The Baltic paradox: wages rise, but the shadow economy holds steady

A new study on the shadow economy by the Stockholm School of Economics in Riga (SSE Riga) shows that wage growth across the Baltic states is not automatically shrinking the informal sector. Last year Latvia's average gross salary reached 1,815 euros, while Lithuania and Estonia both crossed the 2,000-euro mark. Yet shadow economy shares across all three countries remain broadly similar — 21.8% of GDP in Latvia and 20.8% in Estonia, both slightly up on the previous year. Lithuania, which posted the region's highest average salary at around 2,415 euros, saw its shadow economy shrink by 1.1 percentage points to 23.6%, but it still carries the largest informal sector in the Baltics.

Regional gaps complicate the picture

The study stresses that national averages mask sharp internal disparities, nowhere more visible than in Latvia. Last year after-tax wages in Riga and its surrounding region reached 1,990 euros, compared with just 1,302 euros in Latgale. That same region records the country's highest shadow economy share, at 25.7% of GDP. Low-paying sectors such as accommodation and catering, where average gross pay was 1,190 euros, add further pressure toward informal employment, since the cost of everyday goods is similar nationwide regardless of region.

Envelope wages remain the dominant component

Labour shortages are pushing even less productive businesses to raise pay, often partly off the books. Envelope wages remain the largest single component of the shadow economy — 47.1% in Latvia, 43.7% in Estonia and 36.6% in Lithuania. Estonia illustrates that even a high average wage offers no protection: a prolonged recession and tax hikes there drove the shadow economy up by 1.4 percentage points. Lithuania, by contrast, has made gradual progress by rolling out digital tools to curb cash transactions and imposing tougher penalties for illegal employment, particularly in construction.

The study's authors argue that Baltic governments need to narrow regional income gaps and keep modernising public administration digitally to limit the shadow economy's distorting effect on competition and tax revenues.