Chapter 1. Overview of the legal system and governance in Latvia

This chapter provides an overview of the current situation in Latvia and its legal system and governance structure. It focuses on the socio-economic context and examines determinants for a sound business and investment climate. Latvia’s performance is demonstrated based on international benchmarks. This chapter highlights the importance of a sound legal system and effective well-functioning of justice for long-term economic and social outcomes and a thriving business environment.

    

Governance background

Following its independence in 1991 and the dissolution of the Soviet Union, Latvia underwent important political, economic and structural changes as it transitioned into a small democratic country with a market-based economy. Latvia became the 35th OECD member country in July 2016; it joined the European Union in 2004 and has had access to the Schengen area since 2007 and the Eurozone since 2014.

Latvia is a multiparty parliamentary republic, divided into 119 administrative entities, including 110 municipalities and 9 cities. The president is the head of state elected by the Saeima (parliament) with the prime minister politically responsible for the fulfilment of presidential duties under the constitution. Legislative authority is vested in the Saeima, a unicameral parliament comprised of 100 deputies that are elected by proportional representation for four-year terms.

The Judiciary is led by the Supreme Court. The Latvian court system consists of three levels of courts and the Prosecutor’s Office. Ordinary courts or courts of general jurisdiction deal with civil and criminal matters and a specialised jurisdiction hears administrative cases. The Constitutional Court functions separately from the three-tiered court system.

The overall budgetary situation of Latvia is strong; government finances remain solid with low public debt. Latvia benefits from different European financial instruments (e.g. European Structural and Investment Funds, ESIF) boosting investment (OECD, 2017a).

Trust in government, including justice, is generally low compared to OECD countries (Figure 1.1). But it has been increasing since 2007, at a pace above the OECD average.

Figure 1.1. Confidence in national government in 2016 and its change since 2017
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Source: Adapted from Gallup World Poll in OECD (2017b).

Citizen satisfaction and confidence levels with public services also remain below the OECD average (Figure 1.2). With regards to the judicial system, Latvians cite low legal awareness, limited objectivity in the treatment of citizens, unequal access to public services and timeliness of the court system as the main issues. Nonetheless, due to a broad range of reform initiatives introduced by the government, trust in the judicial system has increased since 2014, from 31% to 41% in 2016 (OECD, 2017c, 2015a).

Figure 1.2. Citizen satisfaction and confidence in public services, 2016
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Source: Adapted from OECD (2017c).

The socio-economic context for a sound business and investment climate

In recent years, Latvia’s economy has become one of the fastest-growing economies in Europe (OECD, 2017d) with a positive business environment (EBRD, 2016). Latvia rapidly and consistently recovered from the 2008 global crisis and its 2007-10 recession. In 2016, its economic growth slowed down but picked up during 2017 (Figure 1.3). Latvia’s economic dynamism builds on stronger domestic demand and its open approach to global trade and investment (OECD, 2017a). It is exposed to international developments and its main trading partners, Estonia, Germany, Lithuania Poland and the Russian Federation, with links to other CIS (Commonwealth of Independent States) economies. There exist regional disparities, particularly in the eastern and rural regions: the Riga metropolitan area is a key driver of economic growth, contributing about 69% to the national gross domestic product (GDP) (OECD, 2017e). Informal activity is widespread – estimated at more than 20% of GDP in 2015 (OECD, 2017a).

Figure 1.3. Economic growth in Latvia, 2010-17
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1. Euro area countries which are OECD members.

2. Percentage gap with respect to the weighted average using population weights of the highest 17 OECD countries in terms of GDP per capita and GDP per hour worked (in constant 2010 PPPs).

Source: OECD (2017f); OECD (2017g); OECD (2017h).

Latvia recently implemented numerous legal and structural reforms in labour market, tax and business among others (OECD, 2017i). These reforms are stimulating growth and well-being (OECD, 2017h). It considered the most structural reform priorities identified in the “OECD Going for Growth” initiative, compared to other OECD countries (OECD, 2017e). The Latvian government adopted a number of legislative and procedural changes in order to bring national legislation into conformity with the international standards of the OECD, the European Union, and the World Trade Organization. Regulations regarding the creation of new businesses (including the associated time and costs) and operation of private enterprises appear easy and not burdensome. According to the latest World Bank Doing Business Report, Latvia is ranked 19th out of 190 countries in terms of ease of doing business (Figure 1.4)1. It is the 21st economy worldwide in terms of starting a business, keeping pace with its neighbouring countries and ranking above the average score of OECD countries (Box 1.1).

Figure 1.4. Starting a Business in Latvia and comparable economies
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Note: The distance to frontier (DTF) measure shows the distance of each economy to the “frontier,” which represents the best performance observed on each of the indicators across all economies in the Doing Business sample since 2005. An economy’s distance to frontier is reflected on a scale from 0 to 100, where 0 represents the lowest performance and 100 represents the frontier. The ease of doing business ranking ranges from 1 to 190.

Source: Adapted from World Bank (2018).

Box 1.1. Latvia’s business environment: An international benchmark

While steady reforms have improved Latvia’s ranking in the World Bank Doing Business Index over the years, the Doing Business 2018 profile records a worsening of the country’s overall score compared to the previous year. Latvia ranks 19th among the 190 world economies considered, moving down five places. In 2018, Latvia follows its regional partners – Denmark (3rd), Norway (8th), Estonia (12th) and Lithuania (16th) – but remains above the OECD average. The “Starting a business” indicator remains stable compared to 2017.

With regard to the Global Competitiveness Index (GCI), Latvia ranks 49th overall among 140 countries in 2016-17 (previously 44th place), while in the execution of essential requirements (institutional environment, quality of public infrastructure, macroeconomic environment, health and primary education) Latvia moved down from 37th to 41st place.

With regards to strengthening effectiveness (higher education, goods market and labour market efficiency, financial market development, technological readiness, and market size), Latvia moved down from 39th to 42nd place. The index of business satisfaction and innovation remained unchanged in 2016-17 compared to the previous year, stabilising Latvia at 58th place.

In comparison to the other Baltic countries Estonia (30th place) and Lithuania (35th place), the Latvian Ministry of Economy identifies Latvia’s weaknesses as being in infrastructure, macroeconomic environment, healthcare, higher education, financial market development, business sophistication, innovations and technological readiness.

Source: World Bank (2018); World Economic Forum (2016); Latvian Ministry of Economy (2017).

In addition, due diligence principles of corporate social responsibility (CSR)/responsible business conduct are widely promoted by the Ministry of Welfare, the Employers’ Confederation of Latvia and the American Chamber of Commerce in Latvia (Box 1.2). Latvia’s framework for corporate governance is found largely consistent with the G20/OECD Principles of Corporate Governance, and it appears to broadly protect and facilitate the exercise of rights (OECD, 2017d).

Box 1.2. Microindex and the Sustainability Index

The Latvian National Contact Point, together with the Employers’ Confederation of Latvia and the Latvia Free Trade Union, launched the “Microindex”, an evaluation methodology for small and medium-sized enterprises (SMEs) and micro-enterprises that aims to further sustainable development and corporate social responsibility (CSR) best practices. The index provides SMEs and their suppliers with the opportunity to objectively review their work and evaluate the need for improvements. It examines five spheres of enterprise activity: long-term business strategy, work environment, market relations, environment, and community. Participating companies publish the results of 40 criteria online at www.ilgtspeja.lv/atbildigabiznesanovertejums.

The “Microindex” is incorporated in Latvia’s annual “Sustainability Index”, an initiative that assists companies to develop, implement and measure their sustainable practice and encourages companies to integrate corporate responsibility into their business strategy. It also sets objective criteria for the community and public and non-governmental organisations to evaluate and support companies contributing to the long-term sustainability of the Latvian economy, environment, and society. The methodology used in both indices was developed by a wide range of Latvian experts based on global examples such as the Dow Jones Sustainability Index and Corporate Responsibility (CR) Index by Business in the Community, and is in alignment with ISO 26000 and the Global Reporting Initiative guidelines. The results are published at www.ilgtspejasindekss.lv.

Source: Extracted from OECD (2014a).

As in other Baltic States, the capital market in Latvia is small. The most competitive sectors are woodworking, metalworking, transportation, information technology (IT), green tech, healthcare, life science, food processing and finance; some of which were identified by the Latvian Investment and Development Agency as having the highest potential for new investment (US Department of State, 2017). State-owned enterprises (SOEs) represent a great part of the market (OECD, 2017d); however, “private enterprises may compete with SOEs on the same terms and conditions” (US Department of State, 2017). A levelled playing field is one of the core corporate governance principles in Latvia. The outright majority of enterprises operating in Latvia are micro, small and medium-sized companies (OECD, 2017d).

As mentioned above, Latvia’s economy is also strongly driven by trade; the value of exports and imports equals 119% of GDP (Heritage Foundation, 2017). Latvian export products and markets have diversified and improved, however, Latvia still largely relies on raw materials and natural-resource-intensive products (OECD, 2017e). Latvia’s three largest export markets are Lithuania, Estonia and the Russian Federation (OECD, 2017e). Participation in global value chains continues to be low; few successful Latvian firms have much higher productivity, employment and wages in comparison to overall entrepreneurship in the country (OECD, 2017e). In addition, skills mismatch and widespread informality prevent firms from entering global value chains (OECD, 2017e).

Unemployment in Latvia decreased recently, yet remains high (OECD, 2017a). The official rate of registered unemployment is above 8%, with a high proportion between the ages15-24 (OECD, 2017e). There is a high incidence of long-term unemployment, adding to widespread poverty. And the high unemployment rate likely reflects regional and skills mismatches between workers and jobs (OECD, 2017a).

Significant skills shortage and mismatch are factors that have held back productivity in Latvia for many years (OECD, 2017g, 2016b). For instance, in 2013 a third of employers mentioned an inadequately educated workforce as a constraint on their activities and the business environment more generally (EBRD, 2016). It significantly impedes adoption of advanced technologies and management practices (OECD, 2017e ). There is a need to provide more training for the unemployed with better income support; it could help tackle unemployment, provide qualified employees matching economic needs and widely distribute benefits of economic growth (OECD, 2017a).

Introducing policies to enhance the participation of women in the labour force and to access well-paid positions could further improve the supply of skills (OECD, 2017e). Women constitute 55% of the labour market in Latvia (OECD, 2016c). The share of women in civil service is 63.7% while 54% are in senior positions (OECD, 2017c). The female share of seats on boards of the largest publicly listed companies amounts to 28% (OECD, 2016d).

According to the OECD’s Better Life Index, Latvians are less satisfied with their lives than the OECD average (Figure 1.5). The most impaired dimensions highlighted by the Better Life Index are: access to well-paid jobs, the healthcare system and housing. In addition to long-run unemployment, weak social safety nets and high taxes on low wage incomes contribute to informality, low poverty and the emigration of young people. Additional public spending is required to improve economic opportunities, access to housing, healthcare and education.

Figure 1.5. Well-being in Latvia
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Source: OECD (2017e).

Law and access to justice for doing business and inclusive growth

A sound legal system and the effective functioning of justice institutions are key contributors to long-term economic and social outcomes and a thriving business environment (OECD, 2013; Acemoglu, Johnson and Robinson, 2005). The rule of law, justice and access to redress may support contract enforcement, reduce transaction costs (which are impeded by theft, corruption, weak property rights, etc.) and facilitate longer-term investments and engagement in trade for stakeholders (Acemoglu, Johnson and Robinson, 2005).

A sound and clear legal framework supports steady economic growth by creating an enabling business environment and strengthening the national marketplace in which economic activity takes place (OECD, 2015c). Moreover, it contributes to the attractiveness of the national legal system in the global marketplace, in particular with regard to business activities (OECD, 2010a). Maintaining such a legal framework feeds into the economic and social well-being of citizens, distributing the benefits across society. A legitimate and equally accessible judicial system is found to maintain business markets by determining “the rules of the game”, securing fair competition and protecting property rights. It is also an essential factor for fostering good governance, legal certainty and predictability, thereby enhancing the development of business and investment climates and supporting private sector growth in compliance with outlined regulatory frameworks (OECD, 2015d).

Strengthening access to justice is thus necessary to create a supportive environment for business and to enable a level playing field for economic stakeholders, including SMEs. The OECD Policy Framework for Investment (PFI) suggests that when key elements of effective access to justice are missing or inefficient (e.g. complex, costly, and lengthy procedures), companies including SMEs may limit their activities (OECD, 2015c). Perceived ability to settle a potential dispute efficiently and effectively, including enforcing a contract and securing property rights can unlock investment decisions. The rule of law, including effective, timely and efficient justice and legal services can give businesses the chance to thrive, taking into consideration elements such as the level of impact on regulatory frameworks, addressing skills mismatch, R&D, access to finance, more equitable financial markets that channel resources into productive activities, and any accompanying restructuring and displacement.

Addressing the legal needs of businesses: A driver for growth

Building on the strong tradition of legal needs surveys of individual citizens, OECD countries are increasingly focusing on understanding the legal needs of business in order to improve the business environment and promote socio-economic growth. The traditional approach to the delivery of legal and justice services mainly focused on institutional performance. It does not consider the types of justice problems businesses have, what institutions they engage, the “effectiveness” of legal dispute mechanisms and what works, for whom and for what types of legal and justice needs.

This report places particular emphasis on addressing the legal needs of businesses as a driver for inclusive growth. There is growing evidence that the ability to address legal problems can contribute to inclusive growth by creating jobs, reducing work days missed due to legal problems, providing stable housing, resolving debt issues and stimulating business activities.

The shift towards user centricity (e.g. needs of different types of business) serves as the guiding principle to design the policy agenda and evaluate legal and justice service content and delivery. It considers the perspective of a range of business types and sizes, individuals and specific groups, and aims to inform the design of services that are more responsive to business needs. This is expected to be translated into achieving efficiency and the sound functioning of the justice system.

Balancing user perspectives with public interest

Importantly, Latvia recognises the importance of a robust system of legal and justice services in addressing market-related challenges, such as: corruption, insider trading and abusive self-dealing. The efficiency of the judiciary was enhanced by the consolidation of small district courts. Nonetheless, as mentioned, trust in the justice system remains a challenge, similar to other public institutions (OECD, 2017c).

OECD work confirms that the effectiveness of justice systems and the sound commercial law framework have an important role in stimulating competitiveness and economic development (OECD, 2016e, 2014b). It is recognised that it is dependent, among other things, “on the existence and fulfilment of clear laws and norms, most importantly the legal certainty of firms and contracts guaranteed by trustworthy and objective court systems […] the idea being that regions that lack such legal systems impose higher transaction costs to market participants” (OECD/IMCO, 2013). The security of property rights, justice institutions, contract and debt enforcement, and mortgage contracts are of great relevance.

Objectives and organisation of this report

Improving access to justice is increasingly recognised as a critical dimension of inclusive growth and as a means of improving citizen well-being and economic performance (OECD, 2015e). In this context, countries are developing user-centred approaches to delivering legal and justice services (OECD, 2015f). Latvia joins this global trend, adopting a broader strategy to strengthen not just the judicial sector, but also law enforcement authorities. An overall assessment of the justice sector serves to encourage evidence-based policies that deliver swift, reliable and trustworthy justice.

Given that Latvia started implementing extensive measures to reflect the needs of businesses, the OECD was invited to undertake a mapping of legal needs and review the accessibility and responsiveness of governmental justice services (i.e. Enterprise Registry; Patent Office, State Land Service and Land Registry offices; Courts and Alternative Dispute Resolution mechanisms). Building on these needs and the experience of businesses, the assessment further aims to identify the crucial problems for businesses in the implementation of the Commercial Law and regulatory framework and their suitability to the different forms of commercial activity.

This report draws from the comprehensive review carried out by the OECD Secretariat as part of Latvia’s accession process in 2014, as well as from direct insights and up-to-date information collected during fact-finding missions to Riga and strategy meetings, which took place in March, June, August and October 2017. In addition, OECD undertook an online survey among business stakeholders operating in Latvia (with around 300 respondents). The data results should be interpreted with caution, however, and should be considered jointly with the results of stakeholder interviews and consultations. The survey was disseminated by the Court Administration and promoted through various governmental and business websites. Wide stakeholder consultation was conducted in March 2018 focusing on the substantive issues and to validate the preliminary findings of the first draft report.

Chapter 1 presents and discusses the current organisational and procedural arrangements deployed by the government to pursue administrative simplification and promote an increasingly business-friendly environment in Latvia. By placing specific focus on procedures regulated by the Latvian Commercial Law, the chapter seeks to identify actions that could further facilitate doing business based on evidence drawn from Chapter 3 related to costs associated with administrative procedures.

Chapter 2 examines the accessibility of services for businesses and presents a concept of a continuum of legal and justice services. In line with the OECD Serving Citizen framework it focuses on services provided by the state (Enterprise Registry, State Land service and Registry and the Patent Office). The chapter places a particular emphasis on digital tools and provides an overview of e-services available for businesses in Latvia. This chapter also identifies the characteristics and impact of legal problems experienced by Latvian businesses.

Chapter 3 seeks to measure administrative costs related to selected procedures prescribed under the Commercial Law. It identifies and analyses possible simplification measures that may support the starting-up or re-organisation of business operations and translate into cost savings. The main focus of this chapter is on reducing the administrative burden generated from selected business registration procedures administered by the Latvian Enterprise Registry i.e., registrations of an individual merchant and a limited liability company with decreased capital, and reorganisation of a limited liability company through merger by acquisition. The chapter presents evidence that may substantiate legal amendments and changes in procedural practice presented in Chapter 1, and make the relationship with businesses more efficient.

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Note

← 1. We note, on the other hand, that the World Bank Doing Business Index also stops its “starting a business” procedure at the moment the registration at the State Revenue Service ends. Businesses in Latvia must still comply with additional procedures before starting their activities.