Lithuania

   

Economic Policies

#18
Key Findings
Recovering handily from export interruptions, Lithuania falls into the upper-middle ranks internationally (rank 18) in the area of economic policies. Its score on this measure has improved by 0.5 points since 2014.

Growth rates have accelerated again after a short slowdown. Producers have adjusted to a drop in exports to Russia by reorienting toward other markets. A controversial new labor code has come into force after adjustments seeking to balance labor-market flexibility and employee protection.

Unemployment rates have declined to moderate levels. The mismatch between labor supply and market demand has become the main labor-market issue. Minimum wages have been steadily increased. Labor taxes are high, as are tax-evasion rates. A major tax reform is being discussed.

Structural deficits have been very low, and debt is moderate by EU standards. A fiscal-discipline law provides incentives for the continuation of balanced fiscal policies. R&D and innovation have been funded in part through EU structural funds, but remain relative weaknesses.

Economy

#23

How successful has economic policy been in providing a reliable economic framework and in fostering international competitiveness?

10
 9

Economic policy fully succeeds in providing a coherent set-up of different institutional spheres and regimes, thus stabilizing the economic environment. It largely contributes to the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
 8
 7
 6


Economic policy largely provides a reliable economic environment and supports the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
 5
 4
 3


Economic policy somewhat contributes to providing a reliable economic environment and helps to a certain degree in fostering a country’s competitive capabilities and attractiveness as an economic location.
 2
 1

Economic policy mainly acts in discretionary ways essentially destabilizing the economic environment. There is little coordination in the set-up of economic policy institutions. Economic policy generally fails in fostering a country’s competitive capabilities and attractiveness as an economic location.
Economic Policy
8
Lithuania’s economic policies have created a reliable economic environment, fostering the country’s competitive capabilities and improving its attractiveness as an economic location. In its 2018 Doing Business report, the World Bank ranked Lithuania 16 out of 190 countries overall. The country’s position in this rating is very close to the target of 15th place set by the Skvernelis government, which formed after the parliamentary elections in late 2016. The criteria assessed most positively included registering property (ranked 3), enforcing contracts (ranked 4) and dealing with construction permits (ranked 12). Meanwhile, resolving insolvency (ranked 70) was assessed least positively. Lithuania climbed five positions in the 2018 report from 21 out of 190 countries in 2017. This is attributable to an increase in the number of indicators, including a substantial change in terms of access to electricity (ranked 55 in 2017 and 33 in 2018). In the Global Competitiveness Report 2017-2018, the World Economic Forum ranked Lithuania 41 out of 137 countries, scoring above average on higher education and training (ranked 29), macroeconomic environment (ranked 29) and technological readiness (ranked 30), but below average for market size (ranked 78). Lithuania dropped six positions in the 2017-2018 report, which is attributable to the sluggish implementation of reforms. However, the report did not take into account the adoption of the new Labor Code, which will improve the country’s ranking in the area of labor market efficiency in the next report.

The European Commission has identified the following challenges to Lithuania’s long-term competitiveness: unfavorable demographic developments, labor market deficiencies and high emigration rates, growing levels of poverty and social exclusion, a lack of competition and interconnections in the country’s infrastructure (particularly its energy system), low energy efficiency (especially in the case of buildings), a low level of R&D spending, and poor performance with respect to innovation. A new economic challenge has arisen from Russia’s ban on food and agricultural imports from the European Union, in place since autumn 2014. This has disproportionately affected Lithuania, as its ratio of food exports to Russia to GDP was the highest in the European Union. However, Lithuanian companies managed to reorient their exports to other markets, demonstrating their flexibility. Despite a slowdown in export growth due to trade-restriction measures and the recession in Russia, it is expected that private demand will continue to remain strong in Lithuania and if euro zone growth continues this should drive Lithuanian exports. According to European Commission, after several years of growth rates above the EU average, Lithuania’s GDP growth rate slowed to 1.7% in 2015 due to a significant drop in exports to Russia, but recovered again to reach 2.3% in 2016 and is projected to increase to 3.8% in 2017.

Although the 2008 to 2012 government stabilized Lithuania’s economy and public finances through substantial fiscal consolidation, other reform efforts have been more limited, in particular those relating to the labor market, social policies, energy efficiency and the energy sector. However, the government formed after the 2012 parliamentary elections continued and completed some of its predecessor’s projects. Construction of the new liquefied-natural-gas terminal (LNG) was finished in December 2014, for example, and another important project establishing electric-power transmission connections with Sweden was completed by the end of 2015, with the first electricity link to Poland becoming operational in 2016. These projects are expected to provide alternative energy-supply sources, and have received significant attention. Mostly due to low prices in the Nordic countries, electricity prices in Lithuania decreased in 2016 to 2017, providing evidence of the economic benefits of additional sources of supply. Further infrastructural integration projects – including the completion of a second electricity link to Poland, withdrawal from BRELL (Russia managed electricity grid) and construction a natural gas connection to Poland – are high on the agenda of the current government (for more on energy projects see Vilpišauskas 2017). The 2012 to 2016 government presented Lithuania’s accession to the euro zone in January 2015, another major economic policy event, as a signature achievement. However, accession to the euro zone was supported by all major political parties and much of the preparation for accession had been undertaken by the previous government. The recent increase in the inflation rate in Lithuania, which has become the central public concern as evidenced by Eurobarometer surveys, has been attributed in part to the introduction of the euro. Though experts largely link the increase in inflation to Lithuania’s need to catch up economically and the monetary policies of the European Central Bank.

Considerable political emphasis has been placed on structural reforms but a significant number of these have been left unimplemented. Streamlining the regulatory environment for businesses is one of the few areas where some progress has been achieved, especially in terms of the number of procedures and days required to start a new business. However, inefficient government bureaucracy remains the second most problematic factor for doing business in the country, according to surveyed business executives. In the Global Competitiveness Report 2017-2018, the World Economic Forum ranked Lithuania 101 out of 137 countries for efficiency of the legal framework in challenging regulations and 97 for the burdens imposed by government regulation. Toward the end of its term, the 2012 to 2016 government reformed the Labor Code and social protection, including the pension system. The Labor Code came into force on 1 July 2017 after the new government altered some provisions in a search of a better balance between labor market flexibility and employee protection in the Lithuanian parliament.

Citations:
World Bank Group, Doing Business Report 2018: http://www.doingbusiness.org/~/media/WBG/DoingBusiness/Documents/Annual-Reports/English/DB2018-Full-Report.pdf
COMMISSION STAFF WORKING DOCUMENT, country report Lithuania 2017: https://ec.europa.eu/info/sites/info/files/2017-european-semester-country-report-lithuania-en.pdf
The 2017 – 2018 Global Competitiveness Report of the World Economic Forum: http://www3.weforum.org/docs/GCR2017-2018/05FullReport/TheGlobalCompetitivenessReport2017%E2%80%932018.pdf
Standard Eurobarometer 86, Public Opinion in the EU, Autumn 2016, Brussels: European Commission 2016
Vilpišauskas, R. `The evolving agenda of energy security in the Baltic Sea Region: persistent divergences in the perception of threats and state-market relationship,’ in Sprūds, A., Andžans, A. Security in the Baltic Sea Region: Realities and Prospects, Riga Conference Papers 2017, Riga: LIIA, p. 187-199

Labor Markets

#31

How effectively does labor market policy address unemployment?

10
 9

Successful strategies ensure unemployment is not a serious threat.
 8
 7
 6


Labor market policies have been more or less successful.
 5
 4
 3


Strategies against unemployment have shown little or no significant success.
 2
 1

Labor market policies have been unsuccessful and rather effected a rise in unemployment.
Labor Market Policy
6
Though Lithuania’s labor market proved to be highly flexible during the financial crisis, probably due to low compliance with the Labor Code, persistent labor-market challenges undermine economic competitiveness. With unemployment rates declining in recent years, the mismatch between labor supply and market demand in has become the main issue of the labor market. It is increasingly difficult for businesses to find suitable skilled labor. Although immigrant workers from Ukraine and Belarus increasingly fill job vacancies in sectors such as construction and transport, immigration procedures are complex and create significant barriers to employment. Skills shortages are emerging in certain sectors of the economy, which will become more acute in the future. In its 2017 report, the European Commission recommended addressing skills shortages through effective active labor market policies, adult learning and improved educational outcomes by rewarding quality in teaching and higher education.

In the Global Competitiveness Report 2017-2018, Lithuania ranked highest for the flexibility provided in determining wages (ranked 13 out of 137 countries). However, hiring and firing practices were considered relatively very restrictive (ranked 111 out of 137 countries), and taxation has a very negative effect on incentives to work (ranked 117 out of 137 countries). Implementation of the new Labor Code is expected to make hiring and firing practices more flexible, thus improving the country’s position in this ranking.

In recent years the minimum wage has been increased a number of times by the previous and current governments. After the roughly 20% rise in 2013, increases to €300, €325 and €350 per month followed in 2014, 2015 and 2016, reaching about 50% of average monthly earnings in the business sector. In 2017, the minimum wage was further increased to €380 per month and the Tripartite Council agreed to set at €400 per month from 2018 (still subject to approval by the government). The council decided to depoliticize the setting of the minimum wage by indexing it to the average wage. Though the increase in the minimum wage contributes to increased economic consumption, a high minimum wage to average wage ratio increases the risk of unemployment for low-skilled workers. However, unemployment rates have continued to decline, falling to 7.9% in 2016, and are projected to decline further to 7.3% in 2017 and 6.8% in 2018 (European Commission forecasts). Relatively high rates of emigration to other EU member states have partially compensated for the country’s inflexible hiring-and-firing rules and rigid labor code. In the coming years, the shortage of labor, and structural mismatches between the supply and demand of skilled labor will be the biggest constraint on the economy’s continued convergence to the EU average.

Citations:
COMMISSION STAFF WORKING DOCUMENT, country report Lithuania 2017: https://ec.europa.eu/info/sites/info/files/2017-european-semester-country-report-lithuania-en.pdf
The 2017 – 2018 Global Competitiveness Report of the World Economic Forum: http://www3.weforum.org/docs/GCR2017-2018/05FullReport/TheGlobalCompetitivenessReport2017%E2%80%932018.pdf

Taxes

#8

To what extent does taxation policy realize goals of equity, competitiveness and the generation of sufficient public revenues?

10
 9

Taxation policy fully achieves the objectives.
 8
 7
 6


Taxation policy largely achieves the objectives.
 5
 4
 3


Taxation policy partially achieves the objectives.
 2
 1

Taxation policy does not achieve the objectives at all.
Tax Policy
8
In Lithuania’s tax system, a significant share of government revenue is generated from indirect taxes, while environmental and property taxes are relatively low. According to the World Economic Forum, tax rates have become the most problematic factor for doing business in the country. In particular, taxes on labor (personal income tax and social security contributions), which combined are above the average tax burden on labor in the European Union, have become a barrier to the competitiveness of Lithuanian businesses. Furthermore, there is significant tax evasion. According to the European Commission, the VAT gap (as a percentage of theoretical VAT liability) is significantly higher than the EU average. The European Commission has recommended implementing policies to improve tax compliance (particularly VAT compliance) and broaden the tax base by targeting sources that are less detrimental to growth.

In terms of horizontal equity, there are mismatches between various groups of economic actors with similar tax-paying abilities. Labor is taxed somewhat more heavily than is capital, while specific societal groups such as farmers benefit from tax exemptions. Previous governments have reduced the number of exemptions given to various professions and economic activities with regard to personal-income tax, social-security contributions and VAT. Social-security contributions are high, exceeding 30% of wages. While there are ceilings on payments from the social-security fund (pensions), there are no ceilings on contributions to it. The implementation of the new “social model” reduced social security contributions for employers by 0.5% from 1 July 2017 and will gradually introduce a progressive cap for employers’ contributions. Also, as of 1 January 2012, the tax base was broadened through a new tax on individuals owning residential real estate valued above €290,000, with a 1% rate on the value above this amount. In 2015, the value at which property tax must be paid was lowered to €220,000, while the rate was reduced to 0.5%.

In terms of vertical equity, the Lithuanian tax system to a certain extent imposes a higher tax burden on those with a greater ability to pay taxes, insofar as large companies pay larger sums than do small companies, but there is a flat income-tax rate of 15%. However, an element of progressivity is introduced through the use of an untaxed income threshold currently fixed at around €1,633 per year, thus favoring those receiving lower wages. The government increased the income tax threshold from €200 per month to €310 per month from January 2017 to make the income tax system more progressive. In addition, there will likely be unforeseen benefits to raising the income tax threshold for families with children.

In terms of revenue sufficiency, despite the fact that a process of fiscal consolidation has occurred on the expenditure side, some gap between tax revenues and government expenditure remains. However, it is less an outcome of low taxation than a significant shadow economy, extensive tax avoidance, and insufficient structural reforms in education and health care (where budgetary resources are dispersed across many organizations, despite a declining population and low quality of service provision). Social-security contributions are a particular concern, as this gap has led to significant indebtedness within the State Social Security Fund. While the increase in economic activity in the post-crisis period is expected to generate more government revenue, some observers have proposed the creation of additional tax-revenue sources in order to make Lithuania’s fiscal position more sustainable. To make the tax system less distortive and encourage economic growth, the government could reduce the tax burden on labor, especially social security contributions and strengthen incentives for paying taxes. Despite the recent review of the tax system, the only specific reform proposal to have been adopted was a decrease in the real-estate tax threshold and parallel rate reduction. Social-security contributions came into effect for the special category of small enterprises that for several years were excluded from this responsibility under a policy intended to foster entrepreneurship and reduce the tax burden on start-up business activities. An improvement in VAT and excise-tax collection was noted by analysts in 2015, and attributed partly to improvements in tax administration, and partly to the reduction in the incidence of fuel and tobacco-product smuggling from Russia’s Kaliningrad region and Belarus due to a general decline in trade with Russia.

In 2017, the Skvernelis government announced a new tax reform. The reform included a further increase in the income tax threshold, an adjustment to the VAT rate, and the introduction of a profit tax, social security contribution holidays for new businesses, several other tax exemptions and a progressive property tax on properties worth over €220,000. It is likely that the implementation of some reform measures that require additional budget expenditure (e.g., direct financial support for children) will be provided from the so-called change baskets. By the end of 2017, once these minor changes had been approved by the parliament, the debate on major tax and social security reforms began to gather pace.

Citations:
COMMISSION STAFF WORKING DOCUMENT, country report Lithuania 2017: https://ec.europa.eu/info/sites/info/files/2017-european-semester-country-report-lithuania-en.pdf
Tax Reforms in EU Member States 2015: Tax policy challenges
for economic growth and fiscal sustainability, September 2015, http://ec.europa.eu/economy_finance/publications/eeip/pdf/ip008_en.pdf.
The 2017 – 2018 Global Competitiveness Report of the World Economic Forum: http://www3.weforum.org/docs/GCR2017-2018/05FullReport/TheGlobalCompetitivenessReport2017%E2%80%932018.pdf

Budgets

#11

To what extent does budgetary policy realize the goal of fiscal sustainability?

10
 9

Budgetary policy is fiscally sustainable.
 8
 7
 6


Budgetary policy achieves most standards of fiscal sustainability.
 5
 4
 3


Budgetary policy achieves some standards of fiscal sustainability.
 2
 1

Budgetary policy is fiscally unsustainable.
Budgetary Policy
8
During the financial crisis, Lithuania’s fiscal situation deteriorated rapidly. The fiscal deficit grew to 3.3% of GDP in 2008, and to 9.4% of GDP in 2009. As a result of fiscal consolidation, the deficit dropped to 7.2% in 2010 and again to 5.5% in 2011. In 2014, the European Council adopted a decision allowing Lithuania to join the euro area as of 1 January 2015, in part recognizing its work in regaining control of the deficit. However, despite relatively high rates of economic growth, the 2012 to 2016 government was only able to reduce the budget deficit toward the end of its political term. According to European Commission forecasts, the general government surplus will be around 0.1% in 2017, down from 0.3% in 2016. The structural deficit is expected to be close to 1% between 2017 and 2019. Government debt also expanded during the crisis, reaching 39.8% of GDP in 2012 (from the pre-crisis low of 16% in 2008); it is expected to stabilize at around 40% of GDP over the coming years.

Despite these improvements in Lithuania’s fiscal performance since the crisis, the country faces a number of challenges in terms of keeping its public finances sustainable. Factors such as projected expenditure related to an aging population, relatively high migration rates, and the vulnerability of its small and open economy to external shocks pose significant risks to the consolidation path projected by the government in its convergence program. The goal of introducing the euro in 2015 preserved the government’s determination to maintain the deficit at a level below 3% of GDP, while the fiscal-discipline law provides an incentive to maintain a balanced fiscal policy as the economy keeps growing. Although spending pressures are increasing, it has been difficult to increase total tax revenues (29.4% of GDP in 2015), in part due to geopolitical tensions, the impact of Russia’s import ban on the Lithuanian economy, and slow recovery in the euro zone economy, which is the main export market for Lithuanian businesses. Geopolitical and social concerns prompted a major increase in defense and social expenditures under the Butkevičius and Skvernelis governments. In 2018, defense spending will for the first time reach 2% of GDP. Elsewhere, old-age pension increases have been set for 2018. The draft 2018 state budget, which was approved in October 2018, has a deficit of €468.5 million, but the general government balance is expected to reach a surplus of 0.2% of GDP in 2018.

Citations:
COMMISSION STAFF WORKING DOCUMENT, country report Lithuania 2017: https://ec.europa.eu/info/sites/info/files/2017-european-semester-country-report-lithuania-en.pdf

Research and Innovation

#20

To what extent does research and innovation policy support technological innovations that foster the creation and introduction of new products?

10
 9

Research and innovation policy effectively supports innovations that foster the creation of new products and enhance productivity.
 8
 7
 6


Research and innovation policy largely supports innovations that foster the creation of new products and enhance productivity.
 5
 4
 3


Research and innovation policy partly supports innovations that foster the creation of new products and enhance productivity.
 2
 1

Research and innovation policy has largely failed to support innovations that foster the creation of new products and enhance productivity.
R&I Policy
7
Lithuania’s economy is characterized by the exploitation of cheap factors of production rather than innovation-led growth. According to the EU Innovation Scorecard, the country performs below the EU average, falling into the “moderate innovators” group. However, its overall innovation performance has improved since 2008, despite a small decline in 2015. The country was ranked 38 out of 141 countries assessed in the 2015 Global Innovation Index. The country has set an ambitious target of spending 1.9% of GDP on R&D by the 2020. This level has been slowly increasing over recent years, reaching 1.2% in 2014. Moreover, the share of this sum spent by the business sector was very low (totaling just 0.3% of GDP in 2014), as research and innovation policy is dominated by the public sector and highly dependent on EU funds. Within the country’s innovation system, research is oriented only weakly to the market, research products are not supported with sufficient marketing or commercialization efforts, investment is fragmented, funding levels are not competitive with other European states, and enterprises do not participate in international markets to any significant degree, although there are some exceptions demonstrating good practices in the biotechnology and laser industries. The recent OECD review of the country’s innovation policy recommended introducing favorable framework conditions for innovation, developing innovation-oriented higher education and skills training, improving governance in the innovation system, balancing the policy mix and supporting international knowledge linkages.

Lithuanian authorities have used EU structural funds to improve the country’s R&D infrastructure. So-called science valleys have been developed, integrating higher education institutions, research centers and businesses areas that work within specific scientific or technological areas. However, using this new research infrastructure efficiently remains a major challenge, and cooperation between industry and research organizations remains rather weak. The government has also supported the sector through financial incentives (in particular, an R&D tax credit for enterprises) and regulatory measures. Demand-side measures encouraging innovation are less developed. Excessively bureaucratic procedures are cited by the science and business communities as the main obstacles to research and innovation in Lithuania.

The 2012 to 2016 government developed a new smart-specialization strategy intended to focus resources in science and technology areas in which Lithuania can be internationally competitive, although it has been criticized for investing too heavily in the construction of new buildings and renovation of low-ranking universities’ campuses. In 2016, the parliament approved new science and innovation policy guidelines, which were proposed by the president. The guidelines proposed restructuring the research and higher education systems, supporting innovation development, improving coordination of science and innovation policy, and monitoring science and innovation policy implementation. In June 2017, the parliament approved a resolution to optimize Lithuania’s state universities. The plan proposed merging the existing state universities into two comprehensive universities in Vilnius and Kaunas, and regional science centers (branches of other Lithuanian universities) in Klaipėda and Šiauliai. However, the details of the plan were ambiguous. After intense lobbying by representatives of the existing universities, the initial plan was amended and the ambitions to reduce the number of higher education institutions scaled back. Nevertheless, the government still intends to move ahead with its consolidation efforts and increase financial incentives for universities to improve the quality of teaching and research. Though it remains to be seen if these reforms will advance significantly, and sufficiently consolidate funding and talent.

Citations:
The EU Innovation Scoreboard is available at http://ec.europa.eu/enterprise/policies/innovation/facts-figures-analysis/innovation-scoreboard/
COMMISSION STAFF WORKING DOCUMENT, country report Lithuania 2017: https://ec.europa.eu/info/sites/info/files/2017-european-semester-country-report-lithuania-en.pdf
See the Global Innovation Index 2015 at file:///C:/Users/Vitalis/Downloads/gii-full-report-2015-v6.pdf.
OECD, Review of Innovation Policy: Lithuania, Overall Assessment and Recommendations, June 2016.

Global Financial System

#9

To what extent does the government actively contribute to the effective regulation and supervision of the international financial architecture?

10
 9

The government (pro-)actively promotes the regulation and supervision of financial markets. It demonstrates initiative and responsibility in such endeavors and often acts as an international agenda-setter.
 8
 7
 6


The government contributes to improving the regulation and supervision of financial markets. In some cases, it demonstrates initiative and responsibility in such endeavors.
 5
 4
 3


The government rarely contributes to improving the regulation and supervision of financial markets. It seldom demonstrates initiative or responsibility in such endeavors.
 2
 1

The government does not contribute to improving the regulation and supervision of financial markets.
Stabilizing Global Financial Markets
8
Lithuanian authorities contribute to improving financial-market regulation and supervision. Lithuania joined the euro zone and the single European banking supervisory system in 2015. The Lithuanian Ministry of Finance and the Bank of Lithuania (the country’s central bank) are involved in the activities of EU institutions and arrangements dealing with international financial markets (including the European Council, the European Commission, the European Systemic Risk Board’s (ESRB) Advisory Technical Committee, the European supervisory authorities, etc.). Lithuanian authorities are involved in the activities of more than 150 committees, working groups and task forces set up by the European Council, the European Commission, the ESRB’s Advisory Technical Committee and other European supervisory authorities.

In addition, the Bank of Lithuania cooperates with various international financial institutions and foreign central banks, in part by providing technical assistance to central banks located in the European Union’s eastern neighbors. Lithuania’s Financial Crime Investigation Service cooperates with EU institutions, international organizations and other governments on the issue of money laundering. The country has lent its support to many initiatives concerning the effective regulation and supervision of financial markets. In recent years, the Bank of Lithuania has tightened regulation of short-term lending practices to target so called fast-credit companies and attract foreign financial institutions. At the same time, the Bank of Lithuania has attempted to attract fintech companies to Lithuania, in the context of the United Kingdom leaving the European Union, to increase competition in the banking sector.
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