Explaining and tackling envelope wages in the Baltic Sea region: An institutional perspective

The purpose of this paper is to advance a new way of explaining and tackling the illegitimate wage practice where employers pay their employees an undeclared (envelope) wage in addition to their formal salary. Drawing upon institutional theory, it is here proposed that envelope wages result from the lack of alignment of a society’s formal institutions (i.e. the codified laws and regulations) with its informal institutions (i.e. the socially shared unwritten understandings which reflect citizens’ norms, values and beliefs).

To evaluate this, data are reported from a 2013 Eurobarometer survey involving 1,738 face-to-face interviews with formal employees in four Baltic countries, namely, Estonia, Latvia, Lithuania and Poland.

The finding is that the greater is the asymmetry between the formal and informal institutions (i.e. the level of disagreement of citizens with the codified laws and regulations of formal institutions), the higher is the propensity to pay envelope wages. This is the case at both the individual- and country levels.

To reduce the prevalence of envelope wages, the resultant argument is that the values of employers and employees need to be aligned with the formal institutions. This requires alterations not only in the informal institutions, using measures such as tax education, awareness raising campaigns and normative appeals, but also changes in formal institutions so as to improve trust in government by fostering greater procedural justice, procedural fairness and redistributive justice.

This is the first paper to apply institutional theory to explaining and tackling envelope wages in the Baltic Sea region.