increase the analytical power of the logic model the three types of innovative actions are
further subdivided and specified. Broad coordinating actions comprise participation processes, strategic
analyses and evaluations, feasibility studies, and so forth. More targeted coordinating actions focus in
particular on education and training. Structuring actions can be developing and improving either tangible
assets such as public infrastructure or immaterial assets such as new brands, quality management
processes, etc. Consolidating actions subsume economic activities directly on markets. They are divided
into projects of private actors or at least those activities involving private businesses on the one side and
projects primarily implemented by public institutions on the other side.
In a first step all tourism-related projects are graded according to their content leading to thematic
clusters such as food and drink, nature experience, hiking, rock climbing and so forth. Cross-cutting
destination marketing projects, strategy processes or general education and training activities are
subsumed under the headline “basics”. Within the thematic clusters projects are further analysed in regard
to their direct or indirect connections.
In the next step projects are assigned to one of the different types of innovative actions. The resulting
empirical patterns are in a third step compared to the theoretical model of the innovation spiral. In order
to see by whom the initiatives are carried out, projects are also analysed in regard to the type of project
holders. Thereby the following types are identified: municipalities, destination management organisations
(DMOs), the LAG itself, agricultural associations (AA, basically community owners of forest land), the
Nature Park association (NP), non-profit organisations (NPO) and companies.
A methodological focus on projects funded by LEADER or other OPs to uncover innovation patterns
is not free from limitations. Not any innovative action occurs in the form of projects captured by the
monitoring. Anyway, financial support from LEADER and other OPs is available in principle for all types
of innovative actions and all types of beneficiaries (except big corporations). So, projects are indeed a
good starting point to analyse innovation patterns.
The case study is built on a particular LEADER territory. The case selection is made according to the
following criteria: First the LAG should effectively work according to the LEADER method but need not be
limited to LEADER funding in LDS implementation. Hence, the LAG corresponds more to a consistent
regional management organisation working across the various funding programmes. In other words it must
not be caught into a primarily agricultural interpretation of rural development. Second, the LAG should have
close connections to tourism actors and a large database in regard to tourism-related projects within the
period of reference. Furthermore a good deal of background information on internal structures and
Günter Salchner
535
relationships must be available. Finally the vast abundance of any easy access to solid project data and
background information made the author to choose the LAG he has been working for more than 11 years.
The chosen LEADER territory is located in the Austria Alps. It has an area of about 1,200 km² and
consists of 37 municipalities and four tourism destinations (D1-4) constituted according to the provincial
tourism law. The overall tourism intensity is 100 overnight stays per inhabitant. Yielding a little more
than 3.2 Mio overnight stays per year, the industry’s economic importance is very high. In some parts
even a tendency towards a tourism-based economic mono-structure can be observed (D1 and partly D4).
Two of the four destinations reach 1 Mio (D1) and 1.3 Mio (D4) overnight stays per year. In
economic terms D2 is the weakest area but also there tourism is the most important industry with about
550,000 overnight stays per year. The economy in D3, however, is much more diversified. Anyway, the
hospitality sector accounts for 350,000 overnight stays per year.
In 2008 D2 and D3 began to join forces and set up a common strategy based on a Nature Park
connecting them in close cooperation with the Nature Park association of which they are also members.
Two years later they started to operate on the market at least partly under a common umbrella brand. The
cooperative approach should help to reach higher cost efficiency and brand recognition. However, all four
DMOs cooperate traditionally also with partners in neighbouring areas in terms of product development
and marketing communication.
All in all the integration of tourism in LAG activities both in terms of involved actors and number of
projects is very strong. Representatives of all four DMOs are members of the LAG board and of the
underlying Regional Development Organisation (RDO). They have all been involved in LDS elaboration
and meet regularly in a standing working group coordinated by the LAG management. The DMOs take
frequently over the role of project holders and are also engaged in joint projects. The destination
managers actively exchange know-how and form a powerful link between the LAG and other DMO
stakeholders (hotel owners, etc.).
Findings from data collected and analysed
All in all 87 tourism-related projects were recorded and assigned to one of the four destinations or to the
Nature Park tourism marketing alliance (NP) of D2 and D3. All projects are listed in the appendix part. The
by far highest number of projects falls on these two weaker destinations. 34 projects concern their common
effort to establish Nature Park tourism in cooperation with the Nature Park association. Another 16 projects
were implemented in this area. This high activity level can be traced back to an additional development
programme for the Nature Park area and a common strategy process involving the relevant stakeholders.
This process was initiated and coordinated by the LAG management. However, tourism actors make
intensively use of funding opportunities and try to catch up to the stronger destinations. The strongest
destination (D2), in contrast, shows the lowest number of projects. Here a good deal of tourism development
comes from bigger companies (cable car companies and bigger 4*/5* hotels). These companies are either
not eligible beneficiaries for funding or are not eager to pay the prize of EU funding bureaucracy. The DMO
concentrates primarily on destination marketing and less on product development.
Projects implemented jointly by all four Ds are grouped under the headline common activities (CA).
All in all project holders are predominantly DMOs (34 projects) and municipalities (24 projects) which
corresponds to the dominant nature of projects that is either development or improvement of public
infrastructure or destination marketing. This observation confirms that DMOs and municipalities are in
general very important actors within a tourism destination. Furthermore, they are also the preferred
addressees of LEADER and other OPs. However, private businesses take over the role of project holders
only to a very limited extent. Hotel and restaurant owners are indeed involved in some project activities
(education and training, strategy elaboration, marketing campaigns) but they hardly take over a leadership
536
Günter Salchner
role. In contrast to LAGs in other Austrian provinces, in the case study LAG projects concerning single
corporate investments are the absolute exception. The LAG itself conducts projects primarily in the field
of education and training as well as for pioneer initiatives involving several actors. For the latter the LAG
takes over the role of the neutral focal partner. Other non-profit organisations including the Nature Park
association run tourism-related attractions. Over the years they have become experienced project holders,
in other words members of the so called “project class”. In the case study agricultural associations (AA)
are basically owners of forest land. They play the part of project holders for constructing of forest roads.
Their primary interest is not necessarily tourism development. In order to get public funding in tourism
contexts they have to open their new roads for cycling/mountain biking or hiking. Such mixed uses of
roads are often the only way to foster tourism infrastructure on private land.
Table 1
Type of project holders
Type of project holders
Destination management organisation
Municipality
Non-profit organisation
LAG
Nature Park association
Agricultural Association
Companies
Sum
Dest. 1
10
10
1
21
Dest. 2
1
3
2
6
Dest. 3
2
1
7
10
Dest. 4
5
1
2
8
Nat. Park Com. Act.
13
3
10
3
2
5
4
2
34
8
Sum
34
24
12
7
4
3
3
87
Source: author’s calculations based on 87 tourism-related projects in the case study area
The vast majority of all 87 projects fall in the categories of innovative structuring actions/material assets
(49 projects), which is basically public infrastructure, and consolidating innovative actions involving only
public actors such as DMOs (15 projects). In a narrow and isolated perspective many projects cannot be
qualified as a great novelty as such. Their innovativeness results more from the context. A project for
developing or improving a hiking or cycling path section can either contribute to a new product (e.g. long
distance hiking trail) or just help to keep the status quo. In the first case projects show anyway an innovation
potential in the first instance. Innovative rural tourism development can be made out if these projects group
along a spiral preferably covering all types of innovative actions. And indeed, several such innovation
spirals can be identified. The most prominent ones concern Nature Park tourism (see Figure 1).
About 60% of all projects focus on summer tourism (hiking, cycling, nature experience, rock climbing,
family tourism and bathing). Thereby hiking is the most important and, at the same time, most traditional
development strand. However, as the project patterns reveal for Nature Park tourism hiking projects make
up a distinct innovation spiral in the context of a new long distance hiking trail. Similar patterns can be
observed in cycling tourism whereby here also a link to food and drink occurs (cycling event in combination
with a local food festival). Still in an early stage is hiking tourism in close connection with nature
experience, a new product line derived from the long distance hiking trail. But also here an innovation spiral
little by little evolves. Further innovative developments emerge in nature experience tourism as well as in
herbs products. The strategic foundation for all of these activities stems from a cross-cutting project
categorised under the headline “basics” (broad coordinating innovative action).
Under the strategic umbrella Nature Park tourism a good deal of social capital has formed involving
not only the Nature Park association, municipalities and the DMOs but also owners of restaurants, hotels
and guesthouses, farm women, nature guides and other stakeholders.
The two stronger Ds concentrated to a large part on improvements of mature products. Thereby no
innovation spiral emerged. However, their innovative actions have a focus on cross-border destination
marketing campaigns including new media in cooperation with German partners.
Günter Salchner
537
CAs comprise broad as well as targeted coordinating actions. The first concerns strategy and
evaluation processes in various directions and consequently aim at propelling innovative initiatives. The
second focus basically on education and training for DMO employees. In both cases the LAG plays the
formal part of project holder but implements the actions in close cooperation with the four DMOs. Within
the group of CAs also a consistent innovation spiral in rock climbing tourism can be identified. The
initiative was launched by a neighbouring LAG and spread via the LAG managers to other LEADER
territories. Finally it became a province-wide campaign. The process started with capacity building and
training of climbing actors concerning safety rules and development of climbing routes. After that a
common web-based marketing platform was set up. In several territories climbing infrastructure was
improved or newly developed. In the course of this initiative a good deal of social capital was formed
involving DMOs, mountaineering association, province-wide tourism board and private companies. The
coordinating and networking was done by LAG managers.
Only with nature experience and barrier-free tourism completely new sectors emerged. Both are still in
an early stage and have to be further developed in the coming years. In D3 culture tourism would reveal an
innovation spiral if the period of reference would start in 2001. Until 2006 several projects of all types of
innovative actions contributed to the creation of a new attraction based on the unique cultural heritage of an
ensemble of old fortresses. At the beginning of the recent period 2007-2013 this new attraction was already
introduced on the market. The analysed projects aimed primarily at further improvements.
Table 2
Types of innovative actions
Type of innovative actions
Combinations
Consolidating 2/private and public
Consolidating actions 1/public
Structuring actions 2/immaterial
Structuring actions 1/material
Coordinating actions 2/targeted
Coordinating actions 1/broad
Sum
Dest. 1
Dest. 2
Dest. 3
1
Dest. 4
1
8
Nat. Park
Com. Act.
1
4
3
4
19
2
1
34
2
3
12
5
6
4
1
21
1
6
3
10
8
1
3
1
1
8
Sum
5
4
15
4
49
3
7
87
Table 3
Thematic clusters
Thematic clusters
Hiking
Basics
Cycling
Cultural tourism
Nature experience
Rock climbing
Food & drink
Cross country skiing
Family tourism
Bathing
Barrier-free tourism
Sum
Dest. 1
7
4
3
4
2
Dest. 2
2
1
Dest. 3
1
2
Dest. 4
1
3
2
Nat. Park
10
4
7
Com. Act.
2
7
8
5
5
1
2
2
1
21
6
10
8
34
1
8
Sum
21
15
12
12
10
5
5
3
2
1
1
87
538
Günter Salchner
Source: author’s own interpretation
Fig. 1. Innovation pattern for Nature Park Tourism
Günter Salchner
539
Conclusion and suggestions
Since the beginning of the 1990ies an increasing number of rural areas has established rural
development structures according to the LEADER approach. But after more than 20 years of application
the various evaluations still convey rather ambiguous and even contradicting appraisals. The background
literature on regional innovation systems provides good arguments to discern that the LEADER method
as such is a reasonable development approach. In further consequence its effectiveness would be
primarily a matter of an appropriate transfer into practice. Therefor the paper at hand comes up with the
following conclusions and suggestions.
1. LEADER indeed produces innovation. Some consistent development paths could be identified that
correspond very well to the innovation spiral model. However, LEADER also allows for single
projects that rather contribute to keep the status quo than to trigger new initiatives.
2. Weaker destinations seem to make better use of funding opportunities. Thereby DMOs and
municipalities and partly non-profit organisations take over the role of project holders. The LAG
management acts as an initiator and coordinator. Micro-businesses are little by little joining
innovative initiatives but leave the leading part to existing institutions. However, also the weaker
destinations also have a long tradition and well established competences in tourism.
3. Innovation spirals in rural tourism development emerge primarily from traditional competences.
They constitute often new interpretations or combinations of resources. Innovation has more the
nature of smaller incremental steps than of a revolutionary break-through.
4. Innovative initiatives take often years to enter the market. They grow more in a trial and error
approach than by detailed strategic plans. Innovation spirals are a reasonable tool to make such
development paths visible and allow identifying gaps. Anyway, the LAG management can thereby
play an important initiator’s and coordinator’s role. The dynamics of innovations are not bound to
certain OPs. Hence, in order to evaluate the performance of a LAG the evaluation timeframe must
not be limited to programme periods.
5. Most projects can be assigned to structuring or consolidation actions carried out by public institutions.
More comprehensive activities including for instance education and training, marketing and
infrastructure development have been eligible or manageable more or less in those programmes funded
only with EU sources (e.g. Interreg). Wherever national sources have to complement EU funds the
sectoral and administrative assignments have made cross-cutting projects much more difficult. Projects
with a narrower direction make it, at first sight, easier to distinguish spiral patterns. However, if multiple
activities can be included in one bigger project the bureaucratic work load (approval and accounting
process) is smaller. The additionality principle regarding EU and national sources is a basic element of
LEADER. Hence, it is suggested to cut the national sources from sectoral assignments and so make
innovative cross-sector and cross-cutting projects easier to manage.
6. There is much scepticism that strategic planning based on a constructivist and technocratic paradigm
works in practice (Malik 2008). Furthermore, the complexity of social processes can make detailed
plans swiftly obsolete. The complexity facing single organisations gets multiplied for regions with
various and manifold actors to be involved in networks and collaborative settings. An in-depth
discussion of strategic management of regions would anyway exceed the scope of the study at hand
(for a critical appraisal concerning this matter see in Rey 1999, Salchner 2010, etc.). Furthermore,
innovation in particular in such complex social systems is far from being a predictable phenomenon.
It is suggested that LDS should less include details plans, number of projects and indicative budgets
but constitute more a strategic corridor within innovative initiatives can grow.
7. According to the Europe 2020 strategy innovation will be a revisited issue in regional and rural
development. A collaborative development of an innovation model involving programme
authorities at provincial and national level and practitioners at grass root level, namely LAG
managers, would be highly beneficial. Therefore the paper in hand could be a good starting point.
540
Günter Salchner
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entwicklung/laendliche-Entwicklung-2014-2020/dialogtag0703.html [Accessed 23 March 2013]
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ländlichen Raum, pp. 3-10, Wiesbaden.
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Günter Salchner
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Appendix
Table 4
Project list of common activities
Description
Code
Theme
Type
Fund
Holder
Education and training campaign
ba1
basics
coord.1
LEADER
LAG
Education and training campaign
ba2
basics
coord.2
LEADER
LAG
Cross border identification barrier-free infrastructure
bf1
barrier-free
coord1/struct.2
Interreg
LAG
Development of climbing tourism
cl1
rock climbing
coord.2/strcut.2
LEADER
LAG
Marketing campaign climbing tourism
cl2
rock climbing
cons.1
LEADER
LAG
Development of rock climbing infrastructure
cl3
rock climbing
struct.1
national
DMO
cl4
rock climbing
struct.1
LEADER
DMO
cl5
rock climbing
struct.1
LEADER
DMO
Table 5
Project list of destination 1
Description
Code
Theme
Type
Fund
Holder
Cross border quality campaign
ba1
basics
cons.1
Interreg
DMO
Cross border foreign markets campaign
ba2
basics
cons.1
Interreg
DMO
Cross border distribution campaign
ba3
basics
cons.1
Interreg
DMO
Cross border social media campaign
ba4
basics
cons.1
Interreg
DMO
Game watching platform
ne1
nature experience
struct.1
LEADER
DMO
Nature film festival
ne2
nature experience
cons.1
LEADER
DMO
Quality improvement/cycle path
cy1
cycling
struct.1
LEADER
mun.
Cycle path underpass
cy1
cycling
struct.1
LEADER
mun.
Marketing campaign/cycling holidays
cy3*
cycling
cons.1
LEADER
DMO
Quality improvement/hiking trail
hi1
hiking
struct.1
LEADER
mun.
hi2
hiking
struct.1
LEADER
mun.
hi3
hiking
struct.1
LEADER
mun.
hi4
hiking
struct.1
LEADER
mun.
hi5
hiking
struct.1
LEADER
mun.
Thematic hiking trail
hi6
hiking
struct.1
national
comp.
Marketing for pilgrim trail
hi7
hiking
cons.1
Interreg
DMO
Linking of cross border cross country ski trail
cc1
cross country ski
struct.1
Interreg
DMO
Architectural competition for local museum
cu1
culture
coord.1
LEADER
mun.
Construction of local museum building
cu2
culture
struct.1
LEADER
mun.
Installation of local museum exhibition
cu3
culture
struct.1
LEADER
mun.
Marketing campaign for cultural tourism
cu4*
culture
cons.1
LEADER
DMO
542
Günter Salchner
Table 6
Description
Code
Theme
Type
Fund
Holder
Improvement of open air theatre
cu1
culture
struct.1
RegCom
NPO
Cross border development study/high altitude trails
hi1
hiking
coord.1
Interreg
NPO
Bridge construction/hiking trail
hi2
hiking
struct.1
SFP
mun.
Development of natural public bath
bth1
bathing
struct.1
SFP
mun.
Cross-country circuit construction
cc1
cross-country ski
struct.1
SFP
mun.
Nordic slider installation/road crossing device
cc2
cross-country ski
struct.1
SFP
DMO
Table 7
Description
Code
Theme
Type
Fund
Holder
Introduction of cross border electronic guest card
ba1
basics
struct.2/cons.1
Interreg
DMO
Cross border marketing for free rail tickets in winter
ba2*
basics
cons.1
Interreg
DMO
Renovation of castle ruin/hiking trail
cu1
culture
struct.1
LEADER
NPO
cu2
culture
struct.1
LEADER
NPO
cu3
culture
struct.1
LEADER
NPO
Installation of historical event hall
cu4
culture
struct.1
LEADER
NPO
Installation of stagecraft in historical event arena
cu5
culture
struct.1
national
NPO
Cross border marketing for medieval events
cu6
culture
cons.1
Interreg
NPO
Marketing campaign for cultural tourism
cu7*
culture
cons.1
LEADER
NPO
Construction of car park for hiking area
hi1
hiking
struct.1
national
mun.
Table 8
Description
Code
Theme
Type
Fund
Holder
Cross border marketing for free rail tickets in winter
ba1*
basics
cons.1
Interreg
DMO
Cross border holiday magazine
ba2
basics
cons.1
Interreg
DMO
Cross border marketing campaign
ba3
basics
struct.2/cons.1
Interreg
DMO
Cycle path link construction/long distance route
cy1
cycling
struct.1
LEADER
AA
cy2*
cycling
cons.1
LEADER
DMO
Rafting and Kneipp cure installation
fa1
family
struct.1
LEADER
comp.
Game and animal park enlargement
fa2
family
struct.1
LEADER
comp.
Construction of thematic hiking circuit
hi1
hiking
struct.1
LEADER
DMO
Günter Salchner
543
Table 9
Project list of Nature park area (destinations 2 and 3)
Description
Code
Theme
Type
Fund
Holder
Strategy development nature park tourism
ba1
basics
coord.1
national
DMO
Brand development/marketing nature park tourism
ba2
basics
struct.2/cons.1
national
DMO
Nature park tourism academy/management training
ba3
basics
coord.2
SFP
LAG
Digital bus timetable display devices
ba4
basics
struct.1
SFP
DMO
Cycling event with delicacies festival
fd1
food/drink
cons.2
Interreg
DMO
Education in herbs pedagogics
fd2
food/drink
coord.2
SFP
LAG
Development of herbs products
fd3
food/drink
struc.2
SFP
NP
Lamb meat campaign
fd4
food/drink
cons.2
SFP
DMO
Valuables and delicacies marketing
fd5
food/drink
cons.2
SFP
DMO
Bird watching path construction
ne1
nature experience
struct.1
SFP
NP
Parking area for bird watching path
ne2
nature experience
struct.1
LEADER
mun.
Mountain hay museum construction
ne3
nature experience
struct.1
SFP
DMO
Nature exhibition, platform, hikes and brochure
ne4
nature experience
struct.1
Interreg
NPO
Exhibition building
ne5
nature experience
struct.1
SFP
NPO
Canopy path construction at alluvial forest
ne6
nature experience
struct.1
Interreg
NPO
Marketing cooperation of nature parks
ne7
nature experience
cons.1
SFP
NP
Marketing cooperation/nature park guesthouses
ne8
nature experience
cons.2
LEADER
NP
Brochure for sculpture trail
hi1
hiking
cons.1
SFP
DMO
Hiking trail construction/tributary valley
hi2
hiking
struct.1
SFP
mun.
Bridge construction/river circuit trail
hi3
hiking
struct.1
SFP
mun.
Trail link construction/river circuit trail
hi4
hiking
struct.1
SFP
AA
Trail link construction/river circuit trail
hi5
hiking
struct.1
SFP
AA
Trail link construction/ long distance trail
hi6
hiking
struct.1
SFP
mun.
Suspension bridge construction/long distance trail
hi7
hiking
struct.1
RegCom
mun.
Marketing concept/long distance trail
hi8
hiking
struct.2
LEADER
DMO
Product develop., market entry/long distance trail
hi9
hiking
struct.2
Interreg
DMO
Quality certification model/long distance trail
hi10
hiking
struct.2
Interreg
DMO
Rest places construction/cycle path
cy1
cycling
struct.1
national
DMO
cy2
cycling
struct.1
LEADER
mun.
cy3
cycling
struct.1
LEADER
mun.
cy4
cycling
struct.1
LEADER
mun.
cy5
cycling
struct.1
LEADER
mun.
cy6
cycling
struct.1
LEADER
mun.
cy7*
cycling
cons.1
LEADER
DMO
544
Günter Salchner
ORGANIZATION THEORY UNDER THE CONSIDERATION
OF ASPECTS OF SOCIAL CAPITAL
Tom Sander, FH Kufstein Tirol University of Applied Sciences, Austria1
Abstract. This paper describes the positive and negative aspects of social capital in
and for organizations. The social capital theory gives the opportunity to explain and
describe processes, behaviour, achievements and functionalities in organizations and of
individuals. There are many issues regarding this research field which makes it
impossible to provide a complete overview with this paper. The basis for this paper is
an overview of the relevant literature regarding social capital and organizational theory.
The result of the paper is the explanation of the influence of social capital on
organizations and the impact of social capital on the result of processes, behaviour or
action of organizations and individuals.
Key words: social capital, organization
JEL code: M10
Introduction
Social capital is part of the organizational theories. Social capital describes the relationship between
individuals and organizations. The results of the relationship are reactions, action and behaviour. The
purpose of the theories is to explain organizations for the scientific work and to give practical
implications. The result of the research helps individuals to understand their environment, processes and
behaviour, especially the behaviour of real organizations. This knowledge is needed to improve, develop
and to change the reality successfully. This paper identifies social capital and explains the impact of
social capital in companies, networks or clubs for example.
Many scientists describe organizations and the processes, functionality and behaviour of
organizations. There are different theories and explanations. This section concentrates on the natural
system, rational system and open system under the consideration of social capital. In addition there are
different ideas and explanations for social capital. The paper identifies social capital as a structure of
relationships between individuals or organizations and social capital as a resource.
Social capital theories under consideration of organizational theory
This chapter presents a short prelude to describe the different explanations of social capital. There are
many scientific institutions and fields that use social capital for their research. The difficulty is that there
does not exist a general understanding about the definition of social capital. In general social capital
explains the consequences of relationships for the activities of the involved parties. This means the social
capital theory provides an explanation regarding the relationships between members in organizations. A
1
Corresponding author – e-mail address: [email protected], telephone: +49 160 98 75 39 17
Tom Sander
545
relationship is only possible if people exchange something with each other (Jans, 2003) (Nahapiet &
Ghoshal, 1998) (Li & Luo, 2011) (Ibarra, Kilduff, & Tsai, 2005) (Lin, 2001) (Coleman, 1988). Burt and
other authors mention in their papers that the informal and formal structure of organizations and the
impact of the structure on the organization is social capital. Burt describes the relationship between
organizations and individuals under the consideration of the structure of Networks. Scott and Davis
mention that the performance of an organization depends on the structure of the organization (Burt, 2002)
(Scott & Davis, 2007) (Nahapiet & Ghoshal, 1998) (Tsai & Ghoshal, 1998) (Oh, Chung, & Labianca,
2004) (Kilduff & Krackhardt, 1994). Granovetter explains in his paper the different relationships and the
different kinds of relationships between humans. He is an advocate for the strong and weak ties concept
between individuals. The differences of the tie influence the value of social capital e.g. reachable
resources or information. Social capital describes the reasons for individuals to cooperate and the
advantages and disadvantages of relationships between individuals and organizations (Granovetter, 1973)
(Coleman, 1988). Individuals use their social capital to achieve their goals. They use resources and skills
of other individuals or organizations. The access to the resources and skills of other sources enable them
to achieve their goals and to satisfy their desires and needs. The social capital theory explains the reasons
for individuals to share and to exchange their resources and skills with other individuals. The social
capital theory has the focus on connections, mainly the relationship between individuals or organizations
(Jans, 2003).
The focus of social capital is the relationship between individuals, how they organize their network
and the transfer of resources. The connection is the channel for and to resources. The theory describes the
consequences of behaviour and exchange of resources. The social capital theory explains the exchange of
resources and the reason for the exchange of resources. The exchange of the resources based on trust to
each other, reciprocity and sympathy. The exchange of resources and information has a social perspective
and depends on the relationship (Jans, 2003) (Ibarra et al., 2005) (Powell, 1990) (Lin, 2001). The
exchange depends on the kind of ties. Distance, centrality, age, clustering and structural holes are the
main variables to describe the density and cohesions of networks or organizations. The density and
cohesion is an important variable for the social capital and to measure the value of the social capital for
the individual (Scott & Davis, 2007). The above mentioned points are indicators to describe networks and
ties. The mentioned variables define the social capital of a person in a network.
Strong ties are very useful for complex issues and challenging tasks for teams. The strong ties support
the exchange of information and decrease the transfer time. However the strong ties related individuals
have a similar understanding about things and they communicate in the same language. Strong ties
describe the relationship between people and all people in the network know each other. That means all
members of the network have a direct access to each other without an agent between them. The social
capital bonds the members in the network. In addition a strong tie is defined by the age, density and
regularity of the relationship (Granovetter, 1973). This condition is very useful for the transfer of
confidential or difficult information. The negative effect of strong ties can be that one member of the
strong ties reflects on all individuals who are related with these strong ties. Weak ties have less cohesion
and regularity. The structural hole means that a person has a relationship to two friends and the two
friends do not have any contact. It is an advantage for organizations to fill the gap between the networks
because that helps organizations to identify new solutions and to identify important information from
another organization. The individual between the networks is defined as an agent. The agent can use his
knowledge and access to resources to support the different networks and can use the position between the
networks to have an advantage (Norris, 2002) (Beugelsdijk, 2003). It might be that weak ties give
information only under certain conditions. In general it is difficult to measure the opportunity costs to
cultivate and maintain ties.
The main point for the transfer of information or resources is the willingness and ability of the
individuals involved. The functionality of organizations needs the transfer of information and resources. An
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Tom Sander
organization cannot exist without any transfer of information or resources. This is the important point to
increase the social capital in organizations. It has to be under the consideration of the mentioned aspects that
the information or resource is valuable for the organization (Hansen, 1999) (Nahapiet & Ghoshal, 1998) (Li
& Luo, 2011) (Bolino, Turnley, & Bloodgood, 2002) (Ibarra et al., 2005) (Coleman, 1988).
Organizational theory describes organizations with their structure, functionality, behaviour, achievements and processes. The organizational theory concentrates on organizations and the theory explains
reasons for organizations to find decisions and their behaviour.
Coleman wrote in his paper on page 96: “…norms, interpersonal trust, social networks, and social
organization are important in the functioning not only of the society but also of the economy” (Coleman, 1988)
This means social capital is important for the economy. Organizations are part of the economy and
they need social capital to exist. Social capital supports the processes and functionality in organizations.
The natural system matches mainly with social capital. Social capital and the natural system are
influenced by the environment. The advantage of social capital is to improve the situation of individuals.
The development of the individual can improve the situation of the organization. The social capital theory
explains the different opportunities for individuals to support each other and to solve problems with the
support of the group or members of the individual network. The situation of an individual is influenced by
the environment (Gerald F. Davis & Marquis, 2005). The natural system explains organizations as a
construct for people. The second point is that the behaviour of individuals has a consequence for the
organizations of the individual and the individual himself. Both points are described deeper in the social
capital theory. There is mentioned that individuals need the access to resources from other network
members to live and to change their situation. The essential points for social capital are trust, reciprocity
and sympathy (Nelson, 1989). The critique and difference between social capital and natural system is
that the natural system reacts to the environment. The individual and the reactions of the individual
depend on the environment and the individuals do not have any engine to do something on their own.
Social capital has an intrinsic motivation aspect and is controlled by the individual (Coleman, 1988).
Social capital does not explain the coordination of activities in organizations as the rational systems
theory is doing (Scott & Davis, 2007). Another factor is the hierarchy. The hierarchy in the social capital
theory is mainly mentioned by Burt who concentrates on the position of a member in a network. The
social capital of individuals that are in the upper level of the hierarchy might amount to more than the
social capital of people on the lower level of the hierarchy. However Burt demonstrates in his papers that
it is not only the position in the hierarchy, that is important for social capital, the connections to other
organizations or individuals outside of the organizations are important for the social capital too. His focus
is on the structure of the network and the bridging functions between different networks of the individual.
This means if an individual is the single contact between two organizations then the individual has the
advantage of being the broker between both networks. This position in the structure gives the owner of
the single contact an advantage because this individual has more access to resources than the colleagues
of the individual might have. The main issue of social capital is the relationship between individuals and
the result of this relationship. Burt describes formal and informal structures. Both kinds of structure have
the opportunity for social capital (Scott & Davis, 2007) (Norris, 2002)(Beugelsdijk, 2003).
The organization as an open system define their members because they have unique behaviour or they
are doing special activities. The social capital theory describes members of a network as humans with
similar interests. Their human capital is an important part of their social capital and increases the interest
of organizations to invite individuals to their organization. The achievement of the organization is to
develop their organization with the knowledge, skills and resources of their members. The main focus is
the information that members provide to organizations. Individuals invest time, money, power or another
resource to reach their goal. They are investing their resources in the organization because they believe in
the organization and trust each other. Trust is one of the most important indicators for social capital (Scott
& Davis, 2007).
Tom Sander
547
The definition of network is ties between nodes. The node can be a group, individual or organization.
The tie is the channel to exchange information or resources to another node. The network contact can be
formal or informal. Open systems can describe the network as an organization but networks differ from
organizations. The difference between an organization and a network is that in an organization resources
can flow easily between the different members and the organization has processes to share resources. The
network describes the whole systems of the world and organizations can be part of a network with other
organizations. Members of organizations in an open system are individuals with the same interests or
background. They have bonds around their networks and differentiate themselves from other individuals
in regard to an individual indicator (Scott & Davis, 2007).
Advantages and disadvantages of social capital in organizations
Different organizations with different goals have conflicts with each other because they have
disjunctive goals (Van De Ven & Poole, 1995). Social capital decreases the conflicts in organizations.
The decrease of internal and external conflicts results in an increase of performance because the
organization concentrates on their core tasks. The reason for the decrease of conflicts is trust. Both parties
trust each other and that reduces the conflict potential. The result is more efficient and effective processes
and organizations. Another point for the increase of efficiency and effectiveness is that individuals with
social capital have a similar understanding about processes and backgrounds or the organization provides
a norm to improve the organization. Both support them to communicate faster and without much
miscommunication. They have similar norms and values. The better performance is the result of strong
and weak ties. (Jans, 2003) (Tsai & Ghoshal, 1998) (Nelson, 1989) (Powell, 1990).
Humans have expectations, abilities, needs and interests. These are the reasons for individuals to enter
a group. Industrial organizations need access to the labour market to recruit employees. The motivating
factor for organizations to recruit new members or employees is to increase the power of the organization,
to develop the organization or to stabilize the growth of the organization. Any new member of the group
has resources and these resources increase the social capital of the member and organization. The
organization is interested in growth and developing. To maintain the growth of the organization or to
increase the growth of an organization it is important for the organization to recruit individuals. The
growth is important for different reasons like the power of organizations, assure the existence of
organizations or access to resources for organizations. Turner mentions that social capital is needed to
develop the economy in a society (Turner, 1999).
This is the reason why organizations recruit individuals. Social capital helps organizations to identify
candidates and to hire employees. The individual decides about membership of an organization and
organizations define which individuals are of interest to join the organization (Coleman, 1988). If potential
candidates know members of the organization then it will be easier to identify suitable candidates.
Organizations use their members to identify candidates or give their members the opportunity to provide
potential candidates to the organization. Candidates with relationships to organizations and their members
are more convinced to enter the organization because these candidates get more and tailored information
about the organization. One important point is the trust between the member of the organization and the
candidate that supports the candidate to find a decision for or against the organization. In addition Han and
Han mention that the quality of recommended candidates is generally very high and valuable for the
organization. The organization uses the social capital of the employee to hire new employees with a high
quality for the organization. This increases the performance of the company because they have candidates
that match the requirements of the organization (Han & Han, 2009) (Granovetter, 1973) (Brito, Waldzus,
Sekerdej, & Schubert, 2010) (Hämmal & Vadi, 2010). There are several negative impacts of hiring
candidates from the employee network. One is that the potential candidates do not have new resources
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Tom Sander
because they have similar resources and information to the employees. It is not possible to find candidates
that are “thinking out of the box” for the organization because the presented candidates by employees have a
similar education, norms and cultural backgrounds. Social capital is the glue between members of
organizations and between different organizations. The cohesion and density of the members of organization
is an important point for the organizational theory (Stiglitz, 1999). Bolino, Turnley and Bloodgood write in
their paper that organizations with a high satisfaction, provided by leadership and relationships increase the
productivity of the employees (Bolino et al., 2002). Social capital is a kind of power and influences the
leadership style in organizations. Another influence on efficiency and effectiveness is trust. As mentioned
above trust is a part of social capital (La Porta, Lopez-de-Silandes, Shleifer, & Vishny, 1999) Social capital
can influence members of organizations. This is an important issue for the organizational theory to explain
leadership and further actions in organizations (Lin, 2001). The negative impact of strong cohesion and
density is that other individuals are excluded. That can have a negative impact on societies. One more
negative issue is the transparency of organizations with strong density and their behaviour for other organizations or communities. The Mafia is a group with a high density and cohesion for example (Putnam, 1995).
Individuals use their social capital because they are trying to reach a goal. This goal is created by
themselves or the environment. An important influence on the environment is the market mechanism, that
is another variable by which individuals define their goals (Scott & Davis, 2007) (Coleman, 1988). As
humans depend on their environment they use their social capital to achieve their goals and to defend
their status. Social capital provides capital to produce products or services. Social capital and the
organization help them to maintain a better position against competitors, enemies or any other
individuals. The organization supports them to achieve their goals. The goals of the organization and the
individual members of the organization might be different. Individuals can misuse the organization to
reach their individual goals. In reality it is not possible to separate the organization from a system which
is given by the environment. This differences influence the kind and type of the organization (Scott &
Davis, 2007).
Technological changes have led to new circumstances regarding organizations and networks. Internet
networks work independently on a technological basis without the influence of individuals or direct nodes
between individuals. The new technologies and resulting opportunities created by new technologies
reduce corruption and other negative effects of social capital. Technologies react and evaluate situations
without any emotions, prejudgments or other human effects. Technology works rationally and is
unbribable. Modern technology reduces the transaction between individuals (Scott & Davis, 2007) (Ibarra
et al., 2005) (G. F. Davis, 2010). However the technology gives organizations new opportunities to build
new structures and to organize themselves. The quality and time spent to reach a decision changed for the
better with the technological changes (Scott & Davis, 2007). The technology develops social capital and
gives social capital new opportunities to transfer resources, to maintain relationships and to create new
ties to individuals with interesting social capital. But not only technology changes the organizations.
Davis and Marquis mention in their paper that organizations are permanently developing themselves and
that changes are observable in organizations. Organizations need changes to reach their goals and to exist
(Gerald F. Davis & Marquis, 2005) (Van De Ven & Poole, 1995). These changes are important for
organizations to exist but the social capital persists and the social capital of the individual is independent
from the organization.
Kilduff, Krackhardt and other authors identified in their paper that prestige is a part of social capital.
Prestige for an individual or organization is described as the status, history, skill set, resources and
presented solutions of a person. Individuals and organizations have prestige. Already a new member in an
organization can increase the prestige of the organization or the prestige of the organization can reflect on
the individual. Positive prestige influences the reputation of an individual or organization. The reputation
helps the member or organization to get access to resources. The resources might not be accessible if the
prestige of the individual or organization is negative. The place of an individual in the formal or informal
Tom Sander
549
structure of an organization might be an indication about the prestige of the member. Prejudgment is a
negative aspect of prestige. If the prestige of an organization or individual is negative then the
organization or employees have a disadvantage. The result is that the negative prestige is transferred to
the organization and member of the organization (Scott & Davis, 2007) (Kilduff & Krackhardt, 1994)
(Labianca & Brass, 2006) (Coleman, 1988) (Stiglitz, 1999).
The task of the organization is that the organizations advocate achievements of their members. That is
one reason for individuals to be members of an organization. These achievements might be negative for
the whole system. The network uses the social capital of their members to reach goals for their members.
This is positive for the network but it can be negative for the whole system or for other individuals (Scott
& Davis, 2007) (Nahapiet & Ghoshal, 1998) (Lin, 2001).
Social capital can serve as a competitive advantage for organizations. As mentioned above social
capital help to develop organizations, provide them with additional information and resources, increase
their knowledge and create new solutions. The members of an organization share norms, narratives,
morals, and ethics standards. This might be very useful for an organization to be more efficient and
effective. Social capital supports organizations to be successful and gives a benefit for the organizations
or individuals. The negative impact of social capital on organizations is that the result of social capital is
the disadvantage for other organizations e.g. corruption. The limitation of relationships and norms given
by the organization can be a barrier for further development and changes. Ethic, norms and moral
concepts are not only an advantage; they may prove to be a disadvantage for the organizations. The same
history and an organization with only strong ties have difficulties in developing themselves and reacting
to changes or new situations (Bolino et al., 2002) (Ibarra et al., 2005) (Labianca & Brass, 2006)
(Coleman, 1988).
Some business is only possible with social capital. As mentioned the main aspect of social capital in
business is trust. Trust increases the efficiency and effectiveness of organizations. There are several
businesses that are based on trust. Businesses based on trust help the companies involved to make more
profit. The second component is penalization that this business is possible. This means if a member
misuses the trust that the involved individual can penalize the wrong doing person. In order to investigate
the wrong behavior organizations need the opportunity to monitor the network. Obligations are the last
part of this construct. Organizations need social capital to do business with each other. With less social
capital business, functionality and action for organizations is more difficult. The diamond market in the
Netherlands is a famous example for business on trust (Coleman, 1988). One other example is an
investment in an organization; individuals invest more in an organization if they trust the organization.
Social capital in Organizations
Social capital has the focus on many scientific fields e.g. economic, political or sociological. Their
focus is on all kind of groups. Putnam’s focus is on a political and society. Lin and Coleman are more
focused on economic issues. Burt’s explanations are focused on sociology. Burt concentrates on networks
and the structure of networks is not only independent of the environment and situation. The network
depends mainly on the individual. Social capitalist theorists identify through their work informal and
formal organizations to explain behavior and consequences (Scott & Davis, 2007) (Putnam, 1995).
The social capital theory explains the individual as an independent active player with self interests.
The social capital theory presents the individual as an independent acting actor with individual goals.
Social capital can be obligations, expectations, information channels and social norms. Organizational
theories use social capital theory as one theory to describe the rational behaviour and decision findingand making process of individuals in organizations. The capital of social capital is not only the network or
having contact to other humans. The social capital is the access to resources given by a contact or an
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Tom Sander
organization. But it is not only access that is important for social capital. In addition it is important to get
the resource if needed. This is the main issue for the social capital and to have the individual advantage of
the social capital. Social capital is constrained by individual’s resources, the opportunity to transfer the
social capital and to “store” the social capital. The structure of social networks influences the existing
social capital of the network. In addition the position of the individual in the network is important for the
social capital. It is important to consider the situation and only in some situations does a social network
constitute social capital. The social capital of a network depends on the objective of the social network
and the objective of the individual. The interest of the individual is to use the network with the social
capital to reach an objective. One indicator for social capital is that the social capital is transferable,
needed and provided if required (Jans, 2003).
The organizations are initially created to reach a goal or to solve a problem. This is the main focus to
found an organization. Social capital can be built without a direct goal. For example people may helps or
support another person thought they do not know when and what they will get back for their support.
They trust that they will get some benefit back in the future for their social capital. (Coleman, 1988)
The advantage of social capital is that it is autonomous. The individuals are responsible for their ties
and the social capital is only accessible for them. Organizations can change their processes but social
capital is independent of organizations. This is the interesting point for companies to hire employees from
competitors to get their social capital. Social capital is transferable from humans to organizations and
organizations can transfer their social capital to their members. The organization alters their number of
relationships if members initiate a new relationship. Any new relation of a member of the organization
changes the structure of relationships of an organization (Bolino et al., 2002). The members of
organizations participate in the same project to find a solution which assists in reaching the goal of the
organization (Browning, 1977). The owner of the social capital is mainly the single individual and the
given social capital is permanently available. The individual gives the commitment that the organization
can use the social capital of the individual. Human capital is one part of the social capital for example.
Only the individual can decide about their own social capital (Turner, 1999). The reward of social capital
is difficult. This means that if a resource is given the chance to get an equal resource back is sometimes
impossible and often difficult. The difficulty is that social capital is not measurable as the value of the
given resource depends on the individual and situation. The value of resources and information over ties
between individuals is difficult to quantify. Some social capital is unique and depends on the situation and
the individual. In addition the organization learns and has benefits from new members with interesting
resources (Hansen, 1999) (Nahapiet & Ghoshal, 1998) (Li & Luo, 2011) (Tsai & Ghoshal, 1998) (Oh et
al., 2004). All humans are responsible for their social capital. They have to create their own social capital.
The creation of social capital for individuals needs the willingness and access ability from the owner of
the social capital, the opportunity to give the social capital and the transferability of the social capital.
Organizations can provide support to get more social capital but the single individual is responsible to
maintain, cultivate and to create social capital. The social capital is not only guided by organizations, it is
guided by the interests of the person and the sympathy to other individuals with interesting resources. The
intangibility of social capital disables the transfer of social capital. That can be a barrier to exchange
social capital. Organizations provide their members with processes and advice with whom they should
cooperate or the organization enables their members to get in contact with other members of the
organization. This is organized by the kind of organization and the individual does not have many
choices. The organization regulates the relationships in the organization. Of course relationships in an
organization between individuals or organization are social capital too (Bolino et al., 2002).
Organizations have a goal and that is to produce products, to create knowledge or to provide a service.
Most organizations have one main goal. The organization has special capabilities for regularly creating
something that has a positive effect for individuals. Social capital is more passive. Individuals use social
Tom Sander
551
capital if they need resources or support. That is not regular and depends on the situation. The individuals
use their social capital for different purposes and depending on the situation (Nahapiet & Ghoshal, 1998).
Emotions have a large influence on social capital. Relationships need emotions and emotions
influence the quality of the relationship. Some connections do not have a rational reason or they are not
rational explainable. As already mentioned, connections depend on the individual.
Organizations have a hierarchy and structure. Social capital has only a structure. The position in the
structure is important for social capital. In organizations the position of an individual in the hierarchy is
important from the perspective of power and influence. The position in the hierarchy supports the social
capital because individuals at a higher level in the hierarchy have access to more resources and information.
However the hierarchy does not substitute the position in the structure of the individual’s network.
Conclusion
The paper describes that social capital and organizational theory are related. The theories describe the
advantages and disadvantages of individuals to be a member of an organization or network. Social capital
explains relationships and organizations need relations between their members for their existence. In addition
an organization needs bridges to other organizations to exchange goods or services, develop their organization,
increases the wealth of the organization and members of the organization and to create new products or
services. Social capital improves the situation of organizations because with social capital organizations can
reduce their transaction costs between organizations and insight of organizations. Social capital reduces costs
because conflicts are reduced, sanctions are lower and the monitoring of processes is not needed for example.
Without social capital some business is not possible. Without the given business which is based on trust
organizations are not able to exist. The transfer of confidential and “difficult to explain” information is easier
with social capital. The negative impact of social capital in organizations is the barrier for individuals who do
not benefit from the organizations goals. Another consideration is prejudgment and negative prestige.
Corruption is one of the main negative effects of social capital (Turner, 1999).
Social capital needs an exchange to exist. The social capital theory explains the behavior of members
of networks. The social capital has a higher focus on the individual. The network of individuals can
include different organizations and social capital theory describes the ties to the different organizations.
The structure of the network can be an advantage or disadvantage for the individual. The structure of the
individual’s network is not formalized and does not depend on an organization. Social capital is created
by the individual and the individual is responsible for their own social capital. The individual can use
their social capital for their interests and decide themselves about their social capital. The benefit for
companies with a high social capital is the better result compared with other companies (La Porta et al.,
1999). To summarize the paper, social capital is needed by organizations to create value for the
organization and the community. The decision finding process is influenced by social capital. Social
capital enables organizations to exchange and provide advantages or disadvantages to their members.
Social capital is focused on individuals and their relationships. Organizations are focused on goals which
they reach with their social capital.
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554
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INDUSTRIAL POLICY: PROS AND CONS. A LITERATURE REVIEW
Kristaps Soms, University of Latvia, Latvia1
Abstract. The discussion amongst economy professionals and academics about the
necessity and possible best solution of an industrial policy and state intervention
concept regained its importance over the last year. Usually the debate is about
comparing several development stages in industrial policy thinking: e.g. modern
industrial policy versus industrial policy of the 20th century or industrial policy of the
East-Asia countries. This literature review undertakes analysis of industrial policy
concepts focusing on discussions about development of thinking and about the pros and
cons of industrial policy.
The aim of the study is to restart a discussion amongst economy professionals and
academics in Latvia about necessity of having an industrial policy in Latvia, and
possible benefits or disadvantages of this economic concept.
Key words: industrial policy, role of state
JEL code: L52
1. Introduction
The question about industrial policy is very contradictive in economic literature and has changed
during the 20th and 21st centuries. Let’s start with the term “Industrial policy” itself. The use of the term
“Industrial policy” in economic literature and among analysts is very broad. Common understanding of
the term is that it describes only industrialization of economy, meaning increasing the share of
manufacturing. Other understandings of the term industrial policy are more used in recent studies. It
implies that industrial policy equals the role of state in an economy, or state intervention made in order to
tackle market or government failures.2
The highest level of state involvement in industrial policy in different regions all over the world was
reached from the 1950s till 1970s, when the governments of Latin American, African and Asian countries were
engaged in economic planning at various levels, changing the structure of economy and market protection.
As regards Latvia, a debate on the necessity of industrial policy was initiated comparatively late after
the independence, i.e., in 2008/2009, when the first analytical studies concerning necessity of the concept
of industrial policy in Latvia were conducted, thus defining the role and activities of the State in fostering
economic development. The first research was followed by recommendations from the Ministry of
Economics regarding the role of the State in the economy. It should be noted that the recommendations of
the Ministry of Economics and empirical studies highlighted the fact that theoretical and empirical studies
of the economic science prove the benefits of an active state intervention in the economy which ensures
that future development and welfare of the state can be free of restrictions and conditions imposed by the
economic structure, and it forms an essential challenge for the present growth in Latvia.
1
2
The term “Industrial policy” is used according to how origin researchers mention it, and may slightly vary during paper
Kristaps Soms
555
The aim of the paper is not to describe historical experience of Latvia’s state intervention policy
within whole time frame of recent 20 years independence time, but to analyse development of industrial
policy concept in economic literature as well as to analyse recent activities of local economic experts and
state authorities on elaboration of industrial policy approach in Latvia.
The method used: review of economic literature on development of industrial policy approach and
analysis of Latvia’s policy documents.
The paper is organized as follows: Section 2 describes industrial policy thinking in economic literature
and changes in it during 20th century. Section 3 describes efforts of Latvia regarding development of
industrial policy approach.
2. Industrial policy
2.1. What is “Industrial policy”?
Let me start with type of activities that form the term industrial policy. I will start with the early
descriptions of the term. Reich (Reich R., 1982) described “Industrial policy” as the set of governmental
actions designed to support industries that have major export potential and job-creation capacity, as well
as the potential to directly support the production of infrastructure. Pinder (Pinder J., 1982) proposed a
definition that includes all policies designed to support industry, including fiscal and monetary incentives
for investment, direct public investment and public procurement programs, incentives for investment in
research and development, major programs for the creation of “national champions” in strategic sectors,
and policies to support small and medium enterprises. Johnson (Johnson C., 1984) defined industrial
policy as government activities that aim to support the development of certain industries in a national
economy to maintain international competitiveness. Chang (Chang H-J., 1994) describes industrial
policies as governmental actions supporting the generation of production and technological capacity in
industries considered strategic for national development. Pack (Pack H., 2000) defines industrial policy as
actions designed to target specific sectors to increase their productivity and their relative importance
within the manufacturing sector. Nabli (Nabli M., Keller J. et al, 2006) argue that any policies or
interventions that influence how industries expand are referred to as “industrial policies”, but there is
distinction between “horizontal” and “vertical” industrial policies. Vertical policies usually target the
economic output of specific industries and even firms. Horizontal policies essentially focus on improving
the quality of inputs in the production process, which presumably benefit all firms. Most common
examples of policies are included in Table 1.
Table 1
Examples of vertical and horizontal industrial policies
Horizontal policies
 Education and vocational training;
 Building appropriate and efficient
public infrastructure;
 Encouraging international technology
transfers;
 Fostering research and development;
 Support for production activities.
Vertical policies
Targeted attraction of Foreign direct investments;
Sector-specific trade negotiations;
Incentives and subsidies for specific sectors or activities;
Support of the competitiveness of given industrial
activities;
 Import tariffs and quotas;
 Export subsidies and credits.




Source: Nabli M., Keller J. et al, 2006; Peres W., Primi A., 2009; Author
556
Kristaps Soms
Peres and Primi (Peres W., Primi A., 2009) argue that the scope of policy depends on two dimensions:
firstly on policy-making capacity, which in turn relies on a set of factors including institutional capacity
for design, implementation and assessment, and secondly on the numbers and scope of the instruments
used, which depend on the development strategy and its specific objectives. These two dimensions define
a policy space, where three types of policies operate. These policies are horizontal, selective and
additionally: frontier policies. Here meaning that frontier policies respond to a broader national
development vision, and aim at creating capabilities in key strategic technological and science areas. This
definition of frontier policy is highly relevant to recent efforts of the European Commission to define Key
Enabling Technologies. But looking on a definition of frontier policy it’s clear, that it is part of a selective
policy and therefore any additional definition of a new subgroup is questionable, being possible within a
more generic framework as a subgroup of “vertical policy” actions.
Here it is worth looking again at the definition of “Industrial policies”: from the perspective of
proponents and opponents. Benhassine and Raballand (Benhassine N., Raballand G., 2009) argue that
proponents of industrial policies dismiss public governance problems and the risk of capture when
compared to the needs of addressing market and coordination failures. Opponents of industrial policy
dismiss market failures and argue that structural reforms and markets will address them, and that any
public intervention will lead to capture. Analysing opposing arguments we could describe state capture as
an insufficient capacity of state institutions to correctly identify the sectors to support. The consequences
like distraction of structural reforms in government sector, rent seeking activities and generation of
government failures outweigh market failures. Summarised arguments of both parties are included in
Table 2.
Table 2
New industrial policies: arguments for and against
Against
 Government intervention leads to increased
corruption and state capture;
 Governments do not have the necessary
information and capacity to pick winners
(sectors who have already have pace or
emerging comparative advantages);
 Industrial policy distracts from key investment
climate and trade policy reforms;
 If public support is carried out, government
support should be limited to non-selective
policies (horizontal policies) such as providing
public goods (infrastructure, education, R&D);
 Little empirical evidence of working industrial
policy.
For
 Market and coordination failures as well as
symmetric information in developing
countries justify interventions in markets;
 Trade policy, investment climate reforms
and providing public goods do not lead to
sustained growth because of fundamental
market failures;
 Most success stories have been based on
smart interventions at the industry-level;
 Selective and sector-specific public
interventions make it possible to tackle
several investment climate constraints
effectively.
Source: Benhassine N., Raballand G., 2009; Author
Despite arguments by Benhassine and Raballand that they looked at a “new industrial policy”
approach, their analysis was highly relevant to the industrial policy approach known in the late 1990s.
A more recent attempt to define industrial policy was introduced by Rodrik (Rodrik D., 2008). Rodrik
describes industrial policy as a process of on-going dialogue between state and the private sector to
generate information for identifying and removing the binding constraints to development.
Kristaps Soms
557
2.2. Evaluation of Thinking about Industrial policy
By reviewing evaluation of the term it is clear, that together with a definition, thinking about industrial
policy and its role within the economy has changed rapidly. Naude (Naude W., 2010) summarized key ideas
of industrial policy dividing them into three phases (Table 3). The first phase is dominance of market failure
often used and cited lasting from the 1940s till 1960s. The second phase completely reshuffles the emphasis
of industrial policy from market failures to government failures. The third phase started a new discussion by
introducing a new discussion topic of “how industrial policy has to be implemented”.
Table 3
Evolution of ideas of industrial policy
Phase
1940s
to late
1960s
1970s
to
1990s
2000s
to
present
days
Key ideas
 Industrialization is necessary for development;
 Market failures would prevent this from happening
automatically;
 Market failures are pervasive in developing countries;
 Industrial policy is needed, particularly infant industry
protection, state-ownership and state coordination.
 Practical obstacles to industrial policy are considered
significant;
 Government failure is worse than market failure.
Industrial policy is invitation to waste and rentseeking;
 Trade liberalization (exports), privatization and
attracting foreign direct investments together with
macroeconomic stability and minimum government
interference are the basic requirements for growth and
industrialization;
 The era of the Washington consensus, especially after
the debt crisis of the early 1980s and the ubiquity of
structural adjustment programs.
 Market and government failures are present;
 The “how” rather than “why” of industrial policy is
important;
 Institutional setting matters but design difficult. Need
to understand political context;
 Flexibility in the praxis of industrial policy is
important;
 Differences exist with respect to the extent to which
comparative advantage needs to be defined, not the
principle;
 Innovation and technological upgrading should be a
central objective of industrial policy;
 Promoting national innovation systems should be an
important objective of industrial policy.
Representative
contributors
Rosenstein-Rodan
P. (1943)
Hirschman A. O.
(1958)
Prebisch R. (1959)
Myrdal G. (1957)
Baldwin R. E.
(1969)
Krueger A. O.
(1974; 1990)
Pack H. (1993;
2000)
Country
examples
South
Korea
Malaysia
Japan
Taiwan
Singapore
Argentina
Nigeria
Amsden A. (1989)
Dosi G. (2009)
Rodrik D. (2004;
2008)
Chang H-J. (2002;
2003; 2009)
Lall S. (2004)
Lin J. (2009)
Nelson R. R.
(1993)
Robinson J. A.
(2009)
Finland
France
Latvia
Source: Naude W., 2010; Author
558
Kristaps Soms
As we can see over time, the ideas behind an industrial policy concept have changed rapidly. Of course
it’s possible to define more precise phases of development of an industrial policy concept, but the aim was
not to describe historical development, but rather to show how controversial the development was, and how
rapidly the ideas behind one concept can change. Partly this shift in thinking can be explained by the rise
and fall of the Washington consensus, which was widely adopted across countries all over the world as part
of the World Bank and the International Monetary fund lending policies. There is a growing amount of
literature on analysis and assessment of inefficiency and inadequacy of the Washington consensus policy.
3. Latvia’s approach in development of a National Industrial policy
Industrial policy has been applied controversially in the course of the last 20 years in Latvia. On the
one hand, the State has taken an active part in the economy concerning State-owned companies and has
carried out direct and indirect intervention measures. On the other hand, industrial policy has not been
described or defined before 2008, when the first attempt was made at describing industrialization and
defining its goal. Beņkovskis et al (Beņkovskis, Rutkaste, Vītola, 2009) performed an empirical study to
identify priority sectors in Latvia's economy. Defining of priorities was based on considerations which
emphasised that it is necessary to concentrate the resources available by the State (financial and human)
to foster the growth of national economy thus improving purposeful investment and efficiency of
resources and that the defining of priority sectors is a requisite instrument of structural policy. The
authors acknowledged that the market fails to guarantee a high income and prosperity level that would be
comparable to indicators of the developed countries, and therefore an active and targeted economic policy
is required. However, when production factors are considered, the authors admit that sectors and products
have their own specific set of production factors, which in the course of time have developed among the
existing industries taking into account production circumstances of the specific products, and therefore,
due to the established production factors in the country, it is highly possible that companies will focus on
the production of the existing or closely related products. The export structure that derives from Latvia's
economic openness and dimensions served as the basis for sector identification, and it was assumed that
promotion of export would help to enable faster economic development and increase prosperity. When
comparing historical development of the concept of industrial policy and Latvia's approach to the defining
of industrial poicy, it is essential that alongside the identification of priorities the authors provide also
several crucial restrictions. Firstly, they argue that open protectionism and subsidies are not the
instruments to be employed by the State to support priority sectors. Industrial policy should focus on
provision of production factors and, primarily, on the preparation of human resource base.
The next stage of industrial policy development is related to the actions of the government in respect
of its definition. In 2009 the Ministry of Economics prepared and the Cabinet of Ministers approved
report on recommendations for economic recovery in the medium term. The project provided for two
courses of action. Firstly, strengthening of the competitiveness or horizontal support policy aimed at the
improvement of general business environment and, secondly, the defining of priority sectors. Similarly as
in the previous research, assertions of the Ministry of Economics were based on the presumption that the
resources needed to be concentrated to achieve greater yield and efficiency. State intervention, in
particular selective intervention, was specified as the leading instrument, i.e., the defining of priorities is
necessary in order to get out of the economic structure that emerged during the crisis and as a result of it.
In contrast to the research performed by Beņkovskis et al, the Ministry of Economics extends the
selection instruments to include not only identification of priority sectors and products, but also specific
companies that show high growth potential even though they do not represent priority sectors. The
priority sectors that were defined from practical perspective were comparatively widely supported in the
activities performed by ministries representing various sectors and aimed at the improvement of
production factors, including also direct subsidies and grants.
Kristaps Soms
559
Present approaches to the concept of industrial policy in Latvia are based on the latest contemporary
theories, primarily on the works of Rodrik, Hausmann et al. In 2012 the Ministry of Economics presented
a new structural policy approach to national economy, naming it as the National Industrial Policy. Experts
from the Ministry of Economics have performed an up-to-date analysis of the economic structure and
development, as a result of which several corrections have been introduced in respect of the previously
offered instruments for the implementation of the concept of industrialization in Latvia. Though the
document mentions that the development of export-oriented sectors and the change of economic structure
for the benefit of such sectors should lie at the centre of industrial policy, it does not define priority
market segments, producers or sectors, but rather the basic principles. As mentioned earlier, the latest
industrial policy in Latvia is based on the opinions of Rodrik, Hausmann et al, as a result of which an
emphasis in the development of the concept of industrialization falls on a single crucial basic principle
that industrialization policy is not aimed at "picking the winners" but rather the process that includes a
dialogue between the public and private sector to identify the binding constraints that prevent new
economic activities and to offer solutions how to prevent or overcome such constraints. In the document
prepared by the Ministry of Economics this process is emphasised as a crucial element of industrial policy
and lies at the basis of the analytical part of the document.
Assessing the current proposal of National industrial policy from the perspective of implementation
instruments, it can be concluded that six courses of action are recommended: addressing labour force
availability and qualification issues, development of industrial zones, facilitating access to finance,
increasing innovation capacity, promoting export and reduction of energy costs. As becomes obvious
from this list of actions, the activities are primarily related to the tackling of horizontal issues by
minimising the presence of selective instruments. Analysis of the recommended instruments clearly
shows that broad selectivity has been abandoned in favour of horizontal support instruments — tax
initiatives, financial instruments, as well as instruments that promote knowledge and skills of the labour
force, innovation and entrepreneurship. A minor selectivity will be retained during the phase when certain
planned State intervention instruments are applied and it will be necessary to make criteria-based ranking
in order to select the most successful cooperation partners or projects.
Conclusion
1. Industrial policy is still a controversial issue in economic literature and there is a place open for future
debate on what the meaning of industrial policy is and how to implement it in countries with different
environments, levels of economic flexibility and economic development.
2. More and more countries are developing their approaches to industrial policy even without
recognizing it, but some countries, like Latvia, do it with a clear set of preconditions and goals to
achieve.
3. The best proposal for developing an industrial policy is that every country has to take its own way in
development: by starting with a close and open dialogue process with key stakeholders, by taking into
account the economic environment and by reasonably assessing the possibilities of the national
institutional framework.
4. Latvia’s approach in development of industrial policy firstly has been based on very selective and
narrowed scope of proposals, the set of priority industries has been determined, but upon one year of
implementation the approach has changed to those based on findings and works of Rodrik, Housmann
et al, which implies that “picking winners (priorities)” approach has to be eliminated and strong
dialogue between government and stakeholders is essential to assess economy with the aim to find out
market and government failures.
560
Kristaps Soms
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562
Kristaps Soms
PROBLEMS OF DEVELOPMENT OF NATIONAL SOCIAL-ECONOMIC
SYSTEM IN CONDITIONS OF GLOBALIZATION
Natalia Spiridonova, Saint-Petersburg State University of Economics, Russia1
Abstract. In our days it’s impossible to find a country not involved in the process of
globalization. The influence of globalization may be both positive and negative. What
does it depend on? The aim of this paper is to investigate the asymmetric impact of
globalization on the development of various socio-economic systems in the modern
world. It’s necessary to analyse different aspects of globalization, such as measuring of
economic effect, choice of models of modernization, role of government etc. Special
attention should be paid to the problems of adaptation to the conditions of the various
countries of economic globalization. Particular features of adaptation of Russian
economy to globalization are also analysed.
Key words: globalization, the neoliberal model, “challenges” of globalization, models of modernization,
westernization Analysis methods such as comparative analysis, SWOT been used
JEL code: F62
Introduction
Global change of the modern world led to radical changes in the organization of the national
framework of society, too. There is a process of formation of a single economic space in the global, a
process of formation of the world economy as a single market and not as a network of independent
national economies linked by trade and investment flows. In this case, it is not a full merger with the
world economy, but the modification of the national industrial and post-industrial systems in the process
of their integration into the united economic area.
Appeared relatively recently – in the 80-ies of the last century, the theory of globalization is
represented in the works of F. Fukuyama, S. Huntington, I. Wallerstein, M. Archer, R. Robertson, J.N.
Rosenthau, L. Sklair, O. Ianni, A. Appadurai, U. Beck, T. Levitt , K. Omae, J. W. Meyer, M. Alle, J.
Sachs, A. Warner etc.
Historical analysis of the processes of globalization, including in terms of economic inequalities
between countries of the world, conducted A. Maddison, J. Williamson, P. Krugman, A. Venables.
Modern aspects of the world economy globalization and international economic integration are discussed
in the works of Russian scientists: Avdokushin Y.F., Akopova Y.S., Buzgalin A.V., Glazyev S.Y.,
Delyagin M.G., Lviv D.S., Primakov Y., Rybalkin V.Y., Sapir Y.V., Utkin A.I., Shishkov Y., Yakovets
Y. etc.
Thus, the study of the theoretical and methodological aspects, the rationale for the influence of
integration and globalization on socio-economic development of individual countries, problems of
globalization studied all over the world. However, most studies are of a private character, and consider
only one problem. At the same time, both the theoretical and the empirical level the question remains
1
Corresponding author – e-mail address: [email protected], telephone: +7 911 941 6999
Natalia Spiridonova
563
unanswered: what consequences for the formation of national models of development leads globalization
of the world economy?
This study uses a combination of methods of modern economic theory, applied to the study of
international economic relations and the problems of global development. The main methods of this study
are functional, comparative and systematic analyses.
The aim of this paper is to investigate the asymmetric impact of globalization on the development of
various socio-economic systems in the modern world. The paper addresses issues such as effects of
globalization on different types of economies, the basic model of modernization, the role of TNCs and
especially the involvement of Russia in the integration processes.
Problems of development of socio-economic systems in today’s globalized world
Globalization has weakened the traditional national system of state regulation of the economy but has
not led to the creation of international, supranational regulatory, which would fill any resulting gap. The
state can’t effectively use the traditional tools of macroeconomic regulation as before, for example:
import curbs, export subsidy, exchange rate, and discount rate. If necessary, TNC and TNB can oppose
government practices a strong economic potential and lobbying in various countries, which may reduce
the expected effect of the measures taken.
Contemporary neo-liberal model of globalization is aimed at extracting the maximum benefits for
developed countries, excluding the interests of other countries sufficiently. The model has generated
differentiation of the world: for the country winners and losers due to globalization. Developing countries
and emerging economies have difficulties in adapting to the challenges of globalization. The difficulties
stem from the fact that developing countries do not have much money (as the developed countries), their
national legal, economic, administrative systems and mechanisms are not fully prepared, etc. Therefore,
developing countries and emerging economies are often forced to accept the rules imposed by the
stronger players of the world economy. The growing wealth gap between rich and poor countries is
leading to the expulsion of the last of them to the margins of the global economy, an increase in
unemployment and poverty. Objective parameters of evaluation of the economic effects of globalization
don’t exist yet. There are a lot of factors that could destabilize the state’s economy and lead to a certain
kind of crises because of the complicated structure of the global economic and financial systems. These
factors include inefficient government policy in the area of economic reform and the control of the
banking and financial system. Increased labour mobility makes it difficult to collect taxes, leads to the
risk of budget deficit; worsening conditions in the world’s commodity markets could result in loss of the
main source of income. But, obviously, there is a certain asymmetry in the impact of globalization on
developed and developing countries, which should to be eliminated. As an example, so-called “terms of
trade”, the ratio (Price of exportable goods)/(Price of importable goods). The rise in prices of agricultural
products and raw materials of the third world is far behind the increase in prices for finished commodity.
In 1983-1992 “terms of trade” was reduced by 3.4% per year, equivalent to a loss of U.S. $ 27 billion
each year to developing countries. Over the past five years, States that are not oil exporters lost about $ 40
billion a year due to deteriorating terms of trade (Осипов Ю., 2009).
One of the manifestations of globalization is the financial market. The global financial market has a
high degree of internationalization of capital, while international institutions, to regulate the flow of
capital at the international level, are virtually absent. It would seem that the benefits of intensive
movement of capital are as donors (due to the increase of the investment portfolio and risk
diversification) and recipients (for example, due to additional sources of income). However, loans with no
serious support, artificial overstatement or understatement of the exchange rates, the regulation of interest
rates and so can cause a variety of crises. Striking examples of a chain reaction in the world economy are
564
Natalia Spiridonova
the financial collapse in Southeast Asia in 1997-1998 and economic crisis in Central America, especially
in Argentina and Brazil in 2001-2002. Among the recent economic turmoil, we can identify the U.S.
subprime mortgage crisis in 2008, which led to serious consequences for the whole world because of
lower U.S. demand for food and the rest of the capital (Абрамова А., 2009). Challenge facing the world
is reducing the vulnerability of national economies in the face of increasing their interdependence. At the
moment there are no supra-national regulators, which could ensure the stability of the world economy in
case of a crisis in one of the major powers.
Thus, there are two aspects in adapting the various countries to economic globalization:
 First, more options from liberalization, open society for the impact of globalization;
 Second, adapting to the current economic life by overcoming the challenges of globalization.
Effects of globalization on developed countries and emerging market
Each state uses a system of measures, depending on the status of the country, its geopolitical position,
economic development, ideology, available resources and other factors (see Table 1, 2, 3). In Europe, the
emphasis is on ways to reduce unemployment and deepening Western European economic and financial
integration as a response to the challenges of economic globalization. Japanese scientists pin their hopes
to globalization for overcoming long economic stagnation of the late 90’s. They believe that an effective
adaptation means major changes in the economy, which will make the Japanese economy more open and,
ultimately, more dynamic. They believe globalization helps to stabilize the economy and improve the
standard of living. So far, globalization meant the expansion of exports, imports and Japanese investment
abroad for the Japanese economy. Further globalization will mean increasing presence of foreign
companies in the Japanese economy (Михеев В., 2004).
Table 1
Challenges of globalization and offers opportunities for developed countries (U.S., Luxembourg)
Country
U.S.
Luxembourg
Opportunities
 New markets;
 Relocating dirty and labour-intensive
industries to the peripheral countries;
 Rising incomes;
 Enhanced economic and political
potential;
 Control of international organizations
and processes.
 Address national problems through
international organizations;
 Access to foreign capital and
advances in high technology.
Challenges
 Protection of the domestic market
from the goods of other countries;
 Increased competition in the labour
market;
 Decline in living standards of the less
skilled American workers;
 Maintaining leadership in science and
technology.
 Relationships within integration
groups.
Source: Спиридонова Н., 2013
A practical example of success in a globalized world is the United States. U.S. focus on the following
issues: first, the liberalization of markets in other countries despite the fact that its own market is still
protected. The scandals of the late 90’s (restrictions on steel imports from Russia, Japan, South Korea, or
the “banana war” with the European Union) show U.S. attempts to find an optimal solution to adapt to
globalization. As a result, the U.S. protects the interests of its producers through local and harsh methods
Natalia Spiridonova
565
of protection. Second, maintaining leadership in science and technology. U.S. uses the concept of
globalization to a “brain drain” from other countries for this purpose. Third, the problem of rising
unemployment and falling living standards of low-skilled U.S. workers due to increased competition from
immigrants in the U.S. labour market (WT Woo, 2008).
Of particular interest is the existence of small states in globalization. Big countries cope with the
challenges is not always better than a small country. Today, most of the richest (in terms of life) countries
are small states. Small states get more confidence in the international community than large, because they
have no hegemonic claims. The large size of the state can lead to political, economic and administrative
inertia, to nationalism. Small states are using their specific techniques and ideas in order to successfully
cope with the global competition. It is the presence in the world of small states is a sign of the health of
the international legal relations in general (Кирт Р., 1999). With globalization, the general line of small
states (especially the West) is not sovereignty, but in thought, constitutionally sound transmission of
national sovereign rights to supranational institutions and international organizations. As a successful
example is Luxembourg, which is a member of various European Communities (ECSC, EEC, Euratom).
There are the following directions of adaptation of Asian countries to the challenges of globalization:
state-directed export-oriented model of economic development; further liberalization of foreign capital;
granting independence to the central bank, long-term strategic planning and policy-making on the basis of
transparent laws and regulations; change labour laws to break the traditional system of lifetime
employment and to give greater workforce mobility (one of the South Korean decision to adapt to
globalization).
Table 2
Challenges of globalization and offers opportunities for the economies of developing
countries (e.g., South Korea)
Country
South
Korea
Opportunities
 Continued economic growth;
 Investment attraction;
 Development and implementation of
information technology;
 Growth of national industry.
Challenges
 Strong competition from imports;
 Foreign interference in national
politics.
Orientation of the economy to the domestic market and not for export is the main focus in developing
countries and emerging markets as part of the problems raised. To adapt to the challenges of globalization
they tend to develop production at local and national level; spend most of the money for internal
development; support the business: private, cooperative, public, any; follow the principle of equitable
distribution more than attempts to improve the indicators of economic growth; abide by democratic
process of making economic decisions more than the dictates of the market yield.
Special attention should study the experience of China and its development in a globalizing world (see
Table 3). On the one hand, China is trying to use globalization to address its economic and financial
problems generated by the reforms. First of all, get access to the markets of developed countries, access to
their capital and modern technology. On the other hand, China views globalization as an opportunity for
more development resources from developed countries. Discussion of the relationship of Chinese
socialism and the global economy is a feature of studies of the problem in China. It’s noted that China is
still a communist country and still shows high rates of economic growth. China is the “challenge of
globalization”, interpreted as “the result of the collapse of Soviet-style socialism”. (Михеев В., 2004).
The benefit of globalization for China according to Chinese scientists is the growth of foreign trade,
GDP growth, job creation, tax revenues from foreign companies.
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The negative effects of globalization on China are: specific relation to Chinese companies abroad and
even at home; special benefits for foreigners; overstatement of equipment imported into China by foreign
companies; capture a greater share of property in the joint ventures by foreigners; environmental
contamination; intensification of trade conflicts with the United States and other developed countries,
owing to the transfer labour-intensive production to China from Hong Kong and Taiwan; widening gap in
socio-economic development between coastal and inland areas of China. At the same time the statement
“China has benefited more than the lost of globalization through proper adaptation policy” is the general
opinion (Михеев В., 2004). The Asian financial crisis of 1997-1998 years has stimulated the emergence
of new approaches to the practical aspects of globalization in China as well as in the NIC countries.
Chinese experts began to speak more about the necessity of adjustment in the policy of openness, as well
as the pace of reform of industry and banking sector.
Table 3
Challenges of globalization and offers opportunities for the economies of emerging
markets (e.g. China)
Country
China
Opportunities
 Access to the markets of developed
countries;
 Access to global capital and modern
technologies;
 Additional resources for development;
 Growth of foreign trade;
 Growth of national GDP;
 Creation of new jobs;
 Additional tax payments from foreign
companies.
Challenges
 Delegation of powers to the
international institutions;
 Preservation of ideological and political
identity;
 Loss of sovereignty;
 Environmental contamination;
 Social protection from the negative
effects of globalization;
 Collision of Chinese socialism and the
global market economy.
On the one hand, there is a trend for unification different types of economies on the base of
globalization, for a general liberalization of TNCs. On the other side, the opposite trend exists for
regionalization, implementation of national-historical features of economic models. Together, they create
new opportunities for economies of divergence, unusual in the classical approach. Integration of national
economies into an integrated global system could lead to the formation of the new structure of the
national socio-economic system and speed up the process of modernization.
The basic model of modernization in the present conditions
There are three main models of modernization: westernization, overtaking model, national model.
Westernization (transitology) – the process of transition from traditional to modern economies through
direct borrowing structures, technology, and even a way of life that requires a change of identity2. In the
overtaking model the institutions are imported in accordance with the available opportunities, they
provide industrialization, create industrial culture (Федотова В., 1997). The main disadvantage of
overtaking model is an impossibility to catch up, to reproduce the process of Western modernization.
2
In everyday life, the change of identity means that any person of non-Western societies (Russian or Chinese) should
behave like an American or European.
Natalia Spiridonova
567
The process of integration into the world economy can’t be separated from the process of
modernization of the Russian economy. With globalization, the basic model for Russia is (which can be a
bit weird) national model of modernization, which involves the introduction of Western advances
simultaneously with the solution of local problems by local methods. South-East Asia, Japan, China are
examples of such modernization. There has been achieved not the modernity, but competitiveness with
the West in societies, where technological development goes together with preserving the traditions,
rather closed, local specifics. Development of South-East Asia corresponds with a change in the
relationship between values and institutions, when old values were the source of the institutions of
modernity, when equipment, technology, infrastructure, social institutions are borrowed, but this does not
result in the transformation in the West, as these countries keep their national and cultural identity.
TNC as a factor in determining the role of Russia in the global economy
Every state has to focus on the behaviours of key players in the global economy to form their effective
strategy. As one of the leading actors of globalization is the transnational corporations, Russia should also
have powerful TNCs, with the Russian financial controls and the location of the parent company in
Russia, with operations in all major regions of the world. These TNCs, which focus on the national
interests of Russia, are necessary for equal participation of Russia in the global economy.
At present, the international production of TNC is expanding, foreign sales, employment and assets of
transnational corporations are increasing. Dissemination of TNK is now a factor that enhances the process
of globalization. Those multinational companies make about 90% of all private investment, and their
products account for about 65% of world trade. In 2010, the share of TNCs accounted for 20% of world
GDP, a third of the world’s industrial production. In addition, TNCs are the main suppliers of
technological innovations. The share of TNCs in innovation in technology of mining, processing and
manufacturing products was 78% in the last 5 years (Михеев В., 2004). The added value of all TNCs in
2010 was approximately $ 16 billion, that is, about a quarter of global GDP. Foreign affiliates of TNCs
give more than 10% of global GDP and one-third of world exports (see Fig. 1.) (UNCTAD, 2011).
Source: World Investment Report 2011, UNCTAD
Fig. 1. Largest TNCs have made a quarter of global GDP in 2010 (% and trillion U.S. dollars)
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Natalia Spiridonova
In the 90’s in most developing countries change dirigisme on neoliberal policies has reduced the
influence of the state on the financial sector and the delayed development of the domestic private
financial sector. As a result, the redistribution of financial flows in favor of large foreign corporations and
to the detriment of national ones happened, thanks to the activities of TNCs and TNBs. Public-private
partnerships could be a compromise. The partnership should eliminate inefficient directions of investment
of public funds and increase investment in the private sector, reducing the political and economic risks.
That state TNCs are a new and important source of FDI in the current stage of globalization. There are at
least 650 public multinationals with 8,500 foreign affiliates (see Fig. 2) in the world. By quantity - less
than 1%, but the total foreign investment was about 11% of global GDP in 2010. UN study and, in
particular, UNCTAD World Investment Report in 2011 has not confirmed that the state TNCs operate
mainly commodity industries. Primary sector is less than 9% of the total number of public TNCs
operating in the world at the moment, with about 70% of these are in the service sector (19% in the
financial sector, and 16% in transport and communications) and about 22% in the manufacturing industry.
Source: World Investment Report 2011, UNCTAD
Fig. 2. The ratio of public and private shares in the world of public TNC, 2011
Russia does not occupy the top position in the global markets of industrial capital in spite of the largescale dynamics of the growth of export of Russian capital abroad in recent years. In this sector, Russia’s
share is negligible; it is 0.4-0.5% of FDI in the world’s accumulated FDI (Решетникова Е., 2011). This
situation does not correspond neither to country’s ability, nor to it’s needs. Based on this, we can
conclude that the trans-nationalization of Russia’s economy is minimal, in terms of this parameter.
However, the export of capital from Russia has a positive effect on international trade, commodity
exports, and on increase of the competitiveness of domestic companies and the national economy as a
whole. It also stimulates the inflow of profits and dividends, taxes, which could be much higher if most of
the export of capital would not be illegal origin.
So far, few companies in Russia meet even the general criteria of UN to be considered a TNC. In the
top ten largest 500 corporations in the world (in terms of transnationality) are no Russian TNCs. For
example, “Lukoil”, the leader of Russian multinationals in all indicators of trans-nationality, has the size
of its foreign assets is 58 times less than that of „General Electric”, a world leader in this indicator, and
nearly 20 times less than that of “British Petroleum” (BP). In 2009, the total foreign assets of the 25
largest Russian TNCs were equal to only about 2.4% of the value of foreign assets of the 25 largest TNCs
Natalia Spiridonova
569
(24 of which are based in the U.S., Europe and Japan, and one - in China) and a little more than 17% of
the value of foreign assets of 25 developing country TNCs.
However, the Russian TNCs are active in recent years. Since the beginning of 2001 to early 2010, the
accumulated foreign direct investment by Russian transnational corporations increased from $ 20 billion
to $ 400 billion according to the Central Bank of Russia. For the 2007 - 2010 years foreign assets of the
25 largest Russian international investors increased by 3.5 times (up to $ 70 billion), sales to foreign
buyers and the number of employees in foreign companies doubled to $ 300 billion and 210 thousand
people. In 2009, the foreign assets of Russian multinationals increased by 21.7 billion, almost 2.8 times
more than in the previous year. Thus, at the beginning of 2008, the value of foreign assets of Russian
multinationals exceeded $ 120 billion and $ 140 billion in 2009 (Березной. А., 2010).
For successful adaptation to globalization leading Russian banks should be part of the trans-national
banks (TNB), the leaders in the world rankings, as well. However, the position of Russia in the global
banking system is much weaker than in the field of industrial multinationals. The most important
indicators of the Russian banking system, which includes a lot of small business entities in accordance
with international standards, are lower than the corresponding figures of the top ten of TNB (KP Sauvant,
2008).
Russia’s involvement in the integration process as a way into the global economy
Centre for Economic and Financial Research (CEFR) studied the effect of foreign competition and the
processes of liberalization on domestic industries. All domestic enterprises were divided into several
groups: export-oriented enterprises (in which the export share exceeds 30%, the share of imports is less
than 30% and the index of intra-industry trade is low); import substitution companies facing high
competition from imports (where production is aimed at import substitution in industries and the share of
imports is over 80%); and enterprises from sectors with a high level of intra-industry trade (intra-industry
trade index is greater than 50%), as well as enterprises that produce goods for domestic consumption
only.
The study was concluded that a large number of industries can combine imports with domestic
production. In these industries, the growth of import competition creates incentives for companies to
improve their products and management practices. Opening up the economy to foreign direct investment,
the use of foreign components, as well as work on a foreign customer can produce a similar effect, too.
On average, competition with foreign producers or import promotes more rapid restructuring and
competitiveness of their products. Consequently, competition from foreign goods can have a significant
positive effect on the development and growth of competitiveness of Russian industry, more than the
increase of protectionism (ЦЭФИР, 2002).
Russia seeks to use globalization for the benefit of its own economy. Active international integration,
as the former Soviet Union (EEC), and on a high international level (WTO), has become the main tool to
achieve this at the moment. Not yet possible to state with certainty that WTO accession will impact
positively on the economy of Russia. But gradually reducing protectionism and trade liberalization are
new mechanisms that are not used in the past to the full, and, possibly, it is the international economic
integration will be the basis for the favourable developments in the domestic economy. From this point of
view, the WTO and other trade unions should lead to a substantial change in the institutional environment
and help bring Russian legislation in line with WTO requirements. The ability of local and regional
authorities to put pressure on foreign investors will be reduced. Protection of intellectual property rights
for foreigners and the Russians will be improved. Embedding of the economy to international supply
chains will happen as a result, potential investors will have more information about the country. All this
will contribute to a favourable investment climate in Russia, growth of FDI (Douglas W. Blum, 2008).
570
Natalia Spiridonova
Globalization has covered virtually every sector of the economy; it gradually changes the balance of
external and internal factors in the development of the national economy in the direction of the first of
these. At the moment, no country can realize its future development strategy based solely on their own
resources, regardless of their size and level of development. Modern national socio-economic system
accepts globalization as a historical trend, but does not accept a purely market-based approach to it.
Different types of states have specific mechanisms for survival and development in a globalizing
world. The mechanisms designed to help achieve the optimal level of openness of the national economy.
This level corresponds to the needs and conditions of the economy as well as the specific way to integrate
into the global economy. Success will depend on the effectiveness of management processes, and in
particular, the ability of the state to provide high rates of investment, the State’s policy that encourages
the acquisition and development of new technologies, as well as the establishment of a regulatory
framework, which would provide the conditions for rapid economic development.
Summary Points
1. There is a process of formation of a single economic space, the modification of the national industrial
and post-industrial systems in the context of globalization in the world. The weakening of traditional
national systems of state regulation of the economy is not offset by the creation of international,
supranational regulatory mechanisms. Contemporary neo-liberal model of globalization has given rise
to the differentiation of the peace of the country winners and losers from globalization. Countries
seeking additional opportunities, benefits, trying to adapt to current conditions in the global process of
adapting to the different countries of economic globalization.
2. The consequence of globalization is different for developed countries and emerging economies, as
well as the ability to adapt. Large states cope with the challenges are not always efficient than small
ones. The large size of the state can lead to political, economic and administrative inertia or
nationalism. Small states are using their specific technology and ideas to cope with global competition
successfully. Asian NICs are adapting to the demands of globalization, with the help of state
development on export-oriented economic model. In developing countries and emerging market focus
is on the orientation of the economy on the domestic market, but not for export, for solving the above
problems.
3. Integration of national economies into a single global system can lead to the formation of the new
structure of the national socio-economic system, speed up the process of modernization. There are
three main models of modernization: westernization, overtaking model, national model. For Russia
the basic model becomes a national model.
4. TNCs are one of the leading actors of globalization. Russia should have a powerful TNCs (with
Russian control of capital and headquarters located in Russia) for equal participation in the global
economy and active impact on the global economy. Russia does not occupy first place in the global
markets of industrial capital in the present, trans-nationalization of Russia’s economy is minimal. To
solve this problem it is necessary to develop a mechanism of public-private partnership which should
eliminate inefficient areas of investment of public funds and increase the investment activities of the
private sector, reducing the political and economic risks.
5. Thanks to an active international integration as the former Soviet Union (EEC) and at a higher
international level (WTO), Russia will get additional features and benefits of the liberalization
process. Success depends on the efficiency of the development process and, in particular, the ability of
the state to provide sustained high growth rates of investment and policies that encourage the
acquisition and development of new technologies, as well as the creation of a favourable investment
regulatory framework, which would provide the conditions for accelerated economic development.
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2004, # 1, p. 52.
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2009, #1, pp. 11-22.
Решетникова Е., 2011, Активы российских ТНК выросли за счет приобретения зарубежных
компаний, Российская Бизнес-Газета. [Online] Available at: http://www.rg.ru/2011/06/28/
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Спиридонова Н., 2013, Теоретический анализ экономических систем: Учебное пособие, СПб.,
Питер, 2013, pp. 155-156.
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[Accessed 15 Marth 2013]
572
Natalia Spiridonova
EUROPEAN ECONOMIC GOVERNANCE AND SOCIAL DIALOGUE
Sergejs Stacenko, University of Latvia, Latvia1
Abstract. The social partnership in the EU is seriously affected by the financial crisis and subsequent
economic recession of 2008-2010 and the 2011-2012 sovereign debt crises in Eurozone. The paper
examines social dialogue between unions, employers and governments as a fundamental element of
industrial relations at large. However, a framework of this study is a new EU concept of economic
governance and response of trade unions to this concept. The position of trade unions with regard to
implementation of the economic governance is discussed. The paper provides an overview of the current
challenges that confront public authorities and social partners in the EU. The author had elaborated the
approach to industrial relations and social dialogue taking into account a comparative approach applied
by international institutions in the context of existing socio-economic trends. The research methodology
is based on quantitative data collection as well as qualitative analysis of the available information at the
EU level and in Latvia. In addition, a comparative analysis was applied while models of trade unions
were analysed and the trade unions’ practices as a social partner in the decision-making processes in the
EU and Latvia have been illustrated. Finally the paper considers how the trade unions performance in
Latvia could be encouraged, e.g. through changing tasks and functions and empowering stakeholders to
perform efficiently in general and in relation to the new European social and economic governance.
Key words: European economic governance, trade unions, legislation, social dialogue, social
partnership
JEL code: J50, J52, J53, J54, J58
Introduction
Decision-making in the EU is based on certain conditions that are convincingly presented in a number
of the EU documents and regulations. It is also underlined in the EU2020 Strategy (COM (2009) 647
final). Social Partnership in public administration and economic governance at the EU level and in the EU
Member States refer mainly to trade unions and employers’ organisations as main partners (COM (2011)
813 final  2011/0390 (CNS) in negotiations related to decision-making process in searching for the best
approach to deeper and more efficient European integration process.
Social Partnership and economic governance in the EU was seriously affected by the financial crisis
of 2008-2010, subsequent economic recession, and the Eurozone public debt crises of 2011-2012.
Implementation of monetary and fiscal austerity measures required negotiations with social partners to
prevent undesirable social consequences (ETUC and ETUI, 2012). However, according statistical
information the Euro area unemployment rate was 11.8 at the end of 2012 and the EU-27  10.7%
respectively. The highest unemployment rates have been recorded in Spain (26.6%) and Greece (26.0% 
September 2012) (Eurostat, Euro area unemployment rate, News Releases 4/2013). The crisis which
Europe has been undergoing since 2008 is having an exceptionally severe and ever-increasing impact on
young people; the youth unemployment rate stood at 22.7% in the third quarter of 2012, twice as high as
the adult rate 1 (European Commission, COM (2012) 727 final, Brussels, 5.12.2012), and no signs of
improvement are in sight. Employment relations greatly influenced these employment rates and
1
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573
understanding the industrial relations during the crisis would produce useful conclusions to improve
responses to the possible next economic downturns.
The economic and financial crisis 2008-2010 highlighted systemic complications and, consiquently,
an urgent need to develop new policy responses in economic governance and public administration to
overcome fundamental issues in the context of the followed public debt crisis 2011-2013 as well as its
consequences. The new economic governance is aimed at provide social stability in the EU and alleviate
social hardship. The EU and its member states have put in place a new set of regulations, procedures and
institutions that have come to be known as the “new European economic governance”, which is a
comprehensive Commission package of six legislative proposals to strengthen existing tools and extend
them for coordinating economic and fiscal policy in the EU and more specifically in the euro area – as
part of the EU’s response to the current turmoil on sovereign debt markets. Further provisions are made
for the “European Semester” (Council of the European Union, Brussels, 8 November 2011, 16446/11,
PRESSE 413).
Recent conference by the European Trade Union Institute on “European labour markets in (the)
crisis: Is there light at the end of the tunnel?” shows importance of economic governance and reforms
related to the implementation of the economic governance in the EU Members States. It was highlighted
that governments should focus on labour markets and employment as one of the dimensions included in
the above mentioned legislative proposals. According to László ANDOR, European Commissioner
responsible for Employment, Social Affairs and Inclusion “Governments and social partners must think in
concrete terms about how to create and maintain jobs. Europe needs to boost demand for labour…
employment policy is not only about ensuring that the unemployed are job-ready but also about
stimulating hiring. Member States need to seriously lower the tax wedge on low-paid labour, also by
taxing capital incomes, property and pollution more. Shifting taxation away from labour is a structural
reform conscious of the fact that our economy and society needs more people to work and to make a
living through work.” (Speech 13/88 Brussels/31 January 2013).
The complex nature of the economic downturn influenced employment policies and industrial
relations institutions that are varied in the EU countries (European Commission, 2012, ETUC, 2011).
Social partnership in public administration research is closely linked to analysis of the position and
activities of collective actors e.g. employers’ organisations, trade unions and governments. A fundamental
element of the economic governance, decision-making process in the EU and industrial relations at large
is social dialogue and social partnership between unions and employers. The key institution in this
context is a collective labour agreement. Employment relations greatly influence employment rates. The
organisation of employment relations also influences understanding the industrial relations in public
administration management. Further research related to the above-mentioned changes in the labour
market and the role of social partnership at the time of crises may suggest some conclusions and
recommendations related to practical considerations of adequate responses to economic downturns.
Methodology of research
The framework of the study is the concept of industrial relations in the EU in general and, in public
administration in particular. The role of trade unions in social dialogue and social partnership is an
important element of the framework. The author had elaborated an approach to industrial relations and
social dialogue taking into account comparative method to definitions provided by such international
institutions as International Labour Organisation and Organisation for Economic Cooperation and
Development. An opinion of institutions in the EU and Latvia related to the industrial relations and social
partnership has been considered. The authors also refer to a number of studies by scholars that made
contributions to this area of research. The research methodology is based on quantitative data collection
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Sergejs Stacenko
as well as qualitative analysis of the available information. In addition, a comparative analysis was
implemented while models of trade unions were analysed and the role of trade unions as a social partner
in the decision-making process have been illustrated. The authors applied central tendencies variation
indicators and grouping. In particular, some examples of analytical results of questionnaires, distributed
among representatives from Latvian Free Trade unions Federation, sectoral trade unions and expertinterviews are presented.
Special attention is given to trade unions as a social partner in decision -making process at the EU
level, due to significantly developed social partnership, which is a part of the EU social dimension as
compare to the other parts of the world.
The authors exploited Database on Institutional Characteristics of Trade unions, Wage Setting, State
Intervention and Social Pacts (ICTWSS) European Industrial relations observatory (EIRO) online; The
European Foundation for the Improvement of Living and Working Conditions ; The European Social
Survey, European Trade Union Institute database. The above databases helped to provide institutional
analysis of labour unionization, the role of state in this process and some issues related to unionization as,
for example, trends in collective bargaining and wages.
Legal framework of social partnership in public administration
Social partners at the European level are organised according to three different types of activities. This
system is the most advanced organisational scheme in the international labour practices:
1) Tripartite consultation, exchanges are between social partners and European public authorities;
2) Consultation of the social partners, these cover the activities from consultative committees and
official consultations;
3) European social dialogue, the bipartite work of the social partners, whether or not it stems from
the official consultations of the Commission are based on Articles 153 and 154 of the Treaty on
the functioning of the European Union (TFEU, Official Journal C 115/47, 2008).
In EU Member States the collaboration between state and social partners is an important link between
industrial relations and government policy. It provides the means of adjusting collective bargaining to
national economic, employment and social policy while opening it up to possible influence by social
partners. Two subsystems of social partnership can be differentiated: bipartite consultations and negotiations
between the social partners on one hand, and tripartite consultation and concerted policy-making between
the social partners and the state on the other. Bipartite social partnership encompasses three arenas:
1) the informal practice of negotiations and discussions at cross-sector levels;
2) the collective bargaining system, focused on the sectoral level and representing the core institution
of bipartite social partnership.
Tripartite social partnership relates to all social and economic policy issues, which in formal terms fall
within the purview of state powers and responsibilities.
The European Union has no powers to harmonise the numerous – and in some cases very different –
systems of employment policies and social protection in the member states. Instead, the role of the EU
institutions is to coordinate these systems to protect the main principles of the Common Market, by
applying the Open Method of Coordination. The European Social Charter articulates a number of
fundamental rights in such areas as collective bargaining, protection from unjustified dismissal,
workplace health and safety (European Social Charter, 1996).
At the company-level, social dialogue was implemented in the EU by the adoption of the European
Works Councils Directive in 1994 subsequently revised in 2009 (Official Journal C 340) and in 2002
(Official Journal L 80) a general framework for informing and consulting employees in the European
Community was establish with a Joint declaration of the European Parliament, the Council and the
Sergejs Stacenko
575
Commission on employee representation. It was a successful result of constructive negotiations on
promoting fairer economic development through collaborative efforts to increase productivity and
enhance work conditions.
1. Economic governance and industrial relations
Labour market policies vary in the EU Member States. According to a World Bank experts (Auer,
Cazes, 2003), the most flexible labour market considered to be Denmark. Another countries representing
flexible labour markets are, according to experts, Sweden and UK (Pissarides Ch.A., 2008).The most
common example cited to illustrate the concept of ‘flexicurity’ is the Danish model with Competitive
labour cost level and well-organised labour market with good cooperation between the social partners,
competitive remuneration costs for employees. In addition, employers can terminate of contracts and are
entitled to dismiss skilled and unskilled workers at any time, thus and individual business could adjust its
function and the size the required labour. Wages and work hour rules are the result of negotiations
between labour market institutions or directly at the company.
Table 1
Employment Policies and Regimes in EU-15
Regime
Regime A
Regime B
Regime C
Regime D
1.
2.
3.
4.
1.
2.
3.
4.
1.
2.
3.
4.
1.
2.
3.
4.
Policies
High compensation rates
Strict availability for work requirements
Active LMPs
Low to average employment protection
Low compensation rates
Few formal demands on availability
Varying degree of active LMPs
Limited employment protection
Varying compensation rates
Varying demand on availability
Passive LMPs
Average to high employment protection
Average compensation rates
Strict availability for work requirements
Passive LMPs
High employment protection
Countries
Denmark, the Netherlands,
Sweden
Ireland, United Kingdom
Austria, Belgium, Finland,
Germany
France, Italy, Spain, Portugal,
Greece
Source: Danish Ministry of Finance (2004-2011), Medium Term Economic Outlook
According to a report by the Danish Ministry of Finance on labour market performance in the EU-15,
there are four identifiable regimes of labour market policies (LMPs):
1. The North-European regime (A) – Denmark, the Netherlands, Sweden. These countries have
generous unemployment benefits and disincentive effects are counterbalanced by strict rules
governing availability for jobs, and low to medium employment protection.
2. The Anglo-Saxon regime (B) – the UK and Ireland. Low unemployment benefits, and expenditures on
active labour market policies, few demands for availability, and a low level of employment protection.
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Sergejs Stacenko
3. The Central-European regime (C) – Austria, Belgium, Finland, and Germany. Labour market
policies in these countries are predominantly passive and employment protection is at average
European levels.
4. The South-European regime (D) – France, Greece, Italy, Portugal, and Spain. In these countries,
employment protection is high, unemployment compensation close to the European average, and
labour market policies are passive.
In most countries of the EU employment policies are based on a combination of elements from B and
C regimes. In Latvia, for example, there are elements of these two regimes with the following elements:
low compensation rates, few formal demands on availability, limited employment protection, and passive
labour market policies. To promote implementation of the ‘flexicurity’ principles in Latvia, the Saeima
(Parliament) adopted on 15 May 2009 amendments to the Labour Law, which brought flexibility and
security in employment relations (LR Labour Law amended, 2010).
More flexible labour markets would reduce the costs of companies adjusting to rapid changes of the
highly integrated international economy and improve competitiveness of the EU member states. At the
same time, increased labour participation and higher income security contributes to higher levels of social
inclusion. The ‘flexicurity’ approach is integrated in the Europe 2020 strategy and is expected to
contribute to the achievement of its objectives (European Commission, 2010). ‘Flexicurity’ comprises six
fields of activities which promote labour market flexibility and employment security by mutual
cooperation (Table 2).
Table 2
Fields of activities for implementation of the flexicurity system
Labour legislation and agreements
are sufficiently flexible and
correspond to the interests of both
the employer and the employee
A modern social security system
must be established
Active labour market policies must
efficiently facilitate the transfer
from one workplace to another or
from the status of unemployed to
employed
Adequate assistance to residents in
case of unemployment
Lifelong learning systems
should
be
improved
enabling an employee to be
employed throughout the
working age
Flexicurity must facilitate
mobility and faster return
to the labour market
Source: adapted from European Commission Draft Report “Draft Joint Employment Report (JER)”, 2009/2010, COM(2009) 674/3
Implementing the aims of the Lisbon strategy and the principles of ‘flexicurity’ in Latvia requires
ensuring an effective social dialogue between the Employers’ Confederation of Latvia, the Free Trade
Union Federation, and the government. This is another example of the implementation of social
partnership in the country. Yet the development of this concept is still not included in national
programmes on a large scale and does not enjoy strong government support. Several measures have been
implemented in the recent years to improve the social dialogue on the national and local level. For
example, with the help of European Social Fund financing, Latvian social partners including the
Employers’ Confederation of Latvia and the Free Trade Union Federation of Latvia, local governments,
and the Latvian Association of Local and Regional Governments are involved in employment partnership
and in improving the social dialogue at national and regional levels. This employment partnership could
ensure social dialogue on the local and regional levels and increase the opportunities for social partner
participation in the decision-making process and provision of public services, as well as to improve the
quality of public services provided by non-governmental organisations. Employment policies at all macro
and micro levels are linked to industrial relations. Current socio-economic trends show the existence and
practices of industrial relations in company, industry, and public sector levels of management (European
Foundations for the Improving Living and Working Conditions, 2007). For example, tighter fiscal
Sergejs Stacenko
577
discipline has been one of the policy imperatives of the governments of EU Member States for the past
decade. Social partners involved in this process agreed about the need for tighter control of public
spending.
The fiscal targets set out in the Maastricht process (Official Journal C 191, 1992) under discussion
during the current EU debt crisis have reinforced financial discipline. Strong fiscal discipline has a
number of implications for industrial relations. For example, it has led governments to focus on greater
efficiency and higher productivity in public services resulting in reviews of how public service pay is
determined, grading structures, employment contracts, and working practices. Fiscal discipline has also
provided added impetus to new approaches to public management, such as the ‘strategic management
initiative’ principles, devolved administrative budgeting, clearer objectives for service delivery, more
accountability and flexibility in deploying resources, and devolving managerial decision-making
authority. This change in public management due to the imperative of fiscal discipline on governments,
inevitably led to the establishment of a new type of industrial relations practices in the public services,
health, education and local authorities.
Industrial relations related research is closely linked to analysis of the position and activities of
collective actors, e.g. employers’ organisations, trade unions and governments. A fundamental element
of industrial relations is social dialogue and the key institution in relations between unions and
employers is the collective labour agreement. The complex nature of the economic downturn
influenced employment policies and industrial relations institutions that are varied in the EU countries
(ETUC, 2011; European Commission, 2011). In general, institutions of industrial relations are defined
as ‘arrangements to regulate the employment relationship’ (Milner, 1994). Given that wages are the
most important feature of the employment relationship, the institutions which regulate, set or influence
wages are of particular significance. As a result, trade unions play a major role in industrial relations. A
general trend of growing trade union activity of employees in Europe was recorded between the 1930s
and the 1980s. Collective bargaining performed impressively after World War II, more than tripling
weekly earnings in manufacturing between 1945 and 1970, gaining for union workers an
unprecedented measure of security against old age, illness, and unemployment, and, through
contractual protections, greatly strengthening their right to fair treatment at the workplace (Milner,
1995; Trade Union Congress and the Economic and Social Research Council, 2011). There have
already been several decades of trade unions decline, shrinking union density in the EU countries,
decentralisation of collective bargaining, and lowering of employee participation level. These trends
are observed in most EU countries. Trade union membership statistics released by the European Trade
Union Confederation in 2011 show that union density and collective bargaining coverage ha ve once
again fallen. Less than 31 per cent of workers were covered by a collective agreement in 2010, which is
2 per cent less than in 2009 and 5 per cent less than a decade ago. In 2010, union participation in the
private sector fell from 18 per cent to 17 per cent, and in the public sector from 68 per cent to 64.5 per
cent (European Trade Union Confederation, 2011). This means that across both the private and the
public sector, fewer workers are covered by collective bargaining than at any time since Wor ld War II.
These lowering trends of trade union density rates have spurred policy makers and scholars to study the
organisation of trade unions, their models, and negotiations of collective agreements.
Recently a number of changes and reforms have been taken place as the result of the current
economic problems in the EU and EU Member countries. Despite of the active position taken by the
trade unions, their representation has been weakened as well as actions taken at all bargaining levels.
This could affect the aim, core functions, and institutional tasks of trade unions of protecting and
representing employees. Decentralisation of collective bargaining to the lowest level weakens the
social acquis achieved so far by the trade unions at national and local levels and will affect sectoral
collective bargaining. It also lowers the standard of rights recognised anchored in legislation and
collective agreements, as well as affecting fundamental employment conditions related to working
time, pay, work organisation, working environment, social protection, and workplace health and safety.
578
Sergejs Stacenko
The recently published discussion paper by Christophe Degryse (ETUI, 2012, pp. 69-80) questions the
relevance of the proposed remedies and criticizes the austerity approach which use s “structural
reforms” to undermine the European social model.
It is also important to underline that national reforms affect the hierarchy of social norms. For
example, in some cases in Latvia, there has been recourse to ‘emergency procedures’ by national
legislators to bypass agreements on ‘anti-crisis’ measures agreed upon by social partners and/or prepared
by national governments in consultation with them. As a result anti-crisis measures and labour law
reforms directly or indirectly affected fundamental social rights. Further research related to impact of
legislation on the labour market and the role of social partnership would be helpful.
2. Industrial Relations and Trade unions in Latvia
The evolution of trade unions in Latvia as in the other post-socialist countries is rooted in the
transformation process from the socialist system to a system of market economy and reflects responses to
social and political changes that the country has undergone during last 20 years of independence. As the
result, trade unions in Latvia have been in transition process until Latvia became a member of ILO and
the EU. These memberships influenced transition of trade unions from a model in which state has a
dominant position to a model that represents a social partner unionism. The transition process of
changing the role of trade unions taking place in Latvia is common also to other countries that formerly
were a part of the Soviet Union trade unions’ system. Latvia’s membership in the EU and adoption of a
number of international agreements and conventions has increased the importance of trade unions as trade
unions became a social partner to the government and employers confederation in tripartite negotiations
and thus could influence decision-making process. On behalf of 20 trade unions a single central Trade
Union organisation – the Free Trade Union Federation of Latvia (LBAS) represent their interests.
However, in Latvia as in many other countries in Europe, trade unions’ membership has been declined
dramatically from the early 1990s and until now.
Table 3
2
Changes in the Trade unions membership in Latvia 1995- 2010
Year
Membership
1995
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
320 572
200 100
195 700
179 700
175 500
170 000
169 708
167 424
151 222
151 222
143 000
127 000
Membership in %
to the number of employees
27
24
20
18.3
18
17.2
16.8
16.7
16.5
16.5
16
14
Source: author’s estimations based on European Industrial relations observatory on line (2010) Available http://www.workerparticipation.eu/National-Industrial-Relations/Across-Europe/Trade-Unions2; ICTWSS: Database on Institutional Characteristics
of Trade unions (May 2011), Available: http://www.uva-aias.net/208;The Free Trade Union Federation of Latvia data
2
Data for 2011 and 2012 is not available
Sergejs Stacenko
579
Overall around only 14% of employees are members of trade unions. Membership is higher in some
areas of the public services – in general 33%, but in health and social work, and in education systems a
membership could reach up to – 60%, for example.
Table 4
Employees desire for trade unions membership in Latvia 2006-2010
Total number of employees questioned – 2 378
Employees that would like to obtain membership (%)
Employees that did not like to obtain membership (%)
Trade unions members out of respondents
2006
29.2
43.7
16.1
2010
23.4
64.9
5.8
Difference (%)
-5.8
+21.2
-10.3
Source: authors estimations on Latvian Employers Confederation database: working conditions and risks in Latvia 2009-2010 in
the framework of the research project Nr. 1 DP/1.3.1.3.2/08/IPIA/NVA/002
One of the important elements in employee-employer relations is collective agreements.
Table 5
Changes in activities of trade unions in Latvia 1995-2012
Population
Latvian Free Trade unions Federation (LBAS)
Collective barganing coverage (%)
Proportion of employees in unions
Principle level of collective barganing
1995
2,749,211
1
20
27
company
2012
2,191,580
1
34
14
company
Source: authors’ calculation base on LBAS database; European Industrial relations observatory on line (2010) Available:
http://www.worker-participation.eu/National-Industrial-Relations/Across-Europe/Trade-Unions2;
ICTWSS:
Database
on
Institutional Characteristics of Trade unions (May 2011), Available: http://www.uva-aias.net/208
In Latvia collective agreements cover around 20% of all employees, however, coverage is higher in
the public services at around 55% in health and 90% in electricity sector (Latvian Free Trade Unions
Federation (LBAS) Database. Available at: http://www.lbas.lv/members). Collective bargaining takes
place mainly at local, company level and in the public sector. There are some sectoral agreements,
particularly in the public sector, in various civil service and public companies, for example, energy and
water suppliers and forests. However, higher-level collective agreements are rather policy documents,
dealing with issues in social partnership, than collective bargaining on employment conditions. Principle
level of collective bargaining is at the company level.
The framework for collective bargaining was set out in laws passed in 1998-1999 as well as during the
negotiations on the accession to the EU. The Latvian bargaining coverage is at the lower end of the scale.
Concluded sectoral agreements are very general and in majority of cases they just reproduce the
possibilities offered by the law. The dialogue at enterprise level is more common and better developed,
especially in medium and large enterprises.
In order to understand the conditions under which organisations acquire success and strength, it is
important to consider how trade unions, their leaders and employees interact.
To deal with these issues, questionnaires have been distributed to representatives of the Latvian Free
Trade Union Federation, the Latvian Railway Workers Union (which functions in the state sector and has
16,000 members) to the Latvian Transit Workers Union (in the private sector with 1,000 members), Latvian
Trade unions in Health Sector (12,000), Trade unions of Local Government (5,300), Latvian Trade unions of
education and Science Employees (32,597) in addition to the above, the questionnaires cover a number of
questions about employment policy in the country, strategic planning of employment policy at the company
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Sergejs Stacenko
level, trade union policy related to potential increase of membership and on the role of trade unions in social
dialogue (this question is particularly important in the light of the current economic recession). On the basis
of the analytical results of questionnaires and interviews, distributed among representatives from the abovementioned trade unions, the following major conclusions could be summarised:
1. In general, employees in Latvia have opted for individual strategies rather than collective
strategies to improve their economic situation. This trend weakens employees’ collective identity.
2. Trade unions members’ collective identity and participation are proportional to their feelings of
importance in their organisation.
3. The interviews’ results illustrated that the interviewees considered skilled leadership fundamental
to trade unions’ success. And once the members of the organisation see concrete policy results by
means of their participation, they will have more reasons to participate.
4. Trade union leaders rose up through the union hierarchy mostly through their cultural capital and
expertise.
5. Overall the involvement of trade unions as well as the other social partners is not strong enough,
despite some examples in which unions’ voices were heard.
Latvia was hit by the economic crisis more seriously than others. The economic crisis originated in the
reversal of the domestic real estate boom and worsened rapidly when risk aversion became extreme on
global financial markets. In 2009, GDP had fallen by 18.7%. According to the Ministry of Economy at the
end of the 2010 Latvia managed to overcome the recession, and in 2011 a slow recovery started that is
continued in 2012. Significant budget consolidation measures have been taken to implement the cumulative
fiscal adjustment in 2009-2010 to the amount of 10.5% of GDP. Additional cuts to public spending were
taken in 2011. This trend increased the number of unemployed and the subsequent reduction in demand. As
a result, trade unions have found it more difficult to maintain collective agreements in an increasingly
international competitive economic environment. A number of protests had already been organised by trade
unions against government decisions about state budget reduction for social protection in 2007, followed by
protests in the following years. Despite the substantial decline in membership, unions seem to have retained
as strong voice on the national stage. The European Trade Union Confederation (ETUC) called for a new
social deal across Europe (EPSU/CEMR-EP, 2010) on the economic crisis that would provide an alternative
to the neoliberal policies being proposed by governments in the New Member States including Latvia,
which had been hit by the crises. Another trend related to the crisis is the high loss of trade unions members
due to redundancies, a serious decrease in collective agreements, and the comparative lack of success of
public protest against austerity measures. What most troubles interviewed trade union representatives was
the large number of membership cancelations due to redundancies, leading to a loss of bargaining power,
resources, and representatives. In comparison to its counterparts, trade unions in Latvia are hit harder by
mass redundancies due to the collapse in demand took place primarily in the sectors where trade unions are
traditionally strong, i.e. manufacturing, transportation, communication. The branch unions’, particularly in
the transport and public sector, make more frequent use strikes to achieve their objectives. However, the
position of the Latvian Free Trade Union Federation in the current economic situation has become more
visible and stronger than in the past. Trade union leaders have criticised both tax changes and sectoral
support measures and made their own proposals (together with other social partners), some of which have
been accepted by the government. Trade union resistance prevented the introduction of some measures.
During the process of deepening and widening European integration development of new forms of
partnership at European, national, and company levels occurred. In the European labour movement the
involvement of social partners and in particular trade unions within these institutions provide a solid basis
Sergejs Stacenko
581
for the redefinition of trade unions’ strategy and identity. One of the major influential factors related to
the strategy of trade unions and their collective bargaining is intensified international competition and
currently, domestic economic and financial insecurity. There are, however, some signs of resistance
starting to develop within the European labour movement challenging both the acceptance of austerity
measures to overcome current economic crisis and the strategy of social partnership. These development
take the form of a transnational “social movement unionism” that links diverse groups and networks in
opposition to austerity measures as being a core element of the neo-liberal conception of macroeconomic
and fiscal stability. This is of particular importance due to growing globalization and the mutual
interaction between the world’s economy and negotiations of world leaders with social partners.
At the time when Latvia recovers from economic recession, particularly, from a fall in production, and
when the Latvian government has determined to pursue strict and stable monetary policy and to stabilize
the state’s financial system, in the opinion of the author, an improved governance, transparency, and
involvement of stakeholders in the social dialogue are essential to strengthen the links between economic
development and effective employment policies. It would be important to coordinate financial system
support measures with active labour market policies in order to mitigate structural long-term
unemployment and to avoid social tensions.
The following consequences are taking place as the result of the current economic downturn and
subsequent recession:
 a shift in the balance of bargaining power in favour of employers;
 further weakening of trade unions due to membership losses, resulting in lower representation;
 decreasing capacity of trade unions’ to represent employee interests, influence changes in labour
legislation, to ensure constructive social dialogue, and to strengthen social-democratic policies in
Latvia.
Currently trade unions have found it more difficult to maintain collective agreements in a more
internationally competitive economic environment. It is clear that changes in employment law are a key
factor that explains the declining levels of bargaining coverage in recent years. Improved governance,
transparency, and involvement of stakeholders in the social dialogue are essential to strengthen the links
between economic development and effective employment policies.
Together with monetary and fiscal stimulus policies, negotiation and consultation involving social
partners and trade unions in particular could play a significant role in limiting negative social
consequences and a number of crucial economic recovery objectives such as reform of the global
financial system, restoring and improving growth dynamics to create more and better jobs, promoting
skills and entrepreneurship, revitalising the single market and developing an integrated EU industrial
policy among others. However, it should be taken into consideration, that there are some signs of
resistance starting to develop within the European labour movement challenging both the acceptance of
austerity measures to overcome current economic crisis and the strategy of social partnership.
In Latvia, trade unions could strengthen their efficiency by using lobbing mechanisms in tripartite
negotiations.
Trade unions in Latvia could also apply the EU15 experience and to open an opportunity of organise
trade unions based on the ideological and political views of their members. This could positively
influence the increase of membership.
In conclusion the author underlines, that many trade unions worldwide currently consider
development of transnational organisations. Trade unions in Latvia could also have more ties with the
other Baltic States as they have common history as well as with Scandinavian countries and learn from
good practices on successful negotiations of employment issues with other social partners as well as to
share possible geopolitical interests.
582
Sergejs Stacenko
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Council of the European Union, Economic governance: Council adopts legal texts. Brussels, 8
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László ANDOR, European Commissioner responsible for Employment, Social Affairs and Inclusion.
Labour market: Cinderella of EU recovery strategy? Speech 13/88 European Trade Union Institute
conference “European labour markets in (the) crisis: Is there light at the end of the tunnel?”.
Brussels/31 January 2013. [Online] Available at: http://europa.eu/rapid/press-release_SPEECH-1388_en.htm?locale=en.
EC Working Document. Consultation on the Future “EU 2020” Strategy Brussels, 24.11.2009., COM
(2009) 647. [Online] Available at: http://ec.europa.eu/eu2020/pdf/eu2020_en.pdf.
2012/C 143/18 Opinion of the European Economic and Social Committee on the ‘Proposal for a Council
Decision on guidelines for the employment policies of the Member States’, COM(2011) 813 final 
2011/0390 (CNS).
Auer, P., Cazes, S. (eds.), 2003. Employment stability in an age of flexibility: evidence from industrialized
countries, ILO, pp. 90-105.
Danish Ministry of Finance (2004-2011), Medium Term Economic Outlook.
Degryse, Ch., 2012. The new European economic governance ETUI, Brussels. 84 p.
Bovaird, T., Löffler, E., 2010. Evaluating the Quality of Public Governance: Indicators, Models and
Methodologies. International Review of Administrative Sciences, 2003 69: 313 DOI:
10.1177/0020852303693002.
Milner, S., The Coverage of Collective Pay-Setting Institutions in Britain, 1895-1990. British Journal of
Industrial Relations, March, 1995, 33:1.
Pissarides. Ch.A., 2008. The Labour Market and the Euro. Cyprus Economic Policy Review, Vol. 2,
No. 1, pp. 3-9.
Economic Development – the Crisis is not Over in Benchmarking Working Europe, 2012. ETUC and
ETUI, Brussels, Belgium, pp. 10-20.
European Commission (2012), Employment, Social Policy, Health and Consumer Affairs Council
Employment and Social Affairs, 21 June 2012, Luxembourg, MEMO/12/466, Brussels, 20.06.2012.
Eurostat, Euro area unemployment rate, News Releases 4/2013.
European Trade Union Confederation (ETUC), 2011. The European social dialogue. [Online] Available
at: http://www.etuc.org/a/1751.
Lisbon Treaty Consolidated version of the Treaty, Official Journal C 115/47 of 9 May, 2008.
European Social Charter, Council of Europe Treaty, adopted in 1961, revised in 1996. [Online] Available
at: http://www.hrcr.org/docs/Social_Charter/soccharter.wpd.
European Works Council Directive, Official Journal C 340, 16 May 2009.
Directive 2002/14/EC, Official Journal L 80, 23 March 2002, pp. 29-34.
Latvian Free Trade unions Federation (LBAS) Databases: http://www.lbas.lv/members, 01.03.2011.
Ministry of Economy of the Republic of Latvia, 2010. Report June 2010.
Ministry of Economy of the Republic of Latvia, 2011. Report December 2011.
EPSU/CEMR-EP Joint Statement to the European Council meeting 11 February 2010, on the Economic
Crisis. [Online] Available at: http://www.epsu.org/a/6212.
Sergejs Stacenko
583
CORPORATE SOCIAL RESPONSIBILITY IN RUSSIA:
SPECIAL FEATURES AND MAIN PROBLEMS
Tatjana Sudova, Saint-Petersburg State University, Russia1;
Olga Kanaeva, Saint-Petersburg State University, Russia
The main purpose of the paper is to analyse main particular features of corporate
social responsibility (CSR) in Russia; reveal important problems and outline possible
ways to solve them.
The investigation of the CSR phenomenon is based on modern theories and concepts,
such as corporate social responsibility, corporate social performance and sustainable
development.
Main characteristics of corporate social responsibility in Russia are given in the
paper; main problems are exposed and ways to overcome them are outlined.
Practical implication: the results of the study may be used in the operation of Russian
companies. The conclusions and recommendations are based on empirical study.
Corporate social responsibility is not “terra incognita” for Russia. There were a lot of
philanthropy traditions in Russia in the 18-19th centuries. So it will be better to attribute
contemporary processes in this sphere as a renaissance. There are certain reasons for
Russian business to pay special attention to CSR phenomenon, i.e. economic crisis,
international activity, demographic and social problems etc. Besides, states
(governments) try to redistribute social responsibility – in favor of business.
There are certain results of CSR renaissance in Russia in 2003-2012:
 There are a lot of companies, which demonstrate (or at least declare) their social
responsibility in the non-financial reports (327 reports in 2000-2012);
 Society is now interested in domestic and transnational responsible companies;
 CSR is a sphere of scientific interest, moreover, it’s now an academic discipline.
But at the same time there are certain problems
 the ideas and principles of are not widely known (in comparison with Europe and
USA), especially among domestic companies;
 corporate social activity is a result of non-market pressure, so it is “re-active”, but
not “active”;
 CSR is not treated as a factor of sustainable development of companies.
It’s impossible to receive the benefits of CSR beyond market mechanism. Thus, it’s
difficult to overestimate the role of government in the process of creation and
restoration of the institute of CSR.
1
584
Tatjana Sudova, Olga Kanaeva
Key words: corporate social responsibility, corporate social activity
JEL code: М14
Introduction
Social market economy is the model of economy most extended among the developed countries. For this
model it is typical not only a high level of the income of the population, but also a system of institutes which
allow to provide social justice, securities, high quality of life. “Sociality” of market economy is supported not
only by the state activity (for example, expenditure on education, health care, provision of pensions), but also
coordinated actions and responsible behavior of economic agents both on micro- and macrolevel.
Corporate social responsibility (CSR) is a form of corporate self-regulation integrated into a business
model. The term “corporate social responsibility” came into common use in the late 1960s and early
1970s. Generally, CSR is understood to be the way firms integrate social, environmental and economic
concerns into their values, culture, decision making, strategy and operations in a transparent and
accountable manner, and thereby establish better practices within the firm, create wealth and improve
society. In working definition of the scope of “social responsibility,” the ISO 26000 Working Group on
Social Responsibility identifies organizational governance, environment, human rights, labor practices,
fair operating practices, consumer issues and community involvement as core issues (Hohnen P.,2007).
Corporate social responsibility, according to the classical definition of European Commission, – the
concept reflecting the voluntary decision of the companies to participate in improvement of society and
environment protection The history of CSR shows that social responsibility was not a voluntary initiative
of corporations - in the proper sense of the word. It was (and is) the reaction to society and state pressure.
Corporate social responsibility is now a subject of both scientific and practical interest. A significant
result of researches of corporate social responsibility in the 2nd half of the XX-th century is it’s
understanding as a factor of a sustainable development of the company. Corporate social responsibility
and sustainable development form an integral part of our business decision- making process and
contribute to companies’ competitiveness and reputation.
Companies take into account the interests of their stakeholders: stuff, shareholders, local communities.
It is obvious that social responsibility of business is a reaction to financial, political and moral irritants.
No doubt, companies want to derive certain benefits from their social activity. The scale and nature of the
benefits of CSR for an organization can vary in dependence of the nature of the enterprise, and it’s
difficult to quantify them.
Corporate social responsibility has different forms in dependence on time and a scene of action.
Historically the first form of social responsibility of business there was philanthropy. The long history of
charity of Russian merchants is associated with the Morozovs, Soldatenkovs, Mamontovs, Hludovs,
Guchkovs, Konovalovs, Ryabushinskies. There is a variety of explanations of this phenomenon in scientific
literature – but no standard point of view. Now businessmen are also engaged in this process. For example,
50 largest Russian banks in 2012 spent for charity 6.8 billion rubles in total (www.soc-otvet.ru)
Revival of interest to charity in particular and to socially responsible behavior of business as a whole
at the beginning of the XXI century has a variety of reasons. In our opinion, the main reason is the growth
of general cultural level of people and the corresponding understanding of consequences of decisions
made by them. Responsibility demands the corresponding socio-cultural values and behavioral norms.
The development of the corporate social responsibility in Russia in our days is determined by both
negative and positive economic, social, political processes both in the country and the world.
585
On the one hand, there is a demographic crisis, deep social disproportions and contradictions, neglect
of the social sphere, backwardness of social infrastructure. Many researchers fairly specify that interest to
a problem of socially responsible behavior of the companies is caused by need of formation of new model
of interaction between the state and the business; new model of the social policy assuming redistribution
of burden of social responsibility from the state to business.
On the other hand, we see an exit from long transformational crisis of the 90th years, macroeconomic
stabilization, economic growth, an entry of the companies into the world markets.
Originally CSR in Russia was perceived as set of voluntary social efforts of the Russian companies
directed on formation of full-fledged social infrastructure in the country (Social responsibility, 2003). In
2003 the Association of managers of Russia published results of the first research social activity of the
Russian and international companies working in the Russian Federation. Approximately that time series
of the books, allowed to acquaint wide audience of managers and businessmen with ideas and CSR
practice were published. In 2003 the Association of Managers of Russia presented a series of the books
prepared in a framework “Social program of the Russian business”: “Social responsibility of business:
actual agenda”, “Management of social programs of the company”, “The corporate social report”, “CSR:
public expectations” (AMR, Moscow, 2003). Now CSR is considered as the long-term corporate strategy
directed on formation of steady competitive advantages, by means of forming of the mutually
advantageous relations with company stakeholders.
It is necessary to carry to the main results of development of CSR in Russia in 2003-2012:
 growing of number of the companies showing socially responsible behavior, growth of a variety of
social activity, formation of institute of the non-financial reporting;
 important documents were developed and accepted, such as “The Memorandum of the principles
of corporate social responsibility” (AMR, 2006) and “A social charter of the Russian business”
(The Russian Union of Industrialists and Entrepreneurs – RSPP). In 2007 the second document
was updated and it was recognized as conforming to the environmental and social standards stated
in the Global Compact of the United Nations Organization (UNO). By 2011 the Charter joined 230
companies and organizations in which 5.5 million people were engaged (www.rspp.ru)
In 2008 UNO opened the Russian national network of the Global Compact which joined 28 Russian
organizations, including RSPP;
 maintaining the National register of corporate non-financial reports and formation of institute of
public assurance of non-financial reports (RSPP);
In total 111 organizations published 327 non-financial reports in 2000-2012. At the same time, it
should be noted that for the period 2008-2012. The number of the companies issuing non-financial reports
doubled (State-of-the-art reviews of RSPP, 2008, 2010);
 formation of Library corporate activities (RSPP, is realized since 2008);
 carrying out competitions of public recognition socially responsible companies (RSPP)
(www.rspp.ru );
 approval of the International standard on CSR IC CSR – 26000-2011 (The international committee
on CSR, 2011) (ICO CSR standard – 26000-2011);
 formation of public request for socially responsible business, on the one hand, and formation of
inquiry of the companies on researches in the field of KSO, on the other hand. The great attention
is given to research of problems of corporate social responsibility, problems of formation of the
CSR national model by the Association of Managers of Russia (AMR), the Russian Union of
Industrialists and Entrepreneurs (RSPP), other professional associations; university research
centers;
 actively growing interest to CSR in the academic community, reflection of that is constantly
growing number of publications, dissertation researches, conferences and "round tables";
586
emergence of several authoritative research centers of problems of CSR (university, professional,
corporate). There are the Higher school of management of St. Petersburg State University,
Economics department of St. Petersburg State University, Financial University under the
Government of the Russian Federation etc.;
 specialized periodicals (Business and Society magazine, Internet editions: Mezenat http://www.
maecenas.ru magazine, site Social responsibility of business http://www.soc-otvet.ru etc.);
 large-scale researches of social activity and policy in Russian companies, in particular social
investments.
From 2003 for 2012, in Russia a number of researches (international, national, regional) were carried
out. Their task was to understand how society, business, public authorities perceive CSR; to reveal their
expectations concerning socially responsible business; to carry out the analysis social activity of Russian
and international companies working in Russia; to give an assessment of a condition and dynamics of
social investments. The researchers conducted at the initiative of AMR may be considered as most
significant (2005, 2008); The Economist Intelligence Unit agencies on an initiative and together with OK
RUSAL and with support of PricewaterhouseCoopers (2008); researches of Independent institute of
social policy (NISP, 2008), and also a number of local and regional researches (The Report on social
investments in Russia, 2005, 2008);
 academic courses are included in curricula (Kanaeva O. A., 2012)
As it is emphasized in the conclusion of “The report on social investments in Russia-2008”,
development of corporate social responsibility in Russian business “as a whole corresponds to a universal
tendency of gradual integration of the principles of CSR in corporate strategy, transition to ideology of
the social investments which are equitable to long-term interests and business and society”. (The report
on social investments in Russia, 2008).
At the same time, it is impossible to ignore existence of certain contradictions in formation of
corporate responsibility of business, existence of barriers on the way of formation of socially responsible
thinking and socially responsible behavior of the Russian companies. In our opinion, it is possible to note
the following main problems.
Ideas of socially responsible business didn’t gain the same wide circulation, as in the USA and the
countries of Europe; the number of the companies, applying the principles of socially responsible
behavior in practice, is rather insignificant; as a rule, there are mainly large companies, first of all
international. Small and medium business limits the responsibility to periodic charitable actions.
There is no standard approach to estimation of the contents and possible forms of realization of
corporate social responsibility; high variability of forms of social activity and corporate social activity
takes place. Dominate neoclassical (liberal), traditional (traditional charity) and socially oriented
approaches to understanding of social responsibility. Research of AMR (2008) confirmed that the
companies are traditional committed to the model of “reactive” (not active) CSR. As a result, there are no
clear ideas of the purposes and the directions of social corporate activity, of procedures of elaboration of
social policy and the mechanism of its realization, of its influence on primary activity of the company.
Social activity of the companies carries, as a rule, compelled (non-market) character imposed by
external (administrative) pressure; inducing motive to corporate social activity is not seldom attempt “to
pay off”, improve the image and reputation; there is no understanding of objectivity of process of
socialization of business, increase of its social responsibility. The public inquiry concerning socially
responsible business only is formed, and the understanding of the content of social responsibility of
business by representatives of business community considerably differs from society expectations.
In the majority of the companies system and administrative approaches to the corporate social activity
(CSA) are absent, the companies concentrate attention on the CSA different elements which, with rare
exception, aren’t considered as independent object of management; CSA of many companies is focused
on the solution of internal problems of the companies (first of all, connected with training of the
587
personnel of the company, granting social packages, creating favorable work conditions). In the
companies, as a rule, there are no structural divisions and the employees responsible for realization of
social policy of the company, at the same time many recognize need of training of specialists for this area.
The relation to social investments as to the undesirable expenses which are negatively affecting
financial results of activity of the company is widespread.
The position according to which socially responsible behavior of the companies is considered as a
factor of corporate stability and a sustainable development of society as a whole (an exception didn’t gain
a wide circulation make the large international companies).
Despite tendencies of growth of number of the Russian companies which are carrying out the nonfinancial reporting on a regular basis, opening information in reports on a triple bottom result (economic,
ecological and social productivity); expansions of branch structure of the reporting companies;
improvement of quality of reports, the total number of the companies publishing reports, is rather
insignificant.
In the National Register of non-financial reports 122 companies and 392 reports are registered, which
are issued since 2000. Among them are the ecological reports (ER) – 40, the social reports (SR) – 195,
reports in the field of a sustainable development (OUR) – 116, the integrated reports – 24, industry
reports – 17 (see Table 1 below). In the CorporateRegister.com we may find 46,628 reports given by
9,833 companies (www.corporateregister.com).
Table 1
Non-financial reports (February 2013)
Productive industry
Oil and gas
Energy
Metals and mining
Chemical, petrochemical
and perfume
Woodworking, pulp and
paper
Transport
Number of
companies
Integrated
reports
Number and kinds or reports
Sustainable
Social Ecological
development
reports
reports
reports
55
7
21
26
35
5
16
27
0
1
19
0
Sum
total
15
34
14
6
0
19
2
3
83
85
45
23
4
0
0
4
12
16
3
0
2
7
1
9
Source: http://rspp-rf/simplepage/157
In Russia the reporting of the companies is voluntary, however, for example, in Denmark, Sweden,
Norway, Holland, France, Great Britain is obligatory for the publication. Process of the corporate social
reporting in the Russian oil and gas sector is most continuous – this interest was dictated by transparency
requirements at an exit to IPO. RSPP notes that in ecological reports the Russian companies, unlike
foreign ones, don’t open such important indicators, as the volume of burned gas in torches, oil spills or
number of the contracts cancelled because of non-compliance with the business principles.
Protection of the capital of the organization is the conventional business principle. However firms not
always extend this concept to natural and human resources. The accounting of the ecological factor
promotes a sustainable development of the companies. Increase of degree of ecological responsibility of
business demands improvement of system of indicators which can be used by the companies by drawing
up the non-financial reporting
Various approaches to ecological reporting were developed in different countries. So, in Western
Europe and Great Britain such indicators as dumping and emissions, a ratio of production and raw
588
materials are specified; in Canada and the USA – the volume and nature of toxic emissions. It is possible
to consider the following indicators as the general parameters of the reporting of the company: 1) main
impacts on environment; 2) emissions and dumping; 3) ecological activity of the companies, its ecoefficiency and benefits from carrying out nature protection actions.
Though the population of our country considers business as the main source of environmental
problems, not but people don’t believe that business can solve such problems. Poll of 1255 respondents
(February, 2008) showed that, according to 57.19% of respondents, the problems connected with ecology,
have to be solved by business, the state and society together; 40,37% consider that the state by means of
retaliatory measures has to resolve these issues and only 2.45% believe that business has to resolve
them(Ecological responsibility, 2008).
Existence of the ecological report yet isn’t obligatory in Russia and many other countries, but for
investors, clients, suppliers and local communities such reporting – a marker of socially responsible
behavior of the companies. The companies use social (first of all ecological) reporting to receive the
international certification and advance in the global markets. However, as practice shows, these reports
and projects are often intended to increase ecological budgets of corporations.
It turns out that the ecological policy doesn’t achieve the object, and sometimes not only doesn’t
consider, but, probably, and breaks interests of the population. The social reporting about which the main
target group – local population doesn’t know; projects which don’t conduct to observed improvement of
an ecological situation – all this affects image of the Russian corporations.
Table 2
DJSI Supersector Leaders (2012-2013)
Company
Bayerische Motoren Werke AG
Australia & New Zealand Banking Group Ltd
UPM-Kymmene OYJ
Akzo Nobel NV
GS Engineering & Construction Corp
Itausa-Investimentos Itau SA
Unilever NV
Roche Holding AG
Siemens AG
Swiss Re AG
Telenet Group Holding NV
Repsol SA
Koninklijke Philips Electronics NV
GPT Group
Lotte Shopping Co Ltd
Alcatel-Lucent SA
KT Corp
Air France-KLM
Iberdrola SA
Supersector
Automobiles & Parts
Banks
Basic Resources
Chemicals
Construction & Materials
Financial Services
Food & Beverage
Healthcare
Industrial Goods & Services
Insurance
Media
Oil & Gas
Personal & Household Goods
Real Estate
Retail
Technology
Telecommunications
Travel & Leisure
Utilities
Source: http://www.sustainability-index.com/images/120913-djsi-review-2012-e-vdef_tcm1071-343064.pdf
589
Therefore, formation of feedback mechanisms with the population has to become one of priority tasks
in the field of ecological policy of the Russian corporations. The ecological policy pursued by the
companies aims at violation of positive dependence between the economic growth and negative impact on
environment that is a condition of a sustainable development of corporations and societies as a whole.
In the conditions of the high competition in the world market level of environmental friendliness of
production becomes one of the main factors of competitiveness. Introduction of policy of the corporate
social responsibility is recognized as a factor increasing profitability of the companies, ecologically
responsible behavior becomes the admission in world business community.
Degree of compliance to the international standards has to be size measured. Therefore on September
8, 1999 at the initiative of business community the world share Dow Jones index on a sustainable
development was introduced. This index pays off on a large number of indicators by filling with the
companies of special annual questionnaires. The calculated and checked indicators (about 50) are grouped
in three directions: economic, ecological and social activity of the companies.
The DJSI follow a best-in-class approach, including companies across all industries that outperform
their peers in numerous sustainability metrics. The largest world’s 2,500 companies (by free-float market
capitalization) from the 58 sectors were invited to report annually on their sustainability performance. The
result of the assessment provides an in-depth analysis of economic, environmental and social criteria,
such as corporate governance, water-related risks and stakeholder relations, with a special focus on
industry-specific risks and opportunities.
The top company is annually identified in each of the 19 supersectors derived from the 58 sectors The
2012-2013 Supersector Leaders are (listed alphabetically by supersector, Table 2).
Unfortunately, Russian companies aren’t present in the list.
Conclusions
1. Studying of corporate social responsibility and activity of the companies in the Russian Federation
testifies that there was a practice, differing a huge variety and testifying to different approaches to
understanding of the maintenance of CSR, different degree of an involvement of the companies in CSA,
about use of different forms, methods and instruments of realization of CSR. The listed above features of
perception of ideas and the principles of CSR, modern level of awareness of the importance of socially
responsible business, characteristic for Russia, once again emphasize relevance of the theoretical
researches directed on identification of problems (restrictions) and features of formation of social
responsibility of the Russian companies, on elaboration of the standard approaches to treatment of the
contents and forms of realization of corporate social responsibility, on development of motivational
mechanisms of increase of social responsibility of the companies, and also methods of an assessment of
efficiency of corporate social activity.
2. Corporate social responsibility development in Russia goes in accordance with the world
tendencies, but meanwhile slowly; small and medium business is not involved yet. CSR-development can
be complicated by a number of factors: the overestimated expectations of the population and authorities;
the underestimated ideas of the company of opportunities to carry out social policy.
3. A task of the state is a creation of conditions for a contribution of the business working at its
territory to a sustainable development. Two variants are possible here: 1) development and improvement
of legal base and 2) formation and advance of ideology of responsibility, and not only at the level of
business, but also certain people (for example, socially responsible consumption) and the state itself.
4. Business is committed to creating of economic value, but it shouldn’t be indifferent to how they do
it. Progressive sustainable businesses are gaining competitive advantage by responding to societal signals.
In the long term corporate social responsibility has to become basic ideology of business.
590
Bibliography
Ecological responsibility of the Russian business. [Online] Available at: http://2info.ru/index.
php?dn=article&to=art&id=25 [Accessed 18 March 2013].
Hohnen, P. 2007. Corporate Social Responsibility: An Implementation Guide for Business. 5 p.
Kanaeva O., 2012. Corporate social responsibility: problems of integration into educational programs of
education of economists. Messenger of St. Petersburg State University Economy Series 5. Iss. 3,
pp. 157-171.
[Online] Available at: http://www.corporateregister.com/stats/ [Accessed 12 March 2013].
[Online] Available at: http://www.rspp.ru [Accessed 12 March 2013].
[Online] Available at: http://www.soc-otvet.ru/ [Accessed 5 March 2013].
Social responsibility of business: actual agenda. AMR, M, 2003, 8 p.
State-of-the-art reviews of RSPP according to the non-financial reporting. 2008; 2010.
The international ICO CSR standard – 26000-2011, Social responsibility of the organization.
Requirements.
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The report on social investments in Russia-2008. Integration of CSR into corporate strategy. M, AMR,
2008, 8 p.
591
SATISFACTION OF EMPLOYEES: SEARCHING LINKS BETWEEN
ORGANIZATIONAL CULTURE AND COMMUNICATION
Ligita Šimanskienė, Klaipėda University, Lithuania1;
Audrius Kutkaitis, Klaipėda University, Lithuania
Abstract. Organizational culture determines what kind of people will be attracted to
the organization and the way they will interact within it. Investigations of different
authors in this area are reviewed. Organizations’ future as well as income depends on
managers’ values orientation, his ability to communicate and present ideas to the
employees. The organizational culture exists to unite people, to create a common
conception, to stimulate the prosperity and development of the organization. This is
achieved through leadership and personal communication of individuals; then
individuals interchange ideas, they set up the identity of their organization through
orientation on securities, which exist in the organization. However, organizational
culture is often analyzed in the context of internal or external life of organization, but
not to describe the role of employee’s satisfaction. It is scientific and practical problem,
how to create and evaluate organizational culture through communication while
researching employees satisfaction. It is important to state that satisfaction of employees
can be one of the main engines of organization profitability. The aim of this paper is the
investigation on opinions on employee’s satisfaction at work place influenced by
organizational culture and communication. The research has been done and the results
are that employee’s satisfaction depends in part from existing organizational culture.
The methods that have been used are: the analysis of scientific articles, comparison,
systematic analysis of survey with the help of SPSS methodology, logic based
conclusions.
Key words: organizational culture, communication, manager, satisfaction, employee
JEL code: M14, M12
Introduction
Culture has a crucial role to play in management of organization. An existing management culture
helps determine ways of thinking about organization values. Perhaps its most crucial role is determining
the way in which people are selected, trained, developed and rewarded. One of the main factors of the
modern management is the specific organizational culture. About it a lot of famous scientific monographs
have been written, researches have been done (Schein E., 2004; Cameron K.S., Quinn R.E., 1999; Deal
T., Kennedy A., 1982, Denison D., 1990, Schneider B., 1990). There are also a lot of books with
description and analysis on the influence of leaders on organizational culture (Bennis W., Nanus B., 1998;
1
592
Ligita Šimanskienė, Audrius Kutkaitis
Drucker P.F., 2001; Кэтс Дэ Врэс, 2003). But as usually organizational culture is analyzed in context of
internal or external life of organization, but not to describe the role of employee’s satisfaction. It is
scientific and practical problem, how to create and evaluate organizational culture through
communication while researching employees satisfaction. Because of this, it is important to state that
satisfaction of employees can be one of the main engines of organization profitability. There may be
various factors, which cause employees’ satisfaction: good work place equipment, salary, good
relationship with managers and colleagues, understandable organizational culture. Therefore, if an
organization is a group of people striving for the same aims, then the success of its business depends
directly on the skills and abilities of the working people as well as their understanding equally correctly
what they are doing and aiming for. This is possible only in case of forming the specific organizational
culture. Forming of such culture are conscious, purposeful attempts which require big physical and moral
force, as well as knowledge based on common to all mankind securities, commonly acknowledged moral
norms and the activities of the head of the organization. This gives the employees a possibility to
understand what requirements and hopes are related to them and to get any needed support to do the
work. The ability to manage the work effectively influences the effectiveness of the organization, has a
positive influence on the employees. Well known world organizations remain only due to the highly
specific culture. The aim of this paper is the investigation on opinions on employee’s satisfaction at work
place influenced by organizational culture and communication. Object of research is the relationship of
organizational culture and communication. The tasks of the article are: to analyze the concepts of
organizational culture and its influence on communication; to make research to identify opinions on
organizational culture and communication for searching employee’s satisfaction in organizations. The
used methods are: the analysis of scientific articles, comparison, statistical, systematic analysis of survey
with the help of SPSS methodology, logic based conclusions. Organizational culture, being based on the
values acknowledged by the most of the employees, is performing employees’ loyalty to the organization
through in-between understanding and engagement in the organization duty, as well as is pursuing object,
which benefits all. Organizational culture becomes easy to use, convenient and moral tool of people
management. This tool is to be used by the managers with the help of like-minded colleagues.
1. The Organizational Culture – One of the Main Engines of Satisfaction of
Employees
Organizational culture determines the kind of people who will be attracted to a firm and the way they
will interact within the firm (Dobson P., Starkey K., Richards J., 2004). The culture can be defined as
(Lee K.S., Carter S., 2005): patterned ways of thinking, feeling and reacting, acquired and transmitted
mainly by symbols, constituting the distinctive achievements of human groups, including their
embodiments in artifacts; the essential case of culture consists of traditional ideas and especially their
attached values. Culture can be defined as the set of key values, beliefs, understandings, and norms shared
by members of an organization. Grundey D. (2008) wrote that “organizational culture is a system of
essential values, which are perceived and accepted by all organization’s employees, allowing the
organization to steady reach for its goals and solve problems; it is supported by the organization’s history
and myths, and is demonstrated via traditions, ceremonies, and rituals; as well as uniting the organization
into one entity and which helps the organization to be distinguished amongst other ones”. The concept of
culture helps managers to understand the hidden, complex aspects of organizational life (Daft R.L., 2003).
Culture is a pattern of shared values and assumptions about how things are done within the organization.
This pattern is learned by the members as they cope with external and internal problems and is taught to
the new members as the correct way to perceive, think and feel. Basic assumptions in an organizations’
culture often begin with strongly held values espoused by a founder or early leader. Interesting and more
593
different point of view to this problem has been written by Dibachi, F., Dibachi, R.L.( 2003). They wrote
that there were myths: if you assembled a critical mass of very smart people, gave them resources, and
just left them alone, great things would happen. The truth is that a room full of smart people will not
necessarily have a clue how to organize and manage themselves to succeed. In fact, the smarter they are,
the more time they may spend fighting for dominance, back-biting, competing for attention and ignoring
directives from those they perceive as inferior. So authors decided that “great companies are built on
systems that allow average people to deliver.” We can summarize that this means, that a strong and
clearly understandable system of organizational culture should be created. Many researchers, particularly
those oriented towards consulting, prescribed the widespread use of cultural artifacts as if these could be
designed at random or imported from other organizations and as if organizational cultures could be
categorized according to a universal, generalizable scheme and compared cross-nationally (Tsoukas, H.,
Knudsen, C. 2003). Interpretive-oriented researchers saw cultural artifacts as rooted in their
organizational settings, growing out of their specific values, beliefs, and/or feelings - that is, out of
whatever was meaningful to members situated in those contexts, emerging from the lived experience
within those settings (Tsoukas, H., Knudsen, C. 2003). To achieve continuous development and
prosperity of an organization under market conditions any organization should work profitably. Thus the
organization should be managed purposefully. One of the main factors of the modern management is the
specific organizational culture. As any organization is a group of people striving for the same aims, the
success of its business depends directly on the skill and abilities of the working people to understand
equally correctly what they are doing and what they are aiming for. This is possible only in case of
forming the specific organizational culture (Šimanskienė L., 2002, Šimanskienė L., Tarsevičius T., 2010).
Source: created by authors
Fig. 1. Relationship between organizational culture, communication and employee satisfaction
Interesting research has been done by Duffy, M.K., Scott K.L., Shaw J.D., Tepper B.J., Aquino K.
(2012) where authors have found out that the mediated effect of envy on social undermining behavior
through moral disengagement is stronger if employees have low social identification with co-workers. So we
can add that in these organizations, there cooperation culture through communication is not strong, the
possibility, that people will start fighting or envying each other, grows. Long Ch., Bendersky C., Morrill C.
(2011) research indicates that there are positive effects on job satisfaction when managers supplement their
efforts to promote managerial control with fairness promotion activities that relate directly to their
subordinates’ opportunities to succeed in their job. Nag R., Gioia D.A. (2012) describe how top manager’s
belief about knowledge as a resource has correlation with the ways that executives search or scan for
594
information and how they use that knowledge in practice. Stigliani I., Ravasi D. (2012) pay attention to
sense making process from the individual level to the group level, with some ideas how to do this in a better
way. It is very important if we are willing to do work and want to involve people in this process. In other
words, new methods to communicate with employees were shown. Another interesting research about
possible ways to interact to employees is to communicate with them while paying attention to the voice.
Burris E.R. (2012) has done research and found out results that leaders who engage in supportive forms of
voice get better results. Calm voice and not punishment at the first part of day can influence better results
(Rothbard, Wilk, 2011). Authors have done research and have found alike results, so this can be one of
recommendations for managers how to communicate with employees. Schaubroeck J.M., Hannah S.T.,
Avolio B.J., Kozlowski S.W.J., Lord R.G., Trevino L.K., Dimotakis N., Peng A.C. (2012) found that the
influences of ethical leadership occur not only directly, but also indirectly, across hierarchical levels,
through the cascading of ethical culture. This research one more time shows the direct influence from
leaders and organizational culture. If there are ethical values in organization, we can also expect ethical
behavior from leaders. If not, the situation would be opposite. Similar research results have been found by
Mayer D.M., Aquino K., Greenbaum R.L., Kuenzi M. (2012). There has been found positive correlation
between ethical leadership and leader moral identity symbolization and internalization. Some author’s
(Owens B.P., Hekman D.R. 2012) research shows that leaders increasingly must be able to humbly show
their followers how to grow by admitting what they do not know, and acknowledging the unique skills or
knowledge. We can also add that in some organizations humbling is one of the ways how to involve people
in action. Researches results show that person usually make decision depending on organizational culture
(Gunia B.C., Wang L., Huang L., Wang L., Murnighan J.K., 2012). Organizations full of economically
oriented employees who laud and reward the pursuit of individual economic gain are likely to produce and
reproduce norms of self-interest. In contrast, organizations that not only laud but integrate moral values into
everyday procedures may foster moral norms. So we see how it is important what kinds of values are used
by organizational culture in organizations.
2. The research results and discussion
For carrying out the research, the questionnaire was prepared with the list of questions. In the
formation of questions both positive and negative alternatives for the answers were given. While planning
the research it is necessary to choose the minimum number of respondents in order to make statistically
trustful conclusions. Selective methods are based on the theory of chances, though in selection it is
impossible to avoid mistakes, unless all the population took part in the research. In scientific research
95% is trustworthy (Kardelis K., 2007). In order to get the false answer of 5% it is necessary to inquire
400 respondents from 5,000 people. Such numbers are provided by Ch. Nachmias, D. Nachmias (1985).
They note that it is enough to inquire 385 respondents from 10,000 employees to get 5% of false answers.
The data of the questionnaire was processed by SPSS (Special Package for Social Science) program with
the one-factorial dispersal analysis (ANOVA) because variables are measured by the rating scale. The
data of the questionnaire was processed by SPSS (Special Package for Social Science) program with the
one-factorial dispersal analysis because variables are measured by the rating scale. Researches were done
in 2011. So we have inquired 1034 respondents and we might state that it is the right number to get
reliable answers. There were asked 378 men and 656 women. By positions: top level managers – 1.81
percent, middle level managers – 11.87 percent, lower level managers – 7.24 percent, and 79.08 percent –
employees, i.e. persons that have no subordinates. Even 54, 67 percent of the respondents have higher
education. The most part of the organizations were private (Lithuanian) capital companies – 40.08
percent, whereas private (foreign) capital companies accounted for 16.39 percent, private joint ventures
(foreign and Lithuanian capital) – 9.86 percent, jointly owned by the state and private capital – 1.54
595
percent, state institutions – 31.5 percent. As it was mentioned before, the questionnaire was given to
employees. One of the questions was formulated about satisfaction at work with two relationships:
communication and financial security at work.
Table 1
Respondents answers about satisfaction at work
Possible answers
Yes, everything satisfies me
Yes, communication satisfies me, but the salary is low
Yes, salary is good, but the communication is not
A bit, but I am not searching for another job
No, salary is unsatisfying
No, communication is unsatisfying, too high requirements and too big competition
No, I am already searching for another job
Percentage
25.15
33.20
9.05
22.33
6.04
2.62
1.61
Source: own research
How we see from Table 1 results, the biggest part of respondents are satisfied with communication,
but salary is low (33.20). The second and the biggest result in percent is 25.15 percent. That means that
the big part of respondents said that everything satisfied them. On one hand this percent is not big, but on
the other hand the result is not bad, because as usual people are not satisfied with life in organization. For
some of them it is the lack of friendly atmosphere (organizational culture can be included), lack of salary
and lack of communication with colleagues and managers. The third result is 22.33 percent and it is a
result from people who are not so satisfied at work but who did not search for a new job, so in fact they
are satisfied at this work place. Or maybe they don’t feel strong emotional ties with the organization. It is
interesting to mention that there are 9 percent of respondents, who are satisfied with their salary, but not
with the communication. In general we can state that these respondents work in organizations with
created organizational culture and good communication. Some similar ideas can be found in Hallen B.I.,
Eisenhardt K.M. (2012) research.
Table 2
Financially interested in the organization
Possible answers
I owner of the organization
I own some organizations’ shares
I get some of the production with the discount
I am hired, I get only my salary
Percentage
0.40
2.21
8.25
89.13
Results show in Table 2, that the biggest part of respondents do not have any financial ties with
organization ownership, they only get salary (89.13 percent). But there are some of them, who get
production with discount, have some organizations shares and 0.4 percent of respondents are owners of
organization.
The results show in Table 3, that some parts of owners of organization are not satisfied with their salary.
It is interesting to see that, though it can be explained that owners of organization do not succeed in business
nowadays, because of economic crisis or perhaps of low experience of manager of the organization.
596
Table 3
Correlation between financial ties and satisfaction at work
Possible answers
Yes, communication satisfies
me, but the salary is low
Yes, salary is good, but the
communication is not
A bit, but I am not searching
for another job
No, communication is unsatisfying, too high requirements
and too big competition
No, I am already searching for
another job
I owner of the
organization
%
0.80
I own some
organizations’
shares %
5.60
I get some of the
production with
the discount %
12.80
I am hired, I
get only my
salary %
80.80
–
1.21
7.88
90.91
–
2.22
15.56
82.22
–
0.90
3.60
95.50
3.33
–
–
96.67
–
–
–
100.00
–
–
12.50
87.50
We see from results that these employees who have more financial ties with organization are more
satisfied with their job in general. All respondents who are not satisfied with communication are hired and
do not get any more financial ties. But we can see that some individuals, who get organizational shares or
some production with discount, have mentioned that salary is good but communication is not, they feel
big competition in organization. This means that there is no clear organizational culture in these
organizations, value system is stressful and non-understandable.
Table 4
Correlation between satisfactions at work with communication with manager
Possible answers
Yes, during
celebrations
60.80
46.67
Yes,
sometimes we
drink coffee %
29.60
27.27
No, because
manager does
not let %
5.60
11.52
No, because
I do not
want to %
4.00
14.55
48.89
17.78
20.00
13.33
53.15
22.52
10.81
13.51
30.00
53.85
13.33
23.08
43.33
7.69
13.33
15.38
25.00
12.50
12.50
50.00
%
Yes, communication satisfies me,
but the salary is low
A bit, but I am not searching for
another job
No, communication is unsatisfying,
too high requirements and too big
competition
another job
Source: own research.
597
Interesting results can be seen in Table 4. When we look to part there respondents are satisfied about
everything, they usually communicate with manager during celebrations and communicate with them
when they find time to talk in time of drinking coffee in informal atmosphere. And only 4 percent of this
type of respondents do not want to communicate or 5.6 percent state that manger does not want to
communicate. So we see that for satisfaction at work communication between colleagues and manager is
very important, because on this time they can discuss problems and they can solve them in friendly nonformal atmosphere. When we look to the answers of respondents who are searching for a new job, 50
percent of them do not want to communicate with manager. It is seen that work satisfaction depends on
how people understand organizational culture, how they are involved in it. If the person feels alone, he
becomes unhappy at his workplace, feels lonely and starts to search for a new job. So it is very important
to adapt new employee for new values, to find ways how to attract person and find ways how to
communicate with him. Results show that there is also a correlation between dissatisfaction of salary and
no communication with manager. Results show that the biggest percent of managers (43, 33 percent),
who do not communicate with people, are not satisfied with salary. It means, if manager communicates
more, he can explain to employee why he cannot get bigger salary. It is possible, that after conversations
and explanation about possibility to get bonus from this work people become friendlier, so they may get
more involved in job emotionally and understand requirements of job and values of culture better. Salary
take in the essence not only accountable value but also and emotional value. We can look to some
similarities in another research. He J., Huang Z. (2011) research results demonstrate a relationship
between firm financial performance and a seemingly unimportant proxy variable- the inequality of
director’s board membership. Directors seem to be attentive to the informal hierarchical order among
them and that such attention affects their effectiveness in playing their strategic roles. So if there is more
informal relationship- this can influence more positive results for organization. Wang H., Qian C. (2011)
research show that the positive philanthropy- performance relationship is stronger for firms with greater
public visibility and for those with better past performance, as philanthropy by these firms gains more
positive stakeholders responses. In another words if there are in firms created organizational culture with
philanthropy values, it is seen for publicity and get better results for organization.
Table 5
Correlation between traditions and satisfaction at work
Possible answers
Yes, communication satisfies me,
but the salary is low
A bit, but I am not searching for
another job
No, communication is
unsatisfying, too high
requirements and too big
competition
another job
Yes, I am proud
of it, we are
unique %
22.40
Yes, but they are the
same as in other
organizations %
60.00
I do not
No,
know there are
%
not %
10.40
7.20
9.09
60.61
18.79
11.52
15.56
66.67
8.89
8.89
9.01
55.86
16.22
18.92
6.67
40.00
30.00
23.33
30.77
38.46
7.69
23.08
50.00
12.50
37.50
–
598
When we analyze data from Table 5, we can say that these results one more time confirm the main
idea – if people do not understand organizational culture and they are not involved in this process, they do
not know traditions and so on. Employees who wanted to change job, 37.5 percent state that there are no
traditions in organizations. It is the biggest percent of all respondents group. People also do not know
about traditions in organizations if they are unsatisfied by salary or communication (23.33 and 23.08
percent). We can see that for employees who are satisfied about everything, only 7 percent state that there
are no traditions in organization or they do not know about existing of these traditions (10.4 percent). In
general, we can state that employee’s satisfaction has strong connections with organizational culture.
Organizational culture should teach employees through managers and colleagues. If employees do not
know traditions or do not feel that there are some different traditions – it is a big problem in organization
and even in top level management. Managers should understand influence of organizational culture on
employee satisfaction.
Conclusions
The organizational culture exists to unite employees, to create a common conception, to stimulate the
prosperity and development of the organization. This is achieved through personal communication of
individuals, when the individuals interchange ideas, set up the identity of their organization through
orientation on securities which exist in the organization. Culture is a pattern of shared values and
assumptions about how things are done within the organization. This pattern is learned by members as
they cope with external and internal problems and taught to new members as the correct way to perceive,
think, and feel. Basic assumptions in an organization’s culture often begin with strongly held values
espoused by a founder or early leader.
The research results show that in general respondents are satisfied at their work place. And we find
that there are strong correlation between satisfaction of employee and knowing organizational culture.
People who are satisfied with everything, are usually communicating with managers, know organizations’
traditions. Results show that the biggest part of employees who are searching for a new job, do not have
financial ties with organization – they are only getting salary and do not want to communicate with
managers. These results show that it is very important to involve people in organizations’ life, to use
different motivation forms.
After some analysis of research results, we can recommend to managers: try to understand employees’
wishes (employee wants more financial support or communication, participation in decision making
process); create understandable organizational culture; do questionnaires and ask people about their
wishes; create traditions where employees would like to participate; try understand what kind of
communication form is useful for some individuals (not everybody wants a collective communication
form).
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