Report No. 53185-XK Kosovo Unlocking Growth Potential: Strategies, Policies, Actions A Country Economic Memorandum April 29, 2010 Poverty Reduction and Economic Management Unit Europe and Central Asia Region Document of the World Bank IPARD Instrument for Pre-Accession Assistance for Rural Development IPAK Investment Promotion Agency of Kosovo IT Information technology ITF International Transportation Forum IWB Invest in the Western Balkans KCA Kosovo Cadastral Agency KAA Kosovo Accreditation Agency KCA Kosovo Cadastral Agency KCB Kosovo Consolidated Budget KEK Kosovo Energy Corporation KFOR Kosovo Force KR Kosovo Railways KRPP Kosovo e Re Power Plant LFS Labor Force Survey MFN Most Favored Nation MIS Market Information System MSWL Ministry of Social Works and Labor MTC Ministry of Transport and Communication MTEF Medium-term expenditure framework MTPT Ministry of Transport and Post-Telecommunications MW Megawatt NGO Nongovernmental Organization NQF National Qualifications Framework NRP Nominal Rate of Protection PES Public Employment Office PPP Public-Private Partnerships REER Real Effective Exchange Rate SAFE Framework of Standards to Secure and Facilitate Global Trade SEE Southeast Europe SEETO SEE Transport Observatory SFRY Socialist Federal Republic of Yugoslavia SOK Statistical Office of Kosovo SPS Sanitary and Phytosanitary Standards TIMS Trade Risk Management System TIR International Road Transport TRAINKOS Kosovo Transport Railway Operations JSC UN United Nations UNCTAD United Nations Conference on Trade and Development UNDP United Nations Development Programme UNICEF United Nations Children Fund UNMIK United Nations Interim Administration Mission in Kosovo USAID United States Agency for International Development VET Vocational Education and Training VFAK Veterinary and Food Agency of Kosovo WCO World Customs Organization WfW Woman for Woman WTO World Trade Organization ACKNOWLEDGEMENTS This report was prepared by a core team led by Borko Handjiski. Chapters 1 and 2 were prepared by Borko Handjiski, with core inputs and background papers from Henk Busz (energy), Agim Demukaj (business environment survey and wage competitiveness), and Margit Mischkulnig (foreign investor survey). Carolina Monsalve prepared the policy note on trade and transport facilitation (Chapter 3) (incorporating a contribution from Alexander Kitain), and the chapter was edited by Borko Handjiski. Chapter 4 was prepared by Cristobal Ridao-Cano with contribution from Flora Kelmendi (and a background note from Isil Oral). Chapter 5 was prepared by Sachiko Miyata under the guidance of Caterina Ruggeri Laderchi (based on the results of a migration survey which was implemented jointly with the Statistics Office of Kosovo). The last chapter was prepared by William Sutton based on a background note by Vito Intini. In addition, the following staff provided valuable contributions: Clelia Rontoyanni (Chapter 1, on public administration), Sachiko Kataoka (Chapter 4, on education), Matin Kholmatov (Chapter 5 on migration), and Cora Melani Shaw and Andrew Michael Mitchel (Chapter 6). Useful comments were also received by the peer reviewers, Ardo Hansson and Peter Grassmann (European Commission), as well as by Irina Astrakhan, Krenar Bujupi, Sudharshan Canagarajah, Agim Demukaj, Mohinder Gulati, Martin Humphreys, Ron Hood, Laura Kullenberg, Sarah Michael, Ranjit Nayak, Edon Vrenezi, the IMF's Kosovo team, and Plamen Kaloyanchev and Stefano Dotto from the European Commission. The report benefited greatly from the guidance of Bernard Funck, Sector Manager. The team enjoyed excellent support from Nancy Davies-Cole (responsible for the desktop publishing) and Marija Gavric (logistics support for the team's missions in Kosovo). The team would especially like to thank the Kosovo authorities for hosting the World Bank staff and providing access to information, valuable feedback and their time, as well as the representatives of the business community who gave generously of their time. The work on this report benefited from a generous financial contribution of UKaid from the Department for International Development, as well as financial support from the Swiss Development Corporation to the implementation of the migration survey. Vice President: Philippe H. Le Houerou Country Director: Jane Armitage Sector Director: Luca Barbone Sector Manager: Bernard Funck Team Leader: Borko Handjiski CONTENTS EXECUTIVE SUMMARY ........................................................................................................... v 1. STRATEGIC AND MACROECONOMIC SETTING ......................................................... 1 A. INTRODUCTION ................................................................................................................ 1 B. REAL SECTOR PERFORMANCE ......................................................................................... 2 C. FISCAL POLICY VOLATILITY............................................................................................ 4 D. WEAK EXPORT PERFORMANCE RESULTS IN EXTERNAL IMBALANCES ............................ 8 E. GROWTH POTENTIAL OF UNUSED RESOURCES.............................................................. 10 F. ACCELERATING GROWTH .............................................................................................. 17 2. ENHANCING PROSPECTS FOR PRIVATE SECTOR LED GROWTH ........................ 18 A. INTRODUCTION .............................................................................................................. 18 B. THE REGULATORY ENVIRONMENT IN KOSOVO ............................................................. 19 C. WEAKNESSES IN THE RULE OF LAW ............................................................................. 20 D. BUSINESS REGISTRATION AND LICENSING DIFFICULTIES ............................................. 23 E. INVESTING IN KOSOVO: PERCEPTION OF FOREIGN INVESTORS ..................................... 25 F. ENERGY IN KOSOVO: CONSTRAINTS AND OPPORTUNITIES ........................................... 30 G. SUMMARY AND POLICY RECOMMENDATIONS ............................................................... 35 3. THE ROLE OF TRANSPORT AND TRADE FACILITATION IN IMPROVING EXPORT PERFORMANCE IN KOSOVO ................................................................................ 37 A. INTRODUCTION .............................................................................................................. 37 B. A COMPARATIVE ASSESSMENT OF KOSOVO'S PERFORMANCE ..................................... 37 C. THE ROLE OF TRANSPORT INFRASTRUCTURE ............................................................... 40 D. BORDER CROSSINGS AND REGULATORY BARRIERS TO TRADE..................................... 42 E. TRANSPORT SERVICES AND SUPPLY CHAIN PERFORMANCE ......................................... 52 F. MAIN RECOMMENDATIONS ........................................................................................... 54 4. IMPROVING LABOR MARKET OUTCOMES IN KOSOVO ........................................ 55 A. INTRODUCTION .............................................................................................................. 55 B. DISAPPOINTING LABOR MARKET OUTCOMES................................................................ 55 C. THE REASONS FOR LOW UNEMPLOYMENT .................................................................... 62 D. OPTIONS FOR ADDRESSING THE CHALLENGES IN THE LABOR MARKET ....................... 64 E. SUMMARY AND RECOMMENDATIONS ............................................................................ 68 5. THE ROLE OF MIGRATION AND REMITTANCES ..................................................... 70 A. INTRODUCTION .............................................................................................................. 70 B. MIGRATION FROM KOSOVO .......................................................................................... 71 C. MIGRATION IMPACT ON LABOR MARKET OUTCOMES .................................................. 74 D. IMPACT OF REMITTANCES ON POVERTY, INVESTMENT, AND GROWTH ........................ 77 E. SUMMARY AND RECOMMENDATIONS ........................................................................... 81 6. THE ROLE OF AGRICULTURE FOR STIMULATING EMPLOYMENT AND GROWTH ................................................................................................................................... 83 A. INTRODUCTION .............................................................................................................. 83 B. OVERVIEW OF AGRICULTURE IN KOSOVO .................................................................... 84 C. WHERE DO KOSOVO'S COMPARATIVE ADVANTAGES LIE?.......................... 89 D. THE CONSTRAINTS TO AGRICULTURE DEVELOPMENT .................................................. 91 E. INCREASING KOSOVO'S AGRICULTURAL COMPETITIVENESS ......................................... 97 F. KEY RECOMMENDATIONS ........................................................................................... 103 REFRENCES ............................................................................................................................ 125 ANNEXES Annex 1: BEEPS 2009 Results: Firms Responses on Barriers to Doing Business (2008) ....... 105 Annex 2: Doing Business 2010 Results: Ease of Doing Business in Eastern Europe and Central Asia ............................................................................................................................................ 106 Annex 3: Transport Infrastructure Review ................................................................................ 107 Annex 4: Case Studies ............................................................................................................... 112 Annex 5: List of Recommendations Based on the Transport and Trade Facilitation Audit ..... 114 Annex 6: Increasing Female Labor Supply and Existing Social and Cultural Norms .............. 116 Annex 7: Migration Survey Data and HBS 2009 ...................................................................... 118 Annex 8: Agriculture Sector Analysis ....................................................................................... 123 TABLES Table 1: Key Economic Indicators ................................................................................................ 2 Table 2: GDP Growth in Southeastern Europe ............................................................................. 3 Table 3: GDP Structure by Sector ................................................................................................. 4 Table 4: Ratio of Wages in Financial Sector to Wages in Low-Wage Sectors (2008) ............... 15 Table 5: Procedures for Starting a Business ................................................................................ 23 Table 6: FDI in Kosovo, by Type (in million) ......................................................................... 26 Table 7: Trading across Borders Sub-index ................................................................................ 38 Table 8: Progress in Convergence to EU Standards .................................................................... 39 Table 9: BEEPS Results: Problems Doing Business (Percentage of Firms) ............................... 40 Table 10: Throughput of the Three Main Ports ........................................................................... 41 Table 11: Kosovo Customs: Revenue and Declarations by Customs Station (2007­8) ............. 45 Table 12: Costs and Time of Export and Import Documentation ............................................... 46 Table 13: Strengths and Weaknesses of Kosovo Customs.......................................................... 49 ii Table 14: Population structure, Employment and Labor Force Participation Rates (2008) ....... 56 Table 15: Breakdown of Unused Human Capital (2008) ............................................................ 57 Table 16: Structural Phenomenon of Unemployment (Percentages) (2008) .............................. 59 Table 17: Previous job experience of the Jobless (Percentages) (2008) ..................................... 60 Table 18: Informal Workers (Percentages) (2008)...................................................................... 61 Table 19: Employment, by Sector and Occupation (2008) ......................................................... 62 Table 20: Low and Stagnant Labor Demand (2008) ................................................................... 63 Table 21: Remittances have been the largest external source of financing for Kosovo (as percent of GDP unless otherwise noted) .................................................................................................. 73 Table 22: Local Bank Fees for Receiving Transfers from Abroad (in ) ................................... 74 Table 23: Kosovar Agro-food Trade ( million) ......................................................................... 85 Table 24: Agricultural Land and Labor Costs in the Western Balkans (2005 unless otherwise noted) ........................................................................................................................................... 88 Table 25: The Rural Profile of the Western Balkans .................................................................. 89 Table 26: Allocation to Agricultural Budget, Regional Comparison (2007) ............................ 101 Table 27: Recommended Action Matrix for Development of Agricultural Markets in Kosovo ................................................................................................................................................... 103 FIGURES Figure 1: Kosovo's Government Revenue and Expenditure (2005­9) and Regional Comparison (2008), as share of GDP ................................................................................................................ 5 Figure 2: Merchandise Exports and Imports, 2001­8 ................................................................... 8 Figure 3: International Metals Commodity Index (2005 = 100) (right) and Kosovo Metal Exports in million (left) .............................................................................................................. 9 Figure 4: Average Monthly Gross Wage in Private Sector (in ) ............................................... 13 Figure 5: Percentage of Firms Indicating Corruption (left) and Crime (right) Are Constraints (2008) .......................................................................................................................................... 21 Figure 6: Property-Related Crime Rates in Kosovo (number of cases per year) ........................ 21 Figure 7: Perceptions of the Rule of Law (left) and Court System (right) (percent of respondents)................................................................................................................................. 22 Figure 8: Perceptions of the Efficiency of the Public Administration (percent of respondents) 22 Figure 9: Knowledge about Kosovo (share of respondents) ....................................................... 27 Figure 10: Changes in Perceptions of Kosovo (left) and areas of improvement (right) ............. 27 Figure 11: Probability of Investment (percent of responding firms)........................................... 28 Figure 12: Reasons to Invest (left) and Types of Planned Investment (right), percent of responses ..................................................................................................................................... 29 Figure 13: Kosovo as Part of a Regional Market (share of respondents) .................................... 29 Figure 14: Freight Traffic, 2001­8 .............................................................................................. 41 Figure 15: Firms That Provide Workers Basic Benefits and Protections (2008) ........................ 65 Figure 16: Enrollment Ratio by Gender and Income Groups (2007) .......................................... 67 Figure 17: Migrants' Resident Status in Destination Countries (share of total) ......................... 72 Figure 18: Ways of Transferring Remittances in Kosovo (share of respondents) ...................... 73 Figure 19: Returned Migrants Earn Higher Wages Than Non-migrants at All Skill Levels (monthly wage in ) .................................................................................................................... 76 Figure 20: Labor Market Performance of Migrants and Non-migrants, by Skill Level ............. 77 Figure 21: Share of Migrant-Sending Households by Income Groups, income includes remittances (left), income excludes remittances (right) .............................................................. 78 iii Figure 22: Remittances Received by Consumption (per Capita) Group (in ) ........................... 79 Figure 23: Uses of Remittances (share of respondents) .............................................................. 79 Figure 24: Benefits of Migration Perceived by Return Migrants (share of respondents) ........... 80 Figure 25: Shifts in Agricultural Land Use and Livestock Numbers Over the Last Two Decades ..................................................................................................................................................... 85 BOXES Box 1: The Focus and Methodology of the Country Economic Memorandum ............................ 1 Box 2: Public Administration and the Business Environment in Kosovo .................................... 6 Box 3: The Restarting of Ferronikeli .......................................................................................... 11 Box 4: Promoting Employment in FYR Macedonia ................................................................... 14 Box 5: Kosovo's Exports Are Blocked Due to Lack of Recognition ......................................... 16 Box 6: Starting a Business in FYR Macedonia and Georgia ...................................................... 25 Box 7: Foreign Investor Perception Survey ................................................................................ 26 Box 8: Zinkunie - Dutch Investment in Prizren .......................................................................... 30 Box 9: Infrastructure Development Needs to be Accompanied by Institutional Strengthening . 42 Box 10: The Single Window System .......................................................................................... 51 Box 11: The Government's Employment Strategy ..................................................................... 66 Box 12: Focusing Labor Market Policies on Women ................................................................. 66 Box 13: Migration Survey 2009 .................................................................................................. 71 Box 14: Agricultural Development Critical for Pro-Poor Growth .............................................. 84 Box 15: Kosovo's Climatic Conditions....................................................................................... 87 Box 16: Increasing Rural Employment through Horticultural Production ................................. 90 Box 17: Pestova: Potato Production and Processing Company .................................................. 93 Box 18: Input Supply in Kosovo ................................................................................................. 96 iv EXECUTIVE SUMMARY 1. Kosovo's economic growth in the past decade has been solid, yet, with a gross domestic product (GDP) per capita of 1,760, the country remains one of the poorest in Europe. Following the end of the conflict, output was growing at double-digit rates, driven by the donor-funded reconstruction efforts. Since 2005, annual growth has decelerated to below 5 percent. However, the other countries in Southeast Europe have been growing faster, so the income gap has widened. Kosovo's economy would need to more than double its growth rate to 10 percent per annum over the next decade to reach Albania's income level (assuming Albania's economy continues to grow at 5.5 percent annually over this period). To reach Montenegro's current GDP per capita level of about 5,700, the economy would have to grow at 12 percent per annum for an entire decade. At the same time, Kosovo has the weakest employment track record in Europe: the unemployment rate has reached 48 percent and the employment rate is extremely low (26 percent). Consequently, poverty remains persistent and widespread (though shallow) with 45 percent of the population estimated to consume less than the national poverty line, while 17 percent are extremely poor1. 2. Much of the economic progress in the recent period has been based on donor aid and remittances, which cannot be the foundation of a sustainable economic strategy. In the first years following the conflict, reconstruction efforts drove economic activity. Donor support, though now significantly reduced, has remained an important source of growth, but its role will decline in the medium term. Private sector growth began slowly to emerge in earnest in the past decade. However, economic activity has been concentrated mostly in the services sector, which has grown through large remittance inflows and the international presence in Kosovo. Substantial productive investment in the tradable goods sector has not taken place yet, and this is confirmed by the high and rising imports and very low exports. In the future, sustainable and rapid economic growth will depend on a more active engagement of the private sector, both domestic and foreign. 3. Kosovo has the potential to shift toward faster, private sector­led growth. Kosovo's products have free market access to the European Union (EU) and Central European Free Trade Agreement (CEFTA) countries, so exports could become an important pillar of growth. Unleashing that potential would involve bringing on line three production factors that are now sitting partially idle: labor, land, and energy and minerals. The encouraging news is that unleashing this potential is within the country's own grasp, because most of the current obstacles are of a policy nature. However, simultaneous action will be required on several policy fronts. This Country Economic Memorandum focuses on some of the most important opportunities for growth in Kosovo, and this executive summary briefly introduces the most important findings: Though small and landlocked, Kosovo's location, free market access, and EU membership prospects offer great opportunities for growth through EU and regional 1 These poverty rates are based on the latest available World Bank estimates which refer to 2006. Updated poverty estimates are expected to be published in the second half of 2010. v integration. It also has large, underutilized resources (labor, minerals, and land) that should be tapped and used to attract business investment. Though many aspects of the business environment are favorable, simplified business regulations, strengthened rule of law and security, and greater trade facilitation remain key to activating these idle resources. Foreign investment in the mining and electricity sectors, as well as in export-oriented industries, is crucial to unclogging the bottlenecks and powering growth. Compared to its neighbors, Kosovo also has a competitive advantage in low-cost (but abundant and prime-age) labor. To exploit its unused labor, in addition to creating labor demand, Kosovo should invest in skills development and move towards greater contract flexibility in the labor legislation as well as better enforcement. Finally, the fragmented agriculture land that is now fallow could potentially turn into an important source of employment. Strengthening property rights, completing the privatization process and providing more active support to farmers are necessary to develop further agricultural activity. 4. First, to make trade integration a key pillar of Kosovo's growth strategy, the authorities need to focus on creating a more favorable climate for exports and for export- oriented foreign direct investment (FDI). Kosovo's business environment provides several comparative advantages that are important for a flourishing private sector as well as for attracting FDI in the tradable sectors. For example, the tax system is simple and has low rates, and labor market rigidities are also very low, while at the same time wages are much lower than the region. These advantages, as compared to the region, are very important for attracting foreign investors. However, the following are areas of the business environment that are of great concern to practically all firms in Kosovo, as well as to potential investors: Energy: frequent power outages limit production increasing costs due to the need to use alternative energy sources, and preventing investment in sophisticated equipment. Corruption, crime, and overall functioning of the rule of law: also significantly raise the cost of doing business, for example, Kosovo's firms pay extraordinarily high amounts for security. Costly and lengthy business registration and licensing procedures: deter entrepreneurial activity, or at least push firms to informality. 5. Kosovo will also need to overcome two obstacles to trade. First, when it comes to competing in foreign markets, all other countries in the Southeastern Europe (SEE) region seem to have a comparative advantage over Kosovo in terms of getting their products to the target markets. Albania, Croatia, and Montenegro have direct sea access, which greatly reduces the cost of transport. The former Yugoslav Republic (FYR) of Macedonia is closer to the Greek port of Thessaloniki and has a better trade and logistics environment. Bosnia and Herzegovina, Serbia, and Montenegro are much closer to the Western European markets, which is a key destination for the region's products. 6. Kosovo's transport infrastructure has suffered from years of underinvestment as well as war damage, hence, the maintenance backlog and the need for new investment. Moreover, vi political barriers block Kosovo's exports: the customs stamp of Kosovo's Customs Authority is not recognized by Bosnia and Herzegovina and Serbia and Montenegro, and trucks with Kosovar license plates can only enter Albania, FYR Macedonia, and Montenegro. Finally, getting goods across the border, despite the great progress made in recent years, takes more time and money than in most countries in the region. Kosovo exporters need more documentation than other countries in the region, and the time to export is on average higher than in other SEE countries (see Chapter 3). 7. Overcoming these disadvantages will require both policy measures and infrastructure investment. Chapter 3 on trade and transport facilitation provides a list of policy recommendations on ways to streamline the functioning of customs and other border agencies. Some of these measures, such as synchronizing the operating hours of customs and veterinary inspection services, are very easy to implement and can shorten waiting times at the border. Also, improving the quality infrastructure (standardization, accreditation, and metrology) is important for ensuring that Kosovo's products can enter the target markets. Adopting European and international standards is a must for placing products on the EU market, and increasingly on the CEFTA market because the other CEFTA countries are rapidly adopting EU standards. Progress in this field will also mean a big step forward in the EU integration process because this is one of the core areas of the European acquis communautaire2. 8. At the same time, Kosovo needs to invest in its transport network to meet the increasing demand. In the current environment of limited financial resources, priority should be given to the border crossing points where the bulk of exports exit the country. In addition to having a sustainable financing framework for such investments, greater attention should be paid to the efficiency of infrastructure spending: inadequate procurement and public private partnership (PPP) frameworks could substantially inflate the cost of transport projects. In principle, preference should always be given to transparent and open bidding procedures to obtain the best value. 9. Kosovo's capital base is limited, so the economy has to rely on foreign investment to fully unleash its export and growth potential. A foreign investor survey, which was conducted by the World Bank in 2009, shows that foreign investors have more or less the same concerns about Kosovo's investment climate as domestic firms. Foreign investors are reluctant to invest because of their perceptions regarding public administration inefficiency, complex regulations (for example, to obtain a building permit), and possible corruption, among others. In addition to these challenges, which are described in greater detail in chapter 2, another deterrent to foreign firms' investment is their perception of high political risk in Kosovo. Foreign firms already in Kosovo have a much more positive perception of Kosovo's investment opportunities than foreign firms that have yet to enter the Kosovo market, therefore, to attract more foreign investment, the authorities should take measures to improve Kosovo's image abroad. 10. To improve the business environment the authorities need to act on several fronts, but the main focus should be on ensuring the protection of property, better contract enforcement, and greater transparency to minimize corrupt behavior. Making these 2 The EU acquis communautaire is the body of common rights and obligations which bind all the Member States together within the European Union. vii improvements is not an easy process and is potentially time consuming. Nonetheless, a lot can be accomplished in the short to medium term by: Expanding the real estate cadastre coverage and introducing zone planning Simplifying business registration by introducing a one-stop-shop and reducing registration costs and minimum capital requirements Scrapping unnecessary business regulations related to obtaining licenses and permits (the immediate focus should be on construction permits) Strengthening the capacity (with staff and equipment) of those public institutions that provide services for firms (for example, business registration and permits) Strengthening the court system to improve contract enforcement. 11. Another source of growth for Kosovo lies in its abundant natural resources, particularly those in the energy sector. At present, Kosovo's lignite and other natural resources are largely unused, while energy is the single largest problem for doing business. Putting the vast lignite resources to use would help remove one of the biggest constraints facing Kosovo's firms and could generate substantial revenue for the central budget and possibly electricity exports. Lead, zinc and magnesium resources are also abundant and restarting these mines could make a valuable contribution to employment and growth. create 12. The government is developing an appropriate strategy to solve the energy problem. A program to sharply decrease commercial losses is critical to the health of the sector and the budget. The government has to make electricity theft a criminal offense, start prosecuting offenders vigorously, and provide funding to the courts to deal expeditiously with cases of nonpayment of bills and theft. To generate financial resources for urgently needed investments in the sector, the government should help the Kosovo Energy Corporation's (KEK) management reduce the company's massive overstaffing and institute a program of regular tariff increases, as warranted by investment and operating needs. Finally, swift completion of the tender process for the new lignite mine/plant complex is essential for ensuring a long-term power supply. Restarting other mining capacities requires foreign capital. To attract FDI to the mining sector, the property titles of the state-owned mines need to be clarified before the privatization process continues. Successful privatization will also depend on strengthening the previously discussed areas of the investment climate. 13. As a third source of potential growth, Kosovo's large and untapped labor force is also young and cost-competitive by regional standards, at least at the unskilled level. Kosovo and Albania have the lowest wages in the region, a key comparative advantage for labor-intensive exports. Kosovo's wage competitiveness is very strong in low-skill sectors, but much less in high-skill sectors due to the high skill premium. So, in the short to medium term, the focus should be on attracting more foreign investment into low-skill, labor-intensive, export- oriented sectors to utilize the large number of unemployed Kosovars. 14. Currently, much of the labor force is sitting idle. Despite the solid output growth achieved in recent years, unemployment has increased to 48 percent, according to the latest statistics. Even though some of the unemployed are engaged through the informal sector, viii unemployment is rampant, in particular among youth and women. Pressures on the labor market will continue to mount because Kosovo has the youngest population in Europe, and tens of thousands of people are entering the labor market each year, with few hopes of finding a job. In addition to the economic implications, the lack of employment condemns many people to living in poverty. 15. The main cause for the poor labor market outcome is low labor demand. The private sector in Kosovo is thin and weak; most workers are employed in micro businesses, low value-added sectors, and low-skilled occupations. Moreover, most firms are stagnant, so the prospects for increasing labor demand are low. Many firms operate in the informal sector, which further hurts their productivity. This should not come as a surprise because it takes on average seven weeks to start a business in Kosovo and the cost and minimum capital requirements are substantial. In comparison, it takes less than four days and no minimum capital to start a business in FYR Macedonia and Georgia. At the same time, the availability of flexible work arrangements in the current labor legislation is limited, and firm compliance with the legislation is low. 16. Boosting labor demand requires, first and foremost, improving the climate for doing business. In addition, the labor code should be made easier to enforce and to provide a greater variety and flexibility of employment terms. Such provisions should help increase job formality, and may be also be helpful in promoting greater female employment. It is also important to ensure that that the labor code includes adequate worker protection provisions and that these are well implemented. 17. The low skill attainment of the population is the second most important cause of poor labor market performance. Over half of Kosovo's working age population has not completed secondary education, and only 1 out of every 12 Kosovars holds a tertiary degree. Even though Kosovo is still far from being a skill-intensive economy, there are already signs that the demand for higher skills is increasing and, despite the large number of unemployed workers, some firms are finding it difficult to recruit workers with the appropriate skills. 18. Skill attainment is intrinsically linked to the education sector, and the government has been making significant progress in reforming the education system, but more progress is needed. Increasing education attainment is a long-term process and will require institutional and physical investment in education institutions. The immediate need is to improve the skills for employment through vocational training and tertiary education, but the focus on lower levels of education should be maintained, as in the long-run, it will result in higher basic and general work skills. Post-school learning opportunities--clearly linked to the formal school system--also need to be developed to ensure the continuous upgrading of worker skills to match the labor demand. Finally, the link between education and skill demand should be strengthened by greater collaboration between education institutions and the private sector in designing curricula to develop the skills needed on the labor market. 19. Migration has always been an important part of Kosovo's labor market. Traditionally migration has been high in Kosovo, and it has brought many positive benefits. First of all, it has alleviated some of the labor market pressures. Second, it has brought in ix substantial income through remittances. In 2009, remittances were about 500 million, and were the largest source of external income for Kosovo. Remittances have provided a safety net for the poor and have helped many households stay out of poverty, although this may have increased the reservation wage for the unemployed. Last but not least, migration seems to have led to "brain gain" because returning migrants, though few in number, have acquired new skills and have performed relatively better in the labor market. 20. Public policies can strengthen the contribution of migration to Kosovo's growth story. As migration is expected to continue, the government should strengthen its institutional capacity to monitor and manage migration. Remittance inflows are expected to remain significant, and channeling more of these funds through the banking sector could boost the deposit base, i.e. increase the banks' credit potential. Also, Kosovo's diaspora presents an untapped source of FDI and human capital because so far only few migrants have returned home to invest or work. In principle, migrants are more familiar with the local circumstances and opportunities than a typical foreign investor and therefore should be more likely to invest in their home country. However, at present migrants are faced with the same business environment constraints as local firms, and are therefore not in a hurry to return and invest in Kosovo, which emphasizes even more the urgent need to improve the business climate. 21. Finally, promoting land use for agriculture activity could make a significant contribution to employment, exports, and growth. Agriculture has traditionally been an important economic activity in Kosovo, accounting for as much as a quarter of total output, but today agricultural land use is relatively low. Although some progress has been made in land privatization, the dissolution of the large state-owned agricultural enterprises has created new obstacles to developing the sector. Namely, it has significantly fragmented the farm structure, making the average farm only about 1.4 hectares, and has led to a decline in arable land and irrigation. So, in this context of low land use, high unemployment in rural areas, and low skill attainment of the unemployed, agriculture could become an important source of employment. Developing and re-energizing the agriculture sector could lead to investment in the food industry, which in turn would allow for greater import substitution and exports and would shift employment to more productive activity. 22. To stimulate agriculture activity, the authorities need to strengthen land and agriculture policies, improve agriculture markets, and complete the privatization and consolidation of farm land. On land policies, developing the cadastre system is necessary for strengthening property rights: not only land ownership but also land market information. This is essential for allowing land to be transferred to the more efficient use, and permitting investments to increase agricultural competitiveness. Agriculture policy and spending should be allocated towards investment, rather than market-distorting measures (such as subsidies to uncompetitive farms). This could be achieved through investing in public infrastructure and providing matching grants for private investments with a public good aspect. The current land consolidation program of the Ministry of agriculture, forestry and rural development, which facilitates willing participants to exchange, buy, and sell land parcels, should be continued (and expanded), and the privatization of state-owned enterprises should be completed. x 23. To sum up, Kosovo could make significant economic progress and converge with the rest of the region to European income levels. Rapid and sustained growth would in turn help alleviate poverty, stimulate employment, and improve social indicators, such as health and education outcomes. Reform fatigue, on the other hand, would only widen the income and integration gap with the rest of the region because other SEE countries have been making solid progress in reforming their business environment as well as in EU integration. Overcoming the challenges that keep Kosovo's main resources idle would not only unlock its economic potential, but would also bring Kosovo, through income convergence, economic integration and institutional reform, closer to the European Union. xi Table ES1. Key Next Steps and Policy Recommendations Policy area Key recommendations Next steps Macroeconomic Maintain Implement prudent fiscal policies (avoiding excessive management macroeconomic deficits) stability; Incorporate the annual budget into the Medium Term Expenditure Framework Improve public Improve public investment project planning and investment implementation, and use open bidding for large management. infrastructure projects Private sector Strengthen the rule of Reduce the time and cost for registering a business development law, and, in particular, (introduce one-stop-shops) ensure greater property Expand the real estate cadastre coverage Eliminate unnecessary procedures and strengthen protection; administrative capacity related to the regulatory regime for Improve the business doing business, especially concerning business and regulations to reduce construction licensing informality and Strengthen the court system to improve contract stimulate enforcement. entrepreneurship; Implement the policy measures of the energy strategy that Transform the energy would improve the financial position of KEK and complete the bidding process for the new power plant sector. Trade Further streamline Upgrade transport corridors that are most important for facilitation customs operations; trade Upgrade the road Adopt European product standards Pass the complete set of secondary legislation related to the network; Customs Code Improve the national Synchronize the operating hours of customs and veterinary quality infrastructure. inspection services Develop a value database to reduce appeals concerning customs valuation Labor and Improve labor demand; Improve the labor legislation to allow greater flexibility as migration Strengthen educational well as better worker protection attainment; Strengthen curricula to meet market demand, and improve quality of teaching Facilitate migration. Strengthen the capacity of the institutions responsible for managing migration policy, and take measures to formalize the transfer of remittances Agriculture Strengthen land Develop the cadastre (record and update land data into policies; electronic databases) Improve input markets; Finalize the land consolidation program and complete the privatization of state-owned enterprises Improve public Establish a Market Information System that includes expenditure allocation. information on inputs Allocate public expenditure to more investment and service oriented agricultural support Focus public spending on matching grants for private investments with a public good aspect, for example: agricultural storage facilities or milk collection systems xii 1. STRATEGIC AND MACROECONOMIC SETTING A. INTRODUCTION 1.1. Kosovo has a population of about 2 million, and, with a gross domestic product (GDP) per capita of 1,760, is one of the poorest countries in Europe. Poverty remains persistent and widespread, though shallow3, with 45 percent of the population estimated to be living below the national poverty line, while 17 percent are extremely poor, according to latest available data4. With a 48 percent unemployment rate and a very low employment rate (26 percent), Kosovo has the weakest employment track record in Europe5. However, Kosovo's economy is characterized by a large informal sector, which implies a slightly higher employment than the official record. Nonetheless, unemployment is very high by regional standards. Moreover, the economy remains largely dependent on remittances and donor aid. 1.2. Kosovo's economic growth has been solid since the end of the conflict in 1999. The Kosovo economy has been damaged by the post-conflict uncertainties, broken external trade links, and a long period of insufficient investment in infrastructure. Driven by the massive donor- funded reconstruction effort, GDP growth was initially in double digits in 2000­2001, but moderate thereafter, despite continued donor financing and remittances. The sustainability of this economic performance remains an issue, and as foreign assistance and remittances decline, Kosovo clearly needs to replace these flows with export earnings and foreign investment. Box 1: The Focus and Methodology of the Country Economic Memorandum This Country Economic Memorandum (CEM) is the first one following the declaration of independence and transfer of administration from the United Nations Mission in Kosovo (UNMIK) to the Government of Kosovo. The previous CEM was published in 2004. The principal objective of the CEM is identify the main sources of growth for Kosovo's economy in the medium-term, to assess the key obstacles to unlocking the growth potential, and to provide policy recommendations to remove these obstacles. The scope of the CEM is not all encompassing. The focus is on the most important policy areas for economic growth, and some areas (e.g. financial sector or public administration), while important, are not analyzed in detail either because they are covered in other recent reports (of the World Bank or from other sources) or there is insufficient data available. The analytical findings in the report are based on several sources of information, including: (i) two field surveys (on foreign investment and on migration), (ii) global surveys and reports (such as the Doing Business indicators), (iii) public workshops, (iv) economic data on Kosovo and comparator countries, and (v) discussions with the Kosovo authorities, firms and other organizations. Wherever possible, comparative assessment with the other countries of the region is used. 3 Poverty in Kosovo seems to be shallow and the average incremental consumption needed to escape from poverty is about 10 percent of the poverty line. The shallow poverty is reinforced by Kosovo's moderate Gini coefficient. 4 These poverty rates are based on the latest available World Bank estimates which refer to 2006. Updated poverty estimates are expected to be published in the second half of 2010. 5 Source: Labor Force Survey 2008, Statistical Office of Kosovo (SOK). The methodology in the 2008 survey was changed: persons who produce for own consumption on their farm, and do not sell any of their products, are not considered employed. B. REAL SECTOR PERFORMANCE 1.3. Following the post-conflict economic boom, economic growth has been both moderate. Between 2005 and 2007, growth averaged around 4 percent and was driven by strong increases in investment and consumption. Exports also rose rapidly, but from a very low starting base, so their contribution was more modest. Growth peaked at 5.5 percent in 2008, mainly due to an expansionary fiscal policy, and slowed slightly to 4 percent in 2009. Table 1: Key Economic Indicators 2005 2006 2007 2008 2009 (percent change) GDP real growth 3.8 3.8 4.0 5.4 4.0 GDP per capita 2.4 2.3 2.7 3.8 2.5 Consumption 5.8 2.2 6.1 3.7 2.6 Investment -6.1 1.3 3.9 15.5 12.6 Exports 8.8 31.9 11.7 4.2 -1.2 Imports 4.1 5.7 11.8 6.0 3.5 CPI, period average -1.4 0.6 4.4 9.4 -2.4 (percent of GDP) Investment 24.5 25.6 26.0 28.9 29.3 Current account balance -7.4 -6.7 -8.8 -16.0 -18.7 Official transfers 12.2 10.2 8.7 7.5 6.4 Net foreign direct investment 3.6 9.3 12.6 8.9 7.8 Memorandum items: GDP (thousands of euros) 3,005 3,118 3,411 3,849 3,843 GDP per capita (euros) 1,451 1,485 1,605 1,784 1,754 Population (thousands) 2,070 2,100 2,126 2,158 2,190 Source: Kosovo authorities and IMF staff estimates. 1.4. The global financial and economic crisis has had relatively little impact on the economy, reflecting Kosovo's limited international integration. The negative effects of the crisis were transmitted through three channels: exports, FDI, and remittances. Although Kosovo's exports suffered a sharp decline (about 18 percent) in 2009, their still-small share in GDP (of about 5 percent) meant the impact on overall growth was relatively small. Also, according to preliminary data, FDI fell by 22 percent and remittances by some 8 percent. In addition to the loss of investment appetite, the decline in FDI may also be attributed to the slowdown in the privatization process which came as a result of the transformation of the privatization agency. The fall in remittance receipts has been lower than anticipated, mostly because Kosovo's migration has been long term in nature: 70 percent of migrants have a foreign citizenship (see Chapter 5 for more information). The banking sector has remained stable, with deposits as well as credit to the private sector continuing to grow in 2009 and 2010. There is some evidence, however, that the banks have become more cautious in providing loans, most likely because nonperforming loans are slowly on the rise. The negative effects of the global 2 financial crisis were offset by the continued expansionary fiscal policy of the government, which has maintained moderate growth rates. 1.5. Kosovo's economic performance in the last four years has been relatively weaker than the Southeastern Europe (SEE) region's performance (prior to the crisis). In 2006 and 2007, as shown in Table 2 Kosovo had the lowest growth rate in the region. In 2008, some SEE countries, such as Croatia, had already begun to feel the impact of the economic crisis, and in 2009, the entire region was strongly affected by the crisis. In contrast, Kosovo's performance remained solid and its economy outperformed the entire region, growing at 4 percent. As a matter of fact, Kosovo and Albania were the only two economies to record GDP growth in 2009. However, Kosovo needs to significantly accelerate its growth if it is to reach regional income levels. For example, Kosovo's economy would need to grow at 10 percent per annum for a decade to reach Albania's income level (assuming Albania's economy continues to grow by 5.5 percent annually during this period). And to reach Montenegro's current GDP per capita level of 5,700, Kosovo's economy would have to grow at 12 percent per annum for an entire decade. Table 2: GDP Growth in Southeastern Europe (in percent) GDP per capita, in 2005 2006 2007 2008 2009 US$ Albania 5.5 5.0 6.0 6.5 2.2 4,016 Bosnia and Herzegovina 5.0 6.2 6.8 5.4 -3.4 4,907 Bulgaria 6.2 6.3 6.2 6.0 -5.0 6,546 Croatia 4.2 4.7 5.5 2.4 -5.8 15,637 FYR Macedonia 4.1 4.0 5.9 4.8 -0.7 4,650 Kosovo 3.8 3.9 5.0 5.4 4.0 2,618 Montenegro ... 8.6 10.3 6.9 -7.0 7,925 Serbia ... 5.2 6.9 5.5 -2.9 6,713 Latvia 10.6 12.2 10.0 -4.6 -18.0 14,876 Romania 4.1 7.7 6.0 7.1 -7.1 9,288 Slovenia 4.5 5.8 6.8 3.5 -7.8 25,429 Source: World Bank staff estimates. 1.6. Table 3 shows that Kosovo's economy is concentrated mostly in services and agriculture. Agriculture, which used to account for 25 percent of GDP in the 1980s and early 1990s, has reduced its GDP share to about 12 percent. Construction and real estate combined account for 25 percent of GDP. These sectors have been booming due to the high demand for home construction and as a result of the large international presence. Economic diversification of industry and financial deepening has not yet taken off. Industrial output has been growing in recent years, but its share in GDP is only 11 percent and has actually declined between 2005 and 2007 (due to faster growth in other sectors). Financial intermediation has been increasing, but its share of GDP remains relatively small. 3 Table 3: GDP Structure by Sector (as share of GDP) Sector 2005 2006 2007 Agriculture and Fishing 11.3 11.7 12.0 Mining 0.6 0.6 0.7 Industry, energy and water supply 13.1 12.9 11.2 Construction 8.4 8.9 10.0 Wholesale and retail trade 10.2 10.2 9.4 Hotels and restaurants 0.7 0.8 0.7 Transport, storage and communication 4.2 4.6 3.6 Financial intermediation 2.5 3.0 4.4 Real estate and business services 12.8 12.8 12.4 Public administration and defense 16.8 15.0 13.2 Education 2.8 2.8 2.7 Health and social work 1.7 1.3 1.1 Community, social, and personal services 1.4 1.3 1.5 Taxes on products 13.5 14.1 17.1 Total 100.0 100.0 100.0 Source: Statistical Office of Kosovo (SOK) 1.7. One positive aspect of the recent economic performance has been the solid growth in investment. The Growth Commission (2008) found that a high investment rate of 25 percent of GDP or more is one of the distinctive ingredients for achieving and sustaining high growth rates. In Kosovo, gross fixed capital formation reached about 30 percent of GDP in 2009, coming from double-digit growth rates over the past years. Unlike elsewhere in the SEE region, public investment rates have been very high, especially in the past two years when the capital expenditures share of the government budget quadrupled (to some 11 percent of GDP). Public investment in the other countries of the region has ranged between 3 percent and 7 percent of GDP (Handjiski 2009). The high public investment levels in 2008 and 2009, however, cannot be sustained over a long period. In contrast, private investment growth has slowed since 2008. Moreover, although detailed data is not available, it is believed that much of the private investment goes into residential construction, which is not a productive investment per se. The growing population and booming construction sector confirm this assessment. In any case, the high level of investment can only be maintained if private investment takes over the lead role. 1.8. One factor behind the overall economic performance has been macroeconomic stability. The use of the euro as legal tender, combined with generally conservative fiscal policy (up to 2008) and few price-setting mechanisms, helped keep inflation in check. Prices have been relatively stable in the past decade. Inflation rose abruptly in 2008 (to 9 percent) due to the rise in global commodity prices, but following the economic downturn and the decline in food and oil prices, inflation became negative in 2009 (-2.4 percent year-over-year change). C. FISCAL POLICY VOLATILITY 1.9. Fiscal policy is Kosovo's main anchor for macroeconomic stability, and is therefore a critical factor for its economic growth. Given the lack of monetary instruments (use of euro as legal tender and absence of "lender of last resort function"), fiscal policy is the only 4 macroeconomic instrument in Kosovo. Consequently, fiscal policy has two additional roles to play beyond the provision of public services: maintaining macroeconomic and financial sector stability. Due to these additional roles, fiscal planning should be in a medium-term framework and provide flexibility so that policy actions can respond to shocks. However, following the progress made in the early post-conflict years, deficiencies in implementing fiscal policies began to emerge in recent years, which in turn led to large and sudden shifts in spending. Poor planning and under-spending, underpinned by the government's spending rule as agreed with the International Monetary Fund (IMF), led to a 7 percent of GDP budget surplus in 2007. The accumulated public savings led the government to shift toward an expansionary stance and the budget moved to a balance in 2008 and close to a 7 percent of GDP deficit in 2009 (if the one-off dividend of 5 percent of GDP from the telecom company is excluded). The authorities have introduced a medium-term expenditure framework (MTEF), but its usefulness has proven to be very limited because the annual budget does not utilize the framework. Some progress has been made recently: the initial budget ceilings for the 2010 budget were based on the revenue projections in the MTEF. However, this fiscal framework derailed in the first half of 2010 with the introduction of several new un-budgeted initiatives. 1.10. The public sector in Kosovo is relatively small, yet it is a crucial element for achieving the desired development outcomes. The small size of the public sector comes from the post-conflict administrative set-up in Kosovo and the fact that the United Nations (UN) administration, and later on the Provisional Institutions of Self-Government, pursued liberal market policies, limited state intervention, and privatization of state assets. As shown in Figure 1, by 2007 general government expenditures fell to below 20 percent of GDP, while revenue rose to over 25 percent of GDP. Following the expansionary fiscal policy in 2008 and 2009, primary expenditures rose to 30 percent of GDP and total revenue reached 28.8 percent (due to a large, one-off nontax income6), while tax revenue remained constant. Still, Kosovo's public sector remains the smallest in the region. Figure 1: Kosovo's Government Revenue and Expenditure (2005­9) and Regional Comparison (2008) (as share of GDP) 35.0 60.0 30.0 50.0 40.0 25.0 30.0 20.0 20.0 15.0 10.0 0.0 10.0 5.0 0.0 2005 2006 2007 2008 2009 Revenues Expenditures Expenditure Revenue Source: IMF and World Bank. Note: Data for 2009 are preliminary. 1.11. The public sector, as provider of business-related services and implementer of business regulation, plays a key role in developing an investment climate that supports growth. In this regard, improving the efficiency of the public administration, on both the central 6 Dividend from accumulated profits of the post and telecom company in amount of 5 percent of GDP. 5 and the local level, could eliminate a number of constraints to private sector development. This report does not assess in the detail the shortcomings of the public administration, though it refers to some aspects of it in chapters 2 and 3. However, other reports, including the World Bank's Public Expenditure Review 2010 as well as the Government's Public Expenditure and Financial Accountability 2009 assessment, stress the need to pursue more aggressive public administration reform. Box 2: Public Administration and the Business Environment in Kosovo Kosovo still lacks a professional public administration, which limits policy formulation and implementation capacity. Civil servants continue to be employed on short-term contracts, as during the temporary UNMIK administration. Lack of clear career prospects and low salaries constrain the ability of the public administration to attract and retain qualified staff. The ongoing civil service reform may be expected to partially address these shortcomings by providing civil servants with increased job security and career prospects. However, overcoming the dearth of skilled staff will be at best a medium-term challenge. The poor business environment in Kosovo (see Chapter 2) is partly explained by the low capacity to design and implement policies aimed at improving the business environment. Administrative procedures can be time consuming for business due to inefficiencies resulting from obsolete policies, low skills of civil servants, and low level of automation of administrative processes and government- to-business interaction. Under the decentralization arrangements that are currently under implementation key interactions between business and government (e.g. business registration and licensing, construction permits) fall within the jurisdiction of municipalities, whose administrative capacity tends to be lower than that of the central government. 1.12. The structure and size of the budget is, in principle, adequate and should be conducive to growth. Kosovo's tax system is relatively simple and tax rates and customs tariffs are low. However, tax collection relies excessively on indirect taxes, particularly taxes collected at the border, which makes revenues somewhat vulnerable to external shocks. Tax administration reforms could improve collection of direct taxes and, at the same time, strengthen revenue stability. On the expenditure side, nondiscretionary spending takes up a relatively low share of the budget, mostly due to the low spending on social assistance, so the government can afford to devote a substantial share of the budget to capital expenditures. In 2009, the capital budget was 11 percent of GDP, far more than in any other country in the region. Capital investment is essential given the vast institutional, infrastructure, and social needs of the country. Physical damage during the conflict and a history of neglect has created a backlog of necessary capital investments. At the same time, capital spending offers greater flexibility to policy makers, because this spending can be easily adjusted if the government faces a financing gap. 1.13. Nonetheless, spending efficiency and the effectiveness of the public investment program are concerns. Positive returns from the large investment program can only be achieved if funds are adequately allocated and projects efficiently implemented. At present, capital budget planning and execution face serious weaknesses. First of all, under-execution of capital spending remains high despite the efforts made in the past two years to improve project implementation. The project execution rate increased from about 70 percent in 2007 to 85 percent in 2008, but fell to about 80 percent in 2009. At the same time though, the value of 6 executed capital projects rose from 347 million in 2008 to some 400 million in 2009. But more importantly, the quality and efficiency of expenditures for capital projects are sometimes questionable. Anecdotal evidence suggests that large projects are sometimes financed without prior cost-benefit analysis or that project costs are based on unrealistic assumptions. Then, during implementation, budget units use funds budgeted for one project to start several other projects, and they then seek additional budget funds to complete all started projects. Furthermore, procurement processes have not been fully transparent and competitive. This evidence highlights the inefficient use of public funds, which leads to the waste of public resources, and in turn limits the economic impact of capital spending. The 2010 Public Expenditure Review offers suggestions how to improve the efficiency of spending and how to achieve better allocation of public resources. 1.14. Kosovo's reported public debt stock is very low (6.4 percent of GDP) because it had no public debt when it declared independence. The only loan on its books is from the International Bank for Reconstruction and Development (IBRD; stemming from debt claims contracted by the former Yugoslavia during the 1980s and 1990s), which Kosovo took over when it became member of the World Bank.7 The conditions of this loan are quite favorable, and the debt service requirements are low (0.5 percent of GDP per year). However, Kosovo is also facing other possible liabilities linked to the former Yugoslavia. These contingent liabilities, to the Paris Club, the London Club and other creditors, could be higher than the IBRD loan, and if Kosovo were to assume these liabilities its debt service payments would increase significantly. These contingent liabilities related to the former Yugoslavia are part of the "Ahtisaari package"; however, no discussion with Serbia has been initiated yet. The final outcome of this issue is highly uncertain, and neither the time frame nor the amount of these liabilities can be predicted at this point. 1.15. A debt sustainability analysis (DSA) for Kosovo conducted by the World Bank and the IMF in 2009 indicates Kosovo's risk of debt distress is moderate. The DSA concludes that over the next two decades all debt indicators will remain on a sustainable path for the baseline fiscal and external scenarios. However, the public debt trajectory becomes unsustainable in a scenario of a moderate but permanent increase in the primary deficit. For example, a primary deficit of 2.5 percent of GDP over the DSA projection period (until 2031) would put debt on an unsustainable path. Moreover, Kosovo's narrow export base and high dependence on remittances would magnify the impact of external shocks. This finding underscores the need for devising an effective fiscal anchor based on a medium-term outlook. 1.16. A public debt law was adopted in 2010 that allows the authorities to borrow both domestically and externally. The law sets a ceiling on the overall public debt stock at 40 percent of GDP, which also includes public guarantees and municipal debt.8 Given the current low level of indebtedness, the government has substantial room to meet its financing needs over the long term. However, in the short term, access to external finance will remain limited, and issuing domestic debt would have to take into account the impact on the banking sector and possible crowding-out effects to private sector lending. 7 On June 29, 2009. 8 Municipal long-term debt will be limited to 2 percent of GDP. 7 D. WEAK EXPORT PERFORMANCE RESULTS IN EXTERNAL IMBALANCES 1.17. Kosovo continues to rely heavily on foreign savings to finance its large imports despite notable post-conflict progress. External imbalances have declined compared to the post-conflict years, though they still remain high. Imports, driven by high public investment and private consumption demand, rose to 50 percent of GDP in 2009. The high imports and very low exports have led to high trade and current account deficits (CAD). In the early years following the conflict, CADs were more than 30 percent of GDP. The situation improved somewhat following the post-reconstruction period, with the CAD falling to below 10 percent of GDP in 2007, but it widened subsequently to some 18 percent of GDP in 2009, mostly due to a sharp increase in public spending. 1.18. Remittances, foreign assistance, and FDI have financed the large trade deficit. Remittances have been a very important source of income for Kosovo households for decades, and migration rates continue to be high. In recent years, remittances have been stable at around 13­15 percent of GDP. In fact, these might be even higher because it is suspected that a substantial share of the "Errors and Omissions" item in the Balance of Payments is unrecorded remittances (see Chapter 5). Foreign assistance played a crucial role in the years after the conflict and has declined to about 8 percent of GDP in recent years. FDI was almost nonexistent until 2004, but started to increase sharply in 2005 as the privatization process began and political stability improved. FDI peaked at some 13 percent of GDP in 2007, but declined to about 8 percent in 2008 and 2009 due to a slowdown in privatization9 and the lack of investor appetite due to the global crisis (see Chapter 2). Other external flows are of marginal importance: external borrowing has been very low and consists only of private trade credits and loans, while portfolio investment is practically nonexistent. 1.19. One of the main challenges facing the Kosovo economy is its very low export base (Figure 2 In 2009, exports were 159 million (4 percent of GDP), which equaled the average monthly imports. The trade deficit reached 45 percent of GDP in 2009. Exports were practically nonexistent until 2002 and rose steadily until 2008. Export growth was particularly rapid between 2006 and 2008: 96.8 percent in 2006, 49.1 percent in 2007, and 20.2 percent in 2008. In 2009, due to the impact of the global financial crisis and the fall in metal prices, Kosovo's exports declined by 18.1 percent. Figure 2: Merchandise Exports and Imports, 2001­8 Source: SOK. 9 Most high value factories and other assets of former SOEs were sold by 2007. Since 2008, the privatization process has mainly focused on sale of agriculture land and relatively low value assets. 8 1.20. The main destinations for Kosovo's exports are the European Union (EU) and the SEE region. Half of Kosovo's exports go to the EU, and these exports have been rising as a share of the total exports, from 29.4 percent of exports in 2004. Within the EU, the main markets are Belgium (14.2 percent), followed by Italy (12.8 percent) and Greece (5 percent), although this varies significantly from year to year. Exports to the Central European Free Trade Agreement (CEFTA) members in SEE reached 31 percent in 2008, representing the second most important regional market. Albania (10.6 percent) and the former Yugoslav Republic (FYR) of Macedonia (10.1 percent) are Kosovo's largest regional partners. The share of exports going to Serbia has fallen following Kosovo's declaration of independence--to 5 percent in 2008 from 11.7 percent in 2007--because Serb authorities do not recognize Kosovo's new customs stamps (see Box 5). 1.21. Exports are dominated by base metals and particles of base metals, which reached 63 percent of total exports in 2008. Base metal exports have been rising significantly in the last five years, from 19 million in 2004 to 124 million in 2008, following the privatization of the ferro-nickel company (Box 3), in a period of rising international metals prices. In 2008, iron and steel exports climbed to 105 million, up from 47 million a year earlier. Other base metal exports include iron and steel product, copper, aluminum, and lead. Kosovo's exports of metal began to decline with the fall in demand in the third quarter of 2008. The decline continued in the first half of 2009, but in the second half prices went up again and exports of base metals picked up. In sum, the total annual decrease in 2009 was 30 percent, which is higher than the 18 percent overall decrease in exports. Consequently, the share of base metals in total exports of goods declined to 53.5 in 2009. 1.22. Kosovo's exports suffered the consequences of the global crisis but have been gradually recovering. Exports declined by 43 percent in the first quarter of 2009 compared to the first quarter in 2008, whereas imports only declined by 1.3 percent over the same period. Metal exports declined significantly in the first quarter, from 26 million in the first quarter of 2008, to 13 million in the first quarter of 2009. As figure 3 shows, metal prices started falling in March 2008, reaching in February 2009 the same level as in 2005, but prices have started rising again, suggesting a partial recovery in exports. In the first three quarters of 2009, exports declined by 32 percent year-over-year. Exports began to pick up in the last quarter of 2009, with an increase of 38 percent compared to the final quarter of 2008 when the crisis first hit. Figure 3: International Metals Commodity Index (2005 = 100) (right) and Kosovo Metal Exports in million (left) Source: IMF. Note: The metals commodity index includes copper, aluminum, iron ore, tin, nickel, zinc, lead, and uranium prices. 9 1.23. Much more is needed to set Kosovo on a sustainable path. Increased export competitiveness, however, cannot come about through exchange rate policy because Kosovo uses the euro as its currency. The recent strengthening of the euro compared to the currencies of neighboring countries will have made Kosovar exports relatively more expensive. At the same time, there may have been an appreciation of the real effective exchange rate (REER) in 2008, primarily driven by a higher inflation rate in Kosovo relative to some of its regional trading partners, though according to the Tyrbedari (2009) the REER has on average depreciated over the past five years. While the use of the euro has provided stability, the authorities cannot use exchange rate policy to increase export competitiveness, which highlights the need for structural reforms to improve export performance. E. GROWTH POTENTIAL OF UNUSED RESOURCES 1.24. Kosovo will thus need to bank on its other assets for higher and sustainable growth: its considerable supply of physical and human capital, much of which is sitting idle, as well as its favorable geographical position. The richness in natural resources, the abundant labor force, as well as the access to the regional and European market, offer great potential for economic growth. However, the full exploitation of these assets depends crucially on policy reforms. Natural Resources Are Abundant, but Underutilized 1.25. Kosovo is very rich with mineral deposits, however, their potential has been left untapped for various reasons. Kosovo's soil has abundant deposits of lignite, ferronickel, lead, zinc, magnetite, and other ores. Developing these industries could make a major contribution to economic development through employment and exports. Prior to the dissolution of the former Yugoslavia, the mining sector was an important growth engine for Kosovo's economy. However, the mining capacities suffered from neglect during the 1990s, as well as from war damage. 1.26. The abundant lignite resources, estimated to exceed 10 billion tons, have the potential to make the energy sector a key contributor to growth, rather than a drain, as is now the case (see Chapter 2 for a more detailed analysis of the energy sector). Even though urban sprawl and other land uses have blocked exploitation a significant part of these resources, the accessible quantities could provide electricity generation for decades. Developing the lignite sector would stimulate employment and its accompanying economic activity, as well as possibly exports (if the capacity of the new power plant is higher than the domestic demand). 1.27. The current energy strategy of the government envisages tendering for a new power plant with a capacity of up to 1,000 megawatts (MW; one unit of 500 MW plus a potential second unit of 500 MW). Developing this capacity would fully meet the domestic demand for electricity, eliminating power shortages and the need for generator-use among firms. It would also free up public resources as the need for (expensive) electricity imports would be minimized. At the same time, the extra capacity could allow for exports in the regional market.10 10 Kosovo is part of the regional energy market established between the EU and Southeast Europe. 10 1.28. Other untapped resources include lead, zinc, and magnesite. Kosovo is also well endowed with lead and zinc deposits. The lead-zinc company Trepca was the largest mine in the former Yugoslavia and included integrated mining and manufacturing operations. The mine continued to operate as a state-owned company in the 1990s, but operations were halted in 2000, mostly for political reasons, but also for environmental reasons. Despite donor efforts to rehabilitate the mines with the intention of resuming operations, the mines remain idle. Magnesia production also stopped in 1999, and the two companies that were operating in this industry remain state owned. 1.29. Reviving the mining sector will require substantial investment and can only be accomplished by relying on foreign investors, and possibly some domestic private investors. However, several obstacles need to be overcome to attract the substantial FDI required to restart operations. First of all, the assets of these companies, including mining rights and titles, need to be well defined. More importantly, political risks and other aspects of the business environment would need to be addressed to attract quality investors. Also, before beginning the privatization process, environmental legacy issues would need to be resolved. Chapter 2 discusses some of the main obstacles in the investment climate in greater detail. Box 3: The Restarting of Ferronikeli The only sector in which production has been approaching pre-1990s levels is ferronickel. Ferronikeli ore mining and metallurgical complex was set up in 1984 to produce ferronickel for exports. It produced and exported 6,800 tons of nickel per year before 1990, but after the conflict in 1998 the company was idle. The state-owned company, which in 1998 had some 2,000 workers, was privatized in 2005. The foreign owner, a Greek company, invested in rehabilitating the production capacity and output has grown to become one of the largest nickel smelting and mining operations in Europe, with 13 million tons of nickel ore. The restarting of this facility has had a major impact on economic activity, and, in particular, on exports. By 2008, the company employed over 1,000 workers and exported almost 100 million, which accounted for almost half of total exports. However, one aspect of the privatization of Ferronikeli that should be reassessed in future privatizations is the subsidized electricity purchases granted to the investor. The privatization contract for Ferronikeli allows the company to purchase electricity from KEK at very favorable (below cost) prices, which implies that the company is receiving a large subsidy from KEK, and consequently, from taxpayers. At the same time the direct benefits in terms of mining fees are limited. The contract between the Government and Ferronikeli for subsidized electricity will expire in 2011. 1.30. Agriculture land has also been underutilized, despite the favorable soil and weather conditions. Agriculture has traditionally been an important economic activity in Kosovo, accounting for as much as a quarter of total output. Yet, even when agriculture activity was at its peak, land use was relatively low. In the 1980s, for example, 70,000 hectares (ha) were irrigated, while 200,000 ha could have been irrigated, but weren't. The transition process, underinvestment, and conflict led to a sharp decline in the sector. Its share in total output has fallen to about 12 percent in recent years. 11 1.31. Though some progress has been made in land privatization, land use remains low, and the dissolution of the large state-owned agriculture enterprises has created new obstacles to developing the agriculture sector. The most important change was the privatization of the socially owned farms after decades of state control. Altogether, about 25,000 hectares (ha) of arable farmland have been privatized, with about 40,000 remaining with state- owned enterprises. But this process significantly fragmented the farm structure. Now, the average Kosovar farm utilizes an agricultural area of only about 1.4 ha, which undermines productivity and growth potential. Moreover, irrigation is now only used on approximately 39,000 ha, less than 20 percent of arable land, which makes farming more vulnerable to adverse weather conditions. 1.32. Farmland use has also been hampered by poor property rights and inadequate or nonexistent land-zoning rules. A large portion of the farms and land belonging to state-owned enterprises are without a clear owner, as some of these enterprises have been liquidated and many land tenure documents were destroyed or stolen during the 1999 conflict. As a result, the cadastre system covers only a small fraction of the land. These great uncertainties about land ownership and use rights make investors, especially foreign, wary of investing in this sector. At the same time, the price of agriculture land has skyrocketed in the absence of land and urban planning. Because all land can potentially be used for construction, speculative activity has increased the price of farm land up to 100,000 per ha (in some areas close to cities or major roads). This had led to urbanization of farmland, and at the same time, the high price of farmland has driven away investors that are interested in purchasing land for agricultural use. 1.33. Improving land use could help employ some the large and largely idle labor force. More than 60 percent of the Kosovar population is estimated to live in rural areas, and 53 percent of the rural labor force is unemployed. The rural population has productive potential because 60 percent are under the age of 30. At the same time, 90 percent of the rural populations are landowners (World Bank 2006a). ...And a Large Part of the Labor Force Is Idle 1.34. Indeed, Kosovo's labor force could be another important potential source of growth. The country has the youngest population in Europe: one-third is estimated to be under the age of 15, about half is under the age of 24, and only 6 percent of the population is older than 65 years (World Bank 2004a). At the same time, fertility rates, though declining, remain high compared to most other European countries, which will ensure a continued increase in population and therefore in the labor force as well. 1.35. Unfortunately, much of this human capital has been idle for a long period. The unemployment rate has been increasing since 2005, and in 2008 it reached 47 percent, according to the most recent labor force survey. High unemployment has a long history in Kosovo; even at the peak of its industrialization in 1988 Kosovo's unemployment rate was 36 percent (Statistical Yearbook of SFRY 1988). 1.36. One key asset for Kosovo is that its wages are competitive in comparison to most countries in the region. This competitive advantage should play an important role in promoting Kosovar exports and attracting export-oriented foreign investment. Indeed, Kosovo's wage level 12 is at the bottom of the SEE list. Gross wages in SEE ranged between 200 and 600 in 2008, excluding Croatia, which is a clear outlier and is excluded from the analysis11. The rest of the region falls into two categories: (i) the high-wage countries of Montenegro, Serbia, and Bosnia and Herzegovina, and (ii) the low-wage countries of Albania, Bulgaria, and Kosovo. Kosovo's wages are the lowest in the region, following Albania, though Albania's wage level has been rising faster in recent years. By mid-2009, the average monthly wage in Kosovo's private sector reached 300, about half of the average salary in the high-wage countries of the region. 1.37. Kosovo's wage competitiveness is particularly strong in the tradable sectors, including agriculture and mining which have been identified as sectors with strong potential for growth. Across most tradable sectors, the wage in Kosovo is the lowest in the region, following Bulgaria. The wage difference is less pronounced in certain non-tradable sectors, for example, financial services, in which Kosovo's wage level is similar to that of FYR Macedonia. Figure 4: Average Monthly Gross Wage in Private Sector (in ) 700 600 Albania 500 Bulgaria 400 Kosovo 300 Macedonia Serbia 200 BiH 100 Montenegro 0 2003 2004 2005 2006 2007 2008 2009 Source: National statistical offices. Note: All SEE countries, except Albania, publish monthly gross wages according to the Nomenclature Générale des Activitiés Economiques (NACE, Rev. 1.2) structure of economic activities. However, unlike in all other countries, where wage statistics are collected via survey by statistical offices, in Kosovo the source for monthly wage calculations is the database of the Tax Administration of Kosovo, and the Ministry of Economy and Finance is responsible for calculating the sectoral wage statistics. This might imply greater under-reporting in the case of Kosovo, because some firms might try to pay lower taxes and make smaller contributions. Another important concern is the low level of registered employment. According to these official figures, half of the registered employees work in the public sector. Under-reporting is particularly evident in agriculture: only 1,000 agriculture employees are registered, while the sector creates almost one-fifth of the total value added. 1.38. Relatively low wages in Kosovo are partly explained by the tax wedge, which is smaller compared to other countries in the region. Unlike other countries of the region, Kosovo's wage system has a modest pension contribution, in addition to the personal income tax. The personal income tax is progressive and ranges from 0 percent to 10 percent, and the pension contribution is 10 percent. 11 Average monthly wage was 1,044 in 2008. 13 1.39. Wage growth in Kosovo has also been slower than elsewhere. The average wage in 2009 was only one-third (or 80) higher compared to 2004, while in some countries it doubled during that period. Annual wage growth rates have been positive and stable in the five-year period, averaging about 6.5 percent. Kosovo's labor market in past years has been fairly stable and "shock free", both on the institutional side and in terms of changes in supply and demand. In contrast, some other countries in the region have lost wage competitiveness in recent years. For example, Dutch disease effects in Montenegro, coming from large foreign investment in tourism and real estate, doubled the average salary in less than four years. However, the disaggregated analysis by sector points out to some variations. 1.40. Kosovo's low wage level reveals a significant regional competitive advantage in both tradable and non-tradable sectors, but that is not the full story. Kosovo wages are significantly lower than all other SEE countries, except Albania, and this should be an important incentive for foreign investors. But productivity is the second and equally important element of the labor competitiveness equation. Workers in Germany or the Slovak Republic are paid much more than those in Kosovo, but that is partly because their production output is significantly higher. So, investors are more interested in actual unit labor costs and wage per unit of output. Given the limited data availability, it is impossible to have productivity-adjusted wage comparisons. Kathuria (2008) argues that productivity differences in fact need not be considered: large foreign companies looking at the region could pick any country to invest in and achieve the same productivity as in their home country, assuming that the investor largely controls its own operating environment. Box 4: Promoting Employment in FYR Macedonia FYR Macedonia has been very successful in developing its textile industry because of its relatively cheap labor and close proximity (and duty-free access) to the European Union (Macedonia CEM 2009). The garments and textiles sector (now dominated by garment production) accounts for 40 percent of employment in the manufacturing sector, and for one-fifth of total exports (second behind iron and steel). Production is concentrated in the segments of cut-and-make and cut-make-and-trim apparel, in which raw materials are supplied by the buyer, processed in FYR Macedonia, and exported again. The most important export products are shirts, blouses, and pants. Major destinations for these products are Germany (50 percent), Greece (19 percent), the Netherlands, the United Kingdom, and Italy. Kosovo shares the same competitive advantages as Macedonia, and is even more competitive in terms of labor cost, which is the deciding factor for outsourcing these activities. Apart from FYR Macedonia's tradition in garment production, other important factors that determine the success of this industry are transport and logistics costs. Being able to transport, deliver, and clear goods through customs quickly is critical for the success of this and many other sectors that require just-in- time production and delivery. The fast and efficient customs and logistics services required for just- in-time production can also considerably reduce costs and compensate for small scale. Chapter 3 discusses Kosovo's trade and logistics environment and provides recommendations on how to facilitate exports by moving them quickly and less expensively across borders. 14 1.41. While Kosovo and Albania have the lowest wages in the region, Kosovo seems to have the highest "premium on skills." Unfortunately, data on wages by skill level do not exist for Kosovo. However, business surveys as well as anecdotal evidence point to a large skill gap that increases the relative cost of skilled labor. Almost half of the firms in the 2009 Business Environment and Enterprise Performance Surveys (BEEPS)--more than in the rest of the region--responded that it is difficult to find workers with the right skills and education. This should not come as a surprise given the very low level of skill attainment in the country (see Chapter 4). For example, wages in international organizations, which attract skilled and highly skilled labor, are four times higher than the average salary. 1.42. Another way to estimate the premium on skills is by comparing ratios between sectors with higher skills and sectors with low skills. The financial services sector has the largest share of skilled labor in most countries; it pays the highest wage in each SEE country. Comparing wages in this sector with low-skill sectors, such as construction, catering, or retail trade sheds light on the cost of skilled labor. Differences in wages between high-skill and low- skill sectors in Kosovo are by far higher than in the rest of the region (one exception is the ratio of financial to trade sector wages in Montenegro). For example, ratios between wages in financial sector and the three low-wage sectors were double compared to Croatia. Table 4: Ratio of Wages in Financial Sector to Wages in Low-Wage Sectors (2008) Hotels and Construction Trade Restaurants Bosnia and 2.5 2.5 2.5 Herzegovina Bulgaria 2.6 2.7 3.7 Croatia 1.7 1.7 1.8 FYR Macedonia 2.6 2.1 2.4 Kosovo 3.1 3.4 4.6 Moldova 1.6 2.2 2.6 Source: National Statistical offices. 1.43. In sum, Kosovo's regional wage competitiveness is very strong in low-skill sectors, but probably much less in high-skill sectors due to the high skill premium. Hence, in the short to medium term, Kosovo could attract more foreign investment in unskilled, labor- intensive, export-oriented sectors. The low wages of low-skilled labor give a competitive edge also to domestic exports, which could enable higher export growth once other constraints are addressed. However, basing competitiveness on low costs and unskilled labor-intensive activities will not be a viable strategy for the long term and for achieving EU convergence. Improved education attainment and workforce skills, hence productivity, are fundamental for achieving high and sustainable growth. Regional and EU Integration - Key Element for Unleashing Kosovo's Growth Potential 1.44. Kosovo has the advantage of free and relatively easy access to its two most important markets: the regional (CEFTA) economies and the European Union. Kosovo is part of the regional CEFTA market, which enables it to access customs free a market of over 20 million consumers and a GDP of about 120 billion. The CEFTA market offers free trade in manufactured goods and most agriculture products. It also envisages full liberalization of 15 agriculture trade as well as liberalization in services. To fully utilize the potential of the regional market, Kosovo, as well as the other CEFTA countries, needs to address the remaining non-tariff constraints to greater regional trade integration. Box 5: Kosovo's Exports Are Blocked Due to Lack of Recognition An immediate concern to Kosovo is the fact that two CEFTA countries, Serbia and Bosnia and Herzegovina, refuse to recognize it. The lack of recognition of Kosovo Customs Authority's stamps by Serbia and Bosnia and Herzegovina has affected the overall composition of its trade, with the export share to CEFTA down by 8 percentage points in 2008, reflecting the trade embargo and the need to use indirect transit routes to get goods through the blockade. Meanwhile, the government is unable to fully participate in CEFTA meetings, because it refused to participate with the United Nations Interim Administration Mission in Kosovo (UNMIK)*, which has continued to facilitate Kosovo's participation in international and regional fora, and overall its participation in such meetings has been irregular. The only solution to these problems is political in nature and depends on reaching a political agreement with Serbia and Bosnia and Herzegovina. * UNMIK was the signatory party to the CEFTA Agreement. 1.45. The free trade access to the EU market opens up even larger possibilities for Kosovo's products. For almost a decade now, the European Union has been granting duty-free access for all of Kosovo's products, with some limited exceptions (for example, beef and sugar). The trade relationship between Kosovo and the European Union is asymmetrical, and EU products enter the Kosovo market under its most favored nation (MFN) tariff regime. It would be useful for Kosovo to have a free trade agreement with the European Union because the current agreement prevents Kosovo from entering into diagonal cumulation arrangements with other CEFTA countries (Handjiski et al. 2010). The timeframe for opening trade negotiations with the European Union is not yet clear, but the Kosovo government needs to strengthen the capacity of the relevant institutions to be able to conduct such negotiations (EC 2009a). 1.46. The free trade access to the EU and SEE markets is complemented by Kosovo's geographical proximity to these countries. Kosovo's central position in the Balkans and its relatively close proximity to the main European markets (for example, Germany and Italy) and the port of Thessaloniki are important to its competitive advantage for sectors that outsource production and require just-in-time delivery. Such sectors include textiles, the automotive industry, and other industries that outsource the production of certain parts and components. Closeness to key EU markets and duty-free access should be major draws for foreign investment to outsource production. However, even though Kosovo's proximity to the EU market is similar to those of its neighbors, Kosovo has not witnessed the success that, for example, FYR Macedonia has achieved with textiles (see Box 4) or Serbia with automotive components. This is because proximity and free access are not the only criteria important to investors. Other factors such as political risks and the overall investment climate are also key determinants as to whether a foreign company will locate its production in Kosovo, or in one of the other countries of the region. Chapters 2 and 3 will assess in greater detail Kosovo's competitive disadvantages in some of these areas. 16 F. ACCELERATING GROWTH 1.47. Despite the solid economic performance in the past decade, substantial efforts on several fronts are necessary to raise income and reduce poverty in Kosovo. Growth rates have been high, but lower than regional averages. The economy has remained resilient to the crisis, but that implies that the positive impact from the economic rebound in Europe will also be marginal. Growth so far has been dependent on foreign aid and migrant remittances. Economic diversification is still relatively low. Sustained productivity and output growth in the medium term will have to rely on stimulating domestic economic activity through greater utilization of idle physical and human resources, and in the long term, on investment in more productive capital and skills. 1.48. Reaching its growth goal would involve bringing on line three production factors that are now sitting partially idle: labor, land, and energy and minerals. The encouraging news is that this growth goal is achievable because most of the current obstacles are of a policy nature. The rest of the report thus addresses some of the key policy constraints to achieving faster sustained growth. Chapter 2 looks at the aspects of the investment climate that firms have found to be a major impediment to doing business. Chapter 3 assesses the trade and transport logistics, an essential component for improving Kosovo's export performance. Chapter 4 describes Kosovo's labor market and the potential of its idle labor force. Chapter 5 focuses on migration, which is not only an important source of income for Kosovar households, but also a factor that can stimulate economic activity via "brain gain" and investment from returning migrants. The final chapter analyzes the agriculture sector, which is an important part of Kosovo's economy and a vital activity for its rural population. Each chapter provides recommendations to help Kosovo unlock its growth potential. 17 2. ENHANCING PROSPECTS FOR PRIVATE SECTOR LED GROWTH A. INTRODUCTION 2.1 Kosovo's growth since 1999 has been solid, but driven mostly by international aid and the public sector, as well as by remittances. In the first years following the conflict, reconstruction efforts were the main economic activity. As these investments diminished, private sector growth began only slowly to emerge. In recent years, relatively high growth rates have been maintained by substantial increases in public spending, especially on capital projects; however, the current outlook does not leave much hope that these sources of growth can sustain or increase the growth rates achieved so far. Donor funding is expected to diminish and public resources will remain limited. In the future, sustainable and faster economic growth will depend on more active engagement with the private sector, both domestic and foreign. 2.2 To enhance private sector­led growth, the right conditions must be created on several fronts, including the macroeconomic environment, business regulations, and infrastructure as well as the cost and skills of the labor force. In terms of the business environment, Kosovo has great advantages in a number of issues that are important for a flourishing private sector; for example, the tax system is simple with low tax rates, and labor market rigidities are also very low. At the same time, however, firms in Kosovo face a lot of challenges, and addressing these challenges is critical for achieving faster and sustainable growth. This chapter focuses on the regulatory environment, in particular business registration and licensing, and energy, which have been identified as some of the biggest constraints by firms. Other areas, such as access to finance and the efficiency of the public services, are also important factors for enhancing growth; however, these are not covered in this report and deserve more detailed analysis. 2.3 Accordingly, this chapter looks at some of the key constraints to growth. The analysis mostly draws on the recent Business Environment and Enterprise Performance Survey (BEEPS)12 see Annex 1 for the overall results for Kosovo), the 2010 Doing Business report (see Annex 2), and on a comprehensive survey of foreign investors who have considered investing in Kosovo and the wider region. Sections B and C seek to identify the most important obstacles of the regulatory environment and the rule of law in Kosovo. The following section (D) looks at business registration and licensing difficulties that firms face. Section E focuses on the views of foreign investors on Kosovo. Given the major importance of energy in Kosovo's economy, section E examines the role of the energy sector both from a microeconomic (as a constraint to 12 BEEPS is a European Bank for Reconstruction and Development (EBRD)­World Bank survey established in 1999 that covers all transition countries and was published for the first time for Kosovo in 2009. It reveals the perceptions of business persons on over a dozen aspects of the business environment. Data from BEEPS can be accessed at http://www.ebrd.com/country/sector/econo/surveys/beeps.htm. 18 doing business) and a fiscal perspective (revenue potential). The final section summarizes and provides policy recommendations. B. THE REGULATORY ENVIRONMENT IN KOSOVO 2.4 Kosovo's regulatory environment boasts several very important strengths that have helped create a more vibrant private sector. In many business-related areas Kosovo has introduced modern legislation, often based on EU principles and standards. This has been a legacy of the post-1999 period, when old Yugoslav laws were scrapped and replaced with new legislation prepared by the United Nations Interim Administration Mission in Kosovo (UNMIK). And because Kosovo is considered a potential candidate for EU membership, the legislation in areas covered by the EU acquis has been, in most instances, drafted in compliance with EU requirements. 2.5 Labor legislation is very flexible. Most transition economies have complex labor regulations, a historical legacy from the socialist period, but Kosovo has benefited from the open market policies introduced after 1999. Labor market rigidities in terms of hiring and firing of workers are very low, among the lowest in all of the transition economies. Moreover, the tax wedge on labor is among the lowest in the region because Kosovo applies only a (low) pension contribution in addition to the personal income tax. 2.6 Domestic firms seem to be satisfied with labor regulations. The BEEPS 2009 results show that only 10 percent of firms find labor regulations to be a problem for doing business, much lower than the SEE average (26 percent). Foreign firms seem to share this view; according to the foreign investor survey conducted in 2009, difficulties in employing workers are not mentioned as an important constraint to investment in Kosovo. On the contrary, the labor market in general is perceived as a strong comparative advantage for Kosovo. 2.7 Kosovar firms also benefit from a low and simple tax and duty regimes. Elsewhere, high taxes and complex tax regulations often push firms into the informal sector. In Kosovo, the value-added tax (VAT) rate stands at 16 percent, which is among the lowest in Europe, and the personal income tax rate ranges from 0 percent to 10 percent. The customs duty profile contains only two rates, a standard 10 percent duty and zero duty on certain products. However, low taxes and relatively simple procedures do not by default imply a small informal sector, as there are many other factors that help determine whether firms choose to operate informally. Low taxes also do not mean high compliance. Under-reporting in Kosovo is prevalent despite the very low taxes, and strengthening of the tax administration is necessary to broaden the tax base and ensure consistent tax collection. 2.8 The tax system, the low corporate income tax in particular, has been also positively recognized by the surveyed investors. The tax system contains provisions, such as the carrying forward of losses and VAT deferment, which apply to both foreign and local investors. In contrast to these uniform incentives, targeted investment-related incentives, which are provided in most other countries in the region, are not offered in Kosovo, and this is perceived as a shortcoming by surveyed investors who obviously would prefer to have both. 19 2.9 The efficiency of Kosovo's customs and tax administration is also perceived more positively than in other countries of the region, though frequent inspections seem to pose a burden on firms. In terms of "paying taxes," a Doing Business indicator that includes the time to prepare and file a return and pay taxes as well as the number of payments per year, Kosovo's tax system performs quite well compared to the rest of the region. Only Croatia requires fewer tax payments per year, and the time spent on paying taxes in Kosovo is 40 percent less than in the rest of the SEE countries (World Bank 2010a). In support of this finding, only one-fifth of firms participating in the BEEPS listed the tax administration as a constraint for doing business, while this figure was only half of that in the rest of the SEE region. But at the same time, BEEPS found that firms in Kosovo deal with a high level of scrutiny by the tax authorities: the number of visits by tax officials is double that of the rest of the region. 2.10 In addition to these strengths in the regulatory environment, there are many weaknesses that create serious constraints to private sector development. Factual information and perceptions of businesses show that firms in Kosovo are obstructed by several aspects of the regulatory environment. The following section discusses survey results that paint a picture of strong dissatisfaction of businesses with the functioning of the rule of law. C. WEAKNESSES IN THE RULE OF LAW 2.11 Survey results suggest that corruption seems to be an endemic problem in Kosovo, spreading across most sectors and actors, with some notable exceptions, such as the police. However, in contrast to the overall high perception of corruption recorded in BEEPS, very few surveyed Kosovar firms answered positively to the question on how often and how much in unofficial payments they have made. Although such reluctance to confirm involvement in bribery is common and is somewhat expected, at least some companies respond positively in other countries. For example, in the rest of SEE and in other transition countries, firms respond that they typically pay around 9 percent of the contract value to secure a government contract. And in these countries, overall perception of corruption is almost 50 percent lower than in Kosovo. At the same time, anecdotal evidence points out that similar practice of payments made to secure a government contract is present in Kosovo as well. 2.12 Crime, theft, and disorder seem to pose another significant challenge for Kosovar firms, much more than in other countries of the region. Some 9 out of 10 firms in Kosovo pay for security, according to BEEPS, compared to 6 out of 10 firms in the rest of SEE and Europe and Central Asia (ECA). Similarly, the share of annual sales used for security payments is too high, at around 10 percent, compared to only 4 percent in SEE. The payment for security services is a widespread practice that emerged gradually after the conflict. Now, even though the Kosovo police has over 9,000 employees, 60 percent more than in the late 1980s, crime seems to be on the rise (see Figure 5 below). This could be partially attributed to the very high unemployment and widespread poverty, especially among the youth. Perceived weaknesses and corruption in the court system13 could also be contributing to the prevalence of crime. 13 Several surveys and studies, including the United Nations Development Programme's Early Warning reports and European Commission progress reports for Kosovo, point out these weaknesses in the court system. 20 Figure 5: Percentage of Firms Indicating Corruption (left) and Crime (right) Are Constraints (2008) Source: BEEPS (2008). 2.13 It is even more worrisome that the perception of corruption and crime has worsened in recent years, despite announced efforts to intensify the fight against corruption. In BEEPS 2006, only 6 out of 10 firms indicated corruption as a problem for doing business, but in 2009 this number had increased by 46 percent. There has also been a large increase in theft and other crimes against property in recent years. The number of convictions on theft charges more than tripled between 2005 and 2008. Although some of the increase in convictions could be a result of the improved efficiency of the court system, the massive increase in property-related crimes should be of great concern (Figure 6). Figure 6: Property-Related Crime Rates in Kosovo (number of convictions per year) 4000 3500 3000 Criminal Offenses 2500 against 2000 property 1500 Theft 1000 500 0 2005 2006 2007 2008 Source: SOK 2.14 High perceptions of corruption have proven to be a major deterrent to foreign investment. Foreign firms are especially sensitive to corruption because they tend to be less familiar with, and less able to find their way around, such situations. Foreign investors rate the legal system as a significant drawback to investment in a survey conducted by the World Bank (see Box 7). More than 80 percent of the surveyed firms stated 21 they are dissatisfied with the rule of law and the court system. Corruption of courts was cited as one of the main problems. According to the view of investors, corruption is widespread in the public administration in general and the judiciary in particular (Figure 7). Figure 7: Perceptions of the Rule of Law (left) and Court System (right) (share of respondents) Source: Foreign investor survey, World Bank 2009. 2.15 Foreign firms see the public administration as the root of corrupt behavior. Dealing with the public authorities seems to be one of the biggest challenges for foreign firms interested in investing in Kosovo. More than 80 percent of surveyed investors stated that they are unsatisfied with the efficiency of the public administration. The complex administrative structure, along with inefficiency and bureaucracy, creates the potential for exploitation of personal connections and rent seeking. Corruption is stated as one of the most negative aspects of the public administration (see Figure 8). Figure 8: Perceptions of the Efficiency of the Public Administration (share of respondents) inefficient and slow corruption still under development complex system lack of transparency 0 5 10 15 20 25 30 Source: Foreign investor survey. 2.16 Contract enforcement is another very important area of the rule of law where Kosovo performs poorly. Contract violation is a common issue in Kosovo; firms find it 22 extremely difficult to enforce contracts. The Doing Business 2010 (World Bank 2010a) shows that it takes on average 420 days and 53 procedures to enforce a contract, and the cost of enforcement can reach over 60 percent of the value of the claim. The 2008 Doing Business report for SEE, which surveyed firms in 22 cities, came to a similar finding. Prishtina and Prizren were found to be very difficult cities in which to enforce a contract (rank 20 and 21, respectively, out of 22 cities surveyed). According to Doing Business 2010, it takes on average 420 days to enforce a contract, and the legal costs for enforcement are over 60 percent of the amount of the debt. In Armenia, for example, the cost of enforcement is only 19 percent and the enforcement process takes four months less than in Kosovo. Because legal enforcement is so lengthy and costly, justice is out of reach for most Kosovar firms. BEEPS results confirm this: only 3 percent of surveyed firms used the court system in the past three years. D. BUSINESS REGISTRATION AND LICENSING DIFFICULTIES 2.17 Business registration and licensing are also areas where Kosovo is a poor performer, and these barriers are equally relevant to both local and foreign investors. Registering and starting a business is the first and probably most important hurdle that entrepreneurs face when deciding to invest in a business. Complicated and costly procedures (see Table 5) for starting a firm deter entrepreneurs from investing, or push them into the informal economy. This, in turn, leads to either less investment and less competition, or in the case of informality, limited investment and unfair competition; both cases result in less revenue for the government. Djankov et al. (2002) analyzed the regulations of business entry in 85 countries and found that in low- income countries business entry is typically extremely expensive and lengthy. They also discovered that heavier regulations on entry are generally associated with greater corruption and a larger informal economy. Table 5: Procedures for Starting a Business Cost (% Minimum of capital (% Procedures Time Economy income of income (number) (days) per per capita) capita) Albania 5 5 17 0 Armenia 6 15 3 0 Bosnia and 12 60 16 30 Herzegovina Georgia 3 3 4 0 Kosovo 9 52 43 170 Macedonia, FYR 4 4 3 0 Montenegro 12 13 3 0 Serbia 7 13 7 6 Europe & Central Asia 7 17 8 22 Source: Doing Business 2010 report, www.doingbusiness.org. 2.18 Starting up a firm is extremely costly and time consuming. It takes more than six weeks to start operating a business in Kosovo, much longer than any other country in the region, 23 with the exception of Bosnia and Herzegovina. The Doing Business indicator on starting a business comprises all procedures that are required in order for the enterprise to start operations. In the case of Kosovo, these include, in addition to the formal registration with the Kosovo Business Registry, number of municipally administered permits and inspections. While the registration process itself is fairly quick, obtaining permits and inspections results in major time delays with starting a business. 2.19 At the same time, such burdensome procedures open numerous opportunities for "rent seeking" from public officials. The large number of procedures and required approvals from various institutions provides unnecessary opportunities for corrupt behavior and extortion. For example, before a firm can start operating, an inspection has to visit and approve the business premises. In most countries, such pre-start inspections are considered redundant, and such inspections can be conducted once a firm starts operating. At the same time, such regulations strain the capacity of administrative bodies and prolong starting a business. Reduced interaction with public officials and increased transparency would limit the opportunities for "rent seeking" and make the business registration process more efficient. 2.20 The lengthy and costly procedures are a result of the complex legislation in this area and division of responsibilities between the central and local governments. While UNMIK introduced modern commercial legislation, largely compliant with the EU acquis, implementing legislation still represents a mixture of regulatory acts, some of them recently introduced but others dating from former Yugoslav legislation. This confusing, and in many aspects outdated, legal environment creates fertile grounds for arbitrary application by the authorities (and especially inspection bodies). Many of these burdensome requirements are implemented by municipal authorities. Under the decentralization framework, while business registration remains at the central level, the provision of the service is being transferred to the local level. Moreover, most business permits and inspections are administered by municipalities which also collect the fees from these services. Replacing the unnecessary procedures and fees with some sort of a (simple) local tax would reduce the compliance time for firms and capacity burden for municipal bodies. 2.21 The registration cost and the minimum capital required are several times higher than in the rest of the region. This presents a serious deterrent, so it should come as no surprise that the informal sector is so large. Several countries in the region have made good progress in this area and the positive results are already visible. Albania and FYR Macedonia reduced the time to register a firm to five and four days, respectively. Many countries have eliminated the minimum capital requirement and significantly reduced the administrative cost for firm registration (Box 6). It will be relatively easy for the Kosovo government to replicate some of these reforms. Introducing a one-stop-shop at the municipal level, which will require some physical investment in addition to legislative changes, would shorten the number of procedures and the time for setting up. This process has already started, with support from the World Bank's Business Environment Technical Assistance project, in seven pilot municipalities. 24 Box 6: Starting a Business in FYR Macedonia and Georgia Georgia and FYR Macedonia have been the most successful reformers among transition countries in simplifying business registration. In 2006, it took 21 days and 14 percent of annual per capita income to set up a firm in Georgia. In FYR Macedonia, it costs 11 percent of annual per capita income and 48 days to set up a firm. In addition, the entrepreneur would have to come up with substantial start-up capital (47 percent of annual per capita income in Georgia, and 145 percent in FYR Macedonia). By 2009, both countries had introduced cheaper "one-stop-shop" registration and had scrapped minimum capital requirements, so a firm could be set up in less than 4 days (World Bank 2010a). Two years after the reform of firm registration, the number of newly established firms rose by over 30 percent in FYR Macedonia. 2.22 Dealing with construction permits seems to be an even more crippling factor. According to Doing Business (World Bank 2010a) indicators, it takes 320 days, 21 procedures, and 1,300 percent of income per capita to obtain a construction permit in Kosovo. Only seven other countries in the world, three of which are transition economies, have a more difficult and costly process. And the construction sector is a key element of Kosovo's economy. Infrastructure gaps in transport, education, and other public sectors are vast. The manufacturing sector is marginal, and to achieve more rapid growth Kosovo will have to expand its fixed capital. Finally, Kosovo's population is growing rapidly, which also points out the need for more residential housing projects. Hence, improving the process for obtaining construction permits should be a high priority. 2.23 BEEPS 2009 results show that only 18 percent of surveyed firms found licenses and permits to be a problem for doing business (the share is 29 percent for the SEE region), which at a first glance would contest the importance of this issue. But this could mean that surveyed firms did not need to deal with construction permits recently, or more likely, they chose not to obtain a permit due to the large regulatory burden. Studies have shown that when the construction sector operates in the informal economy, there is less concern for safety, more hazardous construction, and more opportunities for bribery. E. INVESTING IN KOSOVO: PERCEPTION OF FOREIGN INVESTORS 2.24 Given the importance of FDI for promoting private sector­led growth in Kosovo, a foreign investor survey was conducted in 2009 to learn more about the perceived attractiveness of Kosovo to foreign investors (Box 7). The findings of this survey show that investors recognized positive developments in Kosovo. A successful transition to independence and the accession to international institutions such as the World Bank and the IMF have already contributed to bolstering perceptions of Kosovo's stability and improving the perception of its investment climate. 2.25 The role of foreign investment in stimulating economic growth has been well established (Handjiski 2009). FDI has been a key pillar of the growth strategy of many countries, and has played an even greater role in the transition economies that were successful in privatizing state-owned enterprises with foreign capital. The Kosovo government has set 25 economic growth as its top priority and is targeting FDI to be a key contributor. FDI into Kosovo has been very small in the post-conflict period, amounting to less than 400 million (Central Bank of Kosovo) between 2000 and 2005, and about half of this investment came from privatization. FDI inflows increased in 2006, and peaked in 2007 at 440 million (13 percent of GDP), but have begun to decrease. The global economic downturn has taken its toll on FDI in Kosovo, as is the case in the rest of the region. Available funds for investment will continue to be scarce in the period ahead, which means Kosovo will face fiercer competition for limited FDI sources. The section below discusses areas that the authorities should focus on to improve Kosovo's attractiveness to foreign investors. Table 6: FDI in Kosovo, by Type (in million) FDI Type 2004 2005 2006 2007 2008 2009 Equity capital 30 66 191 286 222 212 of which, privatization- related: 6 68 138 105 7 n/a Reinvested earnings 9 17 25 42 56 59 Other capital 4 25 79 113 88 21 Total 49 176 432 545 373 292 Source: Central Bank of Kosovo. Box 7: Foreign Investor Perception Survey The foreign investor perception survey for Kosovo was implemented by the Investment Climate Advisory Services department of the World Bank Group, through its Invest in the Western Balkans (IWB) program and Investment Generation Vienna Office. The Investment Generation Vienna Office is assisting the government of Kosovo on devising a national FDI strategy and an investment promotion strategy to be used by the Investment Promotion Agency of Kosovo (IPAK). The objectives of the survey were to gather information from existing investors, both in Kosovo and elsewhere in the region, about the perceived strengths and weaknesses of the business environment in Kosovo, and provide data on why investors that might have had a good "fit" with Kosovo either did not consider Kosovo, or, if they did consider it, why they did not invest. Source: Author 2.26 Indeed, foreign investors have little knowledge about business opportunities in Kosovo. A little more than a quarter of the surveyed investors indicated they have a very good knowledge about Kosovo, which is less than in the case of Croatia, Serbia, and FYR Macedonia. The lack of knowledge seems to be evident across all sectors 26 Figure 9: Knowledge about Kosovo (share of respondents) Source: Foreign investor perception survey. 2.27 It is difficult for a small, newly established country in a recently conflict-affected region to compete for investors' attention. Political stability is ranked as being most important by investors who considered the region but did not invest. Existing investors, who are more familiar with the actual situation, assigned less importance to political stability: only 20 percent stated it as an important issue, compared to 50 percent of potential investors. The political stability perceptions have improved recently, given that Kosovo has made a peaceful transition to independence and has been admitted to the IMF and World Bank. According to the data in figure 10, more than 60 percent of surveyed respondents said that their perception of Kosovo has improved. Figure 10: Changes in Perceptions of Kosovo (left) and areas of improvement (right) (share of respondents) Source: Foreign investor survey. 27 2.28 These results suggest that the government and IPAK should strengthen its awareness-raising activities. Highlighting the positive experience of existing investors could be a useful way to improve the country's image and attract more investment. In addition, there seems to be a wide gap in the availability of information sources between Kosovo and the other countries in the region. For example, surveyed companies responded that media are the main source for information about Kosovo. In contrast, foreign firms rely much more on site visits, personal work experience, and local contacts to obtain information about the other countries in the region. 2.29 Servicing potential investors by providing timely and relevant information should be one of the key activities of an investment promotion agency. The World Bank Group's Global Investment Promotion Benchmarking 2009 (World Bank 2009e) for Kosovo identifies areas for improvement ranging from sector-specific information such as key strengths, case studies, skills, costs, and comparative data to English-speaking staff who can deal with inquiries. Also, there has been a shift in focus toward existing investors to help them sustain and hopefully expand their businesses. As existing investors in Kosovo have indicated significant interest in expanding their business, the government should seek ways to support them. 2.30 Foreign firms are considering investing in Kosovo. Despite the difficulties due to their lack of situational awareness, many of the surveyed firms are considering investing in Kosovo (Figure 10). Those firms that are already present in Kosovo are most likely to invest; almost half of them stated they will certainly invest further in the next three years. Companies in the information technology (IT) sector, consumer goods and textiles, and logistics are most likely to invest in Kosovo. Figure 11: Probability of Investment (share of respondents) Source: Foreign investor survey. 28 2.31 Those companies that are considering investing in Kosovo14 have noted the high demand, geographical location, and growing market as some of the key reasons to invest (Figure 12). Over half of the firms responded that they were considering greenfield investments. Figure 12: Reasons to Invest (left) and Types of Planned Investment (right) (share of respondents) Source: Foreign investor survey. 2.32 Foreign investors are looking not only at Kosovo's domestic market, but also the potential of the regional market for goods. As part of CEFTA, Kosovo offers almost completely free access to a regional market with a population of over 21 million. Almost 80 percent of surveyed firms see the access to the regional market as a very important benefit (Figure 11). This share is even higher among existing investors. Sectors that command high interest in the regional market include consumer goods, construction and information and communications technology. Figure 13: Kosovo as Part of a Regional Market (share of respondents) Source: Foreign investor survey 2.33 Around 40 percent of surveyed investors stated that the global economic slowdown has affected their investment plans. The main reasons were less funds available for investments, greater uncertainty, and reduced access to credit and financing. Because countries 14 That is, companies that have responded with 50 percent probability for investing in the next three years. 29 are now competing for a smaller pool of FDI, Kosovo will need to improve its attractiveness and increase its efforts to attract investors. Also, while the global economic slowdown will reduce the opportunities for foreign investment in the near future, the survey results indicate that existing investors in Kosovo (and elsewhere in the region) see future potential for investment. To encourage this investment, the government should also focus on the challenges that existing investors face in regard to the rule of law, public administration efficiency, and business registration and licensing. Box 8: Zinkunie - Dutch Investment in Prizren Zinkunie is a 2.5 million foreign investment by a Dutch firm in Kosovo, established jointly with a local firm. The Zinkunie plant began operations in 2008, and now employs about 25 workers. It processes semi-finished zinc and copper products that are exported to the Netherlands for further processing. The experience of this company confirms Kosovo's competitive advantages as identified in the foreign investor perceptions survey. The main reasons for investing in Kosovo were the low labor costs and the good quality of labor, proximity to the European Union, and the longer-term the potential of the regional market. A year after the start of production, the Dutch firm is very satisfied with the investment and is interested in investing an additional 1.5 million in a galvanization plant, which would allow for production of final products that would be exported to the European Union and SEE. In addition, the firm has also started to develop an industrial park for other Dutch firms; it has purchased additional land next to its plant and has constructed the road network. However, this case study also validates the concerns of foreign investors regarding deficiencies in the business environment. Infrastructure, particularly electricity, has been a major issue. The company found it extremely time consuming and expensive (50,000) to get an electricity connection and the plant still does not have undisrupted electricity supply. It often experiences power outages and had to invest in a generator. Administrative procedures are also a major obstacle and have slowed down investment decisions. Obtaining licenses related to the land and construction was extremely difficult, and could have jeopardized the investment. Also, procedures for exemption from import duties for raw materials are very complicated. Having a local partner, a returning migrant who used to work for the Dutch firm in the Netherlands is what ultimately brought this foreign investment to Kosovo. Without the local knowledge, the Dutch investor would have not been able to invest. F. ENERGY IN KOSOVO: CONSTRAINTS AND OPPORTUNITIES 2.34 The poor quality of the electricity supply is one of the biggest constraints to doing business in Kosovo. Lack of steady supply of electricity continues to be the biggest impediment to firms from all sectors of the economy. According to BEEPS, 9 out of 10 firms indicate it as a problem and a third of all firms identify it as their main obstacle to doing business. The unreliable flow of electricity, which has persisted since the end of the conflict, has had, and continues to have, major repercussions for Kosovo's economy, although some improvements have been made recently in providing steady supply of electricity to businesses which regularly pay their electricity bills. First, power shortages reduce output and increase costs because paid 30 workers are idle during the outage period. Second, to prevent outages, most firms have had to purchase power generators, which is a substantial cost item especially for small firms. An estimated 150 MW in back-up generator capacity has been installed, much of it by thousands of enterprises.15 Also, operating costs of producing electricity from power generators is much higher than power from the grid. Third, the outages combined with large variations in the electricity flow often lead to equipment malfunctions, both to firms and to households. Hence, firms that need to use more sophisticated equipment have been deterred from investing in such equipment. 2.35 The electricity sector also puts a severe drain on the budget. Because of old equipment, poor management, low tariffs and high technical and commercial losses, KEK received about 1.1 billion in subsidies during 2000­2009 (an amount equal to total expenditure of the 2010 budget), of which about 0.5 billion came from the Kosovo budget and 0.6 billion came from donors. Despite efforts by foreign management teams, advisors and local management to improve operational efficiency, KEK remains an underperforming public utility. It has system-wide undercapitalization, major operating inefficiencies, and a very poor financial performance and position. The Kosovo budget allocated to KEK about 70 million per year during the last four years for capital investments and power imports, equal to 11 percent of budget expenditures. There is broad agreement that this drain on the budget must stop, and, in fact, some improvement in KEK's performance reportedly started taking place in 2008. 2.36 Nevertheless, the power sector has significant potential. Abundant reserves of good quality lignite are Kosovo's main natural energy resource. Efficient and relatively low-cost production of lignite from a new mine and electricity from proposed new or rehabilitated power plants owned or managed by the private sector would vastly improve the reliability of supply in Kosovo. Privatization of KEK's distribution business should have a very positive impact on payment discipline, provided the government implements supporting measures (prior to proceeding with the privatization). These proposed privatizations are currently under preparation and could materialize in the near future. Instead of a drain on the budget, the sector could become a contributor, and instead of a constraint on growth, the sector could become a growth engine. Electricity: A Constraint 2.37 Poor electricity supply is a great concern for firms. The inadequate power supply continues to be a critical constraint on enterprises in Kosovo, particularly when compared to neighboring countries (World Bank and IFC 2009). Frequent power outages are cited by firms as the most severe constraint on enterprise operations, although the situation is improving (33 percent of respondents in 2009 versus 66 percent in 2004). These outages impose higher operating costs, production losses, and reduce competitiveness. They are particularly burdensome for the manufacturing and construction sectors, where interruptions may bring production to a halt. Firms in Kosovo reported about 43 outages per month compared to about 6 per month in the Eastern Europe and Central Asia region. It requires on average 77 days to get a new electricity connection in Kosovo versus 48 in the rest of Europe and Central Asia, reflecting, 15 This also included generator capacity installed in KFOR bases. 31 in part, the absence of urban planning in Kosovo. Box 8 tells the story of a Dutch investor who had to wait a long time to get a connection. 2.38 Power shortages present a substantial burden. Shortages resulted in average losses to firms equal to 17 percent of their annual sales, compared to less than 4 percent for other transition economies, according to the latest BEEPS survey. In addition, the need for other sources of power increases operating costs for firms. Enterprises' standby generators supply about 18 percent of their electricity needs, and the cost of and operation of a generator represented about 3 percent of operating costs (World Bank 2004a).16 Between 2007 and 2009, over 6 million a year were spent on imports of power generators. This erodes export competitiveness and reduces profit margins, or passes the cost on to domestic consumers through higher prices. However, during 2009, outages have reportedly dropped from almost 15 percent of demand to about 10 percent, and efforts are underway to significantly improve Kosovo's electricity supply in the medium term. Nonetheless, purchases of power generators were on the rise in 2009; some 13,000 units were imported in the first three quarters, compared to 12,369 in the whole of 2008. 2.39 The energy sector in Kosovo is dominated by the electricity sector and associated lignite mines. There is no natural gas system and oil consumption is limited to starting up the power plants and as the fuel for district heating systems in three cities. The Kosovo Energy Corporation (KEK) is the sole producer and distributor of electric power in Kosovo and mines the lignite that fuels its aging power plants, Kosovo A and B.17 On average, about 10 percent of electric power demand needs to be imported. Even so, frequent load shedding (outages) is necessary and the quality of electricity supply is poor. 2.40 The electricity sector is experiencing capacity shortages. KEK's two large power plants, Kosovo A and Kosovo B, are about 40 and 25 years old, respectively, and poorly maintained due to a lack of funds. Both, but particularly Kosovo A, are major polluters, technically unreliable, and experience frequent outages. While nominal capacities are 800 MW and 680 MW respectively, only about 900 MW (60 percent) of the aggregate capacity is available, well below the peak capacity demand needed during the cold season. Most of this capacity comes from Kosovo B. The five Kosovo A units are on average over 35 years old18, very inefficient, and highly polluting. Nevertheless, given the shortage of generating capacity in Kosovo, there is broad agreement that units A3 through A5 should provide service until end- 2015, when a new plant is expected to come on line, with the condition that they be operated according to stricter environmental standards.19 The two Kosovo B units are about 25 years old, but are now operating well below their design base load capacity. With proper investment and maintenance, Kosovo B should be able to operate reliably through about 203020. Investments needed for Kosovo A and B would be about 35­40 million per year from 2010 onwards. In 16 This figure is much higher than in the 2004 report (8­9 percent higher). 17 Since 2006, transmission is the responsibility of a separate company, the Kosovo Electricity Transmission, System and Market Operator. 18 The first two units, A1 and A2, have not been operational in the past ten years. 19 Under the Energy Community Treaty, Kosovo agreed to the mandatory decommissioning of units not in compliance with the EU Directive on Large Combustion Plants, such as Kosovo A, by the end of 2017. 20 New rotors are expected to be installed this year in the two Kosovo B units. 32 addition, very large investments need to be made in a new mine and power plant known as the New Kosovo (Kosovo e Re) Power Project. 2.41 KEK is a major fiscal burden. The fiscal burden of the energy sector on the Kosovo budget has been running at over 70 million in subsidies per year over the last four years, or 11 percent of the budget on average. The main causes for KEK's negative fiscal impact are technical and commercial losses; power imports requiring a subsidy of about 50 million in 200921, a subsidy that will increase in the future as equipment ages and demand and power import prices increase again; and urgently needed investments and maintenance in generation and distribution. Investments for the opening of the Sibovc SW mine have been supported through about 145 million in Kosovo Consolidated Budget (KCB) loans (discussed in more detail later in this section). 2.42 Technical (network) losses are very high. The distribution network has suffered from many years of underinvestment. As a result, technical losses in the distribution system are high, averaging 17 percent. In a well-functioning system the size of Kosovo's, these losses should be around 8 percent. However, reducing losses to that level will require major investments of about 500 million (KEK 2005). The investments needed to significantly improve the distribution network would be about 40 million per year from 2010 onwards. Transmission losses are, at about 3.5 percent, also higher than they should be (2.5-3.0 percent) but this represents less of an issue than the distribution losses. 2.43 Commercial losses (nonpayment and theft) remain a serious concern. Even allowing for the legacy of an infrastructure in poor condition and the need to rebuild management and staff capacity, the operational and financial performance of the power sector since 1999 has been poor. The single most important problem is KEK's low level of both billing and collections, but improvements are taking place: while during 2000­2007 commercial losses constituted about 44 percent of energy entering the network, during 2008­9 this figure went down to about 35 percent.22 Nevertheless, the revenue foregone due to these commercial losses alone is about 96 million per year. 2.44 While fixing the distribution system to reduce technical losses will require major investments, reducing or eliminating commercial losses requires limited investment, but strong political will. Without government action to improve the ability of KEK or a private investor to enforce collections and reduce theft, there is little hope for a significant reduction in the fiscal burden in the future. The one exception is that rapid progress on a new mine/new plant transaction would ensure that the new Sibovc mine would be developed on a priority basis by the selected private investor. This would mean a major and immediate reduction of the fiscal burden on the government because of lignite mining and possible repayment of about 145 million in KCB loans. 21 Parts of the import subsidies go to Ferronikeli; and the existing contract for subsidized electricity ends in 2011. 22 Of which 46 percent are losses due to theft, 34 percent are due to the nonpayment of bills, and 20 percent for energy delivered to minority areas. These are unaudited figures as reported by KEK/PA Consulting. 33 Electricity: Opportunities 2.45 In April 2010, the Parliament of Kosovo approved the Government's Energy Strategy 2009­18 to address the energy sector's problems. The five-pronged strategy consists of phasing out Kosovo A by end-2015, rehabilitating and privatizing Kosovo B, developing the country's renewable energy resources (notably the Zhur hydropower project), proceeding as quickly as possible with the Kosovo e Re Power Plant (previously called Kosovo C), and privatizing KEK Distribution. Work on all of these elements of the strategy is underway with support from the European Union, the U.S. Agency for International Development (USAID) and the World Bank, among others. 2.46 Privatizing KEK Distribution is planned, but prior government actions are urgently needed in order to increase the attractiveness of the company. Because of the continuing poor collection performance of KEK Distribution, the Government has begun the process of separating and privatizing the distribution assets of KEK through a separate transaction. However, the Government has so far been unwilling to take the supplementary measures necessary to make this proposed privatization a success. Yet, this is critical for sustainability of the sector, including for the success of the generation privatization transactions. In particular, the Government has to: (i) make electricity theft a criminal offense and start prosecuting offenders vigorously, (ii) provide funding to the courts to deal with cases of theft and nonpayment of bills expeditiously, (iii) help KEK's management reduce the company's major overstaffing, and (iv) allow a program of regular tariff increases as warranted provided that customer service and quality of supply improve hand-in-hand. These measures would not only increase the proceeds to the budget of the proposed privatization but would also decrease the contingent liabilities the government would have to assume in that context. 2.47 The success of the Government's strategy hinges in part on its ability to develop the Sibovc lignite mine. Kosovo's energy sector relies on large quantities of good quality domestic lignite, situated within shallow discontinuous basins west-northwest of Prishtina. The most significant of these is the Sibovc field, containing nearly 1 billion tons. Although total resources across Kosovo exceed 10 billion tons, urban sprawl and other land uses have sterilized a significant part. The South East Europe Generation Investment Study (EC and World Bank 2006) identified power generated from Sibovc lignite as a prime regional least-cost development option in comparison to gas, imported coal, and hydro (on an energy-equivalent basis) and taking into account several CO2 price scenarios. Sibovc lignite offers a unique resource rent that has not yet been tapped, while lesser deposits provide electricity and growth in other parts of Europe. Delays in the exploitation of the southwestern part of the Sibovc mine (Sibovc SW) remain the main risk to continued coal supply for electricity generation.23 In 2010, Sibovc SW needs to produce about 3.4 million tons because production levels at the old Mirash and Bardh mines are beginning to decline.24 23 The ongoing "truck and shovel" has succeeded in removing and adequate quantity of overburden to enable the start of exploitation of the mine. Nevertheless, the exploitation should be done with large coal excavators which are currently in short supply. 24 The exact timing will depend on the actual production of electricity by Kosovo A and B. 34 2.48 Foreign investment in energy generation is vital for solving the energy issue. Since 2006, the World Bank has supported Kosovo in its efforts to attract private investment for the development of the urgently needed new Sibovc lignite mine and the phased construction of a new power generation plant.25 This new mine/new plant complex is known as the Kosovo e Re Power Plant (KRPP). The most critical investment to be made is in the new mine, and it is expected that the winning bidder will acquire KEK's interest in Sibovc SW and start development immediately after financial close. The combined mine would then provide fuel for the KRPP as well as for Kosovo A (until closure in 2015) and B under standard commercial contractual arrangements. On current assumptions, the KRPP deal could be signed by end-2010, and a power plant of about 500-600 MW, serving mostly the domestic market, could be completed by 2015. 2.49 Decreasing risk appetite could undermine the investment plans. Because of the global financial and economic crisis, prospective bidders have a reduced appetite for risk as well as more limited financing access. Demand for electricity throughout the regional market decreased by about 10 percent from the 2007 level. This has severely affected the electricity export market, which has seen prices tumble from an average of about 130 MWh in 2007 to about 60 MWh by the end of 2009. Throughout the Western Balkans, no major energy sector privatization deals have taken place since the beginning of 2008, with the exception of the privatization of Albania's electricity distribution company. In view of the above, it is unlikely under the current circumstances that the initial KRPP deal will be for more than 1,000 MW (in phases), and even that may be more than bidders are willing to commit to at this stage. The cost of such an investment, including development of the mine, would be in the range of about 1.5 billion. 2.50 Beyond relieving current constraints to business development, electricity production could also become an export product for Kosovo in the long-term. Assuming that the regional electricity demand recovers along with the economic rebound after the crisis, Sibovc's one billion tons of lignite would be enough to power 1,000 MW of supercritical generating units for over a century (average consumption per 500 MW unit: 4 million tons per year). If major technological innovations make lignite-fired power production environmentally more palatable, the generating capacity for Kosovo B and KRPP could be substantially increased. The main revenue to Kosovo would come from lignite fees per ton mined, royalties, carried interest, corporate income tax, and possibly a share of incremental revenues resulting from increases in power prices in the regional export market under a formula yet to be determined. For a generating capacity of 1,000 MW, these could become a significant source of revenue for the central budget. The benefits of a good electricity supply to the Kosovo economy are, of course, very large. Reliable power would remove the biggest obstacle that firms in Kosovo currently face: it would reduce the cost of electricity, eliminate the need to purchase power generators, and allow firms to use more advanced equipment and machinery that is sensitive to electricity shocks. G. SUMMARY AND POLICY RECOMMENDATIONS 25 The Lignite Power Technical Assistance Project, with total grant funding of $12.25 million. 35 2.51 Higher and sustainable growth and convergence to regional income levels are possible only with increased private sector engagement. A more conducive business environment for private sector­led growth requires a wide array of reforms. Kosovo already boasts a number of competitive strengths, such as its simple tax regime with low tax rates and flexible labor legislation. Also, the country's lignite resources could eliminate the current energy short falls and provide a significant boost to fiscal revenue, and possibly exports, in the medium to long term. 2.52 Nonetheless, domestic firms as well as foreign investors face a number of serious barriers that limit their economic activity and growth potential. This chapter discussed the key barriers to economic growth that the government could address in the short to medium term, given its fiscal and institutional constraints. Certain issues although very important for promoting private sector growth, have not been covered because they are either analyzed in other chapters of this report or because their performance indirectly depends on the areas covered in this chapter. For example, the financial sector in Kosovo has been assessed quite poorly by firms, in particular in terms of the cost of finance. Although interest rates cannot be reduced by enacting a law, the authorities could promote financial sector deepening through, for example, modernization of the pledge registry and enhancing the credit information system. Increasing formality, improving contract enforcement, and strengthening property rights would give also more confidence to banks to lend to the private sector. 2.53 There is no room for complacency and the pace of reforms must be increased if the country is to become more competitive. Though this is Kosovo's first appearance in Doing Business (World Bank 2010a), a shadow exercise was undertaken in 2009 that allows progress to be measured. Unfortunately, Kosovo's ranking has deteriorated in all sub-indexes, except on "closing a business," where it remained unchanged. The worsened position is not a result of adverse policy measures over the past year; practically nothing changed in these areas during this period. But other countries have taken steps to improve their business environment and address their shortcomings. For example, in the 2010 report, FYR Macedonia moved from 69th to the 32nd position, it was the second year in a row that the country was a top 10 performer. Other countries, such as Georgia and Armenia, have also made significant progress in recent years and rank higher than many EU countries. 2.54 The following key policy recommendations are proposed: Sustain efforts to strengthen the rule of law, and in particular the fight against corruption and crime. Implement measures to reduce the time and cost for starting a business, particularly at the municipal level. Streamline procedures and strengthen administrative capacity related to the regulatory regime for doing business, especially concerning business and construction licensing. A detailed review of existing regulations and procedures is urgently required to pave the way for designing a comprehensive strategy to reduce the regulatory compliance costs. Strengthen the court system to improve contract enforcement. Implement the key pillars of the energy strategy. 36 3. THE ROLE OF TRANSPORT AND TRADE FACILITATION IN IMPROVING EXPORT PERFORMANCE IN KOSOVO A. INTRODUCTION 3.1 Kosovo's economy is small, even in regional terms, and long-term growth prospects will strongly depend on developing its export potential. In an increasingly globalized world, success in export markets is increasingly affected by the ability of governments to support an environment that promotes efficient and low-cost trade services and logistics. The overall objective for the development of the transport and logistics sectors can be described as the need to reduce what can be termed as the "economic distance" to the main markets. A crucial component of this process is trade facilitation, or, lowering trade transaction costs, which include all costs related to the moving of goods from the factory to the final destination abroad. 3.2 This chapter presents a comparative assessment of Kosovo's trade-related environment compared to the rest of the SEE region, and discusses the improvements that could be made to facilitate flow of goods across the borders. It also provides an overview of the transport infrastructure and the investment required to reduce the time and cost of exports and imports. The final section outlines the key recommendations. B. A COMPARATIVE ASSESSMENT OF KOSOVO'S PERFORMANCE 3.3 To view Kosovo's performance in a broader perspective, this section compares Kosovo's performance on several aspects of the trade-related environment with the performance of the other SEE countries. This comparison draws mostly on international indices that rank countries on the various aspects of trade and transport facilitation.26 Among the international benchmarking exercises reviewed are two World Bank indices: the "trading across boders" sub- index of Doing Business and BEEPS27. 3.4 Kosovo performs poorly in the "trading across borders" sub-index of the Doing Business indicators. The World Bank's Doing Business (2010a) ranks 183 economies on their ease of doing business. On the trading across borders sub-index, Kosovo is ranked 132nd, 19 positions lower than its overall ranking, and considerably below the other countries in the region (see Table 7). Despite the remarkable progress made in the area of customs administration, what is pulling down Kosovo's overall performance is the cost to export and import, reflecting Kosovo's landlocked nature, distance to key ports, and poor road infrastructure. 26 Given its recent change in status, Kosovo is not yet included in a number of international comparative indices. 27 A recent report by the International Finance Corporation (IFC) provides a useful overview of trade facilitation issues in the Western Balkans. The findings of this report, which are preliminary, focus on Albania, Bosnia and Herzegovina, Croatia, FYR Macedonia, Moldova, Montenegro and Serbia, excluding Kosovo. However, the assessment of the trade flows, logistics, and customs issues in the region, as well as the general recommendations, are also of relevance to Kosovo. 37 Table 7: Trading across Borders Sub-index Time Cost to Time Cost to Documents Documents to export ($ to import ($ Country Rank to export to import export per import per (number of) (number of) (days) container) (days) container) Albania 66 7 19 725 9 18 710 Bosnia and Herzegovina 63 6 16 1,125 7 16 1,090 Bulgaria 106 5 23 1,551 7 21 1,666 Croatia 96 7 20 1,281 8 16 1,141 Kosovo 132 8 17 2,270 8 16 2,330 Macedonia, FYR 62 6 12 1,436 6 11 1,420 Montenegro 47 7 14 775 7 14 890 Romania 46 5 12 1,275 6 13 1,175 Serbia 69 6 12 1,398 6 14 1,559 Slovenia 84 6 20 1,075 8 21 1,130 Source: World Bank (2010a). 3.5 Nonetheless, time and procedures to export also seem to be lengthier and more cumbersome than in the better-performing regional benchmarks. The time to export, a crucial factor for export-oriented, just-in-time foreign investment operations, is higher than in its neighbors FYR Macedonia and Montenegro. Also, the number of documents required is higher than in any other country of the region. The countries reviewed are considering the introduction of the concept of authorized economic operators (AEOs) and simplified procedures, and have limited their efforts to allowing large selected importers to clear their cargoes at their factories.28 3.6 Meeting product standards is another area where Kosovo lags behind the region. Exporters face a significant challenge in meeting product standards, especially for agriculture and livestock products. These standards limit export markets, as well as the ability to increase the value of exported goods, because the standards become higher when moving up the product value chain. Policies to improve market access and increase product value have to focus on the capacity to test and certify production, and where appropriate, the logistics to deliver the goods safely. Standards and regulations for goods exported to the European Union are enforced by importers and may include testing on goods or provision of inspectors at production. To meet these standards, exporters must upgrade their production facilities and obtain the 28 The concept of AEOs is one of the building blocks of the World Customs Organization (WCO) Framework of Standards to Secure and Facilitate Global Trade (SAFE), which was adopted by the WCO Council at its 2005 session. The framework is based on four elements: (i) the harmonization of advance electronic cargo information; (ii) the use of a consistent risk management approach; (iii) on request of the customs administration of the receiving nation, the customs administration of the sending nation will perform an outbound inspection of high-risk cargo; and (iv) defined customs benefits to businesses that meet minimal supply chain security standards and best practice. Further details can be found in the WCO SAFE Framework of Standards, Authorized Economic Operator Guidelines at http://www.wcoomd.org/files/1.%20Public%20files/PDFandDocuments/Capacity%20Building/AEO_Guidelines.pd f. 38 necessary certification. Governments can assist this process by developing testing facilities and obtaining international acceptance of the certification provided. 3.7 According to the most recent European Commission's annual progress report Kosovo needs to make significant progress in the legislative and regulatory structures affecting trade, including sanitary and phytosanitary standards. The institutional framework to ensure accreditation, certification, and standardization needs to be improved and implemented effectively--Kosovo is lagging behind in the development of conformity certification standards and had no conformity assessment authorities until late 2009. Progress has been made recently but the gap with the rest of the region remains large. Conformity assessments are necessary to assure compliance with international standards, including third-party conformity assessment activities such as testing, inspection, and certification. Building conformity certification infrastructure is extremely expensive and it is not clear whether Kosovo has the necessary fiscal space. Alternatively, Kosovo should explore the possibility of using the conformity infrastructure of neighboring countries (Handjiski et al. 2010). Table 8: Progress in Convergence to EU Standards Conformity European Country assessment standards adopted authorities 2008 2009 2008 2009 Albania 14,424 15,029 n/a 16 Bosnia and Herzegovina 8,000 9,653 32 35 Croatia 10,695 21,368 123 145 Macedonia, FYR 3,674 6,011 20 36 Montenegro 500 1,530 n/a 0 Serbia 2,805 5,072 325 347 Kosovo 665 1,200 0 4 Source: European Commission Progress Reports 2008 and 2009. Note: n/a is "not available" 3.8 According to BEEPS, customs and trade regulations are also ranked as constraint to doing business. Table 9 presents the results of perceived problems in Kosovo's trade sector.29 Unofficial payments to customs are not perceived to be an issue in Kosovo. In contrast, customs regulations and transport are perceived to be a problem for about a quarter of the firms interviewed. Even though the share of firms stating customs and transport as problems for doing business is similar as in other countries in the region, these constraints may be higher given that the share of exporting firms in the sample for Kosovo is much lower. 29 Percentage of firms stating that (i) bribery is frequent in dealing with customs/imports; (ii) customs regulations are a problem; and (iii) percentage of firms indicating transport as a problem. The ECA region includes all 28 transition countries and Turkey. The SEE countries include Albania, Bosnia and Herzegovina, Croatia, FYR Macedonia, Kosovo, Serbia, and Montenegro. 39 Table 9: BEEPS Results: Problems Doing Business (share of firms) Problems for doing business Kosovo SEE region ECA region Unofficial payments: customs 0.2 4.7 7.1 Customs regulations 22 26 26 Transport as a problem 27 26 33 Source: BEEPS 2008-2009. C. THE ROLE OF TRANSPORT INFRASTRUCTURE 3.9 Conflict and years of neglect have left Kosovo with a transport system that is inadequate for the needs of the country and incompatible with European standards.30 The transport infrastructure was largely neglected during the 1990s, and the conflict that culminated with the NATO bombing in 1999 destroyed or rendered unusable important components of the transport infrastructure. Following the conflict, large-scale reconstruction took place of the main road and rail networks, bridges and tunnels, mostly financed by the donor community. However, the allocation of resources for post-war recovery operations that were focused, and rightly so, on rebuilding the main road and rail infrastructure, along with the limited subsequent support from domestic sources, has resulted in inadequate maintenance operations. The result is a significant maintenance backlog on the road network, particularly on the secondary and local road networks. The rail network is in slightly better condition, because after the conflict with Serbia the limited traffic has slowed down deterioration despite the inadequate maintenance. 3.10 Upgrading the transport infrastructure is necessary to reduce the time and cost of transport. Exports exit the country through two main border crossing points, Hani i Elezit (with FYR Macedonia) and Kulle (with Montenegro). In 2008, 38 percent of exports exited Kosovo through the border crossing point of Hani i Elezit, located in the southern part of Kosovo (linking Kosovo with the port of Thessaloniki in northern Greece). This is also the customs station with biggest flow of cars (passengers) and for trucks carrying imported goods to the Kosovo market. In 2008, there was a reorientation away from Mitrovica, which borders Serbia, toward Kulle, near the border with Montenegro, and, as a result of these changes, nearly three quarters of all exports left Kosovo from Hani Elezit and Kulle. Not surprisingly, given that the exports are heavily concentrated in base metals and mineral products, only 2.8 percent of exports leave the country through the Prishtina airport. Given the importance of Hani i Elezit and Kulle as key border crossing points where the bulk of Kosovo's exports exit the country, improvements in their performance and infrastructure will be needed in the medium-term as exports begin to pick up. 3.11 At the same time, the Government has committed to develop a motorway to Albania (which would go to the border with Serbia in the north), hoping to achieve fast access to the Adriatic Sea and the port of Durres in the south and link to the Trans-European Network Corridor X in Serbia. The full motorway within Kosovo is approximately 117 km in length, and preliminary estimates put the development cost around 750 million to 1 billion. At present, the 30 This section is based in part on the World Bank (2008a) and European Commission Liaison Office to Kosovo (2008­9). 40 main port handling consignments originating from or destined to Kosovo is the port of Thessaloniki in Greece (see Table 10).31 It handles some 70 percent of all consignments, and Bar and Durres account for the rest. The new Durres-Kukes-Morine highway in Albania connects the Adriatic coast with the Kosovo border. It has shortened the distance between Tirana and Prishtina by 65 km, but has reduced the travel time by four hours. This highway is not going to connect to the Kosovo border at the same location where the Vermica border crossing point is currently located; it is therefore important for the governments of Kosovo and Albania to establish a mutually convenient location for this border crossing point. Table 10: Throughput of the Three Main Ports Port throughput (number of Port Location consignments) Thessaloniki Greece 32,850 Bar Montenegro 5,110 Durres Albania 3,056 Source: Kosovo Customs. 3.12 The use of railway transport has picked up over the years, and its significance could continue to grow if the mining sector is developed. Freight transport by volume increased to 832,256 tons in 2008, up from 588,680 tons in 2007 and 545,287 tons in 2006 (Figure 12).32 In 2008, around 39 percent of total Kosovo Railways (KR) freight traffic was nickel minerals, followed by oil, mainly from FYR Macedonia (31 percent of the total), and coal (11 percent). The 41.3 percent increase in freight volume in 2008 was due to a new contract with Ferronikeli (Box 3), to carry nickel ore. Although KR was projecting freight reaching 1 million tons in 2008, this target was not met because transport of Ferronikeli production was 53.6 percent less than planned, the northern line closed, terminating Italian Kosovo Force (KFOR) transportation, and the transport of goods from the company Llamkos, producer of galvanized iron, was only 47 percent of what was expected. Figure 14: Freight Traffic, 2001­8 Source: Kosovo Railways. 31 A forthcoming publication of the World Bank, "Trade and Transit Facilitation for Landlocked Developing Countries," focuses on the inherent disadvantages of landlocked countries compared to countries that have a coastline and deep-sea ports. 32 This remains significantly below past freight traffic, which exceeded 2.5 million tons a year. 41 3.13 The impact of the global financial crisis and the fall in mineral prices reduced rail transport, but the mining sector offers potential for substantial growth in volume. Over the medium term, the potential for further reopening of old, but still viable, extractive and basic industries (such as Trepca) is considerable. For example, freight transport could exceed 3 million tons over the medium term with the reopening of other mines. For 2010­11, freight volumes are likely to remain low, given the limited improvement in global economic conditions and a weak minerals outlook. 3.14 Upgrading the transport infrastructure requires significantly more resources than what seems to be available. The government will only be able to implement the investment plan with considerable support from private investors through public-private partnerships (PPPs) and loans from international financial institutions (IFIs). At present, it is uncertain whether any road section could be financed through a PPP and whether it would be affordable, given the capital grant required. The amount of support available from the IFIs is also likely to be much lower than necessary. This gap will require a scaling back of this ambitious agenda and a phased approach in implementation. In addition, there is considerable scope for value engineering, which should lead to revised designs and reduced costs on certain mountainous sections. The World Bank 2010 Public Expenditure Review provides a detailed assessment of the viability and implementation schedules of these large capital investments, especially in light of the need to ensure that there is adequate funding for maintenance. Sufficient attention should also be given to rehabilitation and reconstruction of existing road assets. Box 9: Infrastructure Development Needs to be Accompanied by Institutional Strengthening Implementing the ambitious transport agenda will require not only financial resources, but also improvements in the institutional setting. The institutional arrangement for managing roads is in need of reform. Within the Ministry of Transport and Communications (MTC), the maintenance program is the responsibility of the Department of Road Infrastructure (DRI), with the supervision of works undertaken by an implementing agency, the Directorate of Roads (DoR). The DoR exercises its duties under the supervision of the DRI, and is also responsible for preparing annual maintenance plans, collecting data on traffic and road safety, checking overloading, and advising the municipalities on road management. Road spending is fully financed from the central budget, but the contract management function is held by a special procurement department in the MTC, and not by the DoR or DRI (ECORYS 2007). This institutional arrangement presents a number of difficulties, not least the existence of two institutions involved in the management of a small network, with limited responsibilities and autonomy in the case of DoR. A recent report (EC 2009b) has highlighted the need for institutional reform, suggesting two operations: full integration of DoR inside the MTC, so that only one institution remains; and the creation of a separate road agency, replacing the DoR. D. BORDER CROSSINGS AND REGULATORY BARRIERS TO TRADE 3.15 The following section looks at the main regulatory barriers, as well as the formal and informal barriers, to trade and transport, and is based on a simplified trade and transport audit that was conducted using the World Bank's standard audit questionnaire (Raven 2001). 42 3.16 There have been considerable changes to the legal and regulatory customs framework following Kosovo's independence. In August 1999, the Customs Service of the United National Interim Administration Mission in Kosovo (UNMIK) was established to perform customs supervision in Kosovo. However, on December 12, 2008, UNMIK Customs Service became Kosovo Customs, following the adoption of the new customs code a month earlier. Meanwhile, the European Union Rule of Law Mission in Kosovo (EULEX) assumed operational responsibility in the rule of law area on December 9, 2008. EULEX international customs officers established a limited presence at the two customs control points in the north of Kosovo (gates 1 and 31). On February 1, 2009, EULEX Customs started to collect data on commercial traffic at gates 1 and 31 on a "24/7" basis. The information collected includes date and time of crossing, details of the driver and vehicle, importing company, quantity of cargo, invoice number and value of invoice, and currency and customs seal or international road transport (TIR) number. The data are shared with Kosovo Customs and Serbian counterparts. On May 20, 2009, EULEX Customs further strengthened customs control with new measures, including the copying of commercial invoices accompanying goods entering Kosovo and the copying of identification cards of truck drivers transporting commercial goods to Kosovo. However, EULEX does not perform any customs clearance procedures. Drivers are handed a notice advising them to ensure customs clearance for their goods and informing them that the nearest clearance point is at the Mitrovice/Mitrovica Trepca complex. Copies are shared with Kosovo Customs and the Customs Administration and Tax Administration of Serbia. 3.17 The Customs and Excise Code is broadly in line with EU standards (EC 2009b). Just like the Community Customs Code, the Kosovo code establishes that the origin of goods that were produced in more than one country will be judged on where the goods underwent their "last substantial, economically justified working or processing." In addition, the Kosovo code goes ahead and actually lists the cases where "last substantial, economically justified working or processing" is not applicable (that is, cases of packaging, labeling, and simple assembly works). The Kosovo code provides for transit under the Convention on International Transport of Goods Under Cover of TIR Carnets (TIR Convention) and ATA carnets (article 96 of the Kosovo code). In addition, inward and outward processing procedures, including suspension and drawback arrangements, are identical. 3.18 There are some differences between the European and the customs code of Kosovo. Both the European and Kosovo codes state that goods can be declared by any person. However, there is a clause in the Kosovo customs code stating that the declarant should be established in the European Union or in Kosovo. In contrast, in the Community Customs Code this does not apply in the case where goods are in transit, while in Kosovo such a relief clause is missing; this can create complications for non-EU goods transiting Kosovo. The Kosovo code provides for much harsher duty payment options; duty should be paid before the release of goods being imported, the Community Customs Code allows 10 days from the moment of the payment amount has been communicated. 43 3.19 Further changes to meet the criteria set in the EU Customs Blueprint 33 (developed by the Directorate-General for Taxation and Customs of the European Commission) relate to the introduction of the AEO concept and a system for pre-arrival and pre-departure processing of documentation. The AEO concept means that businesses can be accredited by customs as AEOs when they prove that they have high-quality internal processes that will prevent tampering with international cargo, including: Ensuring the integrity of information that states what is included as cargo. Secure access to the premises to prevent unauthorized persons from adding goods as cargo. Ensuring the integrity of employees, so that they do not add any goods to the containers or cargo. 3.20 In the European Union, reliable and compliant AEOs benefit from simplifications in the customs procedures and/or from facilitation of customs controls relating to safety and security. They are allowed to submit less data for the pre-arrival and pre-departure declaration and will also be subject to fewer controls as they would be considered secure partners by customs, and because their compliance and reliability would have been thoroughly checked when the AEO certificate was given. It would be even more helpful for the Kosovo Customs legal directorate to further align customs legislation and ensure correct interpretation and implementation of customs rules in operations. 3.21 Adequate legislation regarding customs valuation is undermined by the absence of a value database. Customs value is important for more than just the calculation of customs duties. The Kosovo code lays out a primary and five alternative valuation methods in line with those prescribed by the World Trade Organization's (WTO) Agreement on Customs Valuation (ACV; De Wulf and Sokol 2005). However, Kosovo Customs does not have a value database. 34 Such a database would help eliminate significant ambiguity in the value of a wide range of imported goods and reduce the potential for corruption. At present, Kosovo Customs reported accepting a relatively low ratio--around 75 percent to 80 percent--of invoice-based valuations35. For the sake of comparison, Turkey accepts nearly all transaction values. Given the absence of the database, the latter may imply existence of a potentially large area for arbitrary valuation. And this is confirmed by the high number of complaints by traders; 47 percent of complaints, according to customs annual report in 2008, concerned the valuation of goods. More detailed analysis to determine the underlying cause of these complaints should be undertaken. 3.22 Corruption, at least small scale, does not seem to be a major issue. There were no recorded incidents of corruption involving Kosovo Customs staff in the first months of 2009, according to EULEX. This confirms the perception of businesses stated in BEEPS. However, a United Nations Development Program (UNDP) report of April 2009 on public perceptions of 33 These blueprints, drafted jointly by experts of the European Commission and EU member states, are practical guidelines laying down clear criteria based on EU best practice, against which a customs administration can measure its own operational capacity. 34 A value model is integrated within the Custom's IT system and is used by customs officers at border crossings. The new ASYCUDA World system, which is expected to be installed soon, should provide greater technical possibilities for improving valuation. 35 According to the Kosovo Customs, these invoices account for 95 percent of collected revenue. 44 corruption found that corruption is ranked as the fifth most important problem facing Kosovo, while Kosovo Customs is ranked third in the list of institutions where there is perceived to exist large-scale corruption. Disciplinary procedures were applied to 85 customs officers in 2008, which is about 16 percent of all employees, however, significant number was related to inappropriate (non-corruption related) behavior, for example, not following rules and procedures. 3.23 One of the main objectives of Kosovo Customs is the collection of revenue, including customs duties, the VAT, and excise. The target for 2008 was 583 million, however a total of 606 million was collected--up from 527 million in 2007 despite the problems in the north with the non-functioning of two customs points, gates 1 and 31. The number of declarations as well as revenue per customs officer has been gradually increasing, mostly due to an increase in the number of declarations and imports, although there is considerable variation by customs station (Table 11). Table 11: Kosovo Customs: Revenue and Declarations by Customs Station (2007­8) Total revenue Revenue per staff Declarations per Customs station ( million) ( million) staff 2007 2008 2007 2008 2007 2008 Hani i Elezit 253.6 263.5 3.2 3.5 901 1033 Peja 48.1 63.1 1.6 2.0 563 769 Airport 35.1 41.1 1.3 1.4 621 683 Internal Station 21.7 50.8 4.3 7.3 848 743 Vermica 12.7 13.7 0.4 0.4 350 397 Mitrovica 42.5 39.7 0.8 1.7 717 1216 Dheu i Bardhe 18.2 13.4 0.6 0.4 342 288 Podujeva 29.0 39.7 0.9 1.2 622 635 Other 66.1 79.7 0.2 0.3 0 0 Source: Kosovo Customs. 3.24 The general tariff rate is at 10 percent, and the reduced rate for capital goods and a wide range of intermediary goods is zero. To promote local production, the Kosovo Customs code applies a reduced rate of zero percent customs duty on most raw materials (including fuel) and most equipment for manufacturing, including fuel, all agricultural raw materials such as seeds and fertilizers, among others, and equipment.36 In the region, weighted average tariff rates for manufactured goods are lower than in Kosovo, while higher for agriculture products. Meanwhile, Kosovo's VAT of 16 percent is the lowest in the region. Despite the fact that the rates are not excessively high, there remain significant issues regarding inadequate invoicing, smuggling, and corruption. 3.25 The government should consider reducing taxes on imports of electricity generators. Virtually all businesses have to resort to purchasing electrical generators to keep their businesses powered. Yet electrical generators, in contrast to other investment goods, are subject to import duties and VAT, increasing the cost by over 26 percent. It may be advisable to eliminate these 36 See http://unmikcustoms.org/tarik/. 45 excessive duties to alleviate what is widely perceived to be the most binding constraint to the country's development. 3.26 The list of documents required for trading across borders is typically short and simple. According to the simplified audit, freight forwarders reported that it takes about two days to collect all of the necessary documents for export, matching the findings of BEEPS 37. The following documents are required for clearance: CMR Commercial invoice Certificate of origin issued by the Kosovo Chamber of Commerce The EUR138 document certified by customs for EU-bound exports A sanitary or quality certificate An import or export license Customs declaration. Table 12: Costs and Time of Export and Import Documentation Time Cost (in ) Comments Phytosanitary certificate 2­8 hours 25­50 50 after regular working hours Quality certificate 2­4 hours 25­50 50 after regular working hours Import-export license 5­8 hours 15 Two year validity Certificate of origin 5­8 hours 5­20 EUR1 certificate 1 day 20­30 Driver's visa for EU 2­3 weeks 60 Validity from 15 days countries up to one year Source: Authors 3.27 According to surveyed freight forwarders, road border crossings take between 5 to 8 hours normally, but this can increase to 17 to 20 hours if trucks are not cleared during regular working hours. There are three institutions represented at the border: Kosovo Border Police, the Veterinary and Food Agency, and Kosovo Customs. The procedures are reportedly the same for exporters and importers and include the following steps: 1. The freight forwarder submits a customs declaration online; according to Kosovo 37 According to the BEEPS 2008­9 results, the average time to clear exports through customs is 1.72 days-- comparable to other countries in the region--while the time to clear imports is 8.52 days. However, the number of trading firms that were part of the BEEPS sample (of total 270 firms) is small, hence the results may not be representative. When compared to other countries in the region, the time to clear imports through customs is five times higher than in Bosnia and Herzegovina, and more than three times higher than in Albania. The same survey found that 81 percent of enterprises in Kosovo used imported inputs for production, highlighting the extent of the economic impact of long import delays. 38 The EUR 1 is a preferential certificate of origin. It is required to validate claims for preferential duty treatment (reduced or duty-free entry). It is applicable for all countries that have preferential agreements with the EU. The EUR 1 certifies the origin of the goods to qualify the import for reduced duty rates. 46 Customs, 90 percent of declarations are submitted electronically. 2. Upon arrival of the truck to the border crossing, the entry registration is conducted by a customs officer, and the truck and driver documentation (passport, driver's license, and vehicle documentation) is checked by a customs officer. 3. Irrespective of whether or not the documentation is in order, the truck is directed to the customs terminal parking. 4. A Veterinary and Food Agency agent samples the goods and issues the appropriate certificate, if applicable; there is usually only one agent and thus it may take anywhere from 30 minutes to 12 hours depending on the queue.39 5. The necessary documents are submitted in paper to a customs broker, and it then takes from one to three hours for the broker to process the documents. 6. The customs broker submits the package to the customs officer. It takes two to three hours for the customs officer to process the documents and conduct a visual inspection of the contents of the container or truck. 7. Access fees are paid--a procedure that normally takes less than 15 minutes--and the truck leaves the premises. 3.28 Customs clearance should be available 24 hours a day for the busiest customs terminals. Customs terminals in Kosovo are operated on 24-hour schedule, but working hours for customs clearance are from 8 a.m. to 8 p.m., and this has been reported as one of the reasons for significant delays. The customs terminal at Hani i Elezit processes over 50 percent of all imported goods and there is a strong case for making this border crossing fully operational on a 24/7 schedule for all goods, where as currently only export and import of perishable products, as well as emergency imports, can be cleared 24/7. It would also require cooperation from the Veterinary and Food Agency as well as at least one of the commercial banks, because all of the institutions should have similar working hours. This would also set a higher standard and create incentives for reciprocity on the part of FYR Macedonia's border services. 3.29 At present there is only one public-bonded customs warehouse operated by a logistics company.40 There were approximately 138 private-bonded customs warehouses, owned mostly by relatively large exporters or importers, to be used exclusively for their own needs. Yet there is only one authorized (type A) public-bonded customs warehouse. It is owned by the largest freight forwarder in Kosovo, InterEuropa, a Slovenian firm, and clears about 8 percent of imports and a negligible amount of exports. It received an authorization from customs, but was also required to obtain a business license from the MTC, paying a license fee of about 10,000. Licensing of customs warehouses by the MTC should be abolished, or, at least, should not be priced above the cost of issuing the license itself. It is a widespread practice for businesses in most countries to outsource warehousing. Increasing the number of public customs warehouses operated by freight-forwarding companies would: Help reallocate some of the customs clearance to inland terminals 39 The delay can last 12 hours in cases where trucks arrive close to the closing time of the Veterinary and Food Agency. 40 According to article 104 of the Kosovo Customs code, a customs warehouse may be either public or private. A public warehouse is a customs warehouse available for use by any person for the warehousing of goods, while a private warehouse is a customs warehouse reserved for the warehousing of goods by the warehouse keeper--the person authorized to operate the customs warehouse. 47 Reduce border congestion Simplify international cargo consolidation services Create a more competitive environment in both warehousing and cargo consolidation services. 3.30 There appear to be delays in receiving VAT rebates for firms that use inward processing. There is evidence that receiving VAT rebates takes about two months--the maximum period mandated by the tax code--after all of the required documents are submitted. The outstanding backlog is estimated at 40­50 million. The main reason for the delay is that tax authorities do not accept the customs documents certifying that the goods have been exported or re-exported. Instead, they require exporters to obtain a copy of import declarations from the importer. Hence, exporters in Kosovo depend on the cooperation of their counterparts, something that is not always guaranteed. Not surprisingly, this is even more problematic for smaller exporters and firms whose counterparts change frequently. Enhanced cooperation between customs and tax authorities on VAT rebates is recommended; tax authorities should accept customs clearance of exports as proof of export. 3.31 Risk management improved with the introduction of a "red" and "green" line, but it could be further strengthened. In practice, Kosovo Customs resorts to country profiling due to the limitations of the IT system. Discussions with freight forwarders suggest that there are few inspections of EU cargo, while a large percentage of non-EU cargo is inspected, such as cargo originating in Turkey. Kosovo Customs is exploring an option of adopting a more advanced system. One of the major alternatives being considered is ASYCUDA World, a free system developed by the United Nations Conference on Trade and Development (UNCTAD) and adapted to the needs of developing countries. The system has already been fully mobilized in neighboring Albania. A more modern and advanced system like ASCYCUDA World will allow for improved user experience; improved risk management, including better company profiling; fewer physical inspections; and a faster average border crossing time. 3.32 Kosovo could take a number of measures to expedite customs clearance to reduce export and import costs. Several measures, if implemented, could improve customs processing times. Improved risk-based inspections of cargo could be introduced if the IT system used by customs informs declarants of the outcome of their automated risk analysis every time their declaration is processed. The risk rating should be performed in light of details previously entered by customs headquarters staff members into the customs computer system through an appropriate risk analysis module. Other measures could include: Recognition of foreign country quality and sanitary certificates Operation of border agencies 24/7 days a week, especially for busy border crossings Since 90 percent of customs declarations are submitted online, processing prior to the arrival of cargo at the customs terminal should be feasible Sanitary and customs inspections conducted from a single window. 48 Table 13: Strengths and Weaknesses of Kosovo Customs Strengths Weaknesses Conclusions Accountability The complete set of secondary legislation not yet Scrutiny of all existing passed (though legislation and eventual Primary legislation is in Administrative Instruction modification of place and is EU compliant by the Minister of Economy secondary legislation, and Finance was issued in regulations, policies, October 2009) instructions and/or No new administration standing operational Legal gaps are small instructions issued by the procedures needs to be because former UNMIK director-general, as required completed as soon as rules and regulations are by the Customs and Excise possible still applied Code A professional, standard A fixed time frame for With a Customs and unit is dealing with review of existing Excise Code that is potential breaches of the regulations, policies, and compliant with the EU, code of conduct instructions has not been set it is expected that the Lack of coordination basis for all further Proven performance in between ministries of legislation and revenue collection economy, finance, and regulations will be customs European standards EULEX did not turn to Further analysis needs Complaints on decisions executive responsibilities or to be conducted to seem to focus consistently reverse Kosovo Customs detect underlying on the same issues, decisions in the past six causes of appeals including valuation of goods months complaints Independent review board Complaints and appeals has not met for more than a Efforts are needed to procedures are in place year, generating an appeals decrease the perception backlog of corruption, including Kosovo Customs has an Perception by the public of transparent action plan to prevent and corrupt practices in Kosovo communication combat corruption Customs Sustainability of service Memoranda of understanding with most Complains of understaffing neighboring countries exist, at border/boundary crossing Specialized training in with the intention to review points, however no law enforcement areas them in execution of the assessment appears to have might be needed new Customs and Excise been made Code Examination of vehicles Training plan is not very Human resources and goods are based on risk extensive in more management and analysis derived from the specialized areas of law training do not seem to Trade Risk Management enforcement and prevention be in line with the EU System (TIMS), which (organized crime) Customs Blueprint includes a risk module 49 Government strategy on Infrastructure and Equipment levels at integrated border equipment will need to border/boundary crossing management has been be upgraded at several points are quite different, approved; Kosovo Customs locations in light of the and in several cases not contributed to its integrated border satisfactory preparation management strategy TIMS is not equipped for Examination of vehicles generating information on Recently approved and goods are based on risk serious crime, and no integrated border analysis derived from specific database is management strategy TIMS, which includes a available for specific opens the prospect of risk module intelligence needs improved cooperation If operational plans need to with border police, Operational plans exist for be formally approved by the including at each directorate and form Minister of Economy and border/boundary the basis of internal Finance, there is a risk of crossing points reporting political interference Source: EULEX (2009). Note: This table does not include all the items listed in the report. 3.33 In addition to customs operations, non-customs procedures also seem to slow down and increase the cost of crossing borders. For example, sanitary and phytosanitary standards (SPS) represent a challenge and an opportunity for Kosovo. On the one hand, exports to the European Union may be increased as a result of developing an SPS infrastructure. On the other hand, with the demise of tariff barriers, SPS are increasingly used within CEFTA as a means of protecting domestic producers, a fact that has serious ramifications for Kosovo, given that a third of its exports to as well as a quarter of its imports into the CEFTA region are agricultural goods, the highest in the CEFTA region (Handjiski et al., 2010). 3.34 The Veterinary and Food Agency of Kosovo (VFAK) does not operate on 24/7 schedule at border crossing points. Currently the agency works from 8 a.m. to 8 p.m. at the border. It often has only one representative at each border crossing station. Because the health certificates of neighboring countries are not recognized and routine samplings of 100 percent of food and livestock are conducted, one representative is often not enough, which extends waiting times up to two to three hours. Even longer delays exist in cases where goods are not cleared within normal operation hours. VFAK is closed on Saturdays and Sundays, increasing the waiting time at the border.41 VFAK should consider operating on Saturday and Sundays to be on the same schedule as Kosovo Customs. This measure, along with increased acceptance of relevant certificates issued by neighboring countries--especially at the busiest border crossings--could reduce border crossing time considerably. 41 In addition, it has been reported that to call the phytosanitary representative after hours necessitates payment of an additional 25. Many freight forwarders interviewed reported that a receipt for the extra 25 is usually not issued. 50 3.35 Finally, moving goods across borders could be eased by introducing integrated border management (IBM). At present, border agencies rarely coordinate their activities, partially due to the physical constraints of inadequate border crossing infrastructure. At one of the recently upgraded border crossings, the police and Kosovo Customs are co-located and they check the necessary documents of drivers and their consignment on imports only once. However, at most other border crossings, the customs station is a few hundred meters up to several kilometers away from the border crossing point. This slows down the customs and border clearance by adding another step of document checking into the process, and even leads to additional waiting time for the transfer of documents from the border to the station. At present, border procedures are not single window--even if checks by different border agencies are taking place at the same time, there are different lines and phytosanitary inspections only starts once customs clearance is completed. 3.36 Kosovo has 13 official border crossing points (BCPs) and 2 temporary crossing Box 10: The Single Window System A single window system is a trade facilitation scheme that enables international (cross-border) traders to submit regulatory documents at a single location and/or single entity*. Such documents are typically customs declarations, applications for import/export permits, and other supporting documents such as certificates of origin and trading invoices. The main advantage of having a single window is to increase efficiency through time and cost savings for moving cargoes across borders. In a traditional pre-single window environment, traders normally have to visit multiple government agencies in multiple locations to obtain the necessary papers, permits, and clearance to complete their import or export processes. In practical terms, a single window environment provides one entrance, either physical or electronic, for the submission and handling of all data and documents relating to the release and clearance of an international transaction. This is managed by one agency, which informs the other appropriate agencies. In the case of Kosovo, starting an IBM strategy is a positive step in the right direction, and could be followed in a second phase with a single window system. The Macedonian Customs Administration, for example, introduced in November 2008 an electronic single window for trade facilitation. The new system simplifies the process of exporting, importing and transit of goods, and is a first step toward achieving a fully paperless trade system (Handjiski et al. 2010). *Further details on UNECE's Recommendations and Guidelines for Establishing a Single Window at: http://www.unece.org/cefact/recommendations/rec33/rec33_ecetrd352_e.pdf points. Of the 13 official BCPs, 10 are for road traffic and the remainder for railroads. The stretches between official BCPs, the so-called "green border," are currently the responsibility of the NATO-led KFOR, although it is envisaged that these responsibilities will be transferred to the Kosovo border police in the future. In terms of infrastructure and equipment in road BCPs, the worst working conditions are in Glloboqica (bordering FYR Macedonia), Mucibabe, and Mutivode--both these stations border Serbia--where customs officers are using containers as premises, while as mentioned earlier, there is a customs presence in only one railway BCP, Hani i Elezit. The strategy notes that most BCPs do not have facilities, equipment and adequate space to work, and are therefore not in compliance with EU requirements. 51 E. TRANSPORT SERVICES AND SUPPLY CHAIN PERFORMANCE 3.37 The road transport industry is not well organized and standards are not always maintained. The licensing of all commercial vehicles in Kosovo is undertaken by the MTC's Department of Transport.42 At present, there is no active truck association to represent the interests of the road transport industry There are estimated to be about 90 licensed freight companies, of which 66 are "own account" operators, while vehicles operating in international traffic and delivering goods to Kosovo are mostly based in neighboring countries, although a number of them are joint ventures with local companies. Unlike in the European Union, there are no effective restrictions on access to the profession and vehicles can be purchased in the open market with minimum control from the MTC. Among the key recommendations to strengthen the sector are the following: Improve the recording of licenses Require own account operators to undertake a check on operational standards Encourage the industry to establish a body to represent the road transport industry Ensure that vehicle inspection is conducted in conformity with the law and establish roadside checking of all vehicles on a random basis. 3.38 Kosovo does not issue international road hauler traffic licenses (CEMT licenses), nor is it a signatory of the TIR Convention or ATA Carnet Convention. In the case of the CEMT licenses, the fact that Kosovo is not a UN member state means that it cannot be a member of the International Transportation Forum (ITF). Since CEMT is only valid for operations between two member states, Kosovo is neither issuing nor accepting CEMT licenses. 3.39 The absence of TIR and ATA Carnets creates difficulties for traders and carriers. Carriers encounter difficulties, particularly when traveling to non-EU countries. For example, when transporting consignments from Kosovo to Turkey, they are forced to wait in long lines on several international borders and carry significant amounts of cash to meet the required guarantees for the right of transit. The absence of ATA Carnet implementation creates complications when goods are being imported into Kosovo temporarily. The establishment of a TIR Association to allow cargoes sealed under TIR to be cleared within Kosovo would be recommended, but first the International Chamber of Commerce, the International Roads Union, and the International Freight Forwarders Association (FIATA) must accept Kosovo as a member. 3.40 Another issue faced by the road transport sector is the cost (in time and money) of obtaining EU visas. It can take between two to three weeks to obtain the visa, which is initially issued for only 15 days, although renewed applications can lead to an extension of the visa for a period up to one year. On December 19, 2009, citizens of FYR Macedonia, Montenegro, and Serbia were granted visa-free access to the Schengen countries (which includes most EU countries as well as Switzerland and Norway). Visas will also eventually be abolished for Albania, Bosnia and Herzegovina, and Kosovo, but the time frame is not yet clear. This situation puts Kosovo's truck drivers at a disadvantage in comparison to three of its four neighbors. 42 This section on heavy goods vehicles is based on the European Commission Liaison Office to Kosovo (2008­9). 52 3.41 To assess supply chain performance, three firms were selected as case studies. The objective of the analysis was to quantify the key cost and time elements and identify key bottlenecks in these processes. The three firms selected (see Annex 4) included: A freight forwarder importing agricultural goods to Prishtina via the port of Bar A potato and potato processing company, exporting both potatoes and potato chips to the EU and CEFTA countries A wine exporter, exporting about 40 percent of its produce to Germany. 3.42 The border crossing procedural steps are similar for all three manufacturers. All three producers clear customs at the customs station closest to their production facility. In all three cases, the time spent in a border crossing was between 4 to 6 hours, with an additional 16 to 24 hours to obtain the necessary documentation, with the exception of the driver's visa, which can take about two to three weeks. This is significantly below the figure of 17 days to export and 16 days to import according to Doing Business 2010 (World Bank 2010a), but for exporters it corresponds with the findings of BEEPS, which found that it takes one day to clear exports in Kosovo. The large difference between Doing Business 2010 and the case studies reflects the fact that the case studies covered relatively large firms. Despite this, there is considerable variation among the firms interviewed regarding the time it takes to cross the Kosovo border; according to the wine exporter, on average this takes 5 hours, but can vary from between 5 to 18 hours. The large variation in border processing time is an important issue because the predictability and reliability of supply chains are increasingly important in a world of just-in-time production sharing. Fees are applied to each imported and exported consignment, with the exception of charges for various inspections, which are assessed depending on the nature of goods in the consignment, for example, veterinary inspection for agricultural produce. The weight of the consignment and the depth of the inspection and associated analysis determine the cost. 3.43 Transport is the largest part of the generalized logistics cost. Economic distance to market, or generalized logistical cost, can be defined as the sum of all the time and cost expenditures of moving a consignment to a market (World Bank 2004c). In the case of the importer of agricultural goods, total transportation costs from the Port of Bar to Prishtina is about 1,200 to 1,300 for a 40 ton truck, in addition to a further 200 to 300 for port-handling fees for a container, and this sum dwarfs the costs associated with customs clearance. Meanwhile, for the wine exporter, the time and monetary costs of obtaining customs documentation and customs clearance are significantly below the transport costs to Germany: for a truck full of wine, the documentation and clearance costs are under 250, while the transportation costs are over 3,000. In the case of both the importer of agricultural goods and the wine exporter, the status of Kosovo has led to a diversion of the cargo transport route to avoid Serbia, and this added significant transportation costs in terms of cost and time. For the wine exporter, this has meant that transport costs are an additional 15 percent to 23 percent of the consignment value for a mid- quality wine. The manufacturer exports about 90 percent of its produce, but has to pay VAT and customs duty on all imported inputs, principally bottles and corks, while reimbursement is time consuming because it requires obtaining a copy of the purchaser's import declaration as proof of export. Also, the wine exporter faced delays in obtaining VAT reimbursements. 53 F. MAIN RECOMMENDATIONS 3.44 Considerable efforts are needed to strengthen Kosovo's export performance. Kosovo has a very small export base--10 times lower than its imports--and exports are heavily concentrated. Both on the regional and the EU market, Kosovo is competing with the other SEE countries, which not only have a much stronger export sector, but also a better overall investment climate, a key element for attracting export-oriented FDI. Moreover, the authorities cannot use exchange rate policy to make Kosovo's exports more competitive. This makes it all the more important for Kosovo to implement trade facilitation measures and, in the medium term, to improve its transport infrastructure. 3.45 Enhancing Kosovo's export competitiveness will require infrastructure investment, legislative improvements, and the strengthening of institutional capacities including: Investing in transport infrastructure: Investing in the transport network to deal with the increasing demand.43 (long-term measure) Establishing a sustainable financing framework to evaluate the financial feasibility of the significant transport needs and determine their priority. (short-term measure) Improving the legal and regulatory framework to attain compliance with the EU transport acquis (short to medium-term measure). Ensuring adequate maintenance to preserve the value of the country's transport infrastructure and to avoid future contingent liabilities due to deferred action. Further streamline customs operations and procedures. Annex 5 provides a list of detailed policy recommendations grouped into short-term and medium-term measures depending on the time and effort needed to implement the recommendation. Immediate focus should be on the short-term measures which could lead to immediate improvements in border crossing efficiencies. Improve the functioning of other border crossing institutions (see Annex 5 for a list of short and medium-term policy measures) Develop the "quality infrastructure" (standardization, accreditation, and metrology) to ensure that product can meet EU and international standard requirements. 43 The forthcoming public expenditure review of the World Bank will review these important expenditure choices in the transport sector to come up with concrete and detailed recommendations on the choice and phasing of transport investments over the medium to long term. 54 4. IMPROVING LABOR MARKET OUTCOMES IN KOSOVO A. INTRODUCTION 4.1 Despite rapid economic growth after the conflict, Kosovo displays persistently high rates of unemployment, the highest in the region. Although all groups in the working-age population display poor employment outcomes, youth and women outcomes are particularly acute. The high share of idle human capital in Kosovo is an unused economic resource, while at the same time condemns many people to poverty and destitution. This chapter examines the challenges in the labor market in Kosovo, beginning with a detailed analysis of Kosovo's labor market and the identification of the key factors behind the poor labor market outcomes. Policy options and recommendations are then presented to address these challenges. B. DISAPPOINTING LABOR MARKET OUTCOMES 4.2 Between 2003 and 2008, despite rapid economic growth, the employment rate has remained stable and low, at around 25 percent, the lowest in Europe. Only 24 percent of the working-age population was employed in 2008 (see Table 14), significantly lower than the average for EU-27 countries (66 percent) and far from the Lisbon target of 70 percent for EU countries. Labor force participation rates even decreased during 2003­08, from 53 percent to about 43 percent. The unemployment rate, at 48 percent in 2008, is by far the highest in the region. These numbers seem exceptionally high, and could partly be explained by the high level of informality and the economy. In any case, high unemployment is part of Kosovo's economic legacy, and even at the peak of its industrialization in the 1980s the unemployment rate was about 30 percent. 4.3 Because the negative effects of the global financial crisis on Kosovo's economy have been marginal, the impact on the labor market has also been negligible. Kosovo's economy continued to grow in 2008 and 2009, hence, the labor markets were not strongly affected by the crisis. While for the 27 transition economies of Europe and Central Asia (ECA), for which data are available between June 2008 and June 2009, registered unemployment increased by around 34 percent, Kosovo only experienced a 1 percent increase in registered unemployment. 55 Table 14: Population structure, Employment and Labor Force Participation Rates (2008) Category in percent Population 100 Working age population (15-64) 64 Labor force (employed or looking for a job) 28 Employed 15 Unemployed 13 Idle (working age population not looking for a job and not in school) 28 Jobless (Idle plus those looking for a job) 40 Employment and unemployment trends (2003-2008) Employment Unemployment Labor force rate (%) rate (%) participation rate (%) 2003 25 52 53 2004 29 40 47 2005 29 42 49 2006 29 45 52 2007 27 44 43 2008 24 48 43 Source: Labor Force Survey (LFS) 2003­8. Definitions: Employment rate is the percentage of the working age population (ages 15 to 64) who are currently employed. Unemployment rate is defined as the ratio of unemployed to the total labor force (unemployed and employed). Labor force participation rate is the share of the labor force in the total working age population. Note: LFS methodology changed in 2006 and 2008 which has caused some of the variation in the rates. 4.4 A very high percentage of the working-age population is jobless and out of school, and most jobless people are not even looking for a job (idle). In 2008, 63 percent of the working-age population was jobless and out of school/training (joblessness rate) (Table 185). A close examination of the types of joblessness (those looking for a job--unemployed, and those who are not looking for a job and are not in school--idle) shows that two thirds of the jobless are not even looking for a job. About 43 percent of the working-age population is idle, and 40 percent of those would be willing to work (discouraged workers). 56 Table 15: Breakdown of Unused Human Capital (2008) Panel A (total, by gender and area) Total Male Female Urban Rural Joblessness rate 63 51 76 55 68 Idleness rate 43 26 61 35 47 Unemployment rate 48 43 60 41 53 Employment rate 24 38 11 31 20 Labor force participation rate 43 59 25 50 38 Panel B (by age group) 15­24 25­34 35­54 55­64 Joblessness rate 45 72 68 75 Idleness rate 25 45 49 66 Unemployment rate 74 52 37 27 Employment rate 8 29 35 26 Labor force participation rate 27 52 51 34 Panel C (by education level) Lsec Usec voc Usec gen Tertiary Joblessness rate 70 53 50 21 Idleness rate 53 22 21 7 Unemployment rate 65 44 47 16 Employment rate 9 39 33 76 Labor force participation rate 25 70 63 93 Source: LFS (2008) Note: Lsec = lower secondary education or less; Usec voc = vocational education; Usec gen = upper secondary education; and Tertiary = college degree or higher. 4.5 While all groups face difficulties in finding jobs, people living in rural areas, youth, people with low levels of education, and especially women face the greatest challenges. Only 11 percent of working-age women are employed, significantly below that of men and by far the lowest in the region, and at a long distance from the Lisbon target for female employment (60 percent). Most working-age women are not working, are not looking for a job and are not in school (61 percent), but a large proportion (44 percent) of these women appear to be willing to work 44. There are several reasons for the large gender discrepancy in employment: lower educational attainment among females, insufficient flexibility of the labor legislation, and cultural norms are the most important factors (Annex 6 describes in greater detail the role of social and cultural norms in determining female labor participation). 4.6 The high rates of joblessness among women point to an untapped source of potential economic power. Women account for 49 percent of the population and 48 percent of the working-age population. Evidence from other countries shows that increasing female employment can reduce poverty, boost economic growth, and lead to improvements in social indicators such as health and children's education outcomes. Greater economic equality between women and men is associated with poverty reduction, higher GDP, and better governance (World Bank 2001; Klasen 1999). Evidence from the Middle East and North Africa shows that if 44 The portion of idle men willing to work is only 32 percent. 57 female labor force participation were to increase to the level predicted by women's age and education structure, household earnings could increase up to 25 percent (World Bank 2001, 2003). In Turkey, reaching the female labor force participation target of the 9th Development Plan (from the current 23 percent to 29 percent) is estimated to reduce poverty by up to 15 percent (8 percent) if new entrants take full-time (part-time) jobs (World Bank 2009d). In addition to the extra income it brings to the household, female employment decreases their dependency on their families, and increases their intra-household decision making power. 4.7 The youth unemployment rate, at 74 percent (84 percent among those aged 15­19 years and 71 percent among those aged 20­24 years), is the highest among any group in the working-age population. It is especially worrying that in addition to the high unemployment, a quarter of the youth population (15-24) has given up on seeking employment (and neither is in school). Unemployment and idleness are clearly related to education, with people that have lower secondary education or less displaying very poor employment outcomes. At the same time, the education "bar" to gaining jobs is high, as only those with university education seem to be doing relatively well in the job market (university graduates representing eight percent of the working-age population). 4.8 One of Kosovo's unique characteristics is its demographics: it has the youngest population in Europe. According to Labor Force Survey (LFS) estimates, 15 to 24 year olds account for about 29 percent of the working-age population and 20 percent of total population (the average for Europe is 14 percent). It is expected that roughly 200,000 young people will reach working age in the next five years, while the number of people reaching retirement age will be approximately 60,000. International evidence shows that long spells of inactivity during youth have long-term costs (World Bank 2006b). And evidence from other countries shows that high youth unemployment tends to be associated with increasing crime and social instability. 4.9 Unemployment is mainly a structural phenomenon, as more than half of the unemployed have been looking for a job for more than four years. About 63 percent of the unemployed have been looking for a job for more than two years (long-term unemployed), and 53 percent have been looking for more than four years (Table 19). The share of long-term unemployed increases rapidly with age (79 percent among the 55­64 year olds) and decreases with the level of education (60 percent among those with lower secondary education or less). 58 Table 16: Structural Phenomenon of Unemployment (Percentages) (2008) Panel A (total, by gender and area) Total Male Female Urban Rural Less than 1 month 2 2 2 2 2 Between 1 and 5 months 10 10 9 11 9 Between 6 and 11 months 9 7 11 10 8 Between 12 and 23 months 17 15 19 18 16 Between 24 and 47 months 10 10 11 10 11 Four years or more 53 55 48 50 55 Panel B (by age group) 15­24 25­34 35­54 55­64 Less than 1 month 2 3 1 1 Between 1 and 5 months 18 8 6 5 Between 6 and 11 months 17 6 5 4 Between 12 and 23 months 28 14 12 6 Between 24 and 47 months 17 10 7 5 Four years or more 19 59 69 79 Panel C (by education level) Lsec Usec voc Usec gen Tertiary Less than 1 month 2 2 1 4 Between 1 and 5 months 7 9 12 20 Between 6 and 11 months 7 9 9 15 Between 12 and 23 months 15 16 18 20 Between 24 and 47 months 9 11 12 11 Four years or more 60 53 47 29 Source: LFS (2008). Note: Lsec = lower secondary education or less; Usec voc = vocational education; Usec gen = upper secondary education; and Tertiary = college degree or higher. 4.10 About 90 percent of those who are not working have never worked before, and even among those who have worked before, 98 percent have not worked for two or more years (Table 17Table 20). Only 5 percent of women have had some prior work experience, and 98 percent of those had that experience two or more years ago. The percentage of those without job experience is also particularly high among people with lower secondary education or less (95 percent). Interestingly, the percentage of people with upper secondary education that have no experience is also significantly higher than those with vocational education. 59 Table 17: Previous job experience of the Jobless (Percentages) (2008) Panel A (total, by gender and area) Total Male Female Urban Rural Ever worked 10 17 5 14 8 Have not worked for less than 1 year 1 2 1 1 1 Have not worked for between 1 and 2 years 1 1 1 1 1 Have not worked for 2 years or more 98 97 98 97 98 Panel B (by age group) 15­24 25­34 35­54 55­64 Ever worked 1 6 16 27 Have not worked for less than 1 year 1 1 1 1 Have not worked for between 1 and 2 years 0 1 1 2 Have not worked for 2 years or more 99 98 97 96 Panel C (by education level) Lsec Usec voc Usec gen Tertiary Ever worked 5 21 12 36 Have not worked for less than 1 year 1 2 2 6 Have not worked for between 1 and 2 years 0 2 1 7 Have not worked for 2 years or more 99 95 97 87 Source: LFS (2008). Note: Lsec = lower secondary education or less; Usec voc = vocational education; Usec gen = upper secondary education; and Tertiary = college degree or higher. 4.11 Youth in Kosovo have a long transition from school to work. It takes about 10 years for young males to transition from school to work, as measured by the time it takes for (at least) 50 percent of the population to move from being enrolled in school to being employed (World Bank 2008f). In Macedonia, a country that also faces significant challenges in the labor market, it takes four to five years for young males to transition from school to work. And in developed countries, it takes an average of about 1.4 years for new young entrants to get a stable job. 4.12 The majority of employees hold temporary jobs, many without a labor contract, and the proportion of unpaid family workers is not insignificant, altogether making for a sizable share of informal workers. Following international practices, an informal worker is defined as someone who has a low productivity job or someone who is not covered by labor protections or social insurance. In practice, low productivity workers are defined as self- employed workers with no employees (excluding professionals and workers in skilled occupations), and unpaid family workers. Employees not covered by labor protections or social insurance are defined as those working without a labor contract.45 Employees account for most workers (67 percent), particularly among women (85 percent), although a sizable 9 percent of workers are unpaid family workers (12 percent in rural areas). Most employees hold temporary jobs (65 percent), and the shares are similar across groups, including university graduates, who 45 This is a very restrictive definition of informality among employees, as even people with contracts may not in practice have the benefits and protections they are entitled to by law. The LFS also asks the individual whether he or she has social security benefits in his or her job, which is vague because it does not ask for specific benefits and some benefits are voluntary for the employer under the labor law. 60 even display a greater share of temporary jobs (Table 18). Most employees do work with a contract, but the proportion of those who don't is not insignificant (13 percent). 46 Also, a large number of workers are informal (31 percent). Informality is actually lower among the few women that get to work and significantly higher for youth (50 percent) and workers with lower secondary education or less (57 percent). University graduates have the lowest incidence of informality (4 percent). Table 18: Informal Workers (Percentages) (2008) Panel A (total, by gender and area) Total Male Female Urban Rural Employees 67 63 85 73 62 Temporary 65 65 67 71 59 Without a contract 13 14 7 12 13 Self-employed with employees 9 10 3 10 7 Self-employed with no employees 15 18 6 12 19 Unpaid family workers 9 9 7 5 12 Informal 31 35 18 24 38 Panel B (by age group) 15­24 25­34 35­54 55­64 Employees 65 67 67 74 Temporary 70 67 64 62 Without a contract 31 16 9 5 Self-employed with employees 3 8 10 7 Self-employed with no employees 12 15 17 13 Unpaid family workers 19 10 7 6 Informal 50 35 28 21 Panel C (by education level) Lsec Usec voc Usec gen Tertiary Employees 45 66 70 89 Temporary 71 62 60 74 Without a contract 26 16 10 2 Self-employed with employees 8 9 8 7 Self-employed with no employees 25 17 14 3 Unpaid family workers 21 7 8 1 Informal 57 33 27 4 Source: LFS (2008). Note: Lsec = lower secondary education or less; Usec voc = vocational education; Usec gen = upper secondary education; and Tertiary = college degree or higher. 4.13 Unemployment in Kosovo would be even higher if not for the persistently high levels of migration. Because of the long history of inadequate job opportunities, Kosovo's youth has been migrating to Western Europe. The high level of migration has been an important factor for alleviating the labor market pressures and through remittances has provided a source of income 46 However, if we further define informal employees as either working with no contract or not having social security benefits, the share of informal workers increases to 86 percent, and the total proportion of informal workers to 80 percent. 61 for the unemployed family members that stay in Kosovo. Chapter 5 will analyze in greater detail the effects of migration on employment and poverty, as well as the possible benefits of promoting return migration. C. THE REASONS FOR LOW UNEMPLOYMENT 4.14 The most important cause of joblessness is low labor demand, but low skills are also an obstacle to higher employment. Even if the supply of skills and labor were to be appropriate to market needs, many working-age individuals may still find themselves unable to find productive employment because of the low demand for jobs. At the same time, despite the large number of unemployed workers, some firms are finding it difficult to recruit workers with the appropriate skills. 4.15 The private sector in Kosovo is thin and weak; most workers are employed in micro businesses, low value-added sectors, and low-skilled occupations (Table 19). The most important sectors for employment are wholesale and retail trade, followed by the public sector (education and public administration). Other important private sectors, such as manufacturing, construction, and agriculture, tend to have low productivity. About 50 percent of employees report to be working in a small business (between 1 and 10 workers). Most workers (65 percent) are employed in low-skilled occupations.47 Table 19: Employment, by Sector and Occupation (2008) Sector Share (%) Occupation Share (%) Agriculture, forestry, and fishing 8.0 Legislators, officials, and managers 7.5 Mining and quarrying 1.6 Professionals 18.8 Manufacturing 8.7 Technical specialists 8.6 Construction 8.6 Clerks 6.1 Electricity, gas, water, and sewage 5.2 Service workers 22.4 Wholesale and retail trade 17.1 Agriculture and fishing qualified 6.8 workers Transportation 4.0 Artisans 12.6 Information and communications 1.6 Operators 6.5 Hospitality 4.5 Unskilled workers 10.7 Real estate and financial services 3.2 Public administration and defense 9.7 Education 13.6 Health and social work 6.5 Other services 7.8 Number of employees at work Share (%) unit 1­10 48.4 11­19 20.2 20­49 12.1 50 or more 23.5 Don't know, but more than 10 5.7 Source: LFS (2008). 47 Such as clerks; service workers; agriculture and fishing qualified workers; artisans; operators; and unskilled workers. 62 4.16 Most firms are small and stagnant, resulting in low and stagnant labor demand. Based on the firm survey collected by the World Bank in 2008, 65 percent of firms generate up 25,000 in annual revenue or less and five workers or less (Table 25). Most firms have not experienced any increase in revenue during the last year (76 percent) and 28 percent have even experienced declining revenues. As a result, most firms have not increased their workforce over the last year and many have actually reduced their number of employees. Prospects for the near future were slightly better (54 percent of firms expected an increase in revenues), but even then most firms did not expect any change in their workforce (76 percent). Although low labor demand is pervasive across different skills and occupations, workers in technical occupations are in higher demand than skilled occupations (professionals) and unskilled occupations. There is also some evidence of a skills mismatch, as 34 percent of firms report having difficulties finding professionals (versus 6 percent and 2 percent for technical and unskilled occupations, respectively). Table 20: Low and Stagnant Labor Demand (2008) Panel A1: Panel A2: Panel A3: Firm revenue Shares Change in revenues Share Expected revenue change Share (%) over last year (%) in next 6 months (%) Up to 25,000 65 Increased 25 Increased 54 25­50,000 15 Decreased 28 Decreased 28 51­500,000 13 Unchanged 48 Unchanged 18 501,000+ 8 Panel B1: Panel B2: Panel B3: Number of Change in Expected change of workers workforce over last workforce in next 6 year months Up to 5 65 Increased 15 Increased 22 5­20 19 Decreased 79 Decreased 1 21­50 9 Unchanged 6 Unchanged 76 51+ 8 Source: Firm survey collected by the World Bank in 2008. 4.17 The existence of high and persistent unemployment in an environment of low wages confirms that the reasons for this are of structural nature. As noted in chapter 1, wages in Kosovo are very low. They are among the lowest in the region and similar to Albania and Bulgaria. At the same time, labor market regulations are quite flexible. However, unlike in Bulgaria, and to lesser extent in Albania, the low wages and flexible market have not led to shifts in labor supply and demand, that is, they have not cleared the market. 4.18 The low skill attainment of the population is the second most important factor for poor labor market performance. Over half of Kosovo's active population has not completed secondary education, and only 8 percent have a tertiary degree. There is a great discrepancy among males and females. For example, the share of the male population with a tertiary degree is double the share of females. Some two-thirds of the vast unemployed workforce has less than a secondary degree. So even if a sudden increase in labor demand did arise (for example, from foreign investment), it would be difficult to meet this demand, assuming it requires skilled labor. 63 In fact, even though Kosovo is still far from being a skill-intensive economy, there are already signs that the demand for skills is increasing and the nature of the skills demanded is changing toward more general skills that allow workers (and firms) to survive and quickly adapt to changes in demand. The BEEPS results indicate that 45 percent of businesses feel that the education and training of workers is inadequate. 4.19 Better education attainment would stimulate domestic demand. Successful entrepreneurship is based on having a certain set of skills. Having more people with technical skills (from vocational training) or university degrees, and equipped with better general working skills, would lead to greater entrepreneurial activity, which would generate labor demand. A poor investment climate can deter entrepreneurs from investing in a business, but even the most business-friendly environment would not be able to generate new economic activity if the idle labor force does not possess the skills to start a business. 4.20 The lack of relevant skills has been a long-standing problem. The structure of Kosovo's economy has changed substantially in the past two decades moving from agriculture and heavy industry towards services and lighter industry, but the supply of skills has not responded to these changes in demand: the education and training system is failing to provide adequate learning opportunities, relevant curricula, and effective teaching to produce the skills that are needed in the market. This has its roots in the parallel education system in the 1990s and the absence of institutional infrastructure after the conflict. In addition, Kosovo suffered the inevitable loss of human capital typical to conflict as well as substantial migration before, during, and after the conflict, including of individuals with higher skills. As the economy develops, and skills and knowledge become more important, the quality and relevance of skills produced by the education and training system will become essential for generating sustainable growth and employment. D. OPTIONS FOR ADDRESSING THE CHALLENGES IN THE LABOR MARKET 4.21 The next section discusses options for improving labor market institutions, regulations, and policies as well as what is needed to improve the skills of Kosovo's labor force. Strengthening Labor Market Institutions, Regulations and Policies 4.22 Well-functioning labor market regulations and institutions are very important for generating productive employment and providing workers with protection while ensuring a flexible and dynamic labor market. The current labor legislation provides simple procedures and low costs for firm hiring and firing. Labor taxes are also low and there is no minimum wage. However, even though hiring and firing is easy, the legislation has significant limitations when it comes to flexible work arrangements. For example, there are restrictions on fixed-term contracts, part-time work, working from home, alternative work schedules, and overtime and night work. These restrictions on flexible work arrangements mainly hurt women, who often have larger domestic responsibilities. The labor legislation provides for basic worker protections but many workers work without a contract and/or do not get the benefits they are supposed to get by law, which points to the lack of enforcement and incentives for firms to comply. 64 4.23 A significant proportion of firms do not provide some of the basic benefits and protections stipulated by the current labor legislation. Based on a survey of firms (containing a random sample of 150 registered firms) collected by the World Bank in 2008, 37 percent of firms do not pay the pension contribution for their workers, 43 percent do not provide paid annual leave and 60 percent do not provide maternity leave (Figure 14). The absence of maternity leave, compared to the generous provisions in the previous system, and more importantly the restrictions on flexible working arrangements, limit the chances for women find jobs. Figure 15: Firms That Provide Workers Basic Benefits and Protections (2008) Source: Firm survey conducted by the World Bank in 2008. 4.24 The current labor legislation and services provided by employers make it very difficult for women to juggle work and their roles as caregivers. Among jobless women, 53 percent said that the reason for not looking for a job has to do with their role as caregivers (LFS 2008). According to the firm survey collected by the World Bank in 2008 (Figure 14) only 40 percent of the firms provide maternity leave, 39 percent allow for part-time work, 18 percent allow for work from home, and 26 percent allow flexible working hours for new mothers. About 57 percent of firms report having a childcare facility close to the workplace, however, access to childcare is only available in Prishtina and few of the other larger cities. Childcare centers are nonexistent in small towns and rural areas. When asked about suggestions to facilitate female employment, 29 percent of employers point to part-time work while 28 percent point to the availability of childcare facilities nearby. 4.25 Legislative changes are necessary to introduce more flexibility for work arrangements and to adequately address compliance. In terms of flexibility, the law needs to specify that a working relationship can be established on part-time basis, and part-time workers are entitled to all the rights deriving from the employment relationship on the same basis as full- time employees in proportion to the number of hours worked. Labor contracts could be made more flexible by allowing verbal labor contracts (for a short duration), introducing various types of contracts (e.g. indefinite term, fixed-term, task-specific); and increasing the time limit on fixed-term contracts (as well as removing all restrictions on these contracts). The legislation could also introduce private employment offices which would facilitate job placement. To 65 improve firm compliance, the labor legislation should put more emphasis on enforcement. This issue could be addressed through secondary legislation based on a comprehensive assessment of the current labor inspectorate system. Box 11: The Government's Employment Strategy Because of the economic importance of generating more and better jobs, the Government has recently developed an employment strategy for 2009­12. This is the first such strategy for Kosovo and a great achievement for the Government. The strategy makes use of the MILES policy framework, which identifies the following five elements as critical to job creation: Macroeconomic stability, Investment climate, Labor market policies, institutions, and regulations, Education, skills, and training, and Social protection policies that provide a safety net, but also encourage return to the labor market. The strategy lays the foundation for increasing employment in the medium term, but it lacks a clear prioritization of policies. In particular, if the main cause of joblessness is low labor demand, then policies to improve the investment climate for firms are clearly a priority to move toward sustainable employment. Box 12: Focusing Labor Market Policies on Women Given the low employment rate of women, several donor-funded projects have specifically targeted women. As the government seeks to make ALMP more focused on women and sensitive to their needs (including public works), the experience from two projects offer some guidance on the way forward. The nongovernmental organization (NGO) Woman for Woman (WfW) offers basic literacy and numeracy education, training in a number of fields where there are more opportunities for female employment (e.g. tailoring, cooking, childcare etc.), and business start-up support. To date, 42 percent of WfW participants generate income through different economic activities. In 2010, WfW will open a Women's Opportunity Center that will provide training as well as other services covering business development, job placement, and leadership. This program focuses on a key binding constraint to female employment, namely inadequate skills. It follows international best practices by addressing the multiple needs of women that want to work by providing a comprehensive package of services that include vocational training, life skills training, basic literacy and numeracy education, job placement services, and business development support. Similarly, since 2002, the United Nations Childrens Fund (UNICEF) and the Ministry of Education have been running a literacy program for women, the Dritare Jete or "Windows of Life," to address illiteracy among rural women and improve access to early childhood education. The program focuses on literacy and life skills and allows women to continue their education by making the Dritare Jete equivalent to primary education. The program had reached more than 3,000 women by the end of 2008. Improving the Skills for Work 4.26 Improving the skills of young people for work and life involves providing quality basic education for all, but also meeting the growing demand for intermediate skills and continued skill upgrading after school (lifelong learning) to respond to changes in demand. The transition to secondary school remains difficult for many children, particularly girls and the poor: 81 percent of boys and children in the richest quintile are enrolled in secondary education 66 compared to 67 percent of children in the poorest quintile and 66 percent of girls (Figure 16). Although the data on student learning are very limited, a recent pilot assessment of children in grade 5 shows poor learning outcomes, particularly in mathematics; only 18 percent of students reached the 40 percent passing benchmark. Figure 16: Enrollment Ratio by Gender and Income Groups (2007) Source: World Bank (2007). 4.27 To improve the quality and relevance of education and training, school curricula need to match the needs of the labor market. This could be achieved by teaching practical subjects and thinking and behavioral skills at primary education level, and by blending the academic and vocational curricula in upper secondary. The examination system, in particular, the design of matura (a high stake grade 12 examination which functions as university entrance examination) which favors students in general education, and disadvantages students in vocational education and training (VET), needs to be reforms in such a way that it will provide VET students better access to tertiary education. VET needs improved textbooks, learning materials, and new teaching and learning methods. Then, making higher education the engine of the knowledge economy requires reaching out to both the public and the private sectors with quality assurance. Also, the connection between school and the local economy needs to be strengthened to facilitate the school-to-work transition and boost economic development. The success of these reforms relies on motivated and well-prepared teachers and schools accountable for student learning. Finally, learning opportunities beyond school need to be available for those who need skills upgrading and for those who failed to acquire basic skills the first time around. 4.28 The government is making significant progress in a number of these areas. A new curriculum for general education, emphasizing the right skills and teaching methods, is being prepared. A new teacher career system is being developed that will provide career advancement opportunities and tie them to in-service training and performance. The National Qualifications Framework (NQF) is also under development. The NQF will set the standards for different vocational fields in accordance with demands from employers, and then test and certify these standards. The Government has established the National Qualification Agency to implement the NQF whose primarily role includes the accreditation of VET programs. In addition, the Government is developing a coherent conceptual approach for the establishment of seven Centers of Competence (CoCs). These institutions are intended to deliver high quality VET according to NQF standards, offer short-term skills upgrading, training and adult education, and support other VET institutions. 67 4.29 On higher education, the government has recently started setting up a quality assurance system. The Kosovo Accreditation Agency (KAA) is now operational. A recent evaluation of all 30 private institutions concluded only one should retain the status of university. After the accreditation process, many of the remaining institutions were consolidated and became institutes, colleges, or faculties. Further strengthening of the external and internal quality assurance mechanisms is the next step to ensure the quality of higher education institutions and produce graduates with better skills that match labor demand. 4.30 One important area where there has been less progress is the strengthening of the links between education and training institutions, and the work place. This involves establishing partnerships with local employers to provide work-based learning opportunities, such as internships. Currently, work-based opportunities are very limited in Kosovo, even in vocational education. Also, the regulatory framework does not specify such arrangements. In addition, universities and research institutes can collaborate with local industry through joint projects and technology transfers and establish firms (spin-offs) to commercialize their inventions. At the moment, higher education institutions do very little research. Partnership models between education institutions and industry need to be developed and implemented. 4.31 The other key policy area that requires more attention is lifelong learning, particularly second-chance education opportunities. Because changes in demand require constant skills upgrading, opportunities for lifelong learning opportunities beyond school need to be provided. These opportunities should also be available to those people who are already out of school and do not have the basic skills to be productively employed (second chance learning opportunities). This is particularly relevant for women because 64 percent of women aged 25­54 years have lower secondary education or less. A policy framework for post-school learning opportunities--clearly linked to the formal school system and informed by the demands from the labor market and society--needs to be developed. Skills training needs to include life skills and be complemented with other services such as job placement and counseling and business development support, such as those provided by WfW and Dritare Jete, discussed in the previous section. 4.32 Active Labor Market Policies (ALMP) to create job opportunities and upgrade workers' skills may generate sustainable employment over the medium and long term. ALMP can play an important role in making unemployed, unskilled workers more employable, but generating substantial employment over the short run should not be expected in the current context of low labor demand. E. SUMMARY AND RECOMMENDATIONS 4.33 Kosovo displays persistently high rates of joblessness, the highest in the region, which are mainly due to idleness, although a significant proportion of unemployed would be willing to work. Most jobless people have never worked and most of the unemployed have been looking for a job for more than four years. Although all groups in the working-age population display poor employment outcomes, youth and women are particularly hard hit. Among the few that manage to find employment, many are condemned to temporary jobs, low productivity jobs, or jobs without a contract. 68 4.34 The high rates of unused human capital in Kosovo do not only reduce Kosovo's economic growth, they also condemn many people to poverty. Employment creation is crucial to reduce the poverty in Kosovo, which affects an estimated 45 percent of the population today. The risk of poverty is substantially higher for the unemployed: households with an unemployed head of household have poverty rates around 59 percent, while those where the household head is employed with a salary have much lower although still substantial poverty rates of 36 percent. A reduction in the unemployment rate by 10 percent is estimated to reduce poverty by 6 percent (World Bank 2007, 2008c). Employing the jobless is essential to achieving social, political, and economic stability and ensuring a successful rebuilding process. 4.35 Generating sustainable employment in Kosovo mainly requires boosting labor demand from the tradable sector, improving the investment climate, and maintaining a stable macroeconomic environment. Policies to improve the investment climate and macroeconomic policies are covered in detail in the first three chapters of this report. 4.36 Improving the skills of the labor force is the second precondition for achieving higher and more sustainable employment. While it is crucial to sustain and increase investment in basic education to build a foundation for sustainable growth, the immediate priority for the authorities is employment creation and higher growth. To achieve these short- term goals, the government needs to narrow the mismatch between labor market demand and supply, by improving the quality (skills) of the labor force. First, the government needs to analyze the nature of unemployment (type, length, reasons) by age groups and develop targeted intervention for two very distinct groups. The first group consists of those who have finished their education but have been unemployed for very long period. The government, in collaboration with the private sector, needs to provide this group with second-chance education opportunities to develop relevant skills required in the current job market. The second group consists of the large number of idle youths. The employment rate among the 15-24 year olds is so low that if any one of them is not in school, s/he is most likely to be unemployed or not looking for a job. The government needs to create learning opportunities for the youth by increasing access to relevant education and skill training at upper secondary and tertiary levels. 4.37 Strengthening the labor legislation and its enforcement could also help generate employment (and reduce informality). A new, easy-to-enforce labor code with greater variety and flexibility of employment terms would help increase job formality, and may be helpful in promoting greater female employment. Also, incorporating internship opportunities in the regulatory framework could improve the linkage with businesses. 69 5. THE ROLE OF MIGRATION AND REMITTANCES A. INTRODUCTION 5.1 Migration for Kosovars has been a tradition for many decades, and Kosovo is among the countries with greatest migration in Europe (and in the world).48 In the 1990s, outmigration accelerated because of the hardships of the war, and culminated in 1999 when hundreds of thousands Kosovars had to leave. However, the resolution of the conflict a decade ago does not seem to have provided incentives for the migrants to return (apart from those that were sent back by host countries providing temporary refuge). Migration has provided a safety valve for large part of the population, providing a source of livelihood in an environment of very high unemployment and poverty rates. Remittances have also provided a safety net, helping households diversify their livelihood strategies. For most of the poorest families, remittances represent over 70 percent of their income. 5.2 The pace of migration has not been affected much by the economic crisis. Following the end of the conflict, the pace of migration increased until 2007, and then slightly decreased in 2008. However, it is not clear whether the trend reversal in 2008 was a result of the economic crisis. This might have been just a temporary phenomenon because the migration survey results show that in 2009, the level of migrants reached at least the level of 2007. During this same period, remittance flows remained stable. 5.3 Moreover, the expectations for future migration remain high. About 3.5 percent of the working population age 15 years and older report they are likely to migrate during the next 12 months. An additional 2.1 percent state that they are likely to migrate within the next five years, though often self-reported data on the intention to migrate overestimate future flows. In 2008, the outflow of migrants was about 0.6 percent of the working population. Even in 2007, which saw the peak of outmigration, only about 11,000 migrants left Kosovo (approximately 1 percent of the working population). However, despite the magnitude and history of migration, Kosovo has not yet developed a migration policy and the institutional set up to deal with migration issues is extremely weak. 5.4 Because migration will continue to be an important aspect of Kosovo's economic reality, the authorities should explore how to maximize the benefits of migration and their contribution to economic growth and poverty reduction. This chapter describes the nature of migration in Kosovo and its impact on economic growth, with a focus on migration trends, impact on labor market outcomes, poverty and investment. It also presents policy proposals that could enhance the contribution of migration to Kosovo's economic development. 48 Unless otherwise noted, the data in this chapter come from the Migration Survey or a subsample of the survey that links to the Household Budge Survey (HBS) 2009 (50 percent of households were available from HBS 2009 to allow linkage of the two datasets). 70 5.5 The analysis is mostly based on a unique data source: the Migration Survey that was conducted in the spring of 2009 (Box 13). Box 13: Migration Survey 2009 The Migration Survey took place between April and June 2009. In total, 2,024 households completed the survey. The details of the Migration Survey are presented in the basic information document (SOK and World Bank 2009). To summarize, the survey: Is nationally representative and representative at the strata level of region, rural/urban, and ethnic Kosovar Albanian and Serbian areas. Covers migrants (current and returned) and nonmigrants and includes modules on demographics, length of migration, income levels, and composition of employment sectors. A few demographic questions are also collected from migrant sending households, including the returned migrants. Benefited from an updated listing of households used in the master sample of Kosovo's population, which should ensure greater accuracy than previous surveys. Is designed to link to the HBS 2009 so that data, particularly on consumption levels of the household, can be linked. Is designed to be comparable with HBS 2005, which included some questions on migrants and remittances. Two Important Methodological Notes 1. This report is based on a new population estimate from the Migration Survey 2009 using an updated listing of households in the master sample. The population estimate of almost 1.7 million (see Annex 6, Table A6.1) differs from estimates used by previous analytical studies, including those by the World Bank. The last full population census in Kosovo was in 1981. Since then, various methods have been used to estimate the population. From 2000 until 2008, the population headcount was estimated to be 2 million, and various studies were based on this number. This analysis uses the same population estimate as the HBS 2005/6 (1.6 million), and the results have not been poststratified to 2 million as in some of the previous reports. Care should be taken when comparing the aggregate estimates of the present migration study and previous studies. The total number of migrants can only be estimated more accurately when a census is conducted in Kosovo. 2. The households with migrants covered by the survey are only those that have at least one household member living in Kosovo at the time of survey. Therefore, households that have migrated entirely are not represented in the sample. Therefore, the survey, even if representative, cannot provide an overall estimate of the total number of migrants living outside Kosovo. Source: SOK and World Bank (2009). B. MIGRATION FROM KOSOVO 5.6 Kosovo has one of the highest emigration rates among the transition economies, with migrants moving mostly to Western Europe. One in every four households in Kosovo has at least one household member living outside Kosovo. The main destinations have traditionally been Germany and Switzerland, where almost 60 percent of the total migrants have gone. More recently, other European countries, such as Italy, Sweden and Slovenia, have also become destinations for migrants. 71 5.7 The average age of migrants has been rising since the early 1990s. The average age at the time of migration used to be 19 years in the early 1990s, and gradually increased to 29 in 2009. This is likely to reflect that during the war years many young people left as political refugees (ESI 2006).49 In recent years, migrants have come from the age group most likely to be unemployed. More than 90 percent of all migrants are 20­35 years old. Since 2000, the average age of women migrants has been slightly higher than men. In the early 1990s, women migrants were younger than men, for example, three to five years younger than men during 1991­93. 5.8 The key motivation of migration from Kosovo is employment. At the end of the 1990s, war was a major cause of migration, but now it has been supplanted by unemployment. Migration for family reasons (including marriage) has been rising since 1999. Figure 17: Migrants' Resident Status in Destination Countries (share of total) Source: Migration Survey 2009. 5.9 The long-term nature of migration poses the question as to how long migrants will maintain close ties with Kosovo. Almost 80 percent of migrants from the migration survey were citizens or permanent residents of the destination country. Over 70 percent of them have migration stays of over five years. This seems quite different from what is observed for other Balkan countries. For example, much of Albania migration has been temporary and short term in nature, whether seasonal or circular (Baldwin-Edwards 2002; Carletto and Kilic 2009). Of the migrants who have returned home, they can be best characterized as short-term migrants; over 70 percent of these return migrants had stays of less than five years. 5.10 Remittance trends in the past decade prove that the links between migrants and their families in Kosovo remain strong. The level of recorded migrants' remittances has increased substantially since the late 1990s. According to Balance of Payments (BoP) statistics, 49 Young people migrating or being displaced as refugees due to war and conflict is widely observed in many other conflict countries. In war time, parents typically send their children first to secure their safety (for details, see Boyden and de Berry [2005] and Hart [2008]). 72 remittance flows increased by about 270 percent between 2000 and 2004, but have been relatively stable since (see Table 21).50 However, most of these flows come via informal channels51 so the balance of payment statistics might not capture all flows. Improvements in the data collection methodology in recent years have helped capture better remittance flows (though the "Errors and Omissions" category in the BoP remains large and might include unrecorded remittances). Table 21: Remittances have been the largest external source of financing for Kosovo (as percent of GDP unless otherwise noted) 2004 2005 2006 2007 2008 2009 Remittances 12.2 13.9 15.0 15.1 13.9 12.9 Foreign direct investment 1.5 3.6 9.3 12.6 8.9 7.8 Exports (of goods) 2.2 2.3 3.9 5.2 5.7 4.2 Donor support 11.5 12.2 10.2 8.7 7.5 8.6 Errors and Ommissions 6.2 7.8 8.8 6.8 3.2 6.9 GDP (thousands of euros) 2,928 3,005 3,118 3,411 3,849 3,843 Source: IMF and World Bank estimates. 5.11 Remittances are rarely transferred via banks, so these substantial funds are not directly contributing to the development of the banking sector. According to the migration survey results, less than ten percent of remittances are sent via bank transfers to Kosovo. Almost half of remittances come via money transfer organizations, such as Western Union, which is often the most expensive method of transferring funds. If a larger share of remittances would come through bank transfers, these funds could contribute to expanding the deposit base of banks, which in turn could allow for further credit expansion. It may also motivate people to use more bank services which would reduce the excessive reliance on cash in the economy, and in turn informality. Figure 18: Ways of Transferring Remittances in Kosovo (share of respondents) Source: Migration Survey 2009. 50 One should be aware that problems of data quality are pervasive. Due to the difficulties of measuring remittances sent outside of formal channels, estimating total remittances is difficult and the total value of remittances is potentially much higher than what is captured or reported. 51 The Migration Survey shows that Western Union constitutes the main vehicle of money transfer for remittances in Kosovo, followed by remittances hand carried by relatives and friends returning to Kosovo. 73 5.12 High transfers fees charged by local banks are probably one of the reasons for the low use of bank transfers. It seems that fees for receiving a bank transfer from abroad are much higher in Kosovo then elsewhere in the region. Some of the leading banks have a fixed amount fee (for transfers up to certain amount), so sending small amounts (which is often the case) bears a high relative cost. For example, receiving 100 euro via bank transfer has a fee of five euro, or five percent of the value of the transaction, and the fee for receiving 500 euro amounts to two percent of the funds transferred. Transfer fees in the rest of the region are much lower going from zero in FYR Macedonia to not more than two percent for 100 euro transaction and 0.5 percent for 500 euro transaction in the other countries. If bank fees were to be reduced and larger share of remittances flow through the banking sector, this would increase both the deposit base but also the revenue from transfer fees. For example, if most remittances (e.g. EUR 500 million) came through banks and the fees were reduced to about one percent on average, banks would earn EUR 5 million in transfer fees only (which is more than a fifth of the total banks' profits in 2009). It is important to not though that other factors, such as banks' branch network and financial literacy of the population, could be equally important in determining the use of banks as a transfer channel. Table 22: Local Bank Fees for Receiving Transfers from Abroad (in ) Source: World Bank staff estimates; fee charged by the leading local banks * Several banks have introduced joint bank accounts with Greek and Italian banks which allow free of charge transfers ** If funds are kept on the account for some period (between seven and thirty days) *** If funds are kept on the account for thirty days, otherwise 2 euro 5.13 It is interesting to note though that over half of households from the Migration Survey expect a decline in remittances received in the next 12 months. The survey was conducted during a period when most of Europe was still in a recession, so this could explain the downward expectations. Preliminary data do not yet confirm this, remittances declined by less than 10 percent in 2009, but effects from the crisis might still be coming, with some lag because migrants could be sending remittances from their savings. C. MIGRATION IMPACT ON LABOR MARKET OUTCOMES 5.14 International migration can have important static and dynamic effects on domestic labor markets. These effects include: (i) affecting the labor market participation of those left 74 behind, (ii) the employability of returned migrants if they have gained valuable skills or information abroad, or (iii) affecting demand for labor due to remittances, for example, remittances being invested and creating new jobs, or remittances being consumed on some items--such as housing--which generate a new indirect demand for labor. The following section shows that the effects of migration on Kosovo's labor market have been mostly positive: besides alleviating labor market pressures (as most migrants are unskilled and unemployed), the economy has benefited from "brain gain" of the (few) returning migrants. However, the high remittances might be raising the reservation wage for the recipient households, which in turn would keep people out of the labor market. 5.15 In Kosovo, households with migrants participate less in the labor market than households without migrants. The labor force participation rate52 for households with migrants is 14 percentage points lower than that of non-migrant households (45 percent versus 59 percent). In addition, unemployment in migrant households tends to be much higher than in non- migrant households. The lower labor market outcome for migrant households could be partly explained by the fact that the head of a migrant household is more likely to be female, older, and living in rural areas (population groups that have higher unemployment, as discussed in the previous chapter). But, the lower labor force participation may also be due to the higher reservation wage that remittances set, which has been found statistically significant in number of empirical studies. At the same time, the fact that the same share of individuals from migrant and non-migrant households say that they are willing to work points out that the reservation wage might not be a major deterrent to work. Further analysis would be warranted to draw the right conclusion on this. 5.16 In terms of salary levels, returned migrants seem to be performing slightly better compared to non-migrants. Returned migrants are not necessarily more skilled than individuals who have never migrated, however, their wages seem higher on average (Figure 19).53 Returned migrants earn significantly more at all skill levels (see Annex 7, Table A7.4). This could be due to the fact that returned migrants have different characteristics coming from "selection biases" which have not been captured by the survey. For example, returned migrants could have been more motivated or risk-averse and promoted faster, which could be reflected in their wages. 52 Total labor force is the number of individuals of working ages, that is, between 15 and 65 years. Not worked in last six months is without a job in the last six months, but seeking jobs out of the total labor force. Employment rate is the share of working population of working age who are working. 53 Skill levels are categorized by type of occupation according to the degree of professional skills required: high skills are professional and management, such as doctor, manager, scientist; medium skills are technical, clerical, cashier; low skills are workers in agriculture, mining, machine operators, driver, and so forth. 75 Figure 19: Returned Migrants Earn Higher Wages Than Non-migrants at All Skill Levels (monthly wage in ) Non Migrant Returned Migrant All 600 500 400 300 200 100 0 Low Medium High Total Source: Migration Survey 2009. 5.17 The type of migration that Kosovo has experienced so far cannot be qualified as "brain drain" 54 because the majority (92 percent) of migrants have attained no more than a secondary level of education. Only 5 percent of migrants had a bachelors degree at the time they left Kosovo. However, given the high rates of youth (aged 15­24 years) unemployment in the country (72 percent), it can be expected that in the future brain drain could become more of a problem. A youth study (World Bank 2008f) suggests that it takes on average 10 years for an individual to find work after university. 5.18 There is some evidence of a "brain gain" for Kosovo. Among returned migrants, those in high-skilled occupations are more likely to have increased their education level and be contributing to Kosovo's labor market. Of those working in high-skilled occupations, 25 percent improved their education level compared to 10 percent in medium-skilled occupations and 6 percent in low-skilled occupations. Out of all returned migrants, 8 percent improved their education level while abroad. Women migrants improved their education level more than men while abroad; 14 percent of women compared to only 6 percent of men. 5.19 The role of migration in building up capacity and skills should not be underestimated. Stark, Helmenstein, and Prskawetz (1997) suggest that the hope of migrating in the future might provide a powerful incentive for people to study more, and since not all of the prospective migrants eventually migrate, this can also result in a brain gain. Furthermore, migration can in itself be motivated by the desire to acquire skills and education abroad--note that 3.2 percent of migrants acquire a bachelor or higher degree while abroad and as many as 10 54 Brain drain is the emigration of highly skilled or qualified people from a country. In a broader sense, it also includes those who left after a certain level of schooling, such as secondary completed, and obtained a higher education level after migration since they could have had potential to study if they stayed and continued studying anyways. At the same time, if these people gained further education outside and returned home, then that would be brain gain. 76 percent of migrants improved their completed education level from primary to secondary or from secondary to vocational. If these migrants return, Kosovo could experience a brain gain. Figure 20: Labor Market Performance of Migrants and Non-migrants, by Skill Level Source: Migration Survey 2009 5.20 Returned migrants are performing better than nonmigrants in the labor market: their activity and employment rates are higher at all skill levels (Figure 17). Returned migrants, with their increased education levels, will continue to contribute to Kosovo's labor market by utilizing the experience and knowledge they acquired abroad. The issue is whether Kosovo's labor market will be able to absorb these experienced returned migrants into the workforce with an appropriate skills match and in a timely manner. The previous chapter of this report points out that low labor demand, as well as the lack of skills, is the most important cause of the high unemployment in Kosovo. Creating greater labor demand should accelerate the return of migrants back to Kosovo. 5.21 Having previously migrated is correlated with a perception of better employment prospects. In the Migration Survey, 43 percent of surveyed individuals who had previously migrated reported that migration improved their job prospects. Ten to fifteen percent of respondents reported that their migration experiences provided them with ideas to start up a business or promoted networks with business partners (Box 8 provides an example of returning migrant partnering with a foreign firm). Also, education opportunities are reported to have increased. However, it will be important to continue improving the business climate to ensure that migrants and their households invest in Kosovo and strengthen its production potential. D. IMPACT OF REMITTANCES ON POVERTY, INVESTMENT, AND GROWTH 5.22 Remittances represent a substantial source of income for Kosovo's population and hence have a major impact on poverty. Remittances are a critical part of income, consisting of more than a half of average household income for those households in the lower income groups (World Bank 2009h). Removing remittances sent from abroad, the poverty rate in Kosovo would increase by 2.2 percentage points, and the impact would be much larger, expectedly, to the remittance-receiving households. It is important to note though that migrants mostly come from middle to higher income groups. According to the survey, over 55 percent of migrants come 77 from the two-highest income quintiles of migrant-sending households55 (Figure 20). However, if remittances are excluded from household income, then migrants mostly come from the lowest income group (Figure 21, right). This means that migration, i.e. remittances, has helped low- income families move out of poverty and earn substantial income from sending one or more household members abroad. Figure 21: Share of Migrant-Sending Households by Income Groups, income includes remittances (left), income excludes remittances (right) 30% 30% 25% 25% 20% 20% percent percent 15% 15% 10% 10% 5% 5% 0% 0% Q1 (lowest Q2 Q3 Q4 Q5 (highest Q1 (lowest Q2 Q3 Q4 Q5 (highest income) income) income) income) Source: Migration Survey 2009. Note: The households are grouped based on their annual income per capita (A) including remittances and (B) pre- remittances. 5.23 The average amount of remittances per household received in a month in 2009 is close to the average monthly salary in Kosovo. The Migration Survey asked respondents to report the total amount of remittances received during the last 12 months. The national average of reported household remittances is 320 per month. The amount is not significantly different between urban and rural areas. This is based on the total remittances captured by the Migration Survey (in the amount of 216 million). However, it is common in such surveys for respondents to under-report their income. According to the BoP data, remittances in 2009 were about 500 million, equivalent to roughly 500 per month, per household. 5.24 On average, remittances are going to the poorest consumption group (net of remittances56). In other words, the relative impact of remittance flows on consumption, that is, on poverty, is largest for the poorest households. A similar distribution was found in Tajikistan (World Bank 2009i) though Moldova shows a different distribution (World Bank 2009f). The lowest consumption per capita group received remittances of about 450 per month on average, five times higher than the highest consumption group which received about 90 per month. At the same time, the variance of the remittances is largest among the poorest households. The maximum average remittance amount received by the lowest consumption group is 1,667 per month, while the top three consumption groups received maximum of between 300 and 600 (Figure 21). This could mean that few outliers (i.e. very rich migrants coming from otherwise 55 Income includes remittances. 56 Households are grouped based on their income excluding the remittances received. Consumption is used as proxy for income. Note that Migration Survey 2009 and HBS 2009 data are matched for only a sub-set of households (i.e. those for which HBS 2009 data was available at the time when the analysis was carried out), so the results from the matched sample should be considered preliminary (See Annex 7). 78 very poor households) are skewing the picture, and consequently, that remittance flows are typically much smaller (in line with those for the other income groups). Figure 22: Remittances Received by Consumption (per Capita) Group (in ) Source: Migration Survey 2009 and HBS 2009 (data for first six months only). Note: Average remittances received in each consumption group. The consumption is the household consumption per capita excluding the remittances received per month from Migration survey. Remittances data come from Migration Survey (annual data divided by 12 months) and the consumption groups comes from HBS data. 5.25 While remittances have helped decrease poverty, they have not played a major role in stimulating economic activity. The bulk of remittances seem to be used for immediate consumption, and only a small share goes to business investments, or education (Figure 22). When asked to name the main use of remittances, over 90 percent of households mention food and clothing consumption.57 Eighteen percent of households use some part of their received remittances to invest in a business, and 25 percent of households use some part of their remittances to repair or build homes. Figure 23: Uses of Remittances (share of respondents) Source: Migration Survey (2009). Note: Multiple responses to survey were possible. 57 Self-reported areas on which households spent remittances. Multiple answers (three categories for each remittance-receiving households). 79 5.26 Remittance-receiving households do not seem to invest more than non remittance- receiving households. They spend proportionately more on transport and communication in the household, but they spend less on food, taxes, pension, and rent (Annex 7, Table A7.5). There are, however, no significant differences in their expenditure shares on education, investment, or other consumer goods (Annex 7, Table A7.6). A study in Albania (Castaldo and Reilly 2007) found that the budget share for utilities and nonfood increased for remittance-receiving households. They argue that the remittances increased the households' budget shares on expenditure on durable goods and utilities, and decreased their budget shares on food. 5.27 Other countries' experiences suggest that improvements in the business environment have provided a basis for migrants or remittance-receiving families to invest. The role of diaspora investments and remittances in other countries has been dramatic. In Armenia, a comparable landlocked country with a history of international dispute with neighbors, the government passed reforms to create a more business-friendly environment and flexible financial sector to set the stage, and growth was fueled in part by investments from the migrants or remittances from migrants. From 1994 to 2004 in Armenia, 69 percent of all foreign investments were connected to migrants and 68 percent of all FDI went to migrant-connected firms (Hergnyan and Makaryan 2007). 5.28 In sum, remittances seem to have helped family members to purchase basic necessities, but whether remittances have contributed in any way to investment in business or in education is unclear. A FID (2009) report provides evidence that funding from the diaspora has been critical in starting a business, but preliminary evidence from the migration survey does not support this claim. It seems, therefore, that while the role of migration in providing business ideas is recognized by returned migrants (Figure 23), not all of those ideas translate into investment. Chapter 2 finds that business regulations and corruption are strong deterrents for domestic companies as well as for foreign firms interested in investing in Kosovo. Hence, addressing these and other business environment obstacles discussed in that chapter could stimulate greater involvement of migrants in economic activity in Kosovo. Figure 24: Benefits of Migration Perceived by Return Migrants (share of respondents) Source: Migration Survey 2009. 80 E. SUMMARY AND RECOMMENDATIONS 5.29 Migration has been an important livelihood strategy for a significant share of Kosovo's population and is likely to remain so for the foreseeable future. Migration has traditionally played an important role in alleviating labor market pressures, and this trend is expected to continue. Moreover, remittances have had substantial contribution to economic development: they have helped receiving households enjoy a better standard of living, and in the case of the poorest households, move out of poverty. The Kosovar authorities could explore ways to further capitalize from Kosovo's migration. This could be achieved through a set of policies aimed at: (i) developing the institutional framework for dealing with migration, (ii) strengthening the contribution of remittances to the development of the banking sector, and (iii) engaging the Kosovar diaspora in economic activity in Kosovo. 5.30 Successful migration policy requires a strategic vision on the role that migration should play in Kosovo's development strategy, and an institutional framework to realize this vision. Countries such as the Philippines, which have been very successful in capitalizing from migration, started with a clear vision and strategy as to what could be the contribution of migration to economic development. Implementing a migration strategy needs an institution that would manage migration and would be able to coordinate the various institutions that would be involved in the implementation, given that migration is a complex issue which touches upon many policy areas (education, labor, foreign relations, banking, taxation etc.). The leading institution on migration should also have the necessary capacity to analyze and design policies and to implement these policies through the other relevant institutions. For example, several countries, including the Philippines and Sri Lanka, have created a ministry to accommodate migrants' needs.58 5.31 To increase the developmental impact of remittances, the authorities should create the right incentives and environment to channel remittances through the banking sector. One of the reasons for the limited use of banks to transfer remittances is the high transaction cost. Stimulating greater competition in the banking sector, as well as other measures that would support the development of the sector, could also lead to reduction in fees. There are also policy actions that could directly address this issue: Design and implement a campaign among commercial banks, first of all, to encourage them to develop specific products for migrants and remittance-receiving households to promote saving. Develop the financial literacy of migrants and receiving-households in order to promote the demand for use of formal channels for transfers. 5.32 There are successful examples from countries, including Moldova, Armenia and Philippines where banks have invested heavily in developing specific products and infrastructure related to migration, and the benefits for these banks came out to be far larger than anticipated. 58 In the Philippines, by setting up a ministry of migration and employment abroad, it helps its migrants by regulating overseas employment recruitment, informing migrants of available resources abroad, providing protection and representation through a migrant welfare fund and absentee voting services, and developing recording mechanisms to understand migrants' needs (World Bank 2008d). 81 5.33 Finally, the last objective is to get the diaspora to invest and come back to Kosovo (in particular the high skilled migrants). Kosovo's economy could benefit a lot from the skills and financial resources of the diaspora. There is a range of mechanisms that have been introduced around the world to attract migrants to return, but the results have been mixed. To encourage Kosovar workers and investors from abroad to return to Kosovo, the authorities should address the same issues that are of concern for foreign firms and domestic job seekers. Improving the key constraints in the business environment identified in chapters 2 and 3 is a necessary condition for the diaspora to get more involved in economic activity in Kosovo. Addressing these issues should create more successful cases, such as Zinkunie (see Box 8 in Chapter 2). It should also shift a larger share of the (substantial) remittance flows toward productive economic activity. 82 6. THE ROLE OF AGRICULTURE FOR STIMULATING EMPLOYMENT AND GROWTH A. INTRODUCTION 6.1 The natural resource endowments of Kosovo, its young labor force, and its proximity and free access to the EU market suggest that Kosovo has the potential to boost its agricultural production and exports. These comparative advantages can benefit farmers, if they receive market signals and if local supply chains are efficient enough for the farmers to be competitive in regional markets. But since the 1990s, the agri-food sector has suffered from a breakdown in supply chains and there are significant obstacles to increasing productivity. Problems in the agri-food sector and economic upheaval in general, have crippled the rural economy. With diminishing opportunities and falling incomes, Kosovar agriculture has become an economic activity of last resort, providing a critical source of income. The lack of opportunities and falling incomes are the reason behind the very large number of small and subsistence farms in much of Kosovo and the surrounding region. 6.2 Economic reforms have yielded increasing returns across the region over the last decade, economic growth has accelerated, particularly in the services sector, and incomes have been rising. Yet, this trend is much less pronounced in rural areas. In Kosovo, due to fewer economic opportunities, poor public services and fewer jobs, rural areas are experiencing an increase in out-migration, particularly young of people, to cities or overseas. In some respects these demographic shifts are a predictable consequence of economic change and transformation. However, these shifts are also indicative of the few opportunities available in rural areas. Although farming employs an estimated 35 percent of the total labor force in Kosovo, it is not a vibrant sector.59 The majority of farms are operating at a subsistence or semi-subsistence level, while commercially oriented operators frequently find themselves faced with insurmountable expansion obstacles: lack of access to credit, land, quality inputs, and high-value markets as well as degraded infrastructure. Unless Kosovar rural areas become more dynamic and innovative, there is a significant risk that these potentially profitable farmers will lose out to imports, and that smallholder farmers will remain mired in poverty. By acting exclusively as an employment buffer, Kosovo's agriculture sector is unable to realize its potential as a dynamic economic sector (see Box 14). 59 In 1989, about 26 percent of the active population was employed in agriculture, compared to an estimated 70 percent in 1997 due to years of underinvestment, high unemployment, and loss of other economic opportunities. 83 Box 14: Agricultural Development Critical for Pro-Poor Growth More than 60 percent of the Kosovar population is estimated to live in rural areas, which is well above the average of the SEE region. At the same time, two-thirds of the poor in Kosovo live in rural areas. In 2006, 49 percent of the rural households were poor (2007 World Bank Poverty Assessment) and 18 percent extremely poor (in urban areas this was 37 percent and 14 percent, respectively). Poverty in rural areas is highly correlated with lack of land, livestock or agricultural equipment such as tractors, plows, or trailers. In fact, individuals without productive agricultural assets have the highest estimated incidence of poverty in the rural population. In 2005, about 10 percent of households in rural areas reported being landless and nearly 7 out of every 10 households in this group were classified as poor. Nonetheless, agriculture is still an important sector in Kosovo's rural economy and a potential major source for pro-poor growth. Agriculture is the main source of livelihood for the considerable rural population. The 2007 World Bank Poverty Assessment found that about 90 percent of the rural population has land, 55 percent has livestock and 15 percent lives off their own food products, indicating that a considerable share of the population engages in agriculture. At least 70 percent of rural households depend on agriculture, giving it potentially an important role in alleviating rural poverty. The rural population is on average very young--60 percent is under the age of 30--and unemployment is high, so engaging this population in agriculture would increase employment and growth as well as reduce rural poverty. Source: Author. 6.3 This chapter provides policy proposals that could eliminate the main obstacles holding back the development of Kosovo's agriculture sector. These policy proposals focus on using Kosovo's comparative advantages and overcoming the current constraints to developing the agriculture sector. These proposals are then combined in a recommendations matrix, which provides short-, medium-, and long-term activities. B. OVERVIEW OF AGRICULTURE IN KOSOVO 6.4 Agriculture has always been a key sector in Kosovo's economy, but it declined precipitously during the conflict. In the socialist era, substantial investments were made in agriculture, productivity gradually increased and the number of people working in the sector decreased. Kosovo became largely food self-sufficient, large quantities of agricultural products were exported to ex-Yugoslavia (in particular wine, fruit, and vegetable products), and livestock production accounted for about half of total agricultural revenues. But input provision and output purchases were distorted and dominated by state-owned enterprises (SOEs) in monopolistic positions. In the 1990s, this trend was reversed: investments plummeted, productivity dropped, and the share of the working population in agriculture is estimated to have doubled from one quarter to 50 percent in the last part of that decade. Traditional agricultural export markets were lost and local marketing channels were disrupted. At the same time, there were drastic reductions in the availability of formerly subsidized inputs such as fertilizer and irrigation. The combination of the loss of markets and reduction in subsidies resulted in a dramatic decline in the terms of trade for agriculture. In the face of these shocks, livestock numbers and agricultural land area dropped drastically, especially for orchards, vineyards, and arable land (see Figure 25). The 84 character of agricultural production also changed, becoming predominantly subsistence oriented, with smaller farms reporting in 2005 that 70 percent of their output was devoted to household needs (SOK 2005a). Figure 25: Shifts in Agricultural Land Use and Livestock Numbers Over the Last Two Decades Source: SOK (2009). 6.5 With the decline of agriculture output, Kosovo's agro-food trade deficit has been widening, reflecting a diluted competitive basis. Agro-food imports are large and growing, from 280 million in 2005 to 470 million in 2008, an increase of 68 percent. The value of agro- food exports grew even more rapidly over the same period, from 8 million to 20 million, an increase of 156 percent. But exports are dwarfed by imports, resulting in an agro-food trade deficit that grew to 453 million in 2008. In addition to a lack of competitiveness in Kosovo's agricultural sector, several other factors contributed to this situation. The liberal economic regime (with lower external tariffs) developed after the conflict exposed the domestic market to agro-food imports. Out of total agro-food imports, prepared foodstuffs, beverages and tobacco represent 57 percent of the value, followed by vegetable products (20 percent), and live animals (16 percent). Prepared foodstuffs and beverages, along with vegetable products, are also main exported items. Kosovo trades agriculture goods mainly with its neighbors, in particular Serbia, Macedonia, Albania, and Greece. Table 23: Kosovar Agro-food Trade ( million) 2005 2006 2007 2008 Imports 285.5 319.4 384.1 473.7 Exports 7.9 11.6 18.1 20.7 Net exports (exports minus imports) -277.6 -307.8 -366.0 -453.0 Source: SOK and Kosovo Customs (2009). 6.6 Agricultural imports from Kosovo's trading partners, who receive production and export subsidies, place Kosovo farmers at a disadvantage. Production subsidies and export subsidies are used to support agriculture by many of Kosovo's trading partners. Many of these countries allocate between one-third and two-thirds of their agriculture spending to subsidies. These agricultural budgetary transfers vary, but are highest in Croatia, within the SEE region, 85 and in the EU member states. Agricultural subsidies in these countries facilitate the entrance of better quality products at lower prices into the Kosovar market. Decreasing use of agriculture land 6.7 The share of irrigated agricultural land is low and has decreased significantly over the past 20 years. Irrigation is used on around 39,000 hectares, or less than 20 percent of utilized arable land, down from 70,000 hectares in the 1980s. Currently, the western region of the country--Decan, Rahovec, Peja, and Shterpca--has the most irrigated land. This is the area where historically most of the fruit and vegetable production has taken place. Potentially, about 200,000 hectares could be irrigated. 6.8 The average Kosovar farm utilizes an agricultural area of about 1.4 hectares spread over many small parcels, which perpetuates subsistence farming and a risk aversion strategy. Unfavorable farm structures and underinvestment prevent the sector from meeting its production potential. In 2007, agriculture in Kosovo included approximately 183,000 agricultural holdings (against about 172,000 estimated in 2006), 72 percent of which have less than 1.5 hectares of utilized agricultural land. Small farmers have higher transaction costs, inadequate assets to be able to access credit, and not enough land to produce enough to make it worthwhile to enter the commercial market. 6.9 Land privatization and other reforms were carried out to reverse the decline of the agricultural sector. Reforms begun in the 1990s, and more recently in 2000­2005, to privatize land and agro-enterprises, promote market-oriented production, free market prices, and liberalize procurement and trade policies helped to spur a recovery in the agricultural sector. The most important change was the privatization of the socially owned farms--after decades of state control. Altogether, about 25,000 hectares of arable farmland have been privatized so far with about 40,000 hectares remaining. The privatization has followed a piecemeal approach to avoid a drop in land prices. This process put the productive resources of land and other assets into the hands of private farmers and resulted in two recognized production categories: a few large agricultural enterprises and many small household farms. 6.10 The land market is heavily distorted, dysfunctional, and poses serious constraints to agriculture potential. Land and labor are key determinants of the cost of agricultural products, and although systematic and reliable data on prices of agricultural land are difficult to obtain, anecdotal evidence suggests agricultural land in the Balkans is on average less expensive than land in southern Europe. However, the uncontrolled construction activity throughout Kosovo in the post-conflict period has been heavily distorting the land market for speculative purposes and reduced the availability of agricultural land. The result has been what appears to be a price bubble, with land selling for up to 100,000 per hectare in some areas, well over 10 times regional values for comparable land, and out of reach for most farmers wishing to expand. This is due in part to the absence of land-use planning and land zoning. 86 Box 15: Kosovo's Climatic Conditions Kosovo's climate is continental, with an average of 660 millimeters of rainfall and 170­ 220 frost-free days, while the southeast is influenced by a more temperate climate, with 780 millimeters of rainfall and 196­225 frost-free days. These climatic conditions put Kosovo at a slight disadvantage with the rest of the SEE region. Table. Regional Climate Comparison Number of frost- Climatological Station and Country free days First planting date Tirana, Albania 339 February Prishtina, Kosovoa 220 End of April Sarajevo, Bosnia and Herzegovina 269 April Skopje, Macedonia 281 Early April Belgrade, Serbia 307 End of March Athens, Greece 363 January Rome, Italy 352 March Sofia, Bulgaria 252 April Budapest, Hungary 270 April Zagreb, Croatia 276 April Source: Ramasamy (2008). Note: The first planting date is estimated by an algorithm from Snyder et al. (2005) based on the assumption that the planting is less risky after the first date with 50 percent or less probability of having a frost event (screen daily minimum temperature of < 0°C). Low Productivity of Agriculture Labor 6.11 Kosovo's agricultural labor costs are competitive, but, as shown in chapter 1, productivity is low. Kosovo's agricultural labor supply is the highest in all of ECA, with 1.65 workers per hectare (Shamsiev et al. 2010). Taking average gross monthly labor costs for industry and services as a benchmark, data suggest that labor costs in Kosovo are about 15 percent of those in southern EU countries and about half of some new EU members (Table 24). But at the same time, with an estimated agricultural value added per full-time equivalent worker lower than 2,000 per year, the labor productivity in Kosovo is far below other countries in the region. This emphasizes the need for labor-intensive agricultural production or the need to shift excess labor to other sectors. 87 Table 24: Agricultural Land and Labor Costs in the Western Balkans (2005 unless otherwise noted) Agricultural land Gross labor costs (/hectare)a (/month)b 1 Kosovo 3,100 232 Albania 7,000 161 Bosnia and 420 2,500 Herzegovina Macedonia 2,775 343 Serbia and 316 5,000 Montenegro Bulgaria 1,207 161 Croatia 3,600 841 Hungary 1,500 638 Poland 1,700 586 Greece 8,765 1,984 Portugal n/a 1,557 Spain 16,489 2,135 Italy 14,266 2,904 Source: Compiled by author from various sources. Note: These figures represent average monthly labor costs, defined as total labor costs per month divided by the corresponding number of employees, expressed as full-time units. a. Macedonia (2007), Bulgaria (2008). b. Kosovo (2007), Greece (2003), Portugal, Spain and Italy (2008). 1 Estimates from Kosovo Privatization Agency. The figure refers to privatized land for SOEs above 10 ha. 6.12 Shifts in employment and labor productivity have occurred over the last two decades. While agricultural GDP decreased in the previous two decades, from as high as 25 percent of GDP down to an estimated 12 percent in 2006,60 employment in agriculture remained at high levels. In fact, the share of Kosovo's labor force in agriculture rose to 35 percent, second only to Albania (Table 25). This was the result of job losses in other sectors of the economy rather than from attractiveness of the agriculture sector. Capital investment in agriculture also dropped to almost nothing as the sector became increasingly unattractive and sources of credit dried up. The predictable result was a drop in agriculture labor productivity (value added per worker) to lower levels, compared to the economy-wide average, and the growth of informality in the sector. The drop in productivity was also reflected in agricultural wages, which sank. 60 This figure is lower than the average in the whole ECA region, where the agricultural sector contributed about 14 percent of the GDP in 2004, and lower than the Balkan region un-weighted average of about 15 percent. However, if the large informal sector is included, estimates could easily go up to over 15 percent, because agriculture, as well as trade and construction, is typically under-represented in the official statistics in economies with Kosovo's characteristics. 88 Table 25: The Rural Profile of the Western Balkans Rural population Agriculture, value Labor force in (% of total added (% of GDP, agriculture (% of population, 2006) 2005)b total) Albania 55 23 58 Bosnia and Herzegovina 54 10 n/a Macedonia 31 13 21 Serbia & Montenegroa 48 16 20 Kosovo 64 11 35c Greece 41 5 14 Portugal 42 3 12 Spain 23 3 6 Italy 32 2 5 Source: World Bank Development Data Platform Database; World Bank (2008a; 2006b); World Resources Institute (2003, Bosnia and Herzegovina); and SOK (2008). a. The State Union of Serbia and Montenegro (created in 2003) came to an end after Montenegro's declaration of independence on June 3, 2006, and Serbia's declaration of independence on June 5, 2006. b. Agriculture corresponds to International Standard Industrial Classification of Economic Activity divisions 1­5 and includes forestry, hunting and fishing, as well as the cultivation of crops and livestock production. C. WHERE DO KOSOVO'S COMPARATIVE ADVANTAGES LIE? 6.13 Kosovo's comparative advantages in agriculture need to be rethought in the new, post-1999 environment. The agriculture production in the former Yugoslavia period was based on the policy priorities of the federal government and implemented through heavy input subsidies and guaranteed output prices. In today's context of post-independence and regional and EU trade integration, this policy has changed. Kosovo's comparative advantage in agricultural production seems to be in high-value fruits and vegetables. Such results are derived from analysis of the Domestic Resource Cost Ratio (DRC), a standard indicator of potential international competitiveness that measures the relative efficiency of domestic production by comparing the opportunity costs of using domestic primary factors--land, labor, and capital--to the value added generated (Sutton 2005). DRCs were calculated to assess the average competitiveness of Kosovar commercial farmers for the following commodities: tomatoes, apples, onions, potatoes, cabbage, pepper, plums, pears, and table grapes. These products were chosen because of their relative importance in both gross agricultural output and export potential. The results, presented in table A8.1 in annex 8, demonstrate Kosovo's strong comparative advantage in producing onions, potatoes, tomatoes, plums, apples, peppers and pears, all of which are considered high-value produce. 6.14 The favorable DRCs are due to the current low cost of domestic production factors, including labor and land. Not only are fruit and vegetable (F&V) crops of higher value than cereal crops such as wheat and maize, their production absorbs more labor and should allow Kosovar farmers to generate more revenue from their small plots. In fact, these crops are more likely to be cultivated by small, independent farms. 89 Box 16: Increasing Rural Employment through Horticultural Production Horticultural products often require a considerable amount of rural labor to produce, harvest, and process. This provides a relatively stable source of employment and income. These products can also have a direct impact on food security, particularly in the more remote or poor areas. In contrast, bulk commodities such as wheat, cotton, and tobacco are less labor intensive, are subject to the vagaries of stiff global competition and international pricing, and are often not useful for grower consumption. International trade in high-value agricultural products has been growing faster than for staple crops. Further, household surveys show that on average, farm households that produce F&V or milk are less likely to be poor than households that do not. Currently, annual horticultural (F&V) production and trade are worth about 160 million per year. 6.15 Currently, agricultural producers are receiving prices lower than the international average for some of their outputs even after accounting for transportation, handling, and other costs. Analysis of the Nominal Rate of Protection (NRP)61 for the commodities in paragraph 6.13 shows that for the majority of F&V products (five out of nine), farmers receive less on their sales than they should relative to international prices; for onions, potatoes, tomatoes, plums and grapes, farmers received an amount ranging between 2.4 percent and 46.4 percent less. This means that the sector is implicitly taxed due to market failures. The negative NRPs are most likely due to a variety of market imperfections, including (i) inefficiencies in processing, trading, marketing and transport, and (ii) the inability of producers to meet export quality and standards. Overproduction leads to a glut on the small domestic market during the harvest season coupled with poor farmer-processor links and weak marketing infrastructure. Lack of collection points, cold storage, packing houses, and other postharvest facilities, means that farmers are usually forced to sell to the few available buyers at harvest time, when prices are lowest. 6.16 At the same time, agricultural producers are paying more for their inputs compared to international prices. Effective Rates of Protection (ERPs) were also calculated for the same set of commodities. The ERP is similar to the NRP, but it includes the measurement of market failure in tradable input as well as output markets for the same products. In every case, the ERP is substantially lower than the NRP, meaning that across the board, Kosovar farmers are paying more for their inputs than they should relative to international prices, resulting in an effective "tax" on production. Table A8.3 in annex 8 shows the ERP for the same set of nine products, and measures the market failure in tradable inputs. In sum, even though Kosovo should have a comparative advantage in the production of fruit and vegetable crops due to cheap non-tradable inputs (labor and land), its competitiveness is undermined by inefficiencies and market failures in (tradable) input and output markets. 61 This indicator measures market distortions based on the ratio of the domestic price actually received by farmers (market or private price) to the economic (or social) international parity price of a commodity, both taken at the same point in the marketing chain (usually farmgate) after accounting for transaction costs (Monke and Pearson 1989; Caballero, Calegar, and Cappi 2000). 90 6.17 Despite the market distortions, production of high-value horticultural crops should still be the most profitable strategy. Financial analysis of gross margins (see Table A8.4 in Annex 8) shows the highest profits in production of F&V crops (such as apples, pears, beans, leeks, cucumbers, and strawberries). These have the highest gross margins--in the range of 6,000 to 12,000 per hectare. Greenhouse production is even more profitable. In contrast, cereals such as wheat and maize generate only a few hundred euro per hectare. However, in an environment of limited access to inputs and credit, it is apparent why the latter crops would be attractive to small farmers: the expenses for their production are less than a quarter of those for horticultural crops. If existing constraints and distortions are removed, farmers will be able to reap significant benefits from growing the horticultural crops. 6.18 Focusing on its comparative advantages in agriculture will not only increase Kosovo's output in the sector, it could also boost Kosovo's exports and, more importantly, substitute for imports. Domestic demand is expected to grow faster for horticultural and livestock products. Domestic demand has begun to grow in recent years as purchasing power increases, particularly in urban areas. Over the past decade, demand for F&V has surged more than for any other food category. In the future, domestic demand for F&V is expected to continue to grow. In addition, it is likely that foreign demand--in particular, regional demand-- will bring sizable opportunities for growth and profit in the F&V sector. In contrast, the livestock sector would have a difficult time exporting due to the current poor state of collection and processing in the sector, and competition from lower cost producers in Hungary, Slovenia, and Turkey. Fortunately, due to their higher income elasticity and based on other countries' experience, demand for milk and dairy products in the domestic market is predicted to grow fast. As a result, although it lacks the export potential of F&V, the dairy sector should be able to grow on the basis of increasing domestic demand and substitution for imports. D. THE CONSTRAINTS TO AGRICULTURE DEVELOPMENT 6.19 For Kosovo to exploit its comparative advantages in agriculture, the first step is to address the constraints that are distorting markets and reducing competitiveness. With efficient markets, farmers will receive the price signals they need to make investment decisions, which will help them increase productivity gains for high-value crops. Increased market efficiency will also potentially benefit consumers by reducing retail market prices. Kosovo also needs to address the challenges surrounding the issues of food safety standards and requirements, access to and utilization of quality inputs, poor and inadequate irrigation, credit access, and climate change impacts. To develop high-value agriculture sectors, such as F&V and dairy, it is first necessary to understand current constraints. 6.20 Currently, agricultural productivity and yields are low, as a result of small farm sizes, and lack of access to technical expertise, resulting in outdated farming practices, inadequate use of inputs, lack of credit and inefficient farm management practices. In the case of livestock, faced with the need to find savings to restock their farms after the conflict, many farmers reduced their use of inputs. In the case of dairy farmers, low-quality feed results in low yields in winter months. While there has been some recovery in crop production and yields, small farm sizes mean that farmers cannot produce enough surplus for commercialization. This is 91 also the case for scaling up F&V production. In many cases, even basic production knowledge is limited, and access to the technical expertise and marketing skills required to produce quality products that can compete in export markets is a major constraint. As a consequence of low levels of productivity and the dominance of subsistence production, factories have to deal with many small farmers whose production and collection costs are too high to allow the processing industry to be competitive. The Ministry of Agriculture, Forestry and Rural Development's (MAFRD) current practice to contract private extension services providers is a step in the rights direction. Lack of credit is palliated by remittances but this is limited and does not come with technical support. 6.21 Investments are needed to realize an expansion of the meat and dairy sectors,62 which have good import substitution potential. However, although considerable skills upgrading is required to equip and improve herd management and husbandry skills to levels needed for managing breeds with higher genetic potential. Additionally, investment in locally owned milk collection facilities is needed, including future expenditures to modernize milk processing, cooling, storage, and transport. 6.22 A host of market imperfections have conspired to depress agricultural prices in Kosovo and thereby reduce incentives for production and investment. These factors effectively mask Kosovo's comparative advantages and constrain the development of the sector. To develop markets for farm produce, it is also necessary to develop agro-food processing and distribution. But in Kosovo, market channels are fragmented, exist only in a very rudimentary form, and are dominated by the informal sector. This makes it difficult for farmers and processors to sell their products and receive a good price, and for processors to receive the quantity and quality of inputs they need, when they need them. In general, processors have a small but increasing role in Kosovo's horticultural marketing chain. But compared with the total consumption, local processing is small. There are three reasonably large processing factories and some small-scale factories that process produce such as potatoes and tomatoes when market prices are low (see Box 16 below). There is a small, vibrant cottage industry based mainly on preserves, but the value chain has not yet developed. 62 Apparently, according to the Chamber of Commerce, more than 40 million of private capital has been invested in the Kosovo food industry over the past five years, most from local investors. The largest investments are UHT milk processing (Devolli 50,000 liters/day, Abi 30,000 liters/day), fruit juices (Dona and Pajtimi--both 8,000 liters/hour), potato processing (Pestova), F&V processing (Progress), plus a number of small- and medium-sized dairies (1,000­25,000 liters/day capacity), sunflower oil processors, flour mills/bakeries, slaughterhouses, egg producers, and bottlers of drinking water. 92 Box 17: Pestova: Potato Production and Processing Company Pestova cultivates 300 hectares of land (Pestova owns part of the land and subcontracts the rest from other farmers) and produces potato chips ("Vipa" brand) and French fries. Pestova started production of chips in 2004 thanks to a Dutch project that taught the company about new techniques for potato production. The company now has 30 percent of the chips market in Kosovo, 5 percent in Albania, and 10 percent in Macedonia. Until 2003, Kosovo was a net importer of potato; due to Pestova, Kosovo is now a net exporter. Until 2006, Romania was the biggest market, but after Romania joined the European Union, Pestova could not export anymore because it did not adhere to EU standards. However, at the end of 2008, the company adopted the GLOBALGAP (www.globalgap.org) standards and now it can export to Romania again. However, Serbia has now stopped accepting the phytosanitary certificates issued by Kosovo authorities. Pestova is adopting the most modern packaging techniques and is constantly expanding its market in the region, and now exports to Montenegro as well. Fifty percent of inputs are imported (particularly seeds, machinery, and chemicals) due to the poor quality available from local suppliers, and 50 percent of sales are exported. Since 2007, Pestova has had the European Bank for Reconstruction and Development as a shareholder. 6.23 The lack of vertical coordination (VC) in Kosovo's agricultural value chains is holding back the development of the sector. Research by the World Bank in the transition economies has demonstrated the crucial role that VC plays in the development of the agricultural sector in transition countries (Swinnen 2004; White and Gorton 2004). Traders, processors, and supermarkets in these countries are contracting with farmers to provide basic inputs in return for guaranteed and quality supplies of agricultural products. As it has in many other countries in Europe, VC can help to bridge the gaps in the development of efficient markets in Kosovo. This is especially true for developing high-value export markets, as well as domestic markets, such as dairy, that require coordinated supply chains. VC is particularly important for small farmers in providing market access. The main constraints to the development of VC in Kosovo include: · Underinvested supply chains: VC in the supply chain is essential for improving markets and developing the sector, but at present there is little VC taking place. VC is typically driven by private investment in agro-processing, especially foreign direct investment (FDI). But the poor business environment and high transaction costs discourage such investment. · Poor business environment: The business environment in Kosovo is characterized by a poor investment climate, inadequate contract enforcement, undeveloped judicial system, corruption, poor practical knowledge, and limited management experience. In the BEEPS survey, 80 percent to 90 percent of businesses ranked poor power supply, corruption and crime as top constraints,63 far exceeding the average for the Balkans and the wider ECA region. This discourages the private investment that is so crucial to promoting VC, and reduces the impact of public investments. · Uncertainty of land titling and fragmented land tenure: Unresolved issues of land administration and ownership, along with a fragmented property structure, constrain 63 A survey of 27 agri-processors conducted by the ASPAUK project (2004) has identified some key issues, including (percentage of concerned respondents in parentheses) cost of power/electricity/ diesel (78 percent), import competition (63 percent), cost of raw materials (22 percent), and interest rates on credit (15 percent). 93 the land market and farmers' abilities to invest, expand, and access credit. The core reason for the unclear land titling is the underdeveloped cadastre system. Land administration faces the following challenges: - Property records have not been systematically maintained since the late 1980s, not reflecting fragmentation linked to inheritances or other transactions. - Large irrigation projects and land consolidation activities that were started in the mid-1980s in the most fertile plains of Kosovo remain unfinished. The current land consolidation program, which facilitates willing participants to exchange, buy, and sell land parcels, should be expanded and finished. - Some 30,000 conflict-related claims on rural land are pending at the Kosovo Property Agency. - Use of falsified documents has become widespread over the last decade. - Thirty percent to forty percent of land owners are estimated to be absentee since the end of the conflict; they either migrated to urban areas within Kosovo or abroad. - Construction activities on agricultural land are uncontrolled and land-use planning is inadequate. · High transaction costs for market organization and trade: High transaction costs make it more difficult for agro-enterprises to develop VC. The causes of high transaction costs include the absence of producer organizations and professional associations and a lack of appropriate standards, grades, and packaging. · Poor public services and institutional capacity: The general lack of public services, such as agricultural extension services, appropriate research and market information systems, further increases transaction costs for investors if they have to then provide these services themselves. Business advisory services are also needed because the inadequacy of business and marketing skills among both producers and agro- enterprises reduces their ability to take advantage of market opportunities. Low institutional capacity hinders government's ability to respond to the needs of the sector with appropriate policies, investments, and services. · Inadequate public investment: The lack of investment in electricity supply imposes higher production costs on processors and producers. In many rural areas, poor transportation and communications infrastructure are also constraints. These have the effect of further reducing investment. The lack of a public marketing infrastructure, such as wholesale markets, increases transaction costs and also reduces market opportunities for producers. Poor marketing and storage infrastructure lead to a glut in the small domestic market during harvest season, which depresses prices. Moreover, traders and processors use their monopsonistic position to impose low farm gate prices on farmers, who have little negotiating power. 6.24 The quality and availability of market information need to be improved. Since the breakup of the Yugoslavian economy, the monitoring of production and markets has become much less sophisticated. Agricultural goods are traded through private arrangements between dealers, producers, processors, and retail outlets. Although three organizations collect market 94 prices in Kosovo, the infrequency of the services, the likely inaccuracy of the results, and the inappropriate means of dissemination mean that their output is of little use to most sector actors. 6.25 Food safety and quality standards and systems do not meet international requirements. Food chain safety and the protection of consumer interests are of increasing concern to consumers, NGOs, professional associations and international trading partners, and they affect market opportunities for Kosovo's farmers. Domestically, there is only limited protection for consumers, and no recognized quality-assurance schemes. But, more and more international supermarket chains are moving in and are looking to position themselves as the guardians of consumers. While supermarkets are currently limited to less than 10 percent of horticultural sales in Kosovo, they are growing rapidly and are likely to become the dominant power in the food chain. The two biggest chains in Kosovo, ETC and Ben-af, expect to double their outlets in the medium term. The food safety standards established by international supermarkets have typically become more stringent than those applied by the public sector. Internationally, the markets of Kosovo's main trading partners in the region will become increasingly out of reach as the countries move closer to the European Union and adopt the relevant food safety and veterinary acquis. At present, the internationally recognized third-party standards certification often required for trade is also not available in Kosovo, and public markets do not have reasonable access to simple laboratory tests (a public safety issue). As a result, supermarket chains import the majority of their products from abroad. With regard to exports, a number of exporters based in Peja and Prizren claim that lately it has become increasingly difficult to export fresh produce to Montenegro and Albania due to the inability to satisfy phytosanitary requirements. 6.26 On the production side, low use of inputs and poor access to irrigation and drainage perpetuate dependency on weather conditions and annual fluctuations in crop production, while poor rural infrastructure increases transaction costs. Low-technology production systems typical of Kosovo mean that farmers are dependent on weather conditions for crop yields, leading to sharp annual fluctuations and lower quality. Use of quality inputs such as fertilizers, certified seeds, and improved varieties is also low (see Box 17). Access to modern seeds and seedlings is especially important for the high-value F&V sector because the most advanced technology is often embodied in them, and enhancing quality begins at production. Lack of access to irrigation also reduces yields, increases risk, and discourages production of high-value crops. Annual seasonal floods in the Sinitza plain (without drainage) not only prevent replanting, but also spread nutrient waste and contaminate soil and underground water. 95 Box 18: Input Supply in Kosovo Currently there are more than 150 agricultural input dealers in Kosovo, many of whom are members of the Kosovo Dealers Agro-Input Association. Nearly all inputs are imported, and estimates for the period 2000­2004 show that more than 30 percent of the input supply came from non-specialized input dealers, whose main business was the supply of construction material, fuel, and food stores as well as other items. However, currently more than 90 percent of input dealers' business relies only on supply of agricultural inputs. This is an important development in favor of the specialization of the sector, but there is still a limited use of crop protection products (CPPs), high-quality fertilizers, and quality seeds and seedlings/saplings. This is partly because there is still insufficient information available among input dealers on proper fertilizing and spraying for specific crops, although the situation has improved over recent years. But there is still a need to provide farmers with advice and training, which will stimulate the demand for and diversity of quality inputs. Improvement in supply is particularly needed with regard to seedlings/saplings because only a small portion of input suppliers sell seedlings/saplings to farmers. The main sources for the purchase of seedlings/saplings are the local producers and suppliers who work in the informal economy, with no quality control. Inputs are currently imported from Serbia, Croatia, Germany, the Netherlands, Austria, FYR Macedonia, and Italy. This is a significant change compared with previous years (2000­2005), when inputs were imported mostly from neighboring countries, mostly Serbia and Macedonia. Input suppliers have complained for years about fertilizers smuggled in from Serbia through the North Mitrovica borders. Because these smuggled fertilizers do not go through formal channels, farmers doubt the quality of these inputs. Source: Author. 6.27 The agricultural sector lacks adequate access to credit. Small, rural borrowers have certain characteristics that make them less attractive to commercial lenders: transaction costs are high due to small transaction sizes, geographical dispersion, high risk, and lack of usable, fixed assets for collateral. In Kosovo, although the overall banking credit to the private sector has grown considerably (by more than 250 percent between 2005 and 2008), loans are dominated by the trading sector (42.6 percent). Agriculture continues to have a very low share of total banking sector loans: only 4.1 percent of the total (much lower than Albania or Moldova with 10 percent and 23 percent respectively), and most of it goes to the agro-processing industry. However, total loan amounts have tripled since 2005, from 12 million to 37 million in 2008. Along with the general improvement in the business environment in Kosovo, there has been continuous growth of the maturity structure of loans recorded in the agriculture sector, with about two-thirds of the loans with a maturity over one year in 2005, compared to about 90 percent in 2008. 6.28 However, these improvements in agriculture credit are only weak signals of some recent positive developments. Lack of high-quality investment projects and the risks involved in lending to the agricultural sector still characterize rural finance in Kosovo. In addition, only a limited range of financial products are available and few are designed for the credit needs of agricultural enterprises. Credit is usually extended in the form of very small, high-interest, short- term, microfinance loans for seasonal activities, although another complaint has been that bank loans are not structured for the seasonality of the typical agricultural cycle. 96 6.29 Finally, climate change has important economic implications for Kosovo. The Stern Review on the Economics of Climate Change (Stern 2006) estimates significant economic impacts from climate change, resulting in reduced welfare "by an amount equivalent to a reduction in consumption per head of between 5 and 20 percent". And because of its dependence on weather and the natural resource base, agriculture is a highly climate-sensitive sector (World Bank 2009a). Kosovo will get hotter as a result of climate change, extreme weather events will become more common, and precipitation is likely to decrease in low-lying areas (while possibly increasing in mountainous areas, at least initially). Projections developed by the International Institute for Applied Systems Analysis (IIASA) show that over time, maize could suffer yield declines of 10 percent to 25 percent or more throughout most of the country. On the other hand, there is potential for slight gains in yields in some parts of the country, although these tend to be mountainous areas, which are likely, not suitable for extensive crop production. E. INCREASING KOSOVO'S AGRICULTURAL COMPETITIVENESS 6.30 Given Kosovo's ample supply of agricultural labor, proximity and free market access to the European Union and relatively good climate, Kosovo should have a comparative advantage in the production of high-value horticultural and dairy products. However, there are currently a number of constraints that are reducing Kosovo's agricultural competitiveness and impeding its ability to make the most of its comparative advantages. Based on experience in other transition countries, there are solutions available for addressing these constraints. Policies to Promote Agriculture 6.31 The first priority is to improve the efficiency of agricultural markets by promoting VC. Kosovo can facilitate this process by: · Improving the business environment and encouraging private investment · Reducing transaction costs for market organization and trade · Enhancing public services and institutional capacity · Providing targeted public investment. Improving the Business Environment and Encouraging Private Investment Chapter 2 provides recommendations on how to improve the climate for doing business in Kosovo, and some of these recommendations are particularly relevant for the agriculture sector. - Improve contract law and enforcement: This is particularly important for agriculture because of the very nature of VC and the many actors involved. While long-term reforms of the judiciary and contract law are required, in the short term, alternatives such as out-of-court mediation managed by professional associations should be explored. - Improve implementation and enforcement of the solvency law: Improve implementation of the legal framework on collateral so commercial banks can re- 97 possess land for unpaid debts, while educating both parties on their rights under this law. This would increase the incentive of banks to lend to farmers. - Develop land markets and improve tenure security: Update real estate cadastre and registration records in the Immovable Property Rights Register, and strengthen the capacity of Municipal Cadastre Offices so that they are better able to respond to farmers' and firms' needs. Reducing Transaction Costs for Market Organization and Trade The following actions would help to reduce transaction costs: - Encourage the formation of producer organizations and professional associations: Government should encourage the development of producer organizations to facilitate joint marketing of outputs, which would increase the market power of small producers, as well as help to integrate them into vertically coordinated supply chains.64 - Enhance standards, grades, and packaging: There are many ways Kosovo's government can accomplish this goal, such as by increasing access to standards and grades information and providing training; improving the infrastructure and services necessary for testing and enforcement of standards; promoting the use of improved packaging and storage technology; meeting countries' import requirements to access higher-value markets, including harmonization with EU and other standards systems; and facilitating voluntary, market mechanisms to create incentives to meet these higher standards. Enhancing Public Services and Institutional Capacity In the short term, VC can help to fill some of the gaps in service delivery, but in the long term, government should increase the provision of these services, especially for those not integrated into vertical supply chains. Recommended actions include: - Investing in extension and business advisory services, and improving agricultural education. Rural business development services can serve as an effective nexus for delivering farm extension, business training, new technology, and information services. Improving the agricultural education system will increase the government's capacity to deliver these important services. - Reform the agricultural research system: Make the agricultural research system more demand and market driven so that it responds to the needs of the new, small- 64 In many rural transition economies, relations between the industry and its suppliers were characterized by poor prices and payment terms. The public sector can play a catalytic role in promoting--through legislation and/or taxation--various types of professional organizations in the agri-food sector to facilitate coordination between various players. 98 scale farmers and focuses on those activities in which Kosovo has a comparative advantage. 6.32 To begin, the Kosovo government should promote a market information system that will provide market actors with accurate, timely information. The provision of market information to actors in the agricultural sector increases farmers' trade volume and income and helps reduce risk and transaction costs. Markets for many horticultural products are highly volatile. Prices can change significantly from day to day due to events such as poor harvesting conditions linked to the weather, and most products deteriorate rapidly in quality after harvesting. This means that prices should be recorded and disseminated on a daily basis. But information should also be provided on volumes, demand levels, trends, locations, credit market, weather conditions, news relating to markets, and the regulatory framework. This information is particularly useful to small farmers and entrepreneurs who engage in trade outside of vertically coordinated systems, and would help them to identify opportunities and level the playing field with established middlemen. Collection and submission of market and price data are also very important for decision making and policy analysis support and will be needed in the future for EU accession. 6.33 It is also important to create the conditions for an efficient land sale and lease market to allow farmers who wish to consolidate and expand their farming operations to do so. Supporting land titling and establishing property registries can also make a significant contribution to increasing credit access for rural populations. This support would require revisions to the current legal framework and institutional capacity building in the following areas: - Security of ownership by domestic and foreign owners - Land taxation - Effectiveness of the land administration system - Land registration and cadastre reconciliation - Private real estate services, such as surveyors, real estate brokers, appraisers, and market information providers 6.34 The infrastructure and services necessary for food safety testing and standards' enforcement also need to be improved. In many developed economies, the processing industries, through professional associations, are given some responsibility in establishing quality and safety control and monitoring systems. This is another reason why government should promote the development of such associations. But government also has a clear role to play in the interim. Given the underdeveloped state of the sector, government can facilitate investments and regional agreements for the use of a limited number of high-quality certification laboratories that meet international standards (for example, International Organization for Standardization [ISO] 17025 or European Commission [EC] 2002/657). Based on market demand for laboratory services in Kosovo, a laboratory needs assessment is recommended to take inventory of the current capabilities and deficits of the existing laboratories. 6.35 Kosovo has made progress in establishing a legal basis for food safety. Some key EU regulations and directives have already been transposed, including the hygiene package, legislation on food additives and food contact materials, and the official controls regulation. Recently, a new food law, based on EU regulations, was approved, and it foresees an integrated 99 food chain safety agency. It is important to begin implementing the new law with a long-term view toward achieving Kosovo's EU integration goals. Moreover, it could be important to establish a National Codex Alimentarius Committee,65 with membership drawn from a broad range of stakeholders in food chain safety. All the other countries in the region are members of the Codex Alimentarius Commission established by the EC in 2003. 6.36 Controlling zoonotic and parasitic infections in livestock and the development of a national strategy for phased implementation of Hazard Analysis and Critical Control Point (HACCP)-based food safety management systems are likely to be amongst Kosovo's highest policy priorities for national food chain safety. Process standards66 such as HACCP will be increasingly useful to meet necessary food safety standards in processing plants and export markets alike. The benefits can be considerable in terms of premiums paid in export markets. Meeting these standards also requires training producers and strengthening the quality assurance infrastructure for conducting audits and providing required certification. 6.37 It is also important to increase finance access for the rural sector through innovative, private sector­driven approaches. Greater attention needs to be paid to stimulating and supporting financial institutions that develop innovative financial products that go beyond the traditional "collateral" assessment approach. In rural financial markets around the world, businesses and farmers increasingly benefit from the broadening of financial services such as: Warehouse receipts. With nonperishable crops, farmers can improve the price they receive for their crop by keeping it off the market and waiting for the price to improve as the seasonal glut clears. The farmer can use the warehouse receipt to raise credit and pay off his seasonal costs while awaiting a better price to sell. This requires adhering to recognized storage standards and the availability of proper storage facilities. Forward supply contracts with processors. Obtaining a fixed price for a crop before planting takes the price risk out of the equation. This requires establishment and enforcement of the fixed-price contracts. Banks want to be assured when lending to the processor that the processor will be supplied sufficient product at a competitive price to enable a certain profit. Such contracts are evidence of a competitive supply. Equipment leasing/purchase facilities for farms. Financial leasing is a specialized activity that might be well suited to specific sectors of agriculture, but requires a specialist company rather than having leasing as an additional service provided by commercial banks. The regulatory system in Kosovo allows for leasing arrangements. Overdraft lines of working capital credits for seasonal agro-processors and agri-food traders. 65 The Codex Alimentarius Commission was created in 1963 by the Food and Agriculture Organization (FAO) and WHO to develop food standards, guidelines, and related texts such as codes of practice under the Joint FAO/WHO Food Standards Program. The program aims to protect the health of consumers and ensure fair trade practices in the food trade and promote coordination of all food standards work undertaken by international governmental and nongovernmental organizations. 66 Process standards are simply those that refer to an entire cultivation, packaging, or manufacturing process rather than only the characteristics of the final output or product. Traditional public safety standards measure the final output or product, but there is an increasing tendency toward the higher efficiency of working with improved processes to ensure safety and quality. HACCP incorporates a systematic analysis for potential food safety risks and the identification of appropriate control and monitoring systems to minimize such risks. 100 Short-term trade financing facilities--whether from the financial sector or offered by clients and suppliers. In some cases, the processor supplies seed, fertilizer, machinery services, and other inputs required. The credit is repaid by delivering product to the processor. Public Expenditures in Agriculture 6.38 The public sector, especially through policy and public expenditures, has a critical role to play in the development of Kosovo's agricultural sector. Despite the fact that the Agriculture and Rural Development Plan was approved, the financing of all the proposed activities remains uncertain. The Medium-Term Expenditure Framework (MTEF) for 2008­10 provided only a small fraction of the annual public allocation needed for agriculture (Table 26). The MTEF 2010­12 has partly addressed this problem: agriculture spending was increased by some 50 percent in 2008 and reached about 10 million. Still, the sector receives much larger financial support in the rest of the region, which puts Kosovar producers at a disadvantage. This can party be explained by the fact that some SEE countries are much closer to EU accession, and providing greater support to this sector is in accordance with EU's agriculture policy. Table 26: Allocation to Agricultural Budget, Regional Comparison (2007) Agriculture Ministry Average Share of Administ Share of budget staff monthly salaries in ration administration ( million) salary agriculture cost/ costs in agriculture budget (%) staff budget (%) Kosovo 6.4 609 223 25 4,872 46 Montenegro 12.6 123 450 5 7,021 7 Serbia 207 964 640 4 35,342 16 FYR 25 430 514 11 7,468 Macedonia 13 Albania 50 1,350 467 15 12,499 34 Source: World Bank (2008a). 6.39 However, allocation of resources determines the effectiveness of agriculture spending: there is no evidence that price subsidies for outputs or inputs such as fertilizer, irrigation, energy, or pesticides promote long-term growth. The biggest problem with market subsidies is that they put bureaucrats and politicians in the position of "picking the winners." This can lead to mistakes, costly distortions in the market, and waste. In fact, market support in the form of subsidies may actually delay sector modernization, because badly designed instruments can encourage noncommercial farmers to stay in the sector regardless of their productivity.67 In transition economies, subsidies have not been effective in improving agricultural terms of trade. Agriculture market price policies are not appropriate for pursuing either growth or distributional objectives. These policies are nontransparent; eventually paid for 67 In Bosnia and Herzegovina, for example, direct subsidies for a number of agricultural products are being provided in both entities and the cantons, with levels increasing since 2004. Production-linked support still makes up more than 70 percent of the Federation of Bosnia and Herzegovina's support to agriculture, compared to 25 percent in the Republika Srpska. Although no time series are available for agriculture spending at lower levels of government, there is anecdotal evidence that cantons and municipalities have also increased spending on subsidies. But Bosnian agriculture has shown no signs of improved average competitiveness. 101 by consumers; create market distortions; and incur a higher fiscal cost than other income transfers. Moreover, a small share of producers usually receives the bulk of the subsidies. 68 It is far more effective to design instruments and support systems that allow winners to emerge, namely through public goods and services, decoupled payments, and investment support (Fan and Rao 2003; Lopez and Galinato 2007) Despite this evidence, investment in growth-enhancing public goods, such as advisory services, is still limited. Although services are generally a better investment, only 5 percent to 8 percent of the services budget is allocated for research, with even less allocated for advisory services. 6.40 Agriculture support should be targeted toward public investment in public goods. Reliable and cost-effective infrastructure in rural areas is a precondition for investment in agro- processing, and should be a priority for improvement, especially for the energy sector. These investments are a responsibility of the Kosovar government, but could be based on the expressed needs and demands of the private sector. In addition to energy and transportation infrastructure, these public goods investments should include irrigation infrastructure, communications infrastructure, public storage facilities, wholesale markets, and laboratory testing facilities. Such investments would increase both the temporal and spatial marketing options available so that farmers can obtain higher prices. Some examples include: · Investing in the establishment of modern, wholesale markets. Major deficiencies in Kosovar logistics that adversely affect horticultural exports are the poor maintenance of roads and the shortage of warehouses and cold-storage facilities. Wholesaling not only facilitates establishing a single price for a commodity, but also performs storage and warehousing functions, and allows economies of scale to be obtained in the transportation of produce. If designed and managed well, wholesale markets can play a vital role in channeling a wide variety of produce to consumers. · Financing or co-financing of certification laboratories to verify the quality of private seed production as well as accredited labs to assist with the implementation and verification of improved sanitary and phytosanitary standards, if regional laboratory facilities cannot be used. 6.41 If the government considers providing direct support to farmers and processors, it would be best to look at future EU policy directions. Kosovo could take a more direct route to where EU agricultural policy is heading by spending more on rural development (Common Agriculture Policy [CAP] Pillar 2) and avoiding increases in market support (CAP Pillar 1). This approach would also help to prepare Kosovo to access EU's financial support under the Instrument for Pre-Accession Assistance for Rural Development (IPARD), which could eventually provide millions of euro for Kosovo's agricultural sector. Both IPARD and CAP Pillar 2 include providing matching grants for investments to enhance competitiveness and help achieve other goals. The rural development measures outlined in the Kosovo Agriculture and Rural Development Plan are consistent with the IPARD and CAP. 6.42 Finally, government should increase its capacity to formulate agricultural policy. It is important to reinforce the capacity of the Ministry of Agriculture through education, training 68 The European Union has estimated that in the EU15 in 2005, about 57 percent of the transfers went to only 6 percent of the producers, and in EU25, about 80 percent of the transfers went to only 20 percent of producers. 102 and technical assistance so that it develops effective policies and support programs. Another priority area is to increase the government's capacity to deal with agricultural trade issues in the context of CEFTA and other trade agreements, so that Kosovo can negotiate more advantageous terms. Also, climate change is, and will become an even more, important policy issue. The Ministry of Agriculture, with the help of donors, should begin increasing its knowledge so that it can build capacity in this area. Kosovo has made some very positive moves with respect to agricultural policy, for example, in 2004, customs tariffs and VAT on most categories of agricultural inputs were abolished, and no taxes or levies are paid on exports. F. KEY RECOMMENDATIONS 6.43 Some of the recommendations for increasing Kosovo's agricultural competitiveness can be implemented relatively quickly and with little cost to public finances, while others will require larger efforts and many years to complete. Prioritizing their implementation should be based on the potential impact, ease of implementation, and degree of current coverage. The action matrix that follows (Table 27) provides a summary of the recommendations for developing the agricultural markets in Kosovo, along with an assessment of the timeframe for implementation and degree of coverage by existing or planned projects. Table 27: Recommended Action Matrix for Development of Agricultural Markets in Kosovo Short-term actions (1­2 years) Activity Current and planned actions Land policies Start implementing the land policy program as set Government has approved strategy out in the Kosovo Cadastral Agency (KCA) Strategy and business plan and Business Plan KCA is setting up a new land Record and update land data into electronic information system with donors' databases assistance Continue and expand the land consolidation MAFRD is running a project, but program started in the 1980s which facilitates better coordination with KCA is willing participants to exchange, buy, and sell land needed parcels Business climate Increase rural finance access MAFRD manages a grant program Complete privatization of agricultural SOEs in favor of farmers Support linkages between farmers and processors Some associations have been through the establishment of producer organizations established with the support of Implement a system of warehouse receipts USAID-funded programs Improve contract law and enforcement Input markets Develop a system for domestic/regional testing of Donor-funded activities are plant species to improve their productive supporting the creation of an MIS, characteristics but data are still of poor quality Establish a market information system (MIS) that Donor-funded activities are also includes information on inputs supporting some training events Launch training programs on use of the right mix of fertilizers, pesticides and integrated pest 103 management, and on alternative input management methods Food safety Strengthen the capacity of the Food and Veterinary Government has adopted a new law Agency and its coordination role with other relevant giving more coordination capacity government stakeholders and agencies to the Food and Veterinary Agency Develop institutional agreements on certification and laboratory services with the countries in the region Public expenditures Increase the government's capacity to formulate MAFRD is increasingly allocating agricultural policy more funds for this purpose Allocate public expenditures to more investment- and service-oriented agricultural support MAFRD has started managing a Provide matching grants or co-financing for private grant program in favor of farmers investments with a public good aspect, for example, agricultural storage facilities or milk collection systems Medium-term actions (2­5 years) Activity Land policy Implement the land policy program as set out in the KCA Strategy and Business Plan Business climate Set up one-stop-shops with business administrative and advisory services for farmers in rural municipalities Encourage foreign direct investment by improving the investment climate in Kosovo (see recommendations in Chapters 2 and 3) Food safety Continue adopting an EU-compliant food safety system Develop institutional agreements on certification and laboratory services with the SEE countries Work to integrate fully SPS standards within the region, and remove of non-tariff barriers Public expenditures Invest in extension of business advisory services Support the private sector in adhering to the EU's food safety requirements and enhancing grades, standards, and packaging Introduce the EU's agricultural information system (farm registry and Integrated Administration and Control System) Align agricultural support program to the IPARD objectives Strengthen market-oriented agricultural research and education and develop regional exchange programs Make strategic investments in public marketing infrastructure, such as wholesale markets Invest in testing laboratories to improve standards Long-term actions (5­10 years) Ensure security of land tenure and a well-functioning land market Fully harmonize Kosovo's agricultural policy with the EU's CAP Complete the reform of agricultural education and research system Improve general rural infrastructure, including energy, communications, and transportation 104 Annex 1: BEEPS 2009 Results: Firms Responses on Barriers to Doing Business (2008) Source: www.enterprisesurveys.org. 105 Annex 2: Doing Business 2010 Results: Ease of Doing Business in Eastern Europe and Central Asia Dealing with Trading Ease of doing Starting a Employing Registering Getting Protecting Paying Enforcing Closing a Economy construction across business rank business workers property credit investors taxes contracts business permits borders Georgia 1 1 1 1 1 9 7 9 5 10 19 Estonia 2 9 2 25 6 11 11 3 1 14 8 Lithuania 3 20 6 20 2 11 17 7 4 3 3 Latvia 4 13 9 21 13 1 11 5 3 2 15 Macedonia, FYR 5 2 14 9 14 11 3 1 9 19 22 Azerbaijan 6 5 18 3 4 4 3 15 25 6 13 Cyprus 7 7 8 13 15 20 17 2 2 24 1 Kyrgyz Republic 8 4 3 7 8 4 1 23 22 15 25 Armenia 9 6 7 10 3 11 17 22 16 18 6 Bulgaria 10 12 11 8 12 1 7 12 17 21 11 Slovenia 11 8 5 26 22 22 3 11 14 17 4 Romania 12 10 10 19 20 4 7 20 7 16 17 Belarus 13 3 4 2 5 25 22 27 18 1 10 Kazakhstan 14 17 16 5 9 11 11 8 27 8 7 Montenegro 15 18 19 6 24 11 6 19 8 26 5 Poland 16 23 21 11 19 4 7 21 6 20 14 Turkey 17 14 12 24 10 20 11 10 12 7 23 Albania 18 11 22 16 17 4 2 18 11 22 27 Serbia 19 15 23 14 21 1 15 17 13 23 21 Moldova 20 16 20 22 7 22 22 13 21 5 16 Croatia 21 21 17 27 23 18 26 4 15 13 12 Kosovo 22 27 24 4 16 11 27 6 19 27 2 Bosnia and Herzegovina 23 26 13 18 26 18 17 16 10 25 9 Russian Federation 24 22 27 17 11 22 17 14 23 4 18 Ukraine 25 24 26 12 27 9 22 26 20 11 26 Uzbekistan 26 19 15 15 25 26 25 25 24 12 24 Tajikistan 27 25 25 23 18 27 15 24 26 9 20 Source: World Bank (2010a), www.doingbusiness.org. 106 Annex 3: Transport Infrastructure Review Roads Kosovo is likely to continue experiencing rapid growth in vehicle ownership and use of about 3 percent and 6 percent, respectively.69 As with other European countries, passenger car traffic is likely to grow at much higher rates than commercial traffic. For the main and regional road network, using a base traffic set in 2006 of an annual average daily traffic (AADT) of 10,538 and 4,44870 respectively, in the moderate growth scenario71 the AADT by 2020 will be about 19,500 on the main road network and 8,200 on the regional road network. For the sections where traffic is expected to be the heaviest, particularly around Prishtina, traffic forecasted on the assumption that the two routes (6 and 7) are completed by 2012 yield traffic flows in the range of about 25,000 to 50,000 vehicles per day by the year 2022 (COWI 2006).72 The road network currently extends over 8,000 kilometers (km), but is limited in scope and quality. Kosovo has 630 km of primary roads, 1,295 km of secondary roads, and about 6,571 km of local roads. The road network density of 0.88 km/km2 is above the Western Balkans regional average of 0.56 km/km.2 However, on a different measure of road density (road kilometers per 1,000 people), Kosovo lags behind regional comparators and other lower-middle-income countries. Kosovo is at 4 km per 1,000 people compared to 8.6 km per 1,000 people in transition economies. A recent survey by the Department of Road Infrastructure (DRI) found that 88 percent of the primary road network and 74 percent of the regional road network are in good or fair condition. However, a recent study reported that 94 percent of inspected roads on the local network are in poor or very poor condition and in need of urgent reconstruction. A recent study undertaken by the World Bank in the region clearly indicates that there is a link between good local roads and poverty alleviation in the local communities (World Bank 2008c). The urban transport network is showing considerable signs of strain. The population of Prishtina has doubled over the last decade and is currently thought to be between 450,000 to 600,000 people.73 There are estimated to be approximately 80,000 registered vehicles in the city, and some 200,000 vehicles operating within the municipal boundaries on any given weekday. There is a severe parking shortage in the city center, and only 15 intersections in Prishtina are equipped with traffic lights, which are currently being modernized because not all of them are working. Those that are functioning rely on a system that is over 30 years old and was originally designed in Russia. The economic development in and around Prishtina, and the associated growth in the motor vehicle fleet and its use, is placing a severe and increasing strain on the urban transport infrastructure. 69 According to European Commission Liaison Office to Kosovo (2008d), average growth in the last seven years has averaged 4 percent. 70 The highest observed AADT on a regional road network was used because of insufficient data in 2006. 71 Using a linear annual growth rate of 4.5 percent for all vehicles. 72 Calculation assumes an 80 percent to 2 percent split between passenger cars and commercial vehicles with a pcu unit equivalent of 1 and 2 respectively. 73 Population estimates for Prishtina vary widely depending upon the source. 107 The government's Multi-Modal Transport Strategy and Action Plan has set out an ambitious agenda of capital investments over the long term. The development of the strategic routes 6 and 7 is a high priority for the authorities in Kosovo. The estimated cost for Route 6 is 834 million, and for Route 7, 1.15 billion. In a recent statement of priorities, the government of Kosovo emphasized the importance of improving the transport network and fully integrating it into the regional network (Kosovo 2008). The development of the two routes--which are two routes on the South East Europe Transport Observatory (SEETO) core road network74--are of major importance to Kosovo's economy, and of strategic importance within the region, because they constitute the main links in the regional transport network and neighboring capital cities, while simultaneously connecting the main cities and economic centers within Kosovo (MTPT 2008). Of the two routes, the government of Kosovo has designated the development of Route 7, motorway Vermice­Prishtina­Merdare, as the immediate investment priority. This route, identified as regional Route 7 in the Core Transport Network of SEE, will connect with the Adriatic and Northern Albania, pass Vermice (border to Albania) southwest of Prishtina, and connect at Merdare with Serbia and the Trans-European Network Corridor X in the northeast. The full motorway within Kosovo is approximately 117 km in length, and preliminary estimates put the development cost around 750 million to 1 billion. Designs have been started and completed for Route 7, and some sections are already being upgraded (M9 from Prishtina to Peja and the M2 south of Prishtina) and constructed (first section of Route 7 from the Albanian border to Prizren), financed from the KCB. The government plans to invest 300 million in roads from 2010­12 and to seek additional financing of 480 million for Route 7 and 310 million for Route 6.75 In the same period, the maintenance needs (backlog and current) of regional and magistral roads total 115 million,76 which is much higher than the planned 41 million maintenance allocation for 2010­12.77 While over three-quarters of the road network is under the responsibility of the municipalities, limited resources prevent them from fulfilling their responsibilities. Municipalities receive a general grant from the KCB to cover a wide range of functions. Competing priorities for these funds exist among sectors, and within the infrastructure need: the choice between capital or recurrent expenditures. At the local level, the end result is usually that maintenance loses out in favor of other sectors or in favor of new construction. There are also problems with capacity at the local level, mainly in terms of technical capabilities and financial planning. The MTC implemented a significant program of capital works in 2008, 78 co-financed with the municipalities, to begin to improve the condition of the local road network, but sustainability remains an issue. An additional issue is the inadequate maintenance of "transit" roads, or regional and main roads that cross municipalities. While the MTC provides funding to municipalities for new construction of these roads, their maintenance under the current law is technically the responsibility of the municipalities. This is different from the practice within the 74 SEETO has created a regional consensus to address the problems and develop a core transport network in the region comprising the Trans-European Networkcorridors in the region and other strategic routes connecting national capitals, regional centers, and the main ports and border crossings. 76 HDM-4 analysis of Kosovo road network provided by MTC in September 2009. 78 The 2008 budget allocation is 17.2 million. 108 European Union and elsewhere in the region, where transit roads are built and maintained by the central government. Railways Kosovo has 333 km of a single track, non-electrified rail system with standard gauge, and despite limited maintenance, it is in mostly good or fair condition due to limited traffic. The track runs through many mountainous terrain areas necessitating numerous tunnels and bridges. Principally, there are two lines (north to south) and (northeast to west). The north­south line traverses the country from the border with Serbia (station Leshak) to the border with FYR Macedonia (station Hani i Elezit) for a total of 148 km on the SEETO core Route 10. The northeast­west line comprises three branches: the east line from the border with Serbia (station Podujeve) to Fushe Kosove totals 45 km; the west line from Fushe Kosove to Peje totals 81 km; and the west­south line from Klina to Prizren totals 58 km (Table A3.1). The maximum speed limit is 70 km per hour (km/h), even though the geometry of parts of the network would permit speeds of up to 160 km/h, although investments on tracks to reach the latter speeds appear unjustified by the forecasted traffic. Reconstruction has been the main objective of donor assistance to date, focusing on urgent repairs to the main network, leaving the issue of the maintenance backlog unaddressed. The signaling system is in the process of being refurbished. Table A3.1. Location and Length of Railway Lines in Kosovo Line Section Length Status (km) Fushe 62.8 South Hani I Elezit Open for cargo and passenger Kosove Fushe 78.5 North Leshak Limited operationa Kosove Fushe 81.2 Peje Open for cargo and passenger West Kosove Kline Prizen 58.3 Limited operationb Fushe 14.2 Bardhosh Open for cargo East Kosove Bardhosh Medare 38.0 No operation Total 333.0 Source: Kosovo Railways Business Plan and Medium-Term Expenditure Framework 2010­2012. a. Kosovo Railways is not allowed to operate north of Mitrovica. b. On this line, trains operate on the Kline Xerxe section. Although freight transport had started operating on the northern line, transport on the northern line from Zvecan up to the border of Serbia was terminated in 2008. This section of the northern line was "occupied" by Serbs in the north after the February 2008 independence declaration, and, as a result, trains owned by Kosovo Railways, which manages the railway infrastructure in Kosovo and operates passenger and freight services, operate up to Mitrovica, 109 but do not link Zvecan to the northern part of Kosovo.79 Instead, Serbian Railways operates three return trains daily between Zvecan and Krajlevo, and one between Zvecan and Belgrade. The rolling stock is generally old and in poor condition, except for some donated passenger coaches and locomotives and some recent acquisitions.80 The entire fleet amounts to 9 locomotives, 4 sets of diesel multiple units (DMUs), 13 passenger carriages, and 18 freight wagons. Eight out of the nine locomotives date from the 1960s or earlier--one of them is out of operation--but are in reasonable condition due to good maintenance. Few resources are currently being expended on maintenance of and investment in the railway network, in large part due to financial constraints and uncertainty over the development of the regional transport treaty.81 However, the opening of strategic regional networks or the development of new extractive industries and the need to move heavy bulk freight are expected to lead to increased demands for investment in both railway infrastructure and rolling stock. An intermodal logistical platform is operated in Miradi, 15 km southwest of Prishtina. KR started the development of container terminals in 2004. In 2006, 1,105 containers passed through the terminal, rising to 1,188 in 2007, before declining to 941 containers in 2008. The main reason for the decrease in container traffic was the long strike in the port of Thessalonica in 2008, which had a direct effect on the number of containers transported. Container terminal services generated significant revenues, equal to 170,883 in 2008; in comparison, freight transport generated 3.45 million the same year. Through this container terminal, KR offers intermodal traffic transport, which allows it to compete with the road sector. The government's Multi-Modal Strategy and Action Plan also has an ambitious railway investment plan, although this is smaller in scale than the roads investment program. In the current MTEF, railway projects have not been allocated funds from the KCB. The stated objective is to raise speed in this corridor to 160 km/hr, which will require, among other things, electrification and the construction of a second railway track on a number of sections. The total value of the necessary investment is estimated at about 470 million. However, the cost could be considerably reduced if it was decided to raise speeds to 120 km/hr, or less, which would be more in keeping with the composition and level of current and projected traffic. The railway investment plan should also be complemented by institutional reforms in the sector. There was significant progress on the legal and regulatory framework for the railway sector in 2008. The new law (June 2008) aims to bring the national legislation closer to the railway acquis communautaire.82 The most significant application of the new law concerns the separation of KR into two bodies--one in charge of operation and maintenance of infrastructure and one in charge of train operations. To implement this section of the law, in 2009 the government started the legal preparations for creating two joint stock companies: the Kosovo Railways Infrastructure J.S.C, (INFRAKOS) and the Kosovo Transport Railways Operations 79 In December 2005, Kosovo Railways, previously known as UNMIK Railways, was transformed into a railway company with the name Kosovo Railways Joint Stock Company. 80 The railway has recently purchased one new G1700 diesel locomotive and pre-owned diesel multiple units (DMUs) from Sweden. 81 In 2008, Kosovo Railways posted net income--income minus operational expenditures--of 1.24 million. 82 The acquis communautaire contains all relevant EU legislation (directives, regulations, and so forth) in this sector. 110 J.S.C., (TRAINKOS). However, the Council of Ministers has yet to approve the legal separation. The law also foresees the creation of an independent railway regulatory authority to regulate the railway sector. A number of key institutional railway sector reforms are necessary. At present railway related issues in the MTC are handled within the Railway and Civil Aviation Department. Key reforms that are necessary to develop the railway sector include: The creation of a railway department within the MTC, funded by allocation in the budget. The new railway department should draft legislation for the establishment and supervision of the railway regulatory authority, licensing body, safety authority, and accidence investigation body as specified in the EU rail acquis.83 The railway department should draft a railway act approved by the MTC. Separate the management and accounting operations and infrastructure of Kosovo Railways and then create separate companies. 83 The government has appointed consultants to help establish the railway regulatory authorities and is planning to have them created by the end of 2010. 111 Annex 4: Case Studies A National Freight Forwarder--The Trip from the Port of Bar to Prishtina The freight forwarder imports agricultural goods to Prishtina from abroad via the Port of Bar in Montenegro, a distance of 182 km. In order to import it is necessary to obtain an import license, which costs 24, and there are additional unofficial payments as well. If imported goods arrive and the importer has yet to obtain the license, the official in charge of inspecting these goods can obtain a license, and charge 60, without giving a receipt. This can be problematic, as the freight forwarder cannot prove to the client this additional expense. Port charges are about 200­300 per container and it takes up to two days for the ship to be unloaded and one day for the container to arrive at Peja by truck (typically 24 tons). The transit fee has been abolished and there are no unofficial payments at the port, but there is an ecological payment of 10­25. The truck driver declares at the port that the cargo is transiting to Kosovo; a seal is placed on the transit consignment and it is verified that the consignment fulfills Montenegro's consignment transit requirements. The total cost of transportation between the Port of Bar and Prishtina is between 1,200 and 1,300. It is also circuitous, as the route taken is a mountainous one, whereas the flat primary road would be the quickest, but cannot be travelled because it would require entering Serbia. An additional 20 is paid to the traffic police in Montenegro. At the border in Montenegro, officials check documentation and verify that the transit seal is unbroken, a quick process that takes under 30 minutes, and the truck then proceeds to the Kosovo border in Kulle. At the border, there are many other trucks and the waiting time is about one hour. In Kulle, customs and police check the truck and documentation, a procedure that takes about 10 minutes, and if everything is in order, the truck is allowed to go 18 km to a customs terminal in Peja, where customs clearance takes place. The cost for staying in the customs terminal is 41 per day, although in practice it takes between 4 to 5 hours for customs clearance. A Potato Processing Company The company cultivates and sells potatoes and produces potato chips and french-fries. Until 2006, Romania was the largest market, but following its accession to the European Union, the firm could not export because it failed to meet the required standards, but once it met these standards in 2008, exports to this market resumed. Since 2008, the firm has been dealing with the fact that Serbia does not accept phytosanitary certificates issued by Kosovo. Major export markets include Albania, FYR Macedonia, and Montenegro. About half of inputs are imported, and a similar amount of finished products are exports. Among the major difficulties faced by the company when exporting potatoes to Tirana are the poor quality of roads from Prishtina to Tirana and measures taken by Tirana to protect domestic producers. The reference price for a kilogram of potatoes is 0.18, while the real cost fluctuates between 0.07 to 0.30, considerably raising the VAT paid by the company. The company reported no problems in exporting potato chips to FYR Macedonia. It is noteworthy that in both cases border crossing issues are not perceived to be the main problems, and that the key issues are road infrastructure and high transport costs. 112 Wine Exporter This case study focuses on a wine exporter that exports over 90 percent of its produce, with about 40 percent of its sales going to Germany. Prior to 2008, 25 percent of sales were exported to Serbia, but following the declaration of independence this has ceased because Serbia does not recognize Kosovo's customs stamp. The company imports about 20 percent of its inputs, mostly corks and bottles from Italy and from neighboring CEFTA countries. Among the problems faced by the wine exporter are increased transport costs, because wine must be shipped through Montenegro, Bosnia and Herzegovina, and Croatia instead of through Serbia, raising the costs of transporting a truck full of wine from 2,000 to 3,000. Previously, with UNMIK customs stamps, it was possible for trucks from Kosovo to transit through Serbia. Transport costs increased from about 15 percent to 23 percent of the consignment value for mid-quality wines, while the travel time to Germany doubled to two days, up from one day. The additional costs are difficult to absorb for a brand that has low prices as its key selling point. Other issues cited as problematic are the unreliable supply of electricity, requiring the purchase and use of generators, and cumbersome VAT and customs duty payments. Despite the fact that the company usually exports nearly the totality of its produce, it still has to pay VAT and customs duty on all their imported inputs (bottles and corks). VAT reimbursement is cumbersome because tax authorities request a copy of their EU purchaser's import declaration, which is not always easy to obtain. 113 Annex 5: List of Recommendations Based on the Transport and Trade Facilitation Audit The simplified transport and trade facilitation audit that was conducted in the second half of 2009 proposes the following measures to improve overall trade performance. Customs Short-term measures Development of a value database to reduce appeals concerning customs valuation. The relatively low percentage of accepted transaction values by Kosovo Customs points strongly to the need for such a database. In turn, this should help reducing customs clearance delays associated with customs valuation. Reduction of customs tariff on imported electricity generators, which are vital for business operations in Kosovo. Introduction of a relief clause that allows transit by entities that are not established in Kosovo. Medium-term measures Establish an electronic customs clearance process. As soon as the necessary regulatory framework for an electronic signature is established, Kosovo Customs should consider switching from today's combination of electronic and paper-based customs clearance process to a fully electronic process. Kosovo Customs and tax authorities should improve cooperation to speed up VAT rebates on exports. Introduction of the AEO concept and a system for pre-arrival and pre-departure processing of documentation. Improving customs risk analysis to focus on high-risk cargoes. New risk profiles are needed to ensure a reduction in the level of physical inspections, which will reduce the time spent at borders. Truckers should be informed in writing of the outcome of their automated risk analysis every time their declaration is processed. This is a widely accepted procedure that improves transparency. Other Border Agencies Short-term measures Ensuring the working times of different border agencies are aligned. Border crossing times and costs could be reduced by a combination of the following measures: VFAK 114 operating on Saturdays and Sundays at the busiest BCPs so that working hours are with the same as those of customs and making the major border crossings operational on a 24/7 basis by increasing working hours and cooperation among customs, the food and sanitary agencies, and commercial banks. Given the costs, this could be introduced in Hani i Elezit and Kulle as pilot projects. Simplification of cargo-handling rules at customs stations. Cargo-handling rules at customs stations should be simplified to allow smaller transport vehicles to leave customs station before the custom clearance process is completed. Increased recognition of the quality and sanitary certificates of neighboring countries. Medium-term measures Implementation of the government's IBM strategy. This includes increasing the number of joint operations; organizing and implementing joint actions based on risk analysis; and training on border agencies' laws. Establishment of joint border stations with neighboring countries. It may be useful to initiate collaboration with neighbors to identify border crossings where clearance times could be reduced by having joint border stations. Continued upgrading of customs stations and border crossings infrastructure. Continued development of the institutional framework to ensure accreditation, certification, and standardization are developed and applied effectively. Conformity assessments are necessary to assure compliance with standards, including third-party conformity assessment activities such as testing, inspection, and certification. Building conformity certification infrastructure is expensive and it is not clear whether Kosovo has the fiscal space necessary. Instead, the possibilities of using neighboring countries' infrastructure should be considered. Road Transport Services Following are the key recommendations to strengthen the trucking sector: --Improve the recording of licenses --Require own account operators to adhere to operational standards --Encourage the industry to establish a body to represent the road transport industry --Ensure that vehicle inspections are conducted in conformity with the law and establish roadside checking of all vehicles on a random basis. 115 Annex 6: Increasing Female Labor Supply and Existing Social and Cultural Norms The traditional understanding of gender roles within family and society restricts the access of women to the labor market. These range from social perceptions surrounding women, such as the woman's role is in the home and certain jobs are not suitable for women; the social acceptability of the job will be questioned by the immediate family and social circle; societal approval is crucial. To learn more about these social and cultural norms, how they affect female labor and how policies can help to increase female employment given these norms, the World Bank conducted a qualitative survey of men and women in 2008. Although most women in the survey have never worked, the majority would like to work to gain financial independence and support their family, but a number of women reported frustration in their efforts to combine work with household responsibilities. Most women would like to work and believe that their biggest obstacle to employment is their low level of education. When asked if working women had enough time to also take care of their home and family, female participants expressed varying opinions. Some female participants believed this should not be a problem, as other female members of the household could help. However, other women believed that work could have a significant impact on the family, and on the way children are raised, especially if women work for eight or more hours. Although most men expressed a positive opinion about working women, particularly during difficult times, a number of women reported refusing job offers because of negative perceptions about women working. Opinions were divided regarding the influence of cultural importance and social norms in shaping the position of women in society. While existing perceptions about women's work are hard to change (at least in the short run), there is room for policies that promote female employment opportunities around these perceptions (for example, working with other women and work from home). Another policy that may be helpful in promoting employment for women is the availability of childcare facilities outside of Prishtina. The government could introduce a measure that would encourage the establishment of childcare centers. This could be achieved by promoting early childhood development (ECD), such as preschool education and affordable childcare. Subsidizing childcare and preschool education has several advantages (see Box A6.1). First, access to preschool education, in preparation for school constitutes an important proxy for education quality. International evidence suggests that high-quality early childhood education and care helps prepare young children to succeed in school, and later in life. Second, investments in early education have been shown to provide great economic returns because they are associated with lower repetition and dropout rates throughout a student's lifetime. Third, developing a preschool industry could be economically important because it would create jobs and allow more parents, particularly mothers, to enter the job market. 116 Box A6.1. Public Childcare Programs in Chile and Colombia "Chile Grows with You" (Chile Crece Contigo) The government of Chile launched a social policy initiative in 2006 promoting full support for the country's children from birth. Through it, boys and girls are protected from the moment of conception with relevant and timely services that allow for early stimulation and provide opportunities for their comprehensive development. Under the policy, Chilean children from the poorest families are eligible to attend daycare centers and preschools for free. The aim is to ensure that all children have access to primary health care and that all the families receive tools to better support the growth of their children, not only in terms of health and nutrition, but with psychological support as well. Chile Crece Contigo offers educational programs for all citizens, including specialized aid in education; strengthened legislation and standards of protection for maternity and paternity; and accompaniment for all boys and girls from the first prenatal control until entry into the school system through improved prenatal controls, healthy birth, and improved health controls, especially for the first two years. The program offers direct action to help the poorest 40 percent of households--those who make less than 300,000 pesos (about $560) per month. Colombia's Community Mothers In the mid-1980s, the Colombian government, alarmed by very high rates of infant mortality and malnutrition, launched this far-reaching program to protect preschool-age children, with the help of the United Nations and the Inter-American Development Bank. Welfare centers were created that were run by volunteers known as "community mothers" who organized, on their own or with the help of NGOs, education and care facilities for about 3,000 children. Each mother takes about 15 children into her home and gets the equivalent of about half the legal minimum wage (about $130 a month) and the right to social security and a pension. As a rule, the mothers look after the children between eight in the morning and four in the afternoon, Monday through Friday. They organize their day themselves, guided by the Colombian Institute for Family Welfare educational aims, which focus on making the children aware of values such as solidarity, friendship, and respect for differences. Before being hired, the mothers take a short course to prepare for their future role and take a self-assessment test. The mothers, who now number 82,000, are becoming increasingly important and are in great demand by families disrupted by the violence, which, as of January 1998, had forcibly driven 1.1 million people (42,000 families) from their homes. Source: Female Labor Force Participation in Turkey: Trends, Determinants and Policy Framework (World Bank 2009c). 117 Annex 7: Migration Survey Data and HBS 2009 The Migration Survey is a unique module conducted to match with HBS data of 2009. The Migration Survey took place in April, May, and June of 2009; 2,024 households completed migration survey, out of 2,536 of those who had participated in the HBS. By design, the sample of households selected for HBS is representative of the population at the strata level of region, broken down by rural and urban areas, and ethnic Albanian and Serbian areas, a total of 19 strata. At the time of the analysis, only a limited number of records were available from HBS, so the match between the HBS and the Migration Survey is a sub-sample of total households (i.e. those households for which HBS data was available). Thus, the results based on the matched sample should be seen as preliminary and one should be cautious in drawing conclusions from it. The analysis should be repeated once the full sample of HBS 2009 becomes available. The total number of migrants can be more accurately estimated after the 2011 census is conducted in Kosovo. This report is based on new population estimate from the Migration Survey 2009, with an updated master sample. This differs from estimates used by previous analytical studies, including the estimates used by the World Bank. The last full population census in Kosovo was in 1981. Since then, various methods have been used to estimate the population. From 2000 until 2008, the population was estimated to be 2 million, and various studies were based on this number. However, in 2009, the sampling methodology included an updated master sample with an accurate sampling frame and enumeration areas. This report is based on this new sampling. This report also assumes that the population from the HBS 2005/6 (estimate of 1.6 million) was most likely accurate, and this number is not adjusted (for example, it is not post-stratified to 2 million as in some of the previous reports). Therefore care should be taken when comparing the aggregate estimates of the present migration study and previous studies. Roughly 25 percent of current migrants originate from Prishtina (Table A7.1). Over 35 percent of households in Peje and Prizren have migrants; migrants from these two regions represent about 33 percent of the total migrants. Share of households that have migrant relations in Prishtina has doubled since 2005 (increased from 14 percent to 26 percent of households). 118 Table A7.1. Total Number of Migrants by region of Origin, 2005 and 2009 Percent region 2005 2009 Change change Gjakove 28,016 22,397 -5,619 -20 Gjilani 21,017 15,256 -5,761 -27 Mitrovice 33,668 25,548 -8,120 -24 Peje 24,927 26,786 1,859 7 Prizren 33,812 38,182 4,370 13 Prishtina 25,632 47,614 21,982 86 Ferizaj 15,549 20,104 4,555 29 Total 182,621 195,888 13,267 7 Source: HBS 2005 and Migration Survey 2009. Table A7.2. Share of Migrants by Country of Residence, 2005 and 2009 Migration Percent destination 2005 2009 Change change Diff Macedonia, FYR 7.4 7.4 0.1 1 Switzerland 15.7 21.8 6.1 39 Germany 45.0 36.0 -9.0 -20 United Kingdom 7.8 3.0 -4.9 -62 Other Europe 15.2 27.6 12.5 82 *** United States or Canada 6.3 3.4 -3.0 -47 Other 2.6 0.8 -1.9 -71 Total 100 100 Source: HBS 2005 and Migration Survey 2009. 119 Table A7.3. Household Characteristics by Status of Remittances Reception Household characteristics by status of remittances reception Remittances Non-Receiving Household Characteristics Receiving Remittances Household is Albanian 94% 92% Household in Rural areas 73% 54% *** Number of household members 6.0 6.2 Male headed household 92.0% 96.0% * Age of household head (years) 53.7 51.2 * Number of household members aged between 0 and 14 years old 23.0% 25.0% between 15 and 65 years old 68.0% 68.0% between 66 and 99 years old 9.0% 7.0% Education average of the members (years) 9.3 9.8 * Education of the household head (years) 10.9 11.2 Main source of income is ... Wages salaries public sector 20.0% 29.0% ** Wages salaries private sector 11.0% 20.0% *** Farming 9.0% 6.0% Per diem work 5.0% 12.0% *** Other household business 9.0% 12.0% Pensions 7.0% 9.0% Remittances from abroad 34.0% 0.0% *** Social assistance 2.0% 4.0% * # of rooms in use (inc bathroom and kitchen) 4.1 3.7 *** Dwelling has ... walls of block, bricks or cement 98.0% 97.0% central heating 7.0% 9.0% indoor water taps 91.0% 93.0% flush toilets 85.0% 89.0% electricity 99.0% 99.0% telephone connection 25.0% 30.0% kitchen 85.0% 87.0% bathroom 80.0% 84.0% major damages 1.0% 3.0% * Land area, # ha 0.8 0.7 Observations 208 645 Source: Staff estimates based on matched Migration Survey 2009 and HBS (6 months) Note: *** Significantly difference at 1 percent of significance, ** 5 percent, * 10 percent. 120 Table A7.4. Education Level of Head of Household (percent ) Households Households Differ Education level Receiving not receiving ence remittances remittances None 7 7 Primary 46 30 *** Secondary 33 47 *** Postsecondary 13 16 Average (years) 15.3 15.7 Observations 208 645 853 Source: Migration Survey and HBS 2009 (first six months). The education level of the head of the households not receiving remittances seems to be higher. Though the share of those household heads who have an education level higher than secondary is almost the same, the share of secondary completed is significantly more for households not receiving remittances (Table A7.4). Table A7.5. Differences in the Monthly Earnings (in euro) by Migrant Type Skills Migration type High Medium Low Total (percent) Returned migrants 422 398 331 353 9.3 Difference between return migrants and non- migrants * *** *** Non-migrants 309 263 238 263 65.9 Difference between non-migrants and current migrants *** *** *** Current migrants 1,760 1,545 1,672 1,676 24.8 Difference between current migrants and return migrants *** *** *** Total 380 484 535 492 Observations (percent) (24.9) (9.9) (65.2) (100) Source: Staff estimates using World Bank Migration Survey (2009). 121 Table A7.6. Expenditure Shares in Total Expenditure Expenditure Shares in Total Expenditure Non- Remittances Receiving Type of Expenditure Receiving Remittances Current consumption 0.80 0.82 Food & beverages 0.48 0.52 ** Consumer goods 0.14 0.13 Furnishings/HH Equipment 0.04 0.04 Transport & communications 0.08 0.07 * Miscellaneous 0.06 0.05 Durables 0.00 0.01 Human capital investments 0.06 0.05 Health 0.04 0.03 Education 0.02 0.02 Investments 0.00 0.00 Home Investments 0.00 0.00 Business Investments 0.00 0.00 Others 0.12 0.11 Insurances 0.00 0.00 Taxes and pensions 0.01 0.02 *** Rent 0.00 0.00 * Self-consumption (food) 0.11 0.09 Sum 1.00 1.00 Source: Staff estimates from Migration survey and HBS 2009 (6 months) 122 Annex 8: Agriculture Sector Analysis Table A8.1: Comparative advantage estimates for selected Kosovar crops (domestic resource costs) Product Domestic Resource Cost Onion 0.08819 Potato 0.08177 Tomato 0.09381 Cabbage 0.30889 Apples 0.14015 Pepper 0.14064 Plum 0.11397 Grape 0.32377 Pear 0.15511 Note: the lower the DRC, the lower the relative cost of production, and the greater the international comparative advantage. A DRC of less than one for a product indicates that a country should have a comparative advantage in its production. Source: own calculations Table A8.2: Prices Kosovar farmers receive for outputs relative to international prices (nominal rate of protection) Product Nominal Rate of Protection Onion -46.43 Potato -37.50 Tomato -23.08 Cabbage 15.38 Apples 37.93 Pepper 29.41 Plum -2.44 Grape -16.67 Pear 32.08 Source: own calculations Table A8.3: Calculations of effective rates of protection for selected outputs Product Effective rate of Protection Onion -75.218 Potato -70.719 Tomato -22.745 Cabbage 20.980 Apples 40.401 Pepper 35.452 Plum -10.417 Grape -25.238 Pear 52.310 Source: own calculations 123 Table A8.4: Calculation of Average Standard Gross Margins and Expense Ratios Ratio Unit Yield Own Stand Gross Crop Yield (t) Income Expenses Expenses/ Price () Value () Consumption Margin Income Potatoes 30,000 0.15 4,500 17.50 4,500 2,936 1,564 0.65 Tomatoes 30,000 0.30 9,000 7.70 9,000 4,014 4,986 0.45 Cabbage 30,000 0.15 4,500 11.40 4,500 2,343 2,156 0.52 Maize 4,000 0.30 1,200 2.00 1,200 746 454 0.62 Winter wheat 4,500 0.25 1,125 200.00 1,125 553 572 0.49 Barley 3,000 0.25 750 - 750 441 308 0.59 Apples 24,000 0.40 9,600 7.80 9,600 2,754 6,846 0.29 Eggs 292 0.08 23.36 300.00 23 16 7 0.69 Grapes Wine 12,000 0.45 5,400 - 5,400 2,339 3,061 0.43 Grapes Table 12,000 0.45 5,400 5.00 5,400 2,339 3,061 0.43 Pears 12,000 0.70 8,400 4.20 8,400 2,364 6,036 0.28 Pepper 20,000 0.44 8,800 13.00 8,800 3,810 4,990 0.43 Onions 30,000 0.15 4,500 7.30 4,500 2,810 1,689 0.62 Beans 10,000 1.50 15,000 5.20 15,000 2,292 12,708 0.15 Orchard Seedlings 30,000 1.00 30,000 - 30,000 3,530 26,470 0.12 Watermelon 36,000 0.12 4,320 8.00 4,320 1,655 2,664 0.38 GH Tomatoes 80,000 0.20 16,000 16,000 5,611 10,389 0.35 GH Vegetable 300,000 0.25 75,000 75,000 5,114 69,886 0.07 Seedlings Plums 20,000 0.40 8,000 2.10 8,000 2,664 5,336 0.33 GH Peppers 40,000 0.44 17,600 17,600 3,833 13,767 0.22 GH Cucumbers 100,000 0.11 11,000 5.00 11,000 4,955 6,045 0.45 Sunflower 2,400 0.25 600 600 444 156 0.74 Spinach 16,000 0.20 3,200 1.20 3,200 1,159 2,040 0.36 Leek 16,000 0.60 9,600 5.00 9,600 2,384 7,215 0.25 Garlic 9,600 1.00 9,600 1.00 9,600 3,726 5,873 0.39 Carrot 20,000 0.50 10,000 2.00 10,000 1,752 8,248 0.18 Cucumber 76,000 0.20 15,200 5.00 15,200 2,872 12,328 0.19 Strawberry 15,000 1.00 15,000 3.00 15,000 2,090 12,909 0.14 Honey 15 5 75 2 75 22 53 0.30 Source: SOK (2009), own calculations. 124 REFRENCES Angel-Urdinola, D., and Q. 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World Resources Institute. 2003 (Bosnia and Herzegovina) and Statistical Office of Kosovo (2008). 130 MAP SECTION IBRD 37048 KOSOVO OPSTINA/KOMUNA CAPITALS* MAIN ROADS OKRUG/RRETH CAPITALS** RAILROADS NATIONAL CAPITAL OPSTINA/KOMUNA BOUNDARIES RIVERS OKRUG/RRETH BOUNDARIES INTERNATIONAL BOUNDARIES * The first name is in Serbian and the second one is in Albanian. ** Names of the Okrug/Rreth are the same than their capitals. 20°00' E 20°30' E To 21°00' E 21°30' E Ibar Raska This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other information 0 5 10 20 Kilometers shown on this map do not imply, on the part of The World Bank Group, any judgment on the legal status of any territory, or any endorsement or acceptance of such boundaries. 0 10 20 Miles S ER B I A SE RB SER Iba Leposavic/ “ Leposavic/ r Leposaviq To Prokuplje SERBIA 43°00' N To KOSOVASKA MITROVICA 43°00' N Novi MITROVICA Lab Pazar Zvecan/ Zubin Potok/ Ibar Zveēan Podujevo/ Zubin Potok Podujevė Podujevė Mitrovica/ MONTENEGRO Mitrovicė Mitrovic Kl Reka ina rska To Vucitrn/ Tula To H Berane r Vushtrri g o Leskovac a j l P o d Istok/ Sit a Istog PRISTINA nic a Srbica/ Skenderaj PRISHTINA PEC“ Obilic/ “ Obilic/ Obiliq PRISTINA/ Pec/ Pec/ “ PEJA Kosovo Polje/ PRISHTIN PRISHTINĖ Pejė Glogovac/ Fushė Kosova Fushė Gr ac Klina Drenas an Novo Brdo/ Klina/ ka Novobėrdė Novobėrdė Klin Klinė Kamenica/ Kamenicė Kamenic Beli Drim Sit GNJILANE nic Decani/ a Deēan Mirusa Lipljan/ Dr Daravica Lipjan GJILANI Binacka eni 42°30' N (2656 m) 42°30' N ca Malisevo/ Malishev Malishevė Gnjilane/ ŠAKOVICA Stimlje/ Gjilan To Bujanovac G J A K O VA Orahovac/ Rahoveci Shtime ac ka Šakovica/ Bin Urosevac/ Gjakovė Gjakov Suva Reka/ Ferizaj ga Toplu Theranda UROSEVAC URO SEVAC Vitina/ Beli PRIZREN Viti ALB ANI A A L B NI LBA Drim FE RIZAJI FERIZAJI PRIZRENI Strpce/ Kacanik/ Shtėrpcė Shtėrpcė Kaēanik Prizren/ Prizren hė rd i Ba ini Bi To Dr str Tetovo cai To Kukės Kukės a nin Dragas/ Dragash la P KOSOVO To Sar 42°00' N 42°00' N Skopje OF FY R OF MA CEDO NIA CEDONIA 20°00' E 20°30' E 21°00' E 21°30' E JULY 2009