EKIP– Expert Club for Economics and Politics A Different Opinion
This article is an excerpt from the new report of the EQUIP on urban planning policy in Sofia, authored by Georgi Vuldjev and Teodor Karakolev, which will be officially published on 06.11.2018.
In recent years, in Sofia, we have been fortunate to observe a vivid comparative experiment between two approaches to attracting more investment, stimulating economic growth and generally improving the economic environment in the city. The parallel development of Sofia Business Park and (rather the lack of such in) Sofia Tech Park very clearly shows the contrast in the results of the two alternative approaches to attracting investment in Sofia. The first approach is by creating opportunities for the private sector to unleash its potential in a privatized and market environment that favors entrepreneurship and private investment. The second is the classic state approach of creating a state-managed "park" to attract investment and stimulate innovation.
Private vs. Public: Business Park vs. Tech Park
Business Park Sofia is a completely private project, implemented and managed by private investors. On the other hand, Sofia Tech Park is a completely state-owned project, which was conceived as an idea to absorb a large part of the European funding under the Operational Program for Competitiveness. And although the two projects largely share the same goal – to attract large foreign investors to Sofia, only one succeeds in achieving it, while the other seriously fails, while wasting a huge amount of state resources.
The differences in the success of the two projects are due to the differences in their implementation and management. With regard to Business Park Sofia, the state and municipal authorities take a more reserved approach, with minimal active participation on their part. The intervention of the municipal authorities with regard to the design of Business Park Sofia is limited to changing the General Development Plan of the city, so that the implementation of such a business park project becomes possible. From then on, the initiative for the implementation and management of the project is left entirely in the hands of a private investor.
The result of this approach is the implementation of the most successful project for attracting investors in the territory of Sofia. The business park is the largest of its kind not only in Bulgaria, but also in the Balkans and today is home to the offices of dozens of large Bulgarian and foreign businesses in the fields of information technology, finance, retail, banking, etc. It employs 12,500 people according to official data and the daily attendance is 2,500 people. [1] The park is not supported by public funds, but entirely by private funds, and does not rely on municipal or state subsidies, nor on funding provided by the European Structural Funds.
The success of this project also ennobles the nearby residential complex "Mladost", which is becoming one of the most popular neighborhoods in the city after the construction of the Business Park. The increased demand for properties in "Mladost" and the significant increase in their prices over the past few years (especially compared to other large suburban neighborhoods, but at the other end of the city, such as "Lyulin", for example) is to a very large extent due to the success of Business Park Sofia, especially in terms of opening thousands of new jobs. The park also makes a great contribution to the improvement of the urban environment in the region - on its territory there are particularly pleasant green areas and alleys, which are maintained at an extremely high level and attract visitors every day, especially from nearby residential areas.
On the other hand, Sofia Tech Park has not managed to even come close to this success, despite the fact that tens of millions (80 million leva) of public funding (mostly European funds) have been poured into it [2]. In early 2017, a particularly big scandal erupted over the conflict between the management of Sofia Tech Park and Ivaylo Penchev, the owner of Walltopia – the largest manufacturer of climbing walls in the world.
Ivaylo Penchev was one of the most significant entrepreneurs that Sofia Tech Park initially managed to attract, but subsequently the relationship between him and the park management seriously deteriorated. Penchev's open letter, in which he severely criticized the management of Sofia Tech Park and which was reprinted in a number of media publications, became particularly famous. As a result, the management of Sofia Tech Park was changed, and not for the first time [3]. Changes in the park's management are particularly frequent and seem to be related to changes in the political situation over the years.
Rentierism and regulatory capture in public investment projects
This is the biggest problem with projects like Sofia Tech Park, which are entirely state-owned, managed by civil servants, and are ultimately therefore extremely dependent on the political conjuncture in parliament. The uncertain regulatory environment that can arise as a result of frequent changes in the management of a state-owned enterprise like Sofia Tech Park confuses and ultimately repels the investors it is supposed to attract. Thus, the very structure and nature of a project that is supposed to attract investors achieves exactly the opposite.
In addition to the risks posed by a potentially uncertain regulatory environment, another risk associated with the political dependence of such projects is that of the emergence of rentierism. In the economic literature, "rentierism" is when an economic agent (most often used in relation to private businesses) tries to increase its wealth not by creating more value for consumers, but by redistributing resources through the state apparatus. That is, by lobbying (or corruption) for a variety of policies in support of its private interest - from direct subsidies to the introduction of new regulations that harm competition and help preserve its market share.
The phenomenon of "regulatory capture" is very well documented in the economic literature. Regulatory capture occurs when regulations imposed and implemented by a relevant public institution lead to the preservation and protection of the market share of already established large business players to the detriment of their (mostly smaller) competitors. This is done through lobbying (or corruption) on the part of the large businesses in question. Regulations are generally intended on paper to either protect the interests of workers or consumers, but especially when regulatory capture is present, the result is the opposite, because it leads to less competition. And less competition in the market means less incentive to improve the products and services in question (to the detriment of consumers) and less incentive to improve the working conditions offered by the relevant businesses (to the detriment of workers).
In the case of subsidies, which also includes funding from the European Structural Funds, the same problem exists and its negative effects are much more direct. Large, established players are always in a better position to benefit from such subsidies due to a number of factors, beyond the simple reputational advantage – they can mobilize greater resources for lobbying and even corruption. The latter is a particularly serious risk factor in Bulgaria given the low quality of the justice system and public institutions in general.
What should be the role of the CO in attracting investments?
Due to these factors, the role of the Sofia Municipality should be limited to creating a favorable administrative-regulatory environment, through optimization and reduction of the current regulatory and tax framework. Attempts to improve the business environment by subsidizing certain businesses should be avoided due to the risks described above. This means that the municipality should focus on such policies that will provide an environment in which entrepreneurs can start and expand their businesses as quickly as possible, without being hindered by high tax and administrative costs caused by sluggish, poor-quality and, in the worst case, corrupt municipal institutions.
For this purpose, the quality of administrative services provided by the Sofia Municipality and the regulatory framework it imposes on economic activities in the city should be periodically assessed. It is recommended that such an assessment be carried out at two levels – internal and external, relying on business feedback. There are also a number of annual international surveys, such as the World Bank’s Doing Business Ranking, which assess the quality of the business environment in given countries and/or cities. They can be used for references.
Improving the business environment (which includes the tax system) and the quality of administrative services is directly related to the regulatory burden. The more and different regulations that businesses have to comply with, the more difficult it is to start new businesses and expand existing ones. Small and medium-sized enterprises suffer the most from an excessively burdensome regulatory framework. The additional costs and efforts that businesses have to bear to comply with certain regulations will always have a greater negative effect on small and medium-sized enterprises than on large ones.
This is because the regulatory burden is in most cases a very fixed burden and does not vary according to the size of the enterprise concerned. Accordingly, the additional increase in costs that it brings to small enterprises in relative (one could say "percentage" terms) is higher than for large ones. Furthermore, large enterprises, other things being equal, have more flexibility in terms of dealing with the regulatory burden and potential increase in it, because they can cut back part of their business if necessary to compensate for the new costs. New and small enterprises have much less scope for such actions and accordingly even a slight increase in the regulatory burden can push them out of the market entirely.
Optimization, lower taxes, less regulations - three steps to more investment
Especially when it comes to municipal regulations and taxes, their further increase, in addition to hindering the emergence and development of new and smaller local businesses, also stimulates the relocation of large ones to regions with a more favorable local regulatory environment. Thus, the excessive accumulation of tax and regulatory burden not only strangles local small and medium-sized businesses, but also pushes large companies to relocate at least their business centers (which provide many jobs) to regions with a more favorable business environment in the country or even abroad. Obviously, this is detrimental to the economic development of the respective city.
To avoid this, it is advisable for the Sofia Municipality to follow certain rules in its regulatory and tax policy. It is a good idea to introduce a rule for constant optimization of the regulatory framework, such that for each newly introduced regulation, the municipality is obliged to eliminate two old ones that are no longer so necessary. Thus, instead of simply piling regulation on regulation, the municipality will have to carefully monitor the state of the regulatory framework it imposes and look for ways to optimize it. In addition to the fact that this will lead to a more favorable business environment, such a rule will also improve the quality of the municipality's work, because it will force it to prioritize those aspects of its regulatory policy that are most important and most significantly protect the interests of businesses and consumers. And of course, in the long run, it would lead to a comprehensive simplification of the regulatory framework and, accordingly, the stimulation of more investments.
Regarding taxes, the policy should be similar - instead of increasing, optimization should always be sought. If the municipality's revenues are not sufficient, the first priority should be an analysis of the quality of expenses and their prioritization, in order to establish which types of expenses could be reduced and thus improve the fiscal balance of the municipality. Only after such an assessment has been carried out and non-priority expenses have been reduced can one think about a possible increase in taxes.
It is not natural for public institutions to think like market businesses, which seek constant optimization of their costs and improvement of the quality of their services in order to attract more revenue. Since public institutions are financed by force through taxes, and not through voluntary purchase and sale, they suffer from a tendency towards constant cost inflation, accompanied by a lack of improvement or deterioration of the quality of the service, which is covered by an increase in taxes. In the long run, this leads to excessive inflation of the municipal bureaucracy and a constant deterioration of the economic environment. In order to limit the negative effect of this trend, it is necessary to introduce certain rules (enshrined in law) regarding the way the municipality works, which directly counteract it and force optimization.
[1] Sofia Business Park; Project Parameters
[2] Filipova, Iglika; " Sofia Tech Park": Restart; Capital; 27.07.2018
[3] Penchev, Ivaylo; Ivaylo Penchev with an open letter to Sofia Tech Park; Manager; 10.03.2017
Image source: businesspark-sofia.com
