IV. FYR Macedonia’s Development Challenges

IV. FYR Macedonia’s Development Challenges

1. Accelerating Economic Growth and Job Creation

34. 
    Accelerating and sustaining growth is needed to achieve the government’s ambitious economic and social objectives and for putting fYR Macedonia on the road to EU Accession. It is primarily through job creation that the benefits of this growth will be transmitted to Macedonian citizens. Improving employment obviously will require greater demand for labor through economic growth. But it will also call for supply-side interventions to enhance the skills of the labor force and to provide incentives for workers to increase their participation in the labor market. Job creation will be crucial to increase living standards and reduce poverty, ensure financing for public investments in health, education, and social protection, maintain political stability and enable fYR Macedonia to take fuller advantage of EU accession. As high unemployment has been a long lasting problem for fYR Macedonia, addressing this issue will not be easy.
    

35. 
    The job creation challenge can only be met through a multi-faceted approach that encompasses both labor demand and supply. FYR Macedonia has now approved a National Employment Strategy and a National Action Plan for Employment. These documents have been prepared with support and assistance from the EU. However, while the strategy and action plan addresses many important issues, the country’s jobs agenda must be broader in scope, involving reforms in many sectors beyond the labor market. A comprehensive approach to improving employment requires efforts in a number of areas that encompass sound economic and regulatory policies, an attractive investment climate, efficient labor market regulations and institutions, education and training systems that develop relevant and high-quality skills, and a social safety net that offers protection while encouraging employability.⁵
    

36. 
    The current macroeconomic situation should be favorable for growth and job creation, but continued prudence is essential. Macro stability, for the most part, is not a binding constraint to investment in fYR Macedonia. Inflation is low, foreign debt levels are moderate (below 40%), the budget deficit has been maintained at below 1 percent of GDP, and the current account deficit is, at below 2 percent, the lowest in the region. Concurrent with the decline in the current account deficit, international reserves have increased substantially. With these developments, the Central Bank has been a net purchaser of foreign exchange since early 2005 and has been able to ease monetary policy while maintaining the de facto pegged exchange rate regime. Private sector credit has grown by more than 20 percent per annum over the past few years and is likely to continue to grow at such a pace as interest rates continue to decline. With the new flat tax of 12 percent, fYR Macedonia now has the lowest personal income tax and corporate income tax in Europe. Continued prudence in macroeconomic management will be key to attracting investments and enabling firms to grow and create jobs.
    

37. 
    

    Figure 2: Major Obstacles to Firm Activity in fYR Macedonia, 2005 (% of firms reporting as major or severe obstacles)

    Source: BEEPS 2005

    Making the business climate more favorable for investors is critical. Firm surveys consistently indicate that an unfavorable investment climate is among the most important constraints to growth and job creation in fYR Macedonia. The results of the latest BEEPS survey of firms demonstrate the range of constraints in the investment climate that limit growth and job creation in fYR Macedonia (Figure 2). Most important are issues related to financing, anti-competitive practices and corruption, enforcement of contracts, the functioning of the judiciary, and licensing and regulations. While access to land, workforce skills and infrastructure weaknesses are farther down the list, experience elsewhere shows that they will rise in importance as soon as the economy starts taking off. Most of these factors originate from national policies and institutions, but can also be affected by the municipalities, especially if they become more proactive.
    

38. 
    The cost of capital needs to be reduced and access to capital improved. Despite falling interest rates over the last three years, the cost of financing remains the most important reported factor constraining business activity. Recent reductions in the Central Bank rates have only partially been translated into commercial banks rates, suggesting a relatively uncompetitive banking climate, low banking efficiency and difficulties in assessing credit risks of potential borrowers. Better financial information on enterprise performance would help improve access to capital. It will also help lenders and investors to better evaluate corporate prospects, and make informed investment decisions.
    

39. 
    Changes have been introduced to make the costs of doing business low and predictable, but further reforms are needed. Progress has been made to improve the investment climate, including judicial reforms to ensure better contract and property protection, land and real estate cadastre, enterprise registration, and bankruptcy legislation. However, these reforms are incomplete, and the agenda needs to focus on some of the key remaining bottlenecks. An illustration of the remaining challenge is that fYR Macedonia is still at a disappointing 92^nd place on the overall “ease of doing business measure” in Doing Business 2007.
    

40. 
    Addressing concerns of uncertainty over business regulations is now a priority. The government is strongly committed to regulatory reform and is in process to revamp regulations affecting the business sector, improving the quality of both existing and new regulations. A proper institutional framework has been designed to guide the process at the central government level. To deal with the existing stock of business regulations, a so-called “guillotine” system has been launched in February 2007, requiring a vigorous re-evaluation and re-justification of current business regulations. For future regulations, the government will implement a regulatory impact assessment (RIA) system and institutionalize mandatory consultation mechanisms with the business community.
    

41. 
    Promote Competition. The enterprise restructuring process that followed the privatization of the 1990s has not led to the innovation and managerial improvements that would increase the competitiveness of the private sector. About 60 percent of all privatizations in fYR Macedonia in the 1990s occurred through “insider” buy-outs and this still affects –even after 10 years– the efficiency, managerial performance, and competitiveness of Macedonian enterprises. Although the private sector share in GDP is close to 65 percent, and growing, EBRD’s Transition Indicators still score fYR Macedonia rather low for enterprise restructuring. Remaining opportunities for unfair competition practices, (e.g., tolerated arrears in taxation, wage and social contribution or energy bills) need to be addressed rigorously. There are serious problems in the implementation of the public procurement law and the related sub-legislative instruments that result in unfair competitive practices in public procurement; these problems must be addressed. Moreover, the remaining liberalization agenda requires aggressive implementation, in particular in the telecommunication and air transportation sectors, where lack of competition is resulting in extremely high prices, hurting the private sector and the public alike.
    

42. 
    Foreign Direct Investment (FDI) and trade with more developed countries will help improve the competitiveness of Macedonian companies. In general, Macedonian companies need to improve their competitiveness; they are adjusting too slowly to new market opportunities and investing too little in technology adaptation, development of new products, and in training and skills upgrading of their managers and staff. Experience elsewhere shows that FDI and increased regional and global trade have important side benefits, such as faster transfer of knowledge, technology and improved managerial capacity and better access to foreign markets. FDI levels have been very low even by Western Balkan standards, and significant greenfield FDI is only starting now. Improving this record is a top priority for the government and it plans to implement various measures to this end. Trading with countries that have a more advanced knowledge and technology base can also generate positive “learning” spillovers. However, trade with more technically sophisticated EU partners is relatively low. With the recent accession of Bulgaria and Romania to the EU, fYR Macedonia now enjoys two EU borders (with Greece to the south). This allows for increased investments and access to the deep EU market, but also bears the risk that trade and transit more easily bypasses the country altogether. Thus, actions to alleviate non-tariff cross border barriers become even more pressing.
    

43. 
    Improving agricultural competitiveness is especially important, also in view of the EU accession process. Agriculture accounts for 16 percent of GDP and some 20 percent of employment. The sector is also crucial for the rural economy, where almost half the population lives. Sector performance over the last decade has been mixed, largely dependent on weather conditions. Constraints to competitiveness include low levels of investment in farm technology and supply chains as well as underdeveloped land and rural credit markets. As with other countries in the region, increasing trade liberalization and modernization of the economy are transforming Macedonian agriculture. While opportunities presented by increased trade are great, unless producers and agro-processors can become more competitive, they will have trouble maintaining and increasing external and internal market share as low-cost, high-quality imports increase.
    

44. 
    Overcoming these constraints calls for effective public sector actions to resolve market failures and create an enabling environment for the private sector through transparent, predictable policies and regulations and investment in public goods. FYR Macedonia’s recently acquired status as an EU candidate country presents opportunities in the form of significant additional assistance for the sector, but also imposes additional institutional and regulatory requirements. In light of increasing resources and competition in regional markets, fYR Macedonia urgently needs to raise Ministry of Agriculture, Forestry and Water Economy’s (MAFWE’s) weak institutional and human capacity to facilitate agriculture modernization. In addition, the labor shedding that will occur once the sector becomes more competitive will require careful management.
    

45. 
    Efficient infrastructure and energy supply are also necessary for spurring growth, increasing international trade and improving the business climate more generally. Except for some bottlenecks, the capacity of the road and rail transport infrastructure is sufficient but management and maintenance is inadequate. Structural reforms and institutional strengthening are necessary to improve efficiency in transport asset conservation, based on well-informed programming and budgeting of maintenance needs. International transport links are crucial for the country, and fYR Macedonia’s active participation in the core transport network strengthening between the European Union and its neighboring countries is very important. The fragmented railway system can only fully benefit from new freight transportation opportunities in steel and other industries, if it ensures uninterrupted longer distance railway links. Furthermore, like the other SEE countries, fYR Macedonia has signed the European Common Aviation Area (ECAA) agreement, but to reap the benefits of this extension, the country will have to implement ambitious aviation sector reforms. Finally, fYR Macedonia is a signatory of the Energy Community of South East Europe (ECSEE) Treaty to promote integration of SEE energy markets. Due to its advantageous location, and with further improvement in the performance of its energy sector and increased investment in infrastructure, the country is in a position to take full advantage of its participation in the regional power market.
    

46. 
    Labor market regulations and institutions are important for protecting workers, but they also can play a key role in supporting growth and job creation. The 2005 Labor Law represents an important step in bringing Macedonian labor market rules in line with the norms of a market economy, but the reform agenda is still incomplete. Enterprise surveys suggest that almost one-third of firms still consider labor regulations as a severe factor constraining their growth and, therefore, job creation. Further reforms to make contracting more flexible are needed. Moreover, compliance with labor laws is still problematic, which hinders both worker protection and the formalization of employment. Although more appropriate regulations should naturally lead to better self-enforcement, improving the enforcement capacity of the Labor Inspectorate will also be needed to reduce non-registration and other forms of non-compliance.
    

47. 
    Reducing the labor tax wedge would encourage job creation. In fYR Macedonia, the labor tax wedge is around 40 percent with little variation by wage levels. The tax wedge has already been reduced slightly with recent changes in the income tax. The government is considering reducing payroll taxes further by switching to general budget financing of health expenditures. Cuts in social contributions need to be analyzed carefully to assess both the likely employment payoff as well as the fiscal implications for the social insurance funds. The administration of the collection should be addressed as well. The new system of collecting pension contributions has been implemented since January 2006 and allows better control of compliance, although –as for all social contributions– the enforcement system still needs to be strengthened. The important harmonization of contribution bases across the different systems is now underway. The basis for calculating contributions should be shifted from the current net-wage basis to a simpler gross-wage formula that is considered best practice, and has already been implemented elsewhere in the region.
    

48. 
    Skills of the workforce need to be upgraded. In fYR Macedonia, about one-quarter of firms identify the skills of the workforce as a serious obstacle to growth, but in more dynamic sectors, skills appear to be a more serious problem. As the country further integrates into the European and global economies, it will need to seriously reform education at all levels to ensure that its workforce remains competitive. As these efforts are long term in nature, action needs to be taken now. Education and training have simply not kept up with the changing demands of the post-transition economy. At least 40 percent of today’s youth do not finish secondary school. International assessments of learning outcomes consistently show that young Macedonians have not achieved the skill levels of their counterparts in the EU and other OECD countries. The government has proposed making secondary education compulsory and this is an important step. But it needs to be accompanied by a significant shift in the type of curriculum and teaching offered to students; away from narrow vocationally-oriented courses towards stronger general education competencies plus encouraging creativity, team work, and problem-solving. There is also virtually no opportunity for the large number of dropouts to get back on track through second chance programs. In higher education, fYR Macedonia needs to press ahead with reforming the curriculum to make it more relevant to the labor market, to fulfill the requirements of integration into the European higher education area (the Bologna Process), and to restructure its research capacity.
    

49. 
    Social protection programs can safeguard the income of workers from shocks to employment, and can help them reintegrate into the labor market. The task of cushioning adjustment costs for workers is hampered by a relatively small but complicated and non-transparent social assistance system, with few incentives or support to reintegrate into the labor market. The government plans to revamp this system, including introducing conditional cash transfers for poor families with children to break the inter-generational poverty cycle. At the same time, the ongoing pension reform should eventually reduce the burden on the contribution rate while broadening and improving the support offered by the system.
    

50. 
    The effectiveness of the other two key elements of social protection for workers – unemployment benefits and active labor market programs (ALMPs) – also needs to be significantly improved. Currently, unemployment insurance does not play its intended role of offering temporary support to active job seekers. Most of the current recipients are, in fact, long-term beneficiaries who are being given unemployment benefits as a transition to eventually receiving pensions. While addressing the problem of laid-off workers is complex, this solution eliminates any possibility for an actuarially balanced Unemployment Fund (UF) and for a truly effective unemployment benefit system. Active labor market programs have been used on a very limited scale until now. The government does intend to increase its investment in these programs with the assistance of the EU and others and, if implemented effectively and taking into account lessons learned from international experience, this could enhance employment.
    

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