Report No. 38570-BG Bulgaria Accelerating Bulgaria's Convergence The Challenge of Raising Productivity (In Two Volumes) Volume II: Main Report July 2007 Poverty Reduction and Economic Management Unit Europe and Central Asia Region Document of the World Bank and CulturalOrganization MES Ministry of Educationand Science USPTO United States Patent and Trade Mark Office MLSP Ministry of Labor and Social Policy Vocational Educationand Training MOF Ministry of Finance VETA Vocational EducationandTrainingAct NAVET National Agency. for Vocational VocationalTrainingCenters Educationand Training World Trade Organization Vice President: Shigeo Katsu, ECAVP Country Director: Anand K. Seth, ECCUS Sector Director: Cheryl Gray, ECSPE Sector Manager: Bernard Funck, ECSPE Task Team Leaders: Satu Kahkonen, ECSPE Peter Miovic Table of Contents 1.THE CHALLENGEOFINCREASINGPRODUCTIVITY ........................................................... 1 .......................................................................................................... 2 111. IMPLICATIONSOF BULGARIA'SDEMOGRAPHIC TRENDSFORSECTORAL REFORM ..................... 11. 1. TACKLINGTHECHALLENGE OF INCREASINGPRODUCTIVITY ...................................................... OBJECTIVE OF THEREPORT 3 w. 5 IMPLICATIONS OF THE INCREASING ROLEOF KNOWLEDGE A DRIVEROF GROWTH ...........................................................................................................................FOR AS V. THEROADMAPFORTHERESTOFTHEREPORT........................................................................... SECTORREFORM 7 9 2.PRODUCTIVITYTRENDS INBULGARIA ................................................................................ 11 I. 11 111. OUTPUTGROWTH THE SECTOR LEVEL I1. PATTERNSOFOUTPUTGROWTH 2000-2005 .......................................................................... ACCOUNTING............................................................................................................... IN GROWTH 12 AT DURING2000-2005.................................................. 13 A. Value-added and TFP Growth by Sectors............................................................................. 14 B Decomposition of Productivity Growth................................................................................. . 16 I V.CONCLUSIONS AND POLICY RECOMMENDATIONS ...................................................................... 19 3.IMPROVINGPRODUCTMARKETREGULATION ................................................................. 29 I. RATIONALE FOR IMPROVING PRODUCTMARKET ................................................. 29 A. Product Market Regulation. Investment and Productivity.................................................... REGULATION 29 B. Regulation of Product Markets and Innovation.................................................................... C. Regulation of Product Markets and Labor Market Performance and Functioning..............31 32 11 REGULATIONOF PRODUCTMARKETSBULGARIA . lN ................................................................... A Overall Product Market Regulation...................................................................................... . 32 32 B. Barriers to Tradeand Investment.......................................................................................... 34 C. Barriers to entrepreneurship ................................................................................................. 37 42 w. 111. REGULATIONANDQUALITY OF INSTITUTIONS D. StateControl.......................................................................................................................... .......................................................................... 44 SUMMARY ANDDIRECTIONS REFORM FOR ................................................................................ 45 4.IMPROVINGTHE FUNCTIONINGOF LABORMARKETS ................................................... 49 I LABOR . ....................................................................................................... A. Labor Force Participation and Employment Rates............................................................... MARKET DYNAMICS 49 SO B. Informal Employment and Self-employment ......................................................................... 51 52 53 E. Youth Unemployment............................................................................................................ D. Trends in Unemployment....................................................................................................... C. Participation Rates by Gender andEducation...................................................................... F. Regional Disparities.,............................................................................................................ 54 55 56 I11. EMPLOYMENT I1. G.Labor Potential of the Currently Inactive Population .......................................................... LABOR COSTS,WAGEDYNAMICS, ANDMINIMUMWAGES....................................................... 56 ANDSOCIAL INSURANCE . SYSTEM....................................................................... 58 V. IV. LISBON STOCKHOLM EMPLOYMENT A Unemployment Traps ............................................................................................................ 59 AND TARGETS ................................................................... 61 CHALLENGESFORLABORMARKET A. Institutional Constraints........................................................................................................ POLICIES ............................................................................ 62 62 B. Improving Employment Se~ices ........................................................................................... 63 67 D.Adult Education and Training............................................................................................... C. Employment Regulations....................................................................................................... E. Improvements in Labor Market Statistics.............................................................................. 70 72 VI. CONCLUSIONSANDPOLICY RECOMMENDATIONS ...................................................................... 72 5. GOVERNANCEAND FINANCEREFORMSINPRIMARY AND SECONDARY EDUCATION .................................................................................................................................... 77 1. I1. THEREFORMCHALLENGES......................................................................................................... 77 THEAGENDAFORFINANCEANDGOVERNANCE REFORM ......................................................... 81 A. The Current Primary and GeneralSecondaryEducation System: Input-oriented and Centralized......................................................................................................................... 82 B TheNew Primary and GeneralSecondaryEducationSystem: Outcome-orientedwith Self . 83 IV. WHATHAS 111. INCREASINGBEEN managingSchools.............................................................................................................. EFFICIENCY PRIMARY ANDGENERALSECONDARY EDUCATION...................... ACCOMPLISHEDSoFAR?............................................................................... IN 85 v. POSSIBLEFISCALIMPACT ................................................................................ 87 VI. POLICYRECOMMENDATIONS OF THEREF0RM ...................................................................................................... 89 90 6. IMPROVING VOCATIONAL EDUCATIONAND TRAINING ................................................ 93 I1. I.THESTRUCTUREANDORGANIZATIONOFTHEVETSYSTEM......................................................... GOVERNANCE THEVETSYSTEM ........................................................................................... 94 OF 98 111. CONTINUINGVOCATIONAL . EXPENDITURES EDUCATION ANDTRAINING............................................................ 99 V. EMPLOYMENT GRADUATESONVOCATIONAL EDUCATION......................................................................... 100 VI. THELINKTo THELABOR OF ................................................................................................. 100 VI1.OCCUPATIONALLY-ORIENTED ALTERNATIVESECTOROF TERTIARYEDUCATION...................101 MARKET .......................................................................................... VI11. 102 OPTIONS FORREFORM OF VOCATIONAL SECONDARY EDUCATION ................................ 103 7. STRENGTHENINGTERTIARY (HIGHER) EDUCATION .................................................... 111 I. TYPOLOGY TERTIARYEDUCATION...................................................................................... 11. THESTRUCTUREAND ORGANIZATION OF TERTIARYEDUCATIONINBULGARIA.................... OF 111 113 111 ACCESS TERTIARYEDUCATION . ........................................................................................... 114 V. THEBOLOGNA IV. RELEVANCE OFTHEACADEMIC PROGRAMORIENTATIONTOTHENEEDS LABOR MARKETS To 117 ANDAUTONOMY............................................................................................... ............................................................................................................ 118 OF VI. GOVERNANCE PROCESS VI1. FINANCINGOF TERTIARYEDUCATION ..................................................................................... 119 VI11.FUNDING MECHANISMS ............................................................................................................ 120 121 IX. FACULTY ISSUES ........................................................................................................................ 122 X . ............................................................................................................... XI. OPTIONSFORREFORM OFTERTIARYEDUCATION................................................................... QUALITY ASSURANCE 123 124 8 . TOWARDSRESEARCHAND DEVELOPMENT(R&D) STRUCTURESAND POLICIES SUPPORTINGINNOVATION ..................................................................................................... 131 I BENCHMARKINGBULGARIA R&DANDINNOVATION . OF IN ...................................................... 132 A. European Innovation Scoreboard....................................................................................... 132 B KnowledgeAssessmentMethodology.................................................................................. . 134 13.5 D. How to Catch Up?............................................................................................................... C. Innovation Environment in Bulgaria versus Finland.,........................................................ I1. 137 INSTITUTIONALINNOVATION FRAMEWORKFORR&DAND .................................................... 137 A National R&D and Innovation Strategies........................................................................... 138 B Coordination of R&D Policies............................................................................................ .. 139 140 D. Key Actors ........................................................................................................................... C. Financing Instruments......................................................................................................... 111. FUNDINGAND TYPEOF R&DANDINNOVATION INVESTMENTS ............................................. 141 144 A Investmentin R&D and Innovation..................................................................................... . 144 B. Typeof RhD Financed........................................................................................................ 147 D. OpportunitiesProvided by EUResearchPrograms and Grants........................................ C. EnhancingIndustry Engagement in R&D andApplied R&D ............................................. 147 IV. HUMAN 150 RESOURCES ANDR&D AND INNOVATION .................................................................. 152 A. Availability of Researchers ................................................................................................. 152 B Developing Links with the International ResearchCommunity.......................................... . 153 V. INTELLECTUALINNOVATION PROPERTY RIGHTSAND ............................................................. 153 A Legislative Framework........................................................................................................ B. Patents andScientiJicOutputs............................................................................................ . 153 VI . ROLEOF FDI INPROMOTING R&D AND INNOVATION ............................................................... 154 VI1. CONCLUSIONANDPOLICY RECOMMENDATIONS...................................................................... 155 156 9. BUDGET AND CAPACITY IMPLICATIONS ............................... ,,, ......................................... 159 1. COSTSAND BENEFITS THE PROPOSEDREFORMS................................................................ OF 159 A Product Market Regulation................................................................................................. . B. Improving the Functioning of Labor Markets..................................................................... 159 159 D. VETand TertiaryEducation............................................................................................... C. Governanceand Finance Reforms in Primary and GeneralSecondaryEducation........... 159 160 11. CONSISTENCYOFTHEPROPOSEDREFORMSWITHTHEOPERATIONALPROGRAMS................166 E. R&D .................................................................................................................................... I11. IMPLEMENTATION 167 168 REFERENCES ...................CAPACITY ,............................................................................................................................ ,.,.................,.................................. ,.................................... 171 Table 1.1:Numberof Student by LevelEducation. ISCED-97.................................................................... Table 1.2: Net EnrolmentRatesby LevelofEducation, ISCED-97............................................................. 7 Table 3.1: Indicatorsof Integration:Bulgariaand EU8(percent of GDP) ................................................. 7 36 Table 3.2: Select Global CompetitivenessRankings .................................................................................. 45 years and over) ............................................................................................................................................ Table 4.1: Labor Force Participation(LFP), Employment and Unemployment Rates (population age 15 50 Table 4.2: GDP growth and labor force participationrates (population age 15-64 years), percent in 2006 ..................................................................................................................................................................... 51 Table 4.3: Undeclared Work in select EUcountries; latest availabledata.................................................. 52 Table 4.4: Labor market participation (population of 15-64 years of age), and employment by gender, professionalstatus, and economic sectors, in percent in 2006 (employedpopulation2005) ..................... 52 Table 4.6: Youth Unemployment, Employmentand Labor ForceParticipationRates, 2005..................... Table 4.5: Numberof Long-termRegisteredUnemployed(average per month) ....................................... 53 54 Table 4.7: Labor Market ParticipationRates at Age 15-24 and 25-34 and the Level of Education in 2005, Yo................................................................................................................................................................. 55 2005............................................................................................................................................................. 55 Table 4.8: Labor Market Indicators by Geographical Groupings(population aged 15 years and over), in Table 4.9: LaborCost Index(2000=100)* .................................................................................................. 57 Table 4.10: Dynamicsof averagewages, minimumwages, andnon-taxablemonthly incomes, BGN......58 average annual) ........................................................................................................................................... Table 4.11: Employed and insured population, and the number of pensioners in 2000-2006 (million; 59 Table 4.12: EU EmploymentTargets Accordingto LisbonCriteria, and New Jobs Neededto Reachthem Table 4.13: Expenditures in active and passive labormarket measures, % of GDP in2005...................... InBulgaria................................................................................................................................................... 61 65 Table 4.14: Impacts of ALMPs basedon experience of EUcountries ....................................................... Table 4.15: Rigidity of Employment Indexes............................................................................................. 66 68 Table 4.17: Participationof Adult Populationin Lifelong Learning,%* ................................................... Table 4.16: Incidenceand Compositionof Part-timeEmployment, 2005'................................................. 69 71 Table 5.2: Student-TeacherRatios in Primaryand General Secondary...................................................... Table 5.1:Net School EnrolmentRatesGrowing, but Still Low in Secondary.......................................... 79 Table 5.3 :LargeVariationin Student-TeacherRatios Translatinginto VaryingPer Student Costs..........86 80 Table 6.1: School Types inGeneralEducation(2005) ............................................................................... 94 Table 6.2: Types ofVocationalSecondary Schools inBulgaria(2006)....................................................... 95 Table 6.3: Distribution of Student Enrolment in Vocational Schools by Vocational Discipline and Level, 97 Table 6.4: EnrolmentTrends inVocational Secondary Education, 2001-2006.......................................... percent (2006) ............................................................................................................................................. Table 6.5: Expenditures on General (Upper) andVocational Secondary Schools.................................... 98 100 Table 6.7: Alternative Sector in Select Countries(2004) ........................................................................... Table 6.6: Unemployment Ratesfor Secondary (Vocational andUpperGeneral) Graduates.................-101 Table 6.8: Characteristics ofthe two proposedmodels ............................................................................ 102 ............................................ 107 Table 7.2: Tertiary EducationInstitutionsin Bulgaria, 2006.................................................................... Table 7.1:The Tripartite Systemof Tertiary Educationin Select Countries 112 Table 7.3: Types ofTertiary EducationInstitutionsinBulgaria, Romania, EU8, and EU15...................... 113 Table 7.4: Comparative Analysis of Participationin Secondary Education............................................. 114 Table 7.5: Tertiary EducationParticipationRates in Bulgaria, EU8 and EU15....................................... 115 115 Table 7.7: EnrolmentofNew Entrants in Tertiary Educationin Bulgaria, Romania, EU8 and EU15.....116 Table 7.6: Total Enrolmentin Tertiary Educationin Bulgaria,Romania, EU 8 andEU15...................... 116 Table 7.8: GeneralUpper Secondary School Enrolmentin Bulgaria....................................................... Table 7.9: Distributionof Studentsin Tertiary Educationby Academic Discipline................................. 116 117 Table 7.10:BolognaScorecardfor Selected Countries, 2005 .................................................................. 119 Table 7.11: PublicExpenditures on Tertiary Education, percent of GDP ................................................ Table 7.12: FundingFormulafor Tertiary Educationin Bulgaria............................................................ 121 122 Table 8.1: Bulgaria's performancerelativeto EU25 by indicator ............................................................ 134 Table 8.2: Investment in R&D in Bulgaria, percent of GDP 144 Table 8.3: Allocation of Government R&D Investment Table 8.4: Allocation of R&D Fundsby Type of Research,% of total investment.................................. ........................................................................... ................................................................... 147 Table 8.5: Budget ofthe EU seventhFramework Programfor Research, 2007-2013.............................. 147 150 OperatingCosts of the ProposedVET andTertiary EducationReformProgram.................................... Table 9.1: Rough Estimated Costs (in 2007-2010) and Projected Annual Savings and Additional 161 the RationalizationofVocational Secondary Schools .............................................................................. Table 9.2: Rough Estimated Investment Costs (2007-10) and Savings (starting in 2011) associated with 162 Table 9.3: RoughEstimatesof Investment Costs andAnnual OperationalSavings ................................. Table 9.4: RoughEstimatedCost of Reformofthe UniversityGovernance Structure............................ 163 164 Table 9.5: Rough Estimated Costs and Revenues (Savings) from IncreasedTuition Fees and the Student Loan Scheme Table 9.6: RoughEstimatedCosts and Savings from Introductionof Performance-basedFunding........165 ............................................................................................................................................. 165 Table 9.7: EstimatedOperatingCost Reductionsfrom UniversityConsolidation ................................... 166 Table 9.8: RoughEstimatedCost of ContinuedTeacher and FacultyTraining ....................................... 166 Figures Figure 1.2: MedianPopulationProjectionsby Age Group, 2005-2050........................................................ Figure 1-1: Bulgaria'sConvergenceChallenge............................................................................................. 2 6 Figure2.1:Contributionto OutputGrowthinBulgaria2000-2005, percentagepoints ............................. 12 Figure 2.2: Decompositionof Value-added Growth by year (%; contributionof L. K and TFP sum up to 100%).......................................................................................................................................................... 13 Figure 2.3: Decompositionof Value-added Growth and Growth of Its Components in Bulgaria by sub- period .......................................................................................................................................................... Figure2.4: CumulativeValue-added Growthby Sector in 2000-2005, %................................................. 13 Figure2.5: Structure of Value added by Sector in2005, %........................................................................ 14 Figure2.6: CumulativeEmploymentGrowthby Sector in 2000-2005, %................................................. 14 14 Figure2.7: Structure of Employmentby Sector in 2005, %....................................................................... Figure2.8: CumulativeNet CapitalRealGrowthby Sector in 2000-2005, %........................................... 14 Figure2.9: Structure of Net Capitalby Sector in 2005, % ......................................................................... 15 Figure2.10: CumulativeTFP Growthby Sector in 2000-2005, %............................................................. 15 Figure2.11: Growth Ratesof Value added and Its Components, % (including remunerationof factors) .15 15 of Exportsin Sales by Sector ...................................................................................................................... Figure 2.12: CumulatedTFP Growth and Average FDI-to-Capital Stock Ratios in 2000-2005 and Share Figure2.13: CumulativeLabor ProductivityGrowthby Sector in 2000-2005, % ..................................... 16 Figure2.14: LaborProductivityLevelsby Sector in2005 (economy-wideaverage =I .................... 17 Figure2.15: Shift-Share Analysis of Labor ProductivityGrowthfor Bulgaria2000-2005, % ..................17 00%) 17 Figure2.16: Shift-ShareAnalysis of Labor ProductivityGrowthfor Poland 1996-2003,% 18 Figure2.17: Shift-ShareAnalysis of TFP Growthfor Bulgaria2000-2005, % .......................................... ..................... 18 Figure2.18: Shift-ShareAnalysis of TFP Growthfor Poland 1996-2003,% ............................................ Figure3.1:Product MarketRegulationand Labor ProductivityAcceleration........................................... 19 Figure3.3: Product MarketRegulationin 2003.......................................................................................... Figure3.2: Increasein Average Annual Business Sector ProductivityGrowthover 1995to 2003 ...........30 30 33 Figure3.5: Product MarketRegulationin OECD Countries, 1998and 2003............................................. Figure3.4: Product MarketRegulation,Country Groups........................................................................... 33 Figure3.6: Barriersto Trade and Investment............................................................................................. 34 35 Figure3.7: ForeignDirect InvestmentStock, million EUR........................................................................ Figure3.8: Barriersto Trade and Investmentby type................................................................................. 36 37 Figure3.9: Barriersto Entrepreneurship ..................................................................................................... 38 Figure3.10: Barriersto Entrepreneurshipby Type Figure3-12:Administrativebarriersto start-ups, 2003 and 2006............................................................... Figure3.11: Percentof firms indicatingbusiness licenses and permits as a problemfor doing business..-39 .................................................................................... 40 Figure3.13: State Control........................................................................................................................... 41 Figure3.14: State Controlby Type............................................................................................................. 43 43 Figure3.15: Convergenceto Best Performers in ProductMarketRegulation:Areas of Bulgaria's Relative Strength ....................................................................................................................................................... 46 Figure 3.16: Distance from Best Performers in Product Market Regulation:Areas of Bulgaria's Relative Weakness .................................................................................................................................................... 46 Figure 4.1: Labor Force Participation, Employment, and Unemployment Rates (population aged 15-64), % in 2006 42 .............................................................................................................................................. Figure4.2: "Tax" rate on Low Wage Earners:............................................................................................ 53 Figure4.3: Tax Rate on Low Wage Earners: Tax Wedge on Labor Costs in2005.................................... 59 60 Figure4.4: Doing Business, percent of RespondingFirmsIndicatinga Problemin 2002 and2005 .........63 Bulgaria)...................................................................................................................................................... 64 Figure 4.5: International Comparison of Public Employment Service Staff (2002 and 2003; 2006 for Figure4.6: Underemployment due to Labor Regulations, % in 2002 and 2005 ........................................ 69 Average....................................................................................................................................................... 78 Figure 5.1: Mathematics Performance of Bulgarian EighthGraders Fallen from Above to Below the EU8 Figure5.3: Student-teacherratiosin 87 urban schools in Sofia.................................................................. Figure5.2: Years of schoolingby ethnicity and poorhon-poor................................................................. 79 81 Figure 5.4: Student Numbers Falling Faster than Teacher Numbers. and Driving Fast Growth in Real Figure5.5: The three aspects of a finance and governancereform............................................................. Expenditureper Student.............................................................................................................................. 82 85 Figure 5.6: Student-Teacher Ratios and Drop-OutRates (left chart) and RepetitionRates (right chart) by Schools, Bulgaria, 2004 .............................................................................................................................. 87 2007............................................................................................................................................................. 88 Figure 5.7: Groupings of municipalities, along with baseline amounts and adjustment coefficients for Figure 5.8: Estimated Fiscal Impact of Introducing Per Student Finance to Primary and General Figure 6.1: The EducationSystem in Bulgaria........................................................................................... Secondary Schools...................................................................................................................................... 89 Figure 6.2: Distributionof EnrolmentinVET Programsby Type and Level............................................. 94 96 Figure 6.3: EnrolmentTrends inVocationalSecondary Education Figure 6.4: Percentageof EnterprisesProvidingContinuingVET, 2004 (Source: Eurostat, CVTS2).......97 ............................................................ 99 Figure 6.5: Percentage of Employees Participatingin Continuing VET, 2004 (Source: Eurostat, CVTS2) ..................................................................................................................................................................... Figure6.6: Per Student Public Spendingon General and VocationalEducation, BGN........................... 99 Figure6.7: Distributionof Employees by Type of Education.................................................................. 100 101 Figure 6.8: Organizationofthe VocationalPrograms in the ProposedNew Tertiary Institutions- Model 1 ................................................................................................................................................................... 105 Figure 6.9: Organizationofthe VocationalPrograms in the ProposedNew Tertiary Institutions- Model 2 Figure6.10: Example of Organizationof Programsinthe ConstructionSector....................................... ................................................................................................................................................................... 105 Figure 7.1:Evolutionof Tertiary Education: 1960to 2005...................................................................... 106 112 Figure 7.2: Public Spending per Full-time Tertiary Student in 2005, percent of GDP per capita (source: Eurostat).................................................................................................................................................... Figure 7.3: ProposedGovernance Structure for Tertiary Education......................................................... 120 126 Figure 8.2: Relative strengthsand weaknesses ofthe Bulgarianinnovationsystem................................ Figure 8.1: EuropeanInnovationScoreboard2005 andBulgaria............................................................. 133 135 Figure 8.4: Institutionalstructure of the R&D and innovationsystem in Bulgaria.................................. Figure 8.3: Innovationenvironment inFinlandand Bulgaria................................................................... 136 Figure 8.5: Total R&D Investment by Sector in 2005, % of GDP............................................................ 138 144 Figure 8.8: R&D Investment by Sector, % of total investment (Source: National StatisticalInstitute)...146 Figure 8.7: Share of R&D Financedby Industryin 2005, % oftotal R&D investment ........................... Figure 8.6: Share of R&D Financedby Government in2005, % oftotal R&D investment.................... 145 145 Figure 8-10:Employmentof Researchers by Sector, 2004....................................................................... Figure 8.9: Allocation of GovernmentR&D Investment in 2001-2005 ................................................... 146 152 Figure 8.11: To what degree do you agree that the legal system will uphold contract and property rights? Figure 8.12: Numberof Scientific Publicationsper million Inhabitants, 2002 ........................................ ................................................................................................................................................................... 154 Figure 8.13: InwardFDI Stock ................................................................................................................. 155 Figure9.1: Reforms Themes inVocational andTertiary Education........................................................ 156 160 . Boxes Box 3.1: Reforms of Business Start-ups in Europe..................................................................................... Box 3.2: Alternative PolicyInstruments..................................................................................................... 42 44 Box 5.1:Equity in Education Box 5.2: School Financeand GovernanceReforms: Understandingthe Terms......................................... ...................................................................................................................... 79 Box 8.1:Lisbon Strategy TargetdObjectivesin R&D.............................................................................. 84 Box 8.2: Trainingof Policymakerson Economic PolicyManagement in Finland.................................. 132 140 ACKNOWLEDGEMENTS This report was prepared under the general guidance of Bernard Funck, by a team co-led by Satu Kahkonen and Peter Miovic. Team members were Stella Ilieva (product market regulation, overall support); Arvo Kuddo (labor markets); Leszek Kasek (productivity analysis); Sam Mikhail (vocational and tertiary education); Christian Bodewig and Lars Sondergaard (primary and general secondary education); Jorma Routti, Kimmo Halme, and Tarmo Lemola (R&D and innovation); and Iglika Vassileva (data support). The team benefitedfrom excellent support of the World Bank's Sofia office, led by Florian Fichtl. Albena Samsonova provided invaluable logistical support to missions. Mismake Galatis was responsible for the productionof the report, and providedexcellent administrative support to the work. Peer Reviewerswere Andrew Bums, Andreas Worgotter and Simeon Djankov. The report was produced in close collaborationwith the Bulgarian authorities. Mr. Lyubomir Datsov, DeputyMinister, Ministry of Financewas the immediatecounterpart, and his support and comments were invaluable. However, he is not responsible for the recommendations offered. The cooperation with the rest of the BulgarianGovernment was also excellent, andthe team is gratefulto officials at all levels, who took the time to meet with the team, and providedinformationin a competent and timely manner. Same applies to the private sector entities, NGOs, universities, schools, research centers, and employers' associations visited. The report greatly benefited from these exchanges, and the team wants to thank them for their time and sharedinsights. 1. THE CHALLENGEOFINCREASINGPRODUCTIVITY 1.1 On January 1, 2007 Bulgaria and Romania became the newest members of the European Union (EU). Inthe run-upto this momentousevent, the Bulgarianeconomy and institutionshadgone througha majortransformation. After an initial collapse in output and employment as the old supply-drivenmodes of production were largely destroyed, growth of output and employment has resumed, but now on a demand-driven basis and in an increasingly competitive environment. This is no minor achievement. Nevertheless, Bulgaria still has a long way to go to catch up with its fellow EU member countries. The country's income per capita, at PPS in 2005, was 32 and 56 percent of the average level of EU25 and EUS', respectively. 1.2 Closingthe income gap and facilitating convergencewith other EUcountries is, and has been for some years, an overriding priority for Bulgaria. However, the country is embarking on this road to convergence with two handicaps: the sheer distance that it hopes to traverse, and its rapidly declining working age population.*. For a time, the declining working age populationcan be offset by increasing the labor force participationrate, but this has a limit. Beyondthat, output will inevitably decline, unless offset by productivitygrowth. 1.3 Hence, to close the income gap and converge, Bulgaria needs to raise not just its labor force participationrate, but above all its productivity. To give an idea of the magnitudes involved, Figure 1.1 presents scenarios of Bulgaria's GDP per capita through 2040 under two sets of assumption^.^ Through the year 2015, both scenarios assume that: (i)employment will continue to grow at about 3 percent per year, as it has since 2002, with the employment rate rising to the Lisbon target of 70 percent, and (ii) labor productivity will continue to grow at its recent pace of two percent per year. During this period, Bulgaria's GDP per capita converges from its current level of 34 percent of EU25 GDP per capita to 44 percent by 2015, assumingthat EU25 GDP per capita continues growingat 2 percent per year, as it has on average in recent years (the uppermost trajectory in Figure 1.1). After 2015, the two scenarios diverge. At that point, there will be no more gains to be had from increased employment since the employable labor pool will have been more or less exhausted. From there on, productivity will be the sole driver of GDP growth. Inthe first scenario (the low trajectory), it is assumedthat labor productivitywill continue to grow at 2 percent per year. Inthe second scenario (the middletrajectory), growth in labor productivity accelerates to 5 percent peryear and stays there for the duration. 1.4 Figure 1.1 shows that if the labor productivity growth remains at 2 percent, Bulgaria will never converge. Convergence to EU25 stops in 2015 and for the rest of the projection periodBulgaria's GDP per capita remains at 44 percent of the EU25 GDP per capita. By contrast, ifthe rate of growth of labor productivity increases to 5 percent, Bulgaria's GDP per capita converges to that of EU25 and achieves parity around year 2040. However, to achieve that, Bulgaria will have to push on with its reform program. Ensuring that the rate of growth of labor productivity picks up requires policies and bold 1EU8 refers throughout the report to the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, the Slovak Republic, and Slovenia. Population is projected to decline at 0.7%per year. See discussion on demographic trends later inthis chapter. 3After the analysis for the report was completed, the Bulgarian authorities adjusted GDP figures for 2002-2005. These revisions are not taken into account in the report since they would not substantially alter the conclusions, but redoing all the analysis would take significant amount o f time. reforms, given the magnitude of the challenge. Marginal measures will not be enough to make the country converge. Figure 1.1: Bulgaria's Convergence Challenge EU25-average productivity growth (2% p.a.) - - - - - - . Bulgaria-low productivity growth scenario (2% p,a.) ---- Bulgaria--high productivity growth scenario (2% until 2015, 5% p.a, thereafter) I. OBJECTIVEOFTHEREPORT 1.5 This report aims to assist the Bulgarian authorities in analyzing and identifying an appropriate policy mix in the areas of product and labor markets, human resource development, and research and development (R&D) that would boost productivity and thereby competitiveness, economic growth, and achieve income convergence. The implications of these policies for the government's budget are also briefly explored, includingthe utilization of EUgrant funds. 1.6 The report largely focuses on the supply-side aspects of Bulgaria's R&D and innovation system, its education delivery, and its labor and product markets, and identifies policy options for their improvement. A companion piece, the Investment Climate Assessment, which is being prepared in parallel, deals with the demand side and, usingfirm data, identifiesthe bindingconstraintsto productivity growth from the firm perspective. While there is necessarily some overlap, the two reports together are designed to provide a more comprehensive view of the options to tackle the challenge of boosting productivity. 1.7 The areas selected for the study respond to the priorities identified by the Bulgarian authorities. In this context it is worth noting that this report builds on the analysis of two prior Bank reports on Bulgaria-the Country Economic Memorandum(CEM)4of 2005 and the Public Finance Policy Review (PFPR) of 20065. This study is also closely linked with the World Bank study that benchmarked Bulgaria's product market regulations using the OECD methodology.6 The benchmarkingresults have 4 'WorldBank Bank (2006)BulgariaPublic FinancePolicy Review:LeveragingEUFundsfor Productivity andGrowth. World (2005b), Bulgaria:The Roadto SuccessfulEU Integration-The Policy Agenda, ReportNo. 34233- BG. 6De Rosa,Fay, Ilieva (2006), "Product Market Regulationin Bulgaria:A Comparisonwith OECD Countries." The WorldBank. 2 been partly utilized in this report, along with some of the prior work carried out by the World Bank on education. In addition to the areas covered in this report, other factors, such as adequate infrastructure provision, are important for the quest to raise productivity. However, since they were already covered in earlier reports, they are not includedinthe current report. 11. TACKLINGTHECHALLENGE OFINCREASING PRODUCTIVITY 1.8 Sincethe onset ofthe new millennium,transitioneconomies like Bulgariahavefaced a significantly changedglobal environment. The dimensions of change includeglobalization,the emergence of knowledge as the driver of economic growth, and the "flattening" of the world throughthe high speed informationand communication technology. In economies increasingly based on knowledge, wealth and economic development depend on citizens' capacity to creatively use their knowledge and skills to develop products and services that meet the needs of discriminating globally-connectedconsumers. Public and private organizations develop their competitive capacity by providingtheir employees with life-long opportunities for learning, and retraining. The organizations and enterprises in knowledge economies become first and foremost "learning organizations". Bulgariawill not escape the impact ofthese trends. To keep up, it must adapt, and inthe processraisethe rate of growthofproductivity. 1.9 Innovationdefined as adoption of already existing or development of new technologies, products, and processes-lies at the heart of high productivity. It should, therefore, be the overriding objective for Bulgaria. For all countries, to build and maintain their productive sectors in the face of global competition, enterprises must be able to continuously improve their products and services and for that purpose successfully adopt new technologies and processes-that is, to innovate. However, there is no simple formula to promote innovationand thereby productivity growth. To increase productivity and move Bulgaria to a higher growth path, action would need to be taken on several fronts. Growth is a result of a number of factors, including an enabling institutional framework that provides appropriate incentive^.^ The areas central to productivity growth and on which Bulgaria would need to focus on includethe following: 1.10 Investment in R&D and Innovation Policies: Firms need incentives to innovate: to adopt existing or develop new technologies, products, and business processes that raise productivity. The most basic way to foster innovation is often considered to be investment in R&D. The available empirical evidence suggeststhat R&D investments have a positive impact on productivity growtha8R&D enhances technology transfer by he1 ing firms to learn about advances at the technology frontier. For example, a study on OECD countries shows that countries that are behind the world technology frontier can grow B more quickly, if they invest in R&D and human capital to facilitate adoption of new technologies. Further, the closer a country or an industry is to the world technology frontier, the more important the R&D efforts become-which in this case means not just imitation of existing technologies but their improvementor replacementby entirelynew technologies. 1.11 However,while R&D investments may be one ofthe factors affectingproductivity,they alone are by no means enough to foster productivity growth. Above all, it is necessary to create micro and macro- 7 For a review on current thinking on growth see for example, Rodrik, ed. (2005), In Search of Prosperity; and Aghion (2006), "A Primeron InnovationandGrowth", BruegelPolicyBrief, Issue2006/06,October. See for example Ledermanand Maloney (2001), "R&D and Development." Policy Research Working Paper No 3024, the WorldBank. 9 Griffth, Redding, van Reenen (2000), "Mapping Two Faces of R&D: Productivity Growth in a Panel of OECD Industries."DiscussionPaper Series, No. 2457, Center for EconomicPolicy Research. 3 economic conditions that enable innovationand technological progress. These include promotionof: (i) competitionand entry into productmarkets; (ii)flexible labormarkets; and(iii)an educatedlabor force. 1.12 For Bulgaria, these other areas are the most pressing short-term priorities, and warrant most attentionat the moment. As will be shown in Chapter 2, basedon past productivitytrends, improvements inthese areas can be expected to have most impact on productivity growth in the short and mediumrun in Bulgaria. In Bulgaria, it is the adoption of existing technologies-that is, imitation-that primarily matters at the moment. Ingeneral, Bulgarianfirms are not yet at the technology frontier, but should strive to move in that directionthrough acquisition of best technologies available. To move the country closer to the world technology frontier, Bulgaria would need to start paying increasing attention also to R&D. But that is more of a medium to long-term priority for the country. It is vital that the basic micro and macro-economic conditions are first met and that they are supportiveof innovation. This includes above all promotionof competition, 1.13 Product Market Regulation: Unhindered entry, exit and turnover of firms are crucial for productivity growth. Firms have little incentiveto adopt new technologies, if they are not stimulated by competition." Regulationslimiting entry may hinder the adoption of existing and new technologies, as well as technology spilloversby reducingcompetitivepressures. Hence, policiesthat support competition and encourage outward orientation, flexible product market regulations, and attraction of new FDI inflows, play a key role in sustaining rapidproductivitygrowth. This is particularlythe case for Bulgaria, as will be discussed later inthe report. 1.14 Flexible Labor Markets: Recent research indicates that product and labor market policies are complementary, and hence improvingthe functioning of both markets in parallel would be advisable to promote productivitygrowth. The evidence from OECD countries suggeststhat countries with restrictive product market policies also tend to have restrictive labor market policies, and vice versa." Effectively functioning and flexible labor markets are essential in the quest to raise productivity, since they are the critical link in ensuring that the skills and knowledge can be put to their most productive use. Rigidities in the labor market-such as those that discourage the shedding of redundant labor-hinder innovationand productivity growth, since they make it hard for a firm to move to a new activity and adopt a new technology. The analysis in Chapter 2 suggests that the reallocationof labor across sectors is still rather slow. Thus, further enhancement of labor market flexibility would need to be considered in Bulgaria to promote convergence. 1.15 Equipping Labor Force with Relevant Skills: Finally, having a highly skilled and technically sawy labor force is also essential for new technology adoption, and becomes increasinglyimportant as a country moves closer to the technology frontier. Existing empirical evidence indicates that skill composition of the labor force matters for innovation-an increase in the stock of skilled labor is positivelycorrelated with innovationeffortsi2,and a more educated labor force is quicker in adopting new 10 Recent economic research suggests that there is an inverted U type relationship between competition and innovation: while too little competition leads to no innovation, too much competition can discourage innovation since f m s are not able to reap the benefits of their efforts. See Aghion, Bloom, Blundell, Griffth, and Howitt (2002). 1 1Nicoleti and Scarpetta (2005), "Product Market Reforms and Employment in OECD Countries", Economics DepartmentWorking PaperNo. 472, OECDandthe World Bank. 12 See for example Grossman and Helpman (1991), Innovation and Growth in the Global Economy, Cambridge, MA, MIT Press. 4 techn01ogies.l~Recent research indicatesthat tertiary education investmentincreases a country's ability to make leading-edge innovations,while primary and secondary education impact the country's ability to implement existingtechn~logies.'~The fact that in the age of globalization, knowledge is becomingan increasingly importantdriver of growth further emphasizes the importanceofhigher education. 1.16 Thus, it is secondary and tertiary education that are critical for productivity growth in Bulgaria. In additionto tertiary education, this report covers both general secondary and vocational education and training. However, since none of these education institutionswould be effective without strong primary feeder institutions,the reform of primary education also matters. For that reason it is also covered inthis report. 1.17 Changes inthese various areas are likely to affect productivitydifferently. Increases in labor force participationand employmentcan increase aggregateproductivitygrowthby improvingresourceutilization. Aggregate productivitygrowthcan also increase ifworkers move from lowerto higher productivitysectors, and thereby improveresourceallocation. However, in additionto raisingaggregate productivity, R&Dand innovation,education, and liberalizationof product markets havethe potentialto increasethe rate of growth of productivity. This shift allows any given levelof productivityto be achievedmore rapidly. It is this that Bulgariashouldbe aimingfor. 1.18 Inanalyzingthe appropriatepolicy mix inthe above-mentionedareas, it is importantto reflect at the outset on the implicationsof two trends-Bulgaria's populationdecline, and the increasing importance of knowledge for growth. Inadditionto influencingthe speed of convergence, they also have implicationsfor sectoral policies, inparticularfor education. 111. IMPLICATIONS OFBULGARIA'S DEMOGRAPHIC TRENDS FORSECTORAL REFORM 1.19 Demographic Trends: Of all EU member countries, Bulgaria's population is declining fastest. In early 2004, Bulgaria had 7.8 million people." However, the population is projected to fall to 6.5 millionby 2025, and further to 5.2 million by 2050. Projectionscarriedout by the UN(2007) are similar, with the low/high scenarios of 6.2-6.9 million people in 2025, dropping to 4.2-6.0 million people by 2050. This representsa 0.7 percent decline inpopulationper year. The demographic patterns are similar, but more moderate in all EU8 countries.j6 By contrast, total populationof EU15 is projectedto stabilize, althoughthe share of old peoplewill rise, andthat of childrenand working age populationdecline. 1.20 Consequently, the working age population (people of ages 15-64) will decrease in Bulgaria. Accordingto projections, it will decrease about one percent per year after 2010. As a result, the working age populationis set to go down from 5.4 million in 2004 to 4.2 million in 2025, and 3.1 million in 2050. By 2050, the working age population would represent only 60 percent of the entire population, down from 69 percent in 2004. This means that even if labor force participation rates increased to 70-75 percent, there would be 35-40,000 fewer workers availableeachyear during2010-2030, taperingoff to an annual decline of 20-25,000 workers by 2040-2050. While this may quickly eliminate the current unemploymentproblem in Bulgaria, it also implies that the labor force will have to go through a major l3Nelson and Phelps (1966), "Investment in Humans, Technological Difhsion and Economic Growth," American Economic Review,56(1/2), 69-75. 14See Aghion (2006), "A Primer on Innovation andGrowth", Bruegel Policy Brief, Issue 2006/06, October. Eurostat2005 basedon Bulgaria'sNSI data. l6EU8 refers throughout the report to the Czech Republic, Estonia, Hungary, Latvia, Lithuania,Poland, the Slovak Republic,andSlovenia. 5 upgrading of its education and skill levels, accompanied by large capital investments, to raise its productivity and hence livingstandards to the averageofthose inother EUcountries. 1.21 At the same time, the share of those aged 65 and above will rise from 17 percent in 2004 to 26 percent in 2050. Figure 1.2 presentsthese trends. Becausethe ratio of working age to older people (aged 65+) will be declining steadily, the working age group will need to raise its savings rates sharply over time to take care not only of the current old people, but eventually themselves. They will not be able to expect generations younger than themselves to take care of them, since younger generations will be declining in numbers, while expectations of the living standards once old, will be rising along with the general rise of living standards expected inthe comingdecades. 1.22 The number of babies born each year is projectedto decline from its current range of 65-70,000 per year towards 50,000 per year. This would imply a birth rate of about 1.5 childrenper woman. This is slightly higher than the range of 1.1-1.3 births per woman that has prevailed in the last 15 years. Some argue that this reflects the unfavorable economic conditions of the transition, which are not expected to last. However, even if the birth rate were to recover to the population-stabilizingrate of 2.1 births per woman, which would make it the highest in Europe, it would imply only getting back to the current number of babies born each year. This "baby bust" will have implications above all for the school system, which would needto be kept in mindwhen contemplatingreforms. Figure1.2: MedianPopulationProjectionsby Age Group, 2005-2050 F 6oooooo I I 5000000 1 I I n 4000000 3000000 2000000 2005 2010 2020 2030 2040 2050 Source; Demographic Institute of BAS, Euro stat (2005) and UN(2007). 1.23 Implications for the Education Sector: The decline in the number of births in the past fifteen years is already showing up in the declining student cohorts at primary and lower secondary schools (see Table 1.1). The declinehas beenheld back at the pre-primaryand upper secondary school levelsby a rise in net enrolment rates. However,the riseto net enrolmentrates has a limit, and it is only a matter oftime beforethe populationdeclinewill be reflectedin the decline in absolute numbers at these levels. Only at the tertiary level is there a likelihood that the absolute cohorts will actually grow in numbers, since net enrolment rates can still rise a fair amount (see Table 1.2). 6 Table 1.1: Number of Student by Level Education, ISCED-97 19991 20001 20011 20021 20031 20041 2000 2001 2002 2003 2004 2005 Total 1569011 1522401 1474077 1475262 1451284 1419405 Pre-primary 211,943 200,449 199,206 201,317 201,145 202,803 Primary 392,876 374,361 349,616 333,016 314,221 290,017 Lower secondary 367,055 366,047 358,476 348,317 330,416 312,480 Upper secondary 329,018 329,427 334,813 358,934 374,262 373,160 Post secondary non-tertiary 6,798 5,111 3,572 3,165 2,772 3,036 Colleges 18,461 16,369 16,646 14,801 16,294 18,432 Universitiesandequivalenthigher schools 242,860 230,637 211,748 215,712 212,174 219,477 Source: NSI Table 1.2: Net Enrolment Rates by Level of Education, ISCED-97 19991 20001 20011 20021 20031 20041 2000 2001 2002 2003 2004 2005 Pre-primary 66.4 66.8 73.6 74.2 74.6 73.6 Primary 96.4 96.3 98.5 99.8 100.3 99.7 Lower secondary 81.4 82.4 83.1 83.9 84.2 84.2 Upper secondary 63.1 64.7 68.3 74.9 77.1 77.3 Post secondary non-tertiary 0.6 0.6 0.3 0.3 0.3 0.3 Colleges 2.4 2.2 2.4 2.4 2.6 3.1 Universities andequivalenthigher schools 24 23 22.8 23.9 24.1 25.8 Source: N S I 1.24 Interms of absolute numbers, average enrolmentin schools at all grades from pre-schoolthrough upper secondary will have to adjust downwards to about 60,000 students per grade, which is 20-30 percent below current enrolments, depending on the grade. In tertiary education, where one can expect a rise in enrolment rates for some years to come, the absolute number of students may well stay in the 200- 250,000 range for a few decades. This suggests that when contemplatingthe reforms of the Bulgarian education system, gradual downsizing of the current primary and secondary school system should be planned for, together with the upgradingof the currenttertiary education system. Chapters 5-7 have been written keepingthese developments in mind. IV. IMPLICATIONSOF THEINCREASING ROLEOF KNOWLEDGE AS A DRIVEROF GROWTH FOR SECTOR REFORM 1.25 Inadditionto makingR&D and innovationpoliciespertinent, the increasingroleof knowledge as a driver of growth have implications for education and how it is delivered. Many of the OECD and EU countrieshavealready facedthis challenge. It is nowBulgaria's turn. 1.26 Secondary Education: In responseto increasingimportanceof knowledge, most countries have experienced less difficulty in developing and implementing policies for reform of primary and tertiary education than for secondary education, including vocational secondary education. This has been attributed to a number of distinctive dualities of secondary education, which is both terminal and preparatory, compulsory and post compulsory, uniform and diverse, serving both personal and societal needs, and servingcontradictoryequity and selectivity purposes." These contradictorydualitieshave led 17.World Bank (2002), ExpandingOpportunitiesandBuildingCompetencies for Young People:A New Agenda for Secondary Education. 7 many countries to experiment with more flexible pathways in upper secondary education and devise frameworks to allow students in the general secondary stream to acquire recognized labor market qualifications, and those inthe vocationalstream to acquire academic creditsto allow them to gain access to tertiary education. A study conducted by OECD'* identified the following four elements in secondary education reforms: (i)reducing the number of vocational education programs by broadening the definitions of vocational areas and their qualifications; (ii) creating effective curricular linkages between general and vocational education; (iii)developing combinationof school- and work-based learning, and (iv) buildingpathways betweenvocationalsecondary education andtertiary education. 1.27 The OECD study also suggestedthat the teacher-directed, rote learningthat dominates secondary education needs to be replaced by a new student-centered paradigm, which emphasizes the analysis, application, and synthesis of knowledge in a collaborative learning environment. The continuous upgrading of teachers in the secondary general, and vocational schools is a real challenge in the knowledge economy because of the fast pace of change. A number of guiding principles have emerged and should be taken into consideration for the reform of the system in Bulgaria. These include: (i) upgradingand reform of teacher education and training has to be an integralpart of any reform strategy; (ii)teacher training has to continue throughout the teacher's career; (iii)teacher training should emphasize the importance of student-centered learning; and (iv) group learning complemented by self- study and self-learning shouldbe incorporatedin all teacher training programs. 1.28 Tertiary Education: Four features of the knowledge economy have far-ranging implications for the reform of tertiary edu~ation.'~First, knowledge is being developed and applied in new ways; the informationrevolutionhas expanded knowledgenetworks and expedited the innovationprocess. Second, product development cycles are shorter and the pressures for innovation greater. The product development cycle in the automotive industry, for example, dropped from six years in 1995 to less than two years by 2005. Third, the globalizationof trade is increasingworld wide, puttingadded pressures on transition economies to integrate their policies and practicesand with potentialtrading partners. Fourth, SMEs in the manufacturingand service sectors have become significantplayers in economic growth and employment. 1.29 Over the past three decades, many countries have diversified their once publicly-dominated tertiary education systems in an attempt to respond to the challenge of the knowledge economy. This diversificationincludesmany, or all ofthe following types: e Alternative Tertiary Institutions: Many countries have established, or substantially expanded, institutions that are clear alternatives to traditional universities. The new institutions are different in their mission, governance, and programs. They represent distinctive developments with some remarkable benefitscomparedto universities, includinggreater flexibility, increased access, equity, and responsiveness to identified employers' needs, enhanced occupational orientation, and differentapproach to public service. Examplesof these institutionsincludethe communitycolleges inthe USA and Canada,the Colleges for Further Educationin the UK,the InstitutesUniversitairede Technologie (IUTs) in France, andthe Polytechnics in Finland. 0 Private Institutions: Private sector tertiary institutions have grown rapidly in developed and transition economies. Most EU8 countries have modified their tertiary education regulations to allow the establishmentof privateuniversitiesand institutionsof tertiary education. Poland has 195 private institutionswith enrolmentof about 380,000 undergraduates. Privatebusiness Assessment (PISA). OECD (2000) Knowledge and Skillsfor Life: First Results from the OECD Program for International Student WorldBank(2003b),, Life LongLearninginthe GlobalKnowledgeEconomy. 8 schools have also mushroomed in the past decade: over 95 in Poland, 30 in the Czech Republic, 18 in Romania, and4 in Bulgaria. Virtual Universities: The ICT revolution and the emergence of web-based services have changed the tertiary education landscape dramatically. An estimate made in 2000 indicated that there were over 3000 specialized institutions offering on-line education and training services inthe U.S.20. National as well as regionalvirtual universitiesare beingestablished in many countries, including the African Virtual University, the Virtual University of Monterrey, Mexico, the Arab Virtual University in Kuwait, and the Tun Abdul Razak Universityin Malaysia. Franchise Universities: Franchise universities have been setup in partnership with private or public local universities in a number of developing and transition economies by parent universities in North America, Europe, and Australia. They offer validated courses and programs from the parent university at the site of the local institution. The cost of these programs is usually 25-30 percent of the full cost of similar programs offered by the parent university. 0 Corporate Universities: It is estimated that there are more than 1500 corporate universities worldwide today. Prominent among them are Motorola, Disney, and Toyota universities,to name but a few. Corporate universities may have their own network of physical campuses; operate as virtual universities, or through partnership with formal public or private institutionsoftertiary education. 1.30 LifeLong Learning: Another importantparadigmthat has beenrecognized by all developed and transition economies is the importance of life long learning in all stages of education. The speed of change in the knowledge economy means that skills depreciate much faster than they once did. Employers no longer rely solely on new graduates, or new labor market entrants as the primary source of skills and knowledge. They now increasingly seek out people, who have managed to retool, while already in the labor force. Schools and institutionsof tertiary education thus need to prepare workers for life long learningthat goes beyondthe existingrigid system to includenon-formaleducation and training in programs, such as apprenticeship, and internshipprograms, and structured on-the-job training, as well as informaleducationandtraining, which cantake place inthe home, community, or work place. v. THEROADMAP THEREST OFTHEREPORT FOR 1.31 In chapters that follow, this report examines a number of reforms that could help promote productivity and convergence in Bulgaria. The next chapter analyzes the productivity trends at sectorhranch level in Bulgaria, after which the report turns to the sectoral reforms. Strong capacity to innovate and use the innovations effectively could lead to major gains in productivity in the right businesses environment. Chapter 3 covers some rigidities in the regulationof product markets which, if reduced, would raise efficiency and lower the costs of production. Reductionof rigiditieswould leadto a reallocation of resources to those sectors in which the regulations have been the most binding. The chapter laysout the mainchannels throughwhich this might accomplished. 1.32 The labor market connects the demand for a whole range of skills with the supply of these skills. Iflaborproductivityis to beraised, the labor marketmustbe efficient inreallocatinglabor from lowerto higher productivity areas. It must achieve that in a constantly changing environment, so it must be flexible. Options to improve labormarket functioning are covered in Chapter 4. 2o Olsen, J (2000), Is Virtual Educationfor Real. TechKnowLogia.January-February. 9 1.33 Chapters 5-7 deal with the accumulationof humancapital in a number ofways. Chapter 5 covers the ongoing governanceand finance reforms in primary and general secondaryeducation. Chapters 6 and 7 examine the quality of vocational education and training as well as of tertiary education, with a particular focus on how well and efficiently the relevant institutions are preparing the students for the demands of today's private businesses and public institutions. Reforms in these sectors could lead to major improvements inthe use of publicresources increatingthe neededhumancapital. 1.34 Chapter 8 covers the Bulgarian R&D and innovation sector, both in terms of its size and its effectiveness. Finally, Chapter 9 links the proposed reforms with the budget. While the report concentrates on factors that lead to greater productivity from the supply side, their potential cannot be realized in a business environment that is not geared to facilitating the use of these factors, including matchingthem with the requisitecapital. Therefore, the report touches on this aspect briefly in several chapters, basedon the already existingresearch. 10 2. PRODUCTIVITY TRENDS INBULGARIA 2.1 Since 1997 Bulgaria has implemented important reforms, which have contributed to sustained output and employmentgrowth. The size and scope of the public sector have been substantiallyreduced, the exposure to international trade and competition through trade and foreign direct investment has increased, and progress has been achieved in improving the regulatory environment for doing business. Supported by prudent macroeconomic management, output has expanded by close to 5 percent per year between 2000 and 2005, and is expected to have exceeded 6 percent in 2006. Solid macroeconomic performancesupportedby accelerated structuralreformshas improvedthe environmentfor doingbusiness in Bulgaria. Private sector's share in the economy has increased substantially, and is now comparable to and even higher than in some EU8 countries. Investment surged to close to 30 percent of GDP in 2006, comparedto below 10 percent in 1996-1997,while FDI stock accountedfor close to 50 percent of GDP in 2005. Most of the non-infrastructure enterprises and banks have been privatized or liquidated, bank restructuring has been completed and banking supervision strengthened; trade and prices liberalized; reforms in the energy sector have been implemented in both district heating and electricity sectors; and major public sector and institutionalreforms have been initiated. These actions can be expected to have affectedproductivity growthand/or increasedemployment. 2.2 This chapter presents a detailed sector-based examination of labor and total factor productivity trends in Bulgaria since 2000 as well as those in employment by sector, and identifies critical factors supportingtheir growth. The most striking messagefrom this analysis is that almost none of the growth in labor and total factor productivity during the period 2000-2005 was due to the reallocationof labor and capital from one sector or another. The mobility of production factors, both labor and capital, was low. Instead, the productivity gains were achieved almost exclusively at the intra-sector level. Yet, for rapid sustainable growth in productivity and output in the longer run, it is the reallocation of resources across sectors that are critical. This problemwarrants attentionin Bulgaria. I. PATTERNSOFOUTPUTGROWTH IN2000-2005 2.3 Services and manufacturing were the main sectors driving growth (average annual rate of 4.6 percent) in Bulgaria during the period 2000-2005 (see Figure 2.1, left panel). Both market services (including trade and transport) and non-market ones, constituting together about 60 percent of output, were important contributors to the expansion of the service sector. Unsurprisingly, agriculture was the most volatile sector: it recorded both strong downturns (in 2000 and 2005) and upswings (in 2002 and 2004). On the whole, the decreasing role of agriculture, and the rising role of services are bringing Bulgariaslowly closer to the economic structures prevailing inthe rest of the EU. 2.4 Consumptionand investment led growth on the demand side, while the contributionof net exports was mostlyand increasinglynegative (see Figure2.1, right panel). Relatively strongcontributionfrom the change in inventories,especially in 2005, resemblesthe experienceof several EU8 countries.21Bulgaria's recent EU accession is expected to give a further boost to Bulgaria's exports owing to improved market access, but also raise the risk of increased imports. That could further aggravate the external imbalances, unless a significant portion of the imports are investment goods that would help improve the competitiveness of firms operatingin Bulgariainthe mediumterm. 21For example, Poland had intensive accumulation of stocks in 2004, and massive de-stocking a year after EU accession, whichhad a large impact on GDP growthvolatility. Figure2.1: Contributionto Output GrowthinBulgaria2000-2005, percentagepoints Sector composition Demand-side composition 15 81Consumption 0Agricultureandforestry I investment Gross I andquarrying Mining EBChanae in inventodes 0Manufacturing 0Construction 10 tisticai discrapency -+-Value Added 5 0 I I I I L J/ - - U I I I -5 I I U -10 2000 2001 2002 2003 2004 2006 2000 2001 2002 2003 2004 2005 Sources: NSI; and Bank staff calculations 11. GROWTHACCOUNTING 2.5 As in other post-socialist transition countries, also in Bulgaria early gains in growth were driven solely by total factor productivity (TFP) improvements22,but since 2003 expansion in employment has significantly contributed to output growth (see Figure 2.2). TFP grew at almost 6 percent annually in the period 2000-2002, but decelerated sharply to 2.2 percent per annum during 2003-2005 (Figure 2.3).23 The growth accounting method was used to identify the contribution of different factors of production to overall growth.24 The results also indicate that capital contributed negatively in 2000-2002, but had a marginally positive impact on output growth in 2003-2005.25 This is in contrast to other transition countries, where capital contributed significantly to output growth. The example of Poland is depicted in Figure 2.2 (right panel). 22Growth in TFP is usually attributedto factors such as improvements in human capital, research activity, foreign trade, reallocation of production factors, and "catching up". See for example, Timmer and Szirmai (2000), and Miller(2003). Other variables that havebeen found to be important are demography, macroeconomic volatility, and structural changes such as deregulation or privatization. See for example, Hyeok and Townsend (2004), Escribano and Guasch (2005). In Bulgaria, casual observation of the correlations (at a sector level) between TFP growth and FDIconcentrationor share of export sales inrevenues suggeststhat they are positive.. 23The TFP decline in 2003 is an anomaly, Since TFP is calculated as a residual, its drop in 2003 resulted from an increase of employment that was stronger than the increase in output. This sudden expansion in employment was largely supply-driven, since it was almost certainly due to the launch of the subsidizedjob-creation program "From Social Assistance to Employment", introduced in late 2002 (see Chapter 4). After that, growth in employment was drivenby demand, with the number of people inthe employmentprogramactuallydeclining. 24Output growth (value-added) was decomposed into (i) growth in the factors of production(capital and labor), the and (ii)a "Solow" residual, termed Total Factor Productivity(TFP) growth. See Annex 1 for the methodology. "Thisresultholdsevenifonetakesintoaccountapossibleunderestimationoftherealgrowthofthecapitalstock.. 12 Figure 2.2: Decomposition of Value-added Growth by year (YO;contribution of L, K and TFP sum up to 100%) Bulgaria2000-2005 Poland 1996-2004 lLLd 2000 2001 2002 2003 2004 2005 Source: Bank staff calculations. Note: L-labor; K-capital. Figure2.3: Decomposition of Value-added Growth and Growth of Its Components in Bulgaria by sub-period Decomposition of output growth Growth rates(includingremunerationof factors) 2000-2002 2003.2005 120 90 17.9 60 15.5 30 0 3 0i $ A Y E S ' Y E Z - J ~ 2000-2005 2000-2002 2003-2005 c c kY Source Bank staff calculations. Note. VA-value added, L-labor; K-capital. 111. OUTPUT GROWTH THE SECTOR LEVEL AT DURING2000-2005 2.6 The analysis of output growth across 28 sectors reveals that growth in value added26was most rapid in export-orientedmanufacturingindustries. TFP growth was the main contributor to value added growth in most sectors. Only a few relied on factor accumulation, and the reallocation of production factors across sectors played only a minor role. 2.7 This section first examines the trends, by sector, of value added, employment, investment, and productivity growth using the growth accounting framework. After that changes in productivity-both labor productivity and TFP-are decomposed into effects arising from reallocationof resources across sectors, and those due to within-sectorproductivitygrowth. 26Owingto data availability, value added insteadofoutputtime series were usedinthe analysis. 13 A. Value-added and TFP Growth by Sectors 2.8 Value added increased in real terms at an average rate o f 5.4 percent during 2000-2005, with slightly faster average growth in 2003-2005. Duringthe period 2002-2005 value added rose particularly fast in select manufacturingsectors, financial intermediation (+lo0 percent cumulatively), trade and repair (+69 percent), and other services (+69 percent). The cumulative 6-year output growth was most remarkable in manufacturing (+162 percent), textiles (+134 percent), non-metallic minerals (+134 percent), electrical and optical apparatus (+125 percent), and wood products (+113 percentFsee Figure 2.4 and Annex Table 1 for details. However, these rapidly growing sectors constituted a rather small share of the overall output (see Figure 2.5), so their overall impact i s still small. Figure2.4: Cumulative Value-added Growth by Figure 2.5: Structure of Value added by Sector Sector in 2000-2005, YO in 2005, % 180 1 16 _r 120 4 - " Source: NSI, Bank staff calculations. 2.9 Employment growth (Figure 2.6) and structure (Figure 2.7) largely mirrored growth and structure o f value added, with important exceptions o f real estate and public administration. Also, in 2005 agriculture still employed almost a quarter o f the entire labor force in Bulgaria, and the number o f those working inthe sector had hardly moved since 2000. Figure 2.6: Cumulative EmploymentGrowth by Figure2.7: Structure of Employment by Sector in 2000-2005, YO Sector in 2005, YO I Source. NSI,Bank staff calculations. Source. NSI, Bank staff estimations. 2.10 Net investment was positive in over half o f the sectors, with strongest increases in manufacturing o f coke, refined petroleum product, nuclear fuel, hotels and restaurants, and trade and repair. The rate o f increase in the overall capital stock was modest (2.3 percent cumulatively). Capital stock shrank significantly in non-market services (education, health and social work, public administration; compulsory 14 social security) and mining and quarryingof energy producingmaterials(Figures 2.8 and 2.9). However, since estimates of capital stock are rather uncertain, trends in net capitalgrowth should be interpreted with caution. Figure 2.8: Cumulative Net CapitalReal Growth Figure2.9: Structure of Net Capital by Sector in by Sector in2000-2005, YO 2005, Yo Source; NSI, Bank staff calculations. 2.11 During 2000-2005, TFP grew most rapidly in several export-orientedmanufacturingsectors and, surprisingly, in education. This is likely due to data problems inthe education sector: it is not clear how to properlymeasurevalue-added in education, andthere may have been an overestimate in the decline of the capital stock in education. Overall, TFP growth accounted for the bulk of the real output increase in Bulgaria(81.7 percent), while labor accounted for 15.7 percent, and capital accumulationfor less than 3 percent. If education is treated as an outlier, TFP increased more in manufacturing branches than in services (see Figure 2.10 and Annex Table 1 for details). Among the five sectors with the fastest TFP growth were the modern industrial sectors, such as manufacturing of electrical and optical equipment (1-146 percent cumulative growth), and manufacturingof transport equipment (+87 percent). TFP growth was particularly rapid during the early years, reflecting labor shedding and weak investment. Notably, TFP decreased in sectors that are hardly exposed to foreign competition. These were real estate, renting, business activities, agriculture, hunting, forestry, and fishing. These sectors recorded TFP declines of 13- 16percent over the period(Figure 2.10). Figure 2.11: Growth Rates of Value added and Figure 2.10: Cumulative TFP Growth by Sector I t s Components, YO(includingremunerationof in 2000-2005, YO factors) 160 1401 120 4 3.0 2 0 -0.6 I I 2000 2001 2002 2003 2004 2005 -4 I s J Y $ U - J Y $ S A Y $ u A Y $ U A Y P I - ' C I- I - ' I - > c" Source, NSI,Bank staff calculations 15 2.12 Growth in productivity was in part due to exposure to foreign competition through FDI and growing integrationwith EU. Evidence of the importance of openness is that FDI and exports were both positively and significantly correlated with TFP growth at the sector level (Figure 2.12). Owing to data constraints it was not possibleto computethe correlationbetween TFP growthand innovation. Figure2.12: Cumulated TFP Growth and Average FDI-to-Capital Stock Ratios in 2000-2005 and Share of Exports in Sales by Sector TFP growth and FDI-to-capital stock ratio, % TFP growth and export-to-total sales ratio, % 20i 40 O L 100 0 20 40 60 80 Share of exports in total sales, Jan-Sep 2006 B. Decompositionof Productivity Growth 2.13 Productivity growth can be decomposed into effects arising from reallocation of production factors across sectors, and those comingfrom within the sector. The purpose of such decomposition is to distinguishthe impact of "structural changes" in the economy from the impact of "intrinsic" productivity growth. In the case of aggregate labor productivity, one can distinguishthree separate effects: (i)a static shift effect--the effect of reallocation o f labor towards sectors with above-average initial level of labor productivity; (ii)a dynamic shift effect-the effect of reallocation of labor towards sectors with higher growth in labor productivity; and (iii)a within-sector growth efSect--gains in labor productivity achieved through means other than reallocation of labor, including increases in the capital-labor ratio within the same sector. Along the same lines, aggregate TFP growth can be decomposed into two effects: (i)an intra-sector effect-assuming constant factor-shares; and (ii)a total reallocation effect (TRE)--resulting from shifts of labor and capital between sectors. TRE is measured as the difference between aggregate TFP growth and output-weighted TFP growth at the sector level (see Annex 3 for "shift-share" methodology). Labor Productivity and "Shift-Share"Analysis 2.14 By 2005, the highest levelsof labor productivity were recorded in manufacturingof coke, refined petroleum products, and nuclear fuel, and financial intermediation, real estate, renting and business activities. Growth in labor productivity in various sectors during 2002-2005 and the resulting levels of labor productivity in 2005 are presented in Figures2.13 and 2.14, respectively(details in Annex Table 2). In most cases, strong labor productivity growth resulted in above average labor productivity levels. Unsurprisingly, the lowest productivity levels remained in agriculture, forestry, fishing, leather industry and textiles. During 2000-2005, labor productivitydecreased only in three sectors: (i)real estate, renting and business activities; (ii)public administration and compulsory social security; and (iii)agriculture, huntingand forestry and fishing. 16 Figure2.13: Cumulative Labor Productivity Figure 2.14: Labor Productivity Levels by Sector Growth by Sector in2000-2005, % in 2005 (economy-wideaverage=loo%) 1000% 900% 800% 7W% 600% 500% 400% 300% 200% 100% 0% Source: NSI, Bank staff calculations. Source. NSI, Bank staff estimations. 2.15 Reallocationof labor towards more productivesectors playedonly a small role in shaping overall labor productivity growth, compared to the "intrinsic growth" effects (Figure 2.15). This is similar to the patternobserved in Polandduring 1996-2003 (see Figure2.16). In Bulgaria,the static effect was positive in4 ofthe 6 years coveredby the analysis, which meansthat employment shares grew in sectors with high initial productivity levels. Over the 6-year period this effect accounted for 27 percent of the total labor productivity growth of 24 percent. By contrast, the dynamic effect was negativethroughout the period. This reflects the "structural burden" of the transition economy, in which sectors with rapidly growing productivity were actually shedding labor. The static and dynamic effects were usually acting in opposite directions, with the former slightly stronger. The within growth effect was robust, positive, and dominated the other two, with the exceptionofthe unusual2003, in which all three of them were negative(seeearlier analysis). This may reflect not only labor productivity gains (for example, improvements in labor utilization), but also the flow of capitaltowards moreproductive sector^.^' Figure2.15: Shift-ShareAnalysisof Labor Productivity Growth for Bulgaria 2000-2005, Yo -. 0I.Staticshilleffect[LP(base)'d(S)] ~~ -hift effect [LP(base)' d(S)] 6811.Dynamicshift effect [d(LP)"d(S)] ic shift effect [d(LP) d(S)] 1 1 1 1 . Within growth effect [d(LP) * S(base)] Hill. Within growth effect [d(LP)* S(bare)l A I ..I.,.. I.- +Labor productivity growth 6 10 4 12 2 6 0 0 I - U ---__ -....__ -. 4 2000 2001 2002 2003 2004 2005 2000-2006 2000-2002 2003-2006 Note; The effects 1-111may not sum up to the overall labor productivity growth becauseof rounding. LP-labor productivity; base-base year; S-labor share; and d (. ..)- change between base and final year. Source: Bank staff calculations. ''However, lack of change of the alpha-coefficientvalue (standing for remuneration of labor), which stayed steady at 0.69 between 1999 and 2005 (see Annex Table 2), and the results from the TFP decomposition exercise, suggest that the impact from the change ofthe capital-laborratio insectorswas limited. 17 I! Figure2.16: Shift-Share Analysisof Labor Productivity Growth for Poland 1996-2003, YO 1 - 9 0 1.Within 50.0 arowth effect ldlLPI SlbreIl . . . . I Within growth effect [d(LP) S(bare)] 8.0 aDynamicshift effect [d(LP) d(S)] 40.0 Dynamic shift effect [d(LP) d(S)] 7.0 OStatic shift effect [LP(base)' d(S)] - 0Static shift effect [LP(base)' d(S)] 6.0 30.0 5.0 4.0 20.0 .. ...... .... . 3.0 10.0 -13.9 .......... 2.0 1.0 0.0 0.0 -1 0 1 1996 1997 1998 1999 2000 2001 2002 2003 1996-2003 1996-1999 1999-2003 Source: Bank staffcalculations. TFPand "Shift-Share"Analysis 2.16 During 2000-2005, TFP growth in Bulgariawas predominantlydriven by intra-sectorproductivity improvements. Reallocationof resources across sectors (TRE) contributedvirtually nothing. By contrast, in Poland the reallocationof resources played an important role, particularly in the second half of the 1990s(Figures 2.17 and 2.18). Figure 2.17: Shift-Share Analysis of TFP Growth for Bulgaria 2000-2005, % O T R E (total reallocationeffect) 30 1 1 DTRE (totalreallocation effect) 1 I effect Intra-branch 25 Intra-brancheffect 20 15 10 5 7 0 ' 0 -0 3 -1 - - 2 - - _ _ _ _ _ - - -0.6 - - -.. --- - -5 2000 2001 2002 2003 2004 2005 2000-2005 2000-2002 2003-2005 Note: Intra-branch effect TFP increases are weighted with value added-shares in constant prices; Reallocation effect (TRE) -the - difference between total TFP growth and the intra-branch effect (the sum of TRE and intra-branch effects sum up to total TFP growth-all in logarithms). Both effects may not sum up to the overall TFP growth because of rounding. Source: Bank staff calculations. 18 Figure 2.18: Shift-Share Analysis of TFP Growth for Poland 1996-2003, YO 35.0 -_________-_______ ~ ~ 5 0 300 ......................... 29.4 ntra-brancheffect ........... 4 0 25.0 ........ ...... ........... 11.6 3 0 20.0 -~ ~-~~~ . . . . . . . . . . . . . . . ...... 2 0 15.0 -- - - - - ..... 1 0 12.1 10.0 ........ .............. 8.2 ............. ...... 2.2 0 0 - - - ~ ~ -1 0 5.0 ~ ........... 7.1 9.8 -2 0 0.0 1 1996 1997 1998 1999 ZOO0 2001 2002 2003 1996.2003 1996-1999 2000-2003 Source; Bank staff calculations. 2.17 These decompositionresults suggest that inter-sectoralmobility of productionfactors (both capital and labor) is still low. This contrasts with Poland's experience, where at least capital proved to be relatively mobileacross sectors. This also raises concernsabout the mediumto longterm growth potential of the Bulgarian enterprise sector. In the most dynamic economies growth takes place through the Schumpeterianprocess of "creative destruction", in which firms either actively invest in new technologies and/or organizationalchange, or achieve labor productivity gains through capital-laborsubstitution, inthe process challengingtheir competitorsto do the same or face decline.28The "creative destruction" process includesthe firm entry and exit of firms ("churning"). To gain a better understandingof and confirmthese patterns, firm level analysis is needed. The forthcoming Investment Climate Assessment, a companion piece to this report, is expectedto providethat information. 2.18 Although it is encouraging that employment has been expanding and that intrinsic productivity growth at the sector level has been robust, there remains much potential for achieving productivity gains from reallocationof resources towards more productiveuses. This is especiallytrue of agricultureand the largely publicly-funded "non-market" services, such as other community, social and personal service activities, health, socialwork, and education. IV. CONCLUSIONS AND POLICY RECOMMENDATIONS 2.19 Bulgaria has witnessed rather robust output growth during 2000-2005. Services have been the main driver of output growth, followed by industry. On the demand side, growth came from increases in consumption and investment. Exports, while growing, were overshadowed by imports, with net exports exerting an increasingly strong drag on growth in GDP. However,to the extent that importsreflect a rise in the importsof investmentgoods due to strong growth in FDI, they are likely to eventually show up in risingproductivity and exports, andthus contributeto a sustained expansionof GDP. 2.20 TFP growth was the driver of output growth in most sectors, especially in export-oriented manufacturingwith high concentrationof FDI. TFP, in turn, was driven almost entirely by intra-sector "intrinsic growth" factors, such as organizational or managerialimprovements in the utilization of labor. Almost none of the TFP improvements came from the reallocation of human and capital resources across sectors.29 This suggests that there is a lot of untapped potential, which would need to be exploited. In 28See for example, Aghion and Howitt (2005). *'While this report will cover some of the reasons for labor immobility-such as overregulated product markets, inflexible labor markets and skills mismatches owing to weaknesses in the education system-there are likely to be 19 particular, since in the long run it is the reallocation of resources across sectors that will be key to sustainedand rapidgrowth in TFP, andhence GDP. 2.21 There is a potentially worrisome trend in both TFP and labor productivity (and they are related). The growth rate of both declined between 2000-2002 and 2003-2005. Inthe case of the rate of growth in laborproductivity,its decline was a mirror image ofthe rapidrise in employment (the sum of the two adds up to the rate of growth of GDP). This can continue for some years, given Bulgaria's low employment rate andthe still substantialpoolof unemployed (see Chapter 4). But at some pointthese reserves of labor will run out, and further rapid growth in GDP will depend on the rate of growth of productivity and, as was shown in Chapter 1, with productivity growth remaining at 2 percent beyond that point, Bulgaria's convergence might come to a halt. 2.22 The results suggest that policies that support competition and encourage outward orientation, includingfurther deregulation and reductionof the role of the state in the economy, and attraction of new FDI inflows, will play a key role in sustaining rapid productivity growth in Bulgaria. This could have a particularly large pay-off in various services and agriculture, since these sectors are traditionally less exposed to competitive pressures than the manufacturingsector. Such policies should go hand in hand with effortsto further improvethe investment climate, and increase labor market flexibility. Flexibility in labor markets is crucial in aidingthe process of creative destructionby shifting labor from firms in decline to those on the rise. Rather than protecting existing jobs, policies should aim at equipping workers through education to be better prepared for the changes in the demand for labor and assisting their search for new employment possibilities through active labor market policies. As Michael Spence the 2001 Nobel laureate in economics, said "institutions and policies that retard the movement of people and resources will also retard growth, andgenerally it is better toprotect people and incomes rather thanjobs andjrms." (Spence 2007) 2.23 Finally, the demographics of Bulgaria put an extra premiumon raisinglabor productivity. As the dependence burden of the working age population rises, it will become increasingly difficult for those employed to improvetheir standard of living while at the same time supportingproportionaterises in the standardof living ofthose living on pensions. 2.24 The remaining chapters in this report address the problem of how to shift the drivers of TFP growth increasingly from intra-sector productivity improvements to gains that can be had from inter- sectoral allocations of factors of production, and especially labor. The next two chapters address the question of how to increasecompetitioninthe product markets and how to increase the flexibility of labor markets. They also discuss the inter-linkage of the two. Subsequent chapters address the questions of equipping the labor force with more and better education and acquisition of skills. The penultimate chapter grappleswith the problemof R&D and innovation. R&D will not be the main driver of Bulgaria's growth in the immediate future, but will become ever more important as Bulgaria approaches the technologicalfrontiers in various sectors ofthe economy. As will be argued, R&D and innovationdo best in a system that has a good business environment, flexible labor markets and an excellent education systemthat is sensitiveto the requirementsof business. other reasons as well not coveredby this report (such as weaknesses intransport infrastructureandhousingmarkets). Furtherin-depthanalysiswouldbewarrantedonthis issue. 20 Annex 1: Growth Accounting Methodology: The approach used is the standard growth accounting framework based on an aggregate production function (expressed in growth rates). This approach focuses on the supply-side of the economy (that is, the accumulation of laborand capital, as well as technicalprogress, as the drivers of any increase in output over time). In line with common practice, Cobb-Douglas production functions with constant returns to scale were used and factor markets were assumed to be competitive. The key parameter, the income share of labor (capital) a (1-a) was calculated from national income accounts. Because of data constrains the analysis covered the period 1999-2005, while the growth rates were available from 2000 and the 2005 data were preliminary estimates. Y =f (L,M,K)P (1) Where Y-output; L-labor; M-intermediate materials; K-capital services; and P-productivity of inputs. Reflectingdata availability, value-added instead of output time series were used. Therefore, intermediate materials were removed from the right hand side of the equation. Moreover, the assumption of constant returnsto scale impliesthat a (L)= 1 a(K) and P=TFP (TotalFactorProductivity). - In(VA) =a ln(L) + (1- a)ln(K) + In(TFP)in logarithmes. (4) Interms of growthrates (indicatedby lower-caseletters): In(va) =a ln(1) + (1- a)ln(k) + ln(tfp) (5) Thus, TFP growth is calculated as a residual(the "Solow" residual) usingthe equation: ln(tfp) = ln(va) - a ln(1) - (1- a)ln(k) 21 Annex 2: Data and Methodology Data: The growth accounting exercise for Bulgaria in2000-2005 was based on data available from the Bulgarian National Statistical Institute (NSI) in January 2007. The analysis was made at a level o f desegregation corresponding to the A-3 1 breakdown o f the Statistical Classification o f Economic Activities in the European Community30. Grossfrved capitalformation. A breakdowno f investment by classificationA-3 1 (29 economic sectors) is obtained usingthe structure provided in the N S I annual statistical survey on the expenditure on acquisition o f tangible fixed assets. As for 2005 only data by 17 sectors was available (A-l7), additional allocations and extrapolations were made to arrive at estimates o f the fixed capital formation by the 29 sectors. Capital. The NSI does not provide estimates for gross capital and net capital (Ko,) either in current or constant prices. However, based on the information from NSI, investments in fixed assets (IO,) and value o f amortization by sector3' were estimated. The initial capital stock in constant prices was taken from Ganev, K. (ZOOS), "Measuring Total Factor Productivity: Growth Accounting for Bulgaria", Bulgarian National Bank discussion paper DP/48/2005 (available only in Bulgarian). Since the real growth rates o f capital were not available, an assumption about the capital deflator was made, connecting it with the value added deflator. As the baseline scenario, it was assumed that capital deflators were half o f the value added deflators. Alternative scenarios assumed that the capital deflator increased at the same pace as the VA deflators (bottom scenario), and that capital deflator was equal to zero (capital prices are constant - cap scenario). Based on these simulations, it was concluded that under the baseline scenario the average difference between the economy-wide capital deflators and investments deflators over the period 2000-2005 was minimal. Wage bill and operatingsurplus of the self-employed. The share o f labor costs in value added determines the key coefficient a in the Cobb-Douglas production function. The labor input in the calculations was computed as a sum o f the compensation o f employees and the operating surplus (OS) o f the self- employed. Doing this it was implicitly assumed that the OS is highly labor-intensive, Data on the operating surplus was available from the generation-of-income account o f the N S I national accounts. It was calculated as the difference between the gross value added, and the sum o f the compensation o f employees and nets other taxes on production. Methodology: Estimation of deureciationrates As a check, branch-level depreciation rates (do,) were calculated usingthe following formula: 30 In fact, the analysis was made on 28 sectors. This was because for many economic variables the data on the sector AA (agriculture, hunting and forestry) and BB (fishing) were available as a single aggregate. Additionally there was no data available for the sectors PP (activities o f households) and QQ (extra-territorial organizations and bodies). 3 1Due to the fact that as o f January 2007 there were no data available on fixed capital consumption for 2005, the figures for this year are estimates based on extrapolation o f the data for 1999-2004. 22 Where Qt) denotes net capitaland I(t) in fixed assets (all data in currentprices). investment 1999 2000 2001 2002 2003 2004 2005 Depreciation rate 3.2% 3.3% 3.7% 4.4% 4.9% 5.3% 5.8% Estimation of income shares (cz) There are two methods of estimatinga (labor share intotal income)at the aggregate level: (1) econometric regression of the production function; and (2) the Solow method (based on the income-share of labor in value added). The income share of labor is the total wage bill of employees plusthe operatingsurplus as a proxy for compensation of self-employed. a was estimated for each individual branch using the second method(becauseof shorttime-seriesthat did not allow for econometric regression). The value of a at the aggregate level was in the range of 0.69-0.72 during 1999-2005. This is broadly in line with values normally found in the literature. The estimated value of FC. varies significantly across the analyzed 28 branches. 23 Annex 3 Shift-share analysisof labor productivityand TFP Shift-shareanalvsis of labor uroductivitv The "shift-share" analysis of labor productivity is basedon the following equation: ln(va) - ln(1) =ci ln(1) +(1- ci) ln(k) + ln(tfp) - ln(1) @ ln(va/l) = (1- ci) ln(W1) + ln(tfp) (8), where VA - output, L- labor, andK- capital (small letters indicategrowth rates of the variables). Growth in labor productivity contains two effects: changes in the capital/labor intensity [Wl] and increases in total factor productivity. The aggregate growth of labor productivity is decomposed into three separate effects (Peneder, 2002): Equation(9) Static shift-effect Dynamicshift effect Within growth effect n n n where LP=labor productivity; d(LPT)= growth of LP in time T, by = base year, fy=final year; T=sum over sectors i;Si = share of sector iintotal employment. Shift-share analvsis of TFP Inorder to measurethe impactof changesin both labor andcapitalshares in the various sectorsof the economy on aggregate total factor productivity growth, the shift-share analysis of TFP was conducted. For a given sector i: The productionfunction at the aggregate level can be rewrittenas: ln(va) = C(VAiNA) ln(vai) = C(VAiNA)* 6iln(li) + C(VAiNA)* (1- cii)ln(ki) + C(VAiNA)* ln(tfpi) * (1 1) At the same time at the aggregate level: ln(va) =ci ln(1) +(1- ci) ln(k) + ln(tfp) (12) Usingequations (8) and (11) the difference between aggregateTFP growth, ln(t&), can be calculated and value added-weighted TFP growth in branches, C(VAJVA)* ln(#pJ, which is referred to as the Total Reallocation Effect (TRE). 24 VA. Where: tfp = TFP at aggregate level, tfp,=TFP in sector i, VA = the share of value added in sector i in aggregatevalue added, VA= , 1=Ell k = kl . TRE results from shifts of labor and capital from one sector to another: the last term on the right hand side of equation (12) indicates the effects of changes in capital shares on aggregate TFP, while the previous term indicatesthe effects of changes in labor shares. Links between shift-share analysis of labor productivitv and TFPgrowth Bothstatic and dynamic shvt efsects, as definedabove in Equation(8), describe reallocationof labor to sectors with above-average labor productivity level or growth rates, respectively. They are included in the first term on the right hand side of Equation (12). These two effects turned out to usually act in opposite directions so they did not explain TRE. Nevertheless, the third within growth effect in Equation (8) includes labor productivity gains, which can be attributed to both the contribution of capital as a production factor, and to gains from capital reallocations from sectors with below-average to sectors with above-average TFP growth. The stronger the labor productivity growth resultingfrom more efficient capital utilization in the economy as a whole (measured as the sum of output-weighted TFP), the higher the last term on the right-hand side of Equation(12) andthe higherthe TRE. 25 U a ..E C ..*Be EC E 2 7 e *r ..i; 7 e E - ; sC 5 eC c ..ee - CCC .. Cii C i c d ca 2 iir aEE 4 3. IMPROVINGPRODUCTMARKETREGULATION32 3.1. Competition in product markets provides incentives to firms to reallocate resources to more productive activities, increase innovation and technological diffusion. Inthe process it raises productivity. In addition, less restrictive regulations may affect positively employment by reducingthe rents that some firms extract from overregulation and force firms to expand their a~tivities.Unhinderedentry, exit, and ~ ~ turnover of firms are crucial for productivity growth. As was shown in the previous chapter, in Bulgaria productivity growth has indeed been fastest in sectors most exposed to competition. 3.2. This chapter presents the rationale for improved product market regulation, and explores the links between regulation, investment, productivity, and innovation. It also looks at the effect o f regulation on labor market performance and functioning, and presents analysis of the current state o f product market regulation inBulgaria incomparison with OECD countries. 3.3. The analysis shows that Bulgaria has come a long way in improving its product market regulations. In some areas it performs even better than the OECD average However, distance from the best performers in OECD and EU8 remains still large in some areas, suggesting that further efforts are needed, if Bulgaria is to achieve meaningful gains in productivity and investment. The methodology for benchmarking product market policies used in this analysis does not allow comparison o f another important complement o f regulatory quality-the functioning o f institutions, including the judiciary. Nevertheless, a number o f international comparative studies suggest that Bulgaria will need to further improve the functioning of its institutions to ensure that institutions have adequate capacity to enforce better regulations. I. RATIONALEFORIMPROVINGPRODUCTMARKETREGULATION A. Product Market Regulation, Investment and Productivity 3.4. Policies that encourage competition in product markets have been found to exert positive pressure on productivity growth, especially in countries like Bulgaria, which are far from the EU and world productivity leaders. A number o f studies34point to substantial improvements in productivity as a result o f reducing product market regulations. The gains from product market reforms are found, as expected, to be larger in countries with relatively restrictive product markets, which generally tend to have lower productivity levels. The more profound the product market reforms are in low productivity countries, the faster will be the pace of convergence towards the productivity levels o f the high productivity countries. Figure 3.1 plots the increase in productivity in OECD countries between two periods-1996-2003, and 1985-1995-and the restrictiveness o f regulation in seven non-manufacturing sectors. As shown in the Figure3.1, countries that regulate less tend to have higher productivity growth. 32 This chapter is in part based on the diagnostic and analytical work conducted under the leadership of the ECA Chief Economist Office. The work involved benchmarking Bulgaria and Romania's product market policies and institutions using the OECD methodology and data for OECD countries. The results of this benchmarking exercise for Bulgaria and a detailed description of all indicators can be found in Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay, and Ilieva, The World Bank (2006). 33Conway, Janod, andNicolletti (2005). 34Conway, de Rosa,Nicoletti and Steiner (2006), andNicoletti and Scarpetta(2005a). 'igure3.1: Product Market Regulationand Labor Productivity Acceleration .. ._ _. - _ _ - - -_ __.-* 0 025 Greece 0 020 - 015 United States I 0010 - Aus&alia 0.005 0.000 + Aupia -0.005 Uniled Kingdom Sweden + Belgium -o.olo corrclnlioii coclliciciil = -0.I7 Japan + Spain France -o,o, .1-stiitislic = -0.73 Finland wi/kordr Greece: Portuoal llaly -0.020 correliitioii cmllicicn~= -0.38 I-sliiiislic = -3.1 The potential impact of regulatory reforms in OECD countries is estimated by Conway et al. (2006) to range between 0.2 to 1.8 percentage points increase in labor productivity per year, depending on the size of the productivity gap and regulation gaps, provided that all countries converged to the most liberal regulatorypolicies (Figure 3.2). Potential gains in productivity are smallest in countries such as the UK and the US with high productivity levels and among the most liberal product markets. By contrast, Greece and Portugalwould have increased their labor productivity by 1.8 and 1.4 percentage points per annum, respectively, between 1995 and 2003, if they had aligned their product markets to the best practiceinOECD. Figure 3.2: Increasein Average Annual BusinessSector Productivity Growth over 1995 to 2003 (givena moveto sectoral regulationsthat are least restrictiveto competitionin 19951) Per fen1 2.0 I.8 I.6 1 4 1 2 1.o 0.8 0.6 0.4 0.2 0.0 I.Dstaarc thcevcragc increaseinannual business-sectorproductivityover thcperiod 1995to2003 givcnmeasingin rcgulittion lo lhc icnsl rcslrictivc of competition in non-manufacturing sectors in OECD countries in 1995. Productiviry in the productivity lcader in each sector is afsumcd to grow ut 1.6% per year. The busincss-scctor rosults arc calcuiatcd as wcightcd averages of the sectoral productivity incrcascs using value oddod wcights. Source: Conway, de Rosa, Nicoletti and Steiner (2006) 30 3.5. While data limitationsdo not allow the inclusion of Bulgariain this analysis, the state of product market regulationin Bulgaria, andthe levelof productivity suggest that gains in labor productivitysimilar to those available to but unexploitedby Greece or even higher could be expected, if Bulgaria embarked on profound regulatory reforms. The potential pay-off to these reforms for Bulgaria is therefore very large. 3-6. Regulation of the economy affects productivity levels and growth through several channels. Overregulation in the economy could reduce incentives for firms to increase investment and innovative practices in production of goods and services. A study by Alesina et al. (2005) looks at the effects of regulationon investment in a number of sectors-transport, communication,and utilities. The study finds that reducing barriers to entry and the extent of public ownership, has affected positively capital accumulation in these sectors. Moreover, the impact on investment was much larger where substantial improvements in regulation were implemented, whereas small steps in removingbarriers to entry have not had any discernable impact in relatively restrictive economies. Empirical estimates suggest that product market reforms could lead to an increase in the investment rate on the order of 2 percentage points of GDP in the longrun. This analysis providesfurther arguments for the needto lessen barriers to investment and entrepreneurship in Bulgaria, where investment pickedup only recentlyandthe upgrading of capital stock is still at an early stage35. While barriers to trade and investment have been reduced substantiallyin Bulgaria, and are comparable to the OECD average, their further relaxationtogether with solid improvements in domestic regulatorypolicy couldbring substantial benefitsinterms of the quantity and quality of investment, includingimportantlyFDIinflows. 3.7. As will be shown, Bulgaria fares well on barriers to trade and investment, when compared its immediate peers-Czech Republic, Hungary, Poland, and Slovakia(hereinafterEU4) and middle-income countries (MICs) such as Brazil, Mexico, and Turkey-but needs to deepen reforms to ease barriers to entrepreneurship, if it is to achieve the average levels of OECD and EU15 countries. Barriers to entrepreneurship could constrain trade integration and divert FDI flows from Bulgaria, which would further limit the opportunities to catch up with world productivity leaders. Trade integration and FDI penetration have been found to be powerful sources of transfer of best practices and technologies. Nicoletti and Scarpetta (2003) find that easing barriers to trade and investment as well as some other domestic regulations could improve significantly FDI inward positions of OECD countries. It is estimated that on average inward FDI stocks could grow by more than 10 percent from their initial level in OECD countries.In countries with relativelyrestrictive productmarket policies--suchas Greece, Italy, and France-this growth couldbe between60 and 80 percent. The same would apply to Bulgaria. B. Regulation ofProduct Markets and Innovation 3.8. Restrictiveproduct market policieshave been found to affect negatively investments in ICT, and hence the speed of transfer of knowledge and skills to low level productivity countries. Conway et al. (2006) estimate that 12 percent of cross-country differencesin ICT investment in OECD countries could be attributed to differences in product market regulation. Countries with more liberal product markets tend to have the highest share of ICT investment in total investment, while more restrictivecountries are at the lower end of innovation. ICT investment in Bulgaria remains one of the lowest among the EU countries. Therefore, policies that would encourage the use of ICT could be especially beneficial for Bulgaria's growth agenda. Higher ICT adoption, however, would require a well-educated labor force with adequate skills to produce and use ICT. Discussionon the quality of the human capital in Bulgaria follows in Chapters 5-7. 35World Bank (2005b) Bulgaria: the Roadto SuccessfulEUIntegration-The Policy Agenda. 3.9. Similar analysis on the impact o f product market reforms on innovation has been conducted for EU countries.36 This impact is expressed in increased incentives for firms to innovate when profits and rents o f firms are squeezed by enhanced competition. Product market reforms, such as lowering domestic non-tariff barriers to trade and other barriers to the free movement o f factors o fproduction across borders, have been found to exert pressure on average profitability o f firms, which has a positive impact on R&D intensity, and hence total factor productivity growth. Therefore, reforms that improve significantly product market regulation could support the increase inR&D investment in Bulgaria to levels close to the target under the Lisbon Agenda (3 percent o f GDP, o f which two-thirds are expected to come from the private sector). A discussion o f other policies that may have a bearing on R&D in Bulgaria will be covered in Chapter 8. C. Regulation of Product Markets and Labor Market Performance and Functioning 3.10. The analysis o f Nicoletti and Scarpetta (2005b) reveals that the impact o f product market policies on employment (in non-manufacturing sectors) is even larger than that o f labor market policiesper se. High state control and barriers to entry have had a negative impact on employment rates in OECD countries. It is estimated that lessening these barriers to those in place in product markets in the best performing OECD countries, could increase employment rates between 2.5 and 5 percentage points. It should be noted however, that product and labor market reforms could explain only partially the variation in employment rates among countries. There are likely to be other factors at play that have not been included in the above analysis. 11. REGULATIONOF PRODUCT MARKETS INBULGARIA 3.11. Bulgaria has gone a long way in reforming its product market polices and institutions. However, comparison with best performers in product market regulation suggests that there i s no room for complacency. Reforms aimed at enhancing competition need to continue to ensure firms operate in an environment with less state involvement, lower barriers to entrepreneurship, including barriers to entry, and relying more on incentive-based regulation. Comparing Bulgaria's performance with high and middle income countries that are members o f OECD provides an idea o f where the focus o f reforms should be. 3.12. Product market regulation in Bulgaria has been assessed using the OECD methodology3' that provides comparative estimates on economy-wide, and industry specific regulatory provisions. The assessment o f product market regulation i s based on a survey o f existing policies rather than on the actual enforcement, or outcomes o f these policies, and covers a wide range o f product market policies-public ownership, market access and competition issues, regulatory and administrative policies and processes concerning public administration, and sector specific policies in road freight, railways, passenger air travel, and retail distribution. In addition, information from World Bank's Doing Business database was usedto benchmark administrative burdens on start-up o f companies. A. Overall Product Market Regulation 3.13. The overall indicator o f product market regulation, country by country, shows that Bulgaria has still some way to go to catch up with the best performers in OECD and EU15 in terms o f changing 36Griffith, Harrison, and Simpson (2006). 37 Conway, Janod and Nicoletti (2005). For more information on the results for Bulgaria see Product Market Regulation in Bulgaria: A Comparison with OECD countries, de Rosa, Fay, and Ilieva, World Bank (2006). 32 policies that restrict competition (see Figure 3.3).38 Benchmarking Bulgaria to OECD countries provides useful insights on how Bulgaria compares with the high and middle income countries. The survey for OECD countries was conducted in 2003, while all data for Bulgaria refer to 2006. This provides an opportunity to compare Bulgaria with four EU8 countries-the Czech Republic, Hungary, Poland, and Slovakia (hereafter EU4)--prior to their joining EU. Country group comparison (Figure 3.4) reveals that Bulgaria's performance in 2006 was comparable to the EU4 average before their accession, as well as to other middle income countries (MICs) such as Brazil, Mexico, and Turkey (Figure 3.3). Figure 3.3: Product Market Regulation in 2003 1 5 1 0 5 0 1 Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay and Ilieva, World Bank, 2006. Note: the values are for 2006 for Bulgaria and for 2003 for all other countries. The indicator ranges from 0-least restrictive,to &most restrictive. 3.14. However, the gap between Bulgaria and other countries may be larger now, if these countries have further reformed their product markets since 2003, and have kept up the trend observed since 1998. Between 1998 and 200339, OECD countries implemented a number o f reforms, which led to improvements in the overall product market indicator by close to 30 percent on average (Figure 3.5). These reforms focused on price liberalization, removing barriers to trade and investment, easing the licensing and permits systems, and reducing direct control o f state over business enterprises. Countries with more restrictive policies-including the Czech Republic, France, Greece, Hungary, Italy, Korea, Mexico, Poland and Turkey-made substantial progress in deregulating their economies. Bulgaria's most immediate peers-such as the Czech Republic and P~land~~--focusedon reducing economic regulation by limiting state control over businesses, while progress in easing administrative regulation was more limited. All countries substantially reduced barriers to trade and investment. Figure 3.4: Product Market Regulation, Country Groups 38 The indicators were calculated on the basis of the qualitative and quantitative information obtained from survey answers, which were coded and normalized over a scale of zero to six, with 0 reflecting least restrictive and 6 most restrictive regulations. 39Two surveys have been conducted so far with data for 1998 and 2003. Benchmarking product market regulation has proved to be a usehl tool for monitoring performance of policies and institutions in OECD countries, for identifying gaps, and thus exerting peer pressure on member states. 40There are no data for Slovakia for 1998. 33 I 3.0 1 2.8 I 2 5 2 0 1 5 1 0 0 5 0 0 Slovak Rep. EU15 Czech Rep. Bulgaria EU4 Hungary Poland Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay and Ilieva, World Bank, 2006. Note: the values are for 2006 for Bulgaria and for 2003 for all other countries. The indicator rangesfrom &least restrictive, to &-most restrictive. Figure 3.5: Product Market Regulation in OECD Countries, 1998 and 2003 1998 OECD average n Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay and Ilieva, World Bank, 2006. Note: The indicator rangesfrom &least restrictive, to 6---most restrictive. 3.15. To better understand the divergence o f performance among countries the overall indicator o f product market regulation is decomposed into three broad indicators: (i)barriers to trade and investment; (ii)barriersto entrepreneurship; and(iii)statecontrol. Inthenextsections, acomparisonofBulgaria's performance with other countries is made both usingthese broad indicators as well as some o f their sub- components. B. Barriers to Trade and Investment 3.16. Bulgaria has succeeded in reducing most o f the barriers to trade and investment faster and further than its peers- other MICs and EU4 prior to their accession to the EU. The indicator measures barriers to foreign trade and investment in the form o f tariffs or other regulatory barriers to trade, legal restrictions 34 on foreign ownership, and discriminatory procedures against foreign investors. In this area Bulgaria is close to the average OECD level, and performs even better than the other MICs and EU4 (Figure 3.6). Figure3.6: Barriersto Trade and Investment 2 5 2 4 2 0 1 5 1 0 0 5 0 0 EU15 CzechRep. OECD Bulgaria Hungary EU4 Slovak MlCs Poland Republic Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay and Ilieva, World Bank, 2006. Note: the values are for 2006 for Bulgaria and for 2003 for all other countries. The indicator rangesfrom &least restrictive, to &most restrictive. 3.17. Easing barriers to trade and investment has translated into improved integration o f Bulgaria with global economy. Bulgaria's trade o f goods and service has grown rapidly over the last five years to reach the levels o f the most integrated EU8 (Table 3.1). In 2005, Bulgaria's total foreign trade accounted for close to 140 percent o f GDP. Integration in goods has been expanding on the back o f rapidly expanding imports, while the growth o f merchandise exports has been more gradual. Trade integration in services has been advancing more rapidly than in goods, and is the second highest after Estonia among the new EU member states. Services have also attracted the largest share o f foreign direct investments (FDI) in the country-about 80 percent o f the total stock-mainly in ICT -using and producing sectors, such as financial intermediation and telecommunications. The total stock o f FDI in Bulgaria more than tripled in euro terms between 2000 and 2005 (see Figure 3.7), and in 2005 stood at close to EURlO billion or 45 percent o f GDP. More than 10,000 FDIenterprises operate on the territory o f Bulgaria, and employ more than 255,000 employees, which accounts for close to 12 percent o f the total number o f employees under labor contract. 3.18. Looking forward, strong FDI inflows will be instrumental in ensuring continued macroeconomic stability, and sustained productivity growth. FDI inflows have provided ample coverage o f the rapidly growing external current account deficits in Bulgaria, and so far supported the strong increase in private investment. To continue the trend in an environment in which few enterprises remain to be privatized will take further improvements in the business climate. Attracting FDI with further cuts in corporate income taxation has been exhausted, as Bulgaria levies one o f the lowest corporate tax rates in EU since 2007. In addition, Bulgarian legislation is more or less aligned with the acquis. Therefore, competition for increased FDI inflows would be increasingly based on the regulatory quality, and its effective enforcement. 35 Table 3.1: Indicators of Integration: Bulgaria and EU8 (percent of GDP) Trade integration, 2000-2005 Trade integrationFDIstock Goods Services Total goods & services,2005 2005 Bulgaria 92 29 120 138 45 Czech Republic 116 19 134 144 44 Estonia 125 42 167 174 82 Hungary 116 22 139 137 49 Latvia 75 22 97 110 30 Lithuania 92 17 109 124 29 Poland 56 10 67 74 27 Romania 66 10 76 77 26 Slovakia 130 19 149 150 33 Slovenia 99 18 118 130 10 Average, excluding 97 20 117 124 37 Bulgaria Source: Euro stat, IMF, BNB, and World Bank staff estimates Figure 3.7: Foreign Direct Investment Stock, million EUR 0,000 9,000 8,000 Industry 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 2000 2001 2002 2003 2004 2005 Source: Bulgarian National Bank and World Bank staff estimates 3.19. Bulgaria represents best practice in eliminating all discriminatory and other regulatory barriers to trade and investment, and fares better than OECD and EU15 on average in this area (see Figure3.8, left panel). This means that Bulgaria does not discriminate between foreign and domestic firms, both o f which have equal rights to appeal and redress through competition agencies, regulatory bodies, trade policy bodies, or private rights o f action. The Law on Encouraging Investment adopted in 2003 provides explicitly for equal treatment o f investors. Easing other regulatory barriers includes the use o f internationally certified standards and certification procedures, and engagement in mutual recognition agreements with other countries. Bulgaria has signed mutual recognition agreements with a number o f countries outside EU, and was a member o f CEFTA prior to EU accession, and signed free trade agreement with EFTA countries. However, further progress in aligning with international standards and certification procedures might be warranted. 36 Figure3.8: Barriersto Trade and Investmentby type I OEU4 OOther MlCs OEU15 OlOECD +Bulgaria OEU4 OOther MlCs OEU15 OOECD *Bulgaria "*/ 1.0 - 0.8 - 3.5 3 - 0 6 - 2.5 - 2 - 0.4 - 1.5 - 1 - 0.2 - 0.6 - 0.0 - 0 - discriminatoryprocedures regulatorybarriers ownershipbarriers tariffs Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD countries, de Rosa, Fay, and Ilieva, World Bank, 2006. Note: the values are for 2006 for Bulgaria and for 2003 for all other countries. The indicator ranges from &least restrictive, to &most restrictive. 3.20. Tariff levels in Bulgaria were higher than the EU15 average, but lower than in some EU4. Only the Czech Republic and Slovakia had reduced their tariff levels prior to EU accession, while Hungary and Poland entered EUwith higher tariff levels than Bulgaria had a year before accession. Bulgaria acceded to EU in 2007 with tariff levels already matching those of EU. However, Bulgaria still ranks low in terms o f some aspects o f trading across borders, 104th out o f 175 economies according to Doing Business 2007 (World Bank (2006b)). It takes 6 to 8 days more to export in Bulgaria than in EU4 or other middle income countries, and the cost to export per container is 2/3 higher than inthe Czech Republic. 3.2 1. Also, some foreign ownership barriers still remain in Bulgaria. They are predominantly related to restrictions on privatization o f selected state-owned enterprises (SOEs) in some sectors like electricity generation, gas, and water. These restrictions apply to the sale o f these enterprises both to domestic and foreign investors and take the form o f statutory or legal limits to the number or proportion o f shares that can be acquired by foreign investors in SOEs as well as the use o f special voting rights that the state has in firms to restrict the acquisition of equity by foreigners. InBulgaria, as in other EUcountries, there is a ceiling o f 49 percent o f foreign ownership in the airline sector. C. Barriersto entrepreneurship 3.22. Bulgaria had comparatively lower barriers to entrepreneurship4' in 2006 than its peers in 2003. (Figure 3.9). The "barriers to entrepreneurship" indicator covers policies related to licensing and permits systems, communication and simplification of rules and procedures, general and sector specific administrative burdens, as well as legal barriers to competition, and anti-trust exemptions. Relieving these restrictions has proved to be less pronounced in OECD countries between 1998 and 2003, with progress achieved mainly in easing the administrative procedures for start-ups. The modest progress can 4 1This aggregate indicator should be treated with caution as some of the lower level indicators have been constructed based on a methodology that is not directly comparable to the one used for OECD countries. Such indicators include administrative burdens on start-ups and to a lesser extent the sector specific administrative burdens. 37 be explained by the fact that domestic policies are subject to a large degree o f domestic discretion42in contrast to policies governing foreign trade and investments, which are subject to international agreements includingthe membership o f EUand WTO. Figure3.9: Barriersto Entrepreneurship 2 3 2 0 1 5 1 0 0 5 0 0 Bulgaria Slovak EU15 Hungary EU4 CzechRep. MlCs Poland Republic Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay and Ilieva, World Bank, 2006. Note: the values are for 2006 for Bulgaria and for 2003 for all other countries. The indicator ranges from &least restrictive, to &-most restrictive. 3.23. Although ahead o f its immediate peers (EU4 and other middle income countries) and o f the OECD average (Figure 3.9), Bulgaria needs to deepen reforms to ease barriers to entrepreneurship, if it is to enhance further competition on the domestic market and thus maintain high productivity rates required for accelerated convergence. Bulgaria performs better than OECD and EU4 countries in eliminating anti- trust exemptions to publicly-controlled firms, legal barriers to entry, and administrative burdens for corporation^^^. The only divergence in policies appears to be in sector specific administrative burdens (Figure 3.11). Removing barriers to competition in Bulgaria has been the result o f aligning the competition legislation with the acquis communautaire. Legal barriers inthe form o f restrictions imposed on the number o f competitors exist only in electricity generation, gas import, collection and purification o f water, and the air transport infrastructure. The rest o f the utility sub-sectors have been fully liberalized, with a large number o f the companies in these sub-sectors already privatized, including by foreign investors. 3.24. It should be noted, however, that the product market indicators do not take into account the enforcement o f competition legislation and the quality o f institutions, which may differ substantially in the benchmarking countries. Moreover, comparison o f Doing Business indicators on administrative barriers to start-ups suggests that while Bulgaria has achieved progress in this area, the country is still behind most o f the OECD countries (Fig. 3.12) that have succeeded in reducing by half the duration o f registration procedures and the cost to register a company between 2003 and 2006. Progress in Bulgaria has been more modest. 42DeRosa, Fayand Ilieva(2006). 43This indicator is constructedusing Doing Business data which are not comparableto the data for OECD countries and therefore comparisons basedon this indicator should be treatedwith caution. 38 Figure3.10: Barriersto Entrepreneurshipby Type Antitrust Legal barriers Communication License & Sector specific Administrative exemptions &sirnplif. of permits system administrative burdens for rules & burdens corporations* procedures I Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay and Ilieva, World Bank, 2006. Note: the values are for 2006 for Bulgaria and for 2003 for all other countries. The indicator ranges from &least restrictive, to &most restrictive. 3.25. Bulgaria has achieved progress in improving the communication o f new rules and regulations but there i s room for further improvements to ensure that these rules are actually being adhered to. The indicator on communication and simplification o f rules and procedures refers to the existence o f systemic procedures for making regulations known to affected parties, procedures in place to allow appeal against adverse enforcement decisions, programs for simplification o f administrative burdens, and programs for reducing the number o f licenses and regulatory regimes imposed by the national government. In Bulgaria, an amendment to the Law on Normative Acts in 2003 requires that all new regulations be communicated to affected parties through mass media or representative associations prior to their approval by Parliament. Affected parties have the right to submit comments to the body drafting the regulation within at least one month. Consultations on new legislation are organized with business associations and some o f the new regulations are discussed at the sessions o f the Council for Economic Growth44. In addition, the Law on Administrative Regulation and Administrative Control on Economic Activities were enacted in 2003. The Law regulates the issuance o f new regulations, which can be passed only by Parliamentary approval and requires that new regulations be accompanied by an assessment of compliance costs. Specific guidelines were issued to central and municipal bodies on the design of proposed new regulatory regimes, including the identification and measurement o f costs and benefits, and the establishment o f a process by which new regimes evolve appropriately from concept to implementation. However, to ensure that the intended impact o f these regulation is achieved, uniform application and compliance o f the above mentioned legislation i s warranted both in terms o f the consultation mechanism with affected parties, and in terms o f effective parliamentary control over the issuance o f administrative regulations by different levels o f government. 3.26. To align its communication and simplification policies with those o f the best performers in OECD, Bulgaria would need to design and implement a program for the optimization o f administrative burden imposed on firms and individuals. This program should be developed in consultation with the private sector, and aim at eliminating unnecessary or overlapping regulations, and improving the quality o f existing or new regulation. It should be implemented at all levels of government, including in municipalities, and should outline performance indicators with clearly defined lines o f accountability. The regulatory impact assessment would provide important information about the costs and benefits o f 44 A consultative body established in 2002 under the Council of Ministers and consists of representatives of businesses, and ministers of economy and energy, finance, transport, regional development, and labor and social policy. 39 regulations and their impact on competition. The OECD Guiding Principles for Regulatory Quality and P e r f ~ r m a n c ecould be incorporated inthe development o fthis program. ~ ~ 3.27. Initial steps in developing a Better Regulation program have already been taken. In June 2006 the Council for Economic Growth approved an action plan for introducing best regulatory practices and assigned responsibilities among affected ministries and institutions. A working group has been establishedto study best practices in simplification and modernizationo f regulatory practices. 3.28. The achievements in the simplification o f licenses and permits requirements are visible in the levels o f regulatory and administrative transparency, where Bulgaria compares well with benchmark groups, ranking as well as or better than EU15 or OECD (Figure 3.10). Bulgaria has implemented a number o f important reforms to bring down the number o f licenses and permits at central level, although progress at local level has been limited. A special program for optimization o f the centrally mandated licenses and permits has been in place since 2002. As a result o f this program, 85 percent o f the regulatory regimes slated for optimization have been simplified or eliminated. Moreover, these achievements have been acknowledged by businesses in Bulgaria, who saw licenses and permits as less of a problem in 2005 compared to 2002 (Figure3.11). Figure3.11: Percent of firms indicatingbusinesslicensesand permitsas a problemfor doing business 45 0 35 0 25 0 150 I 5 0 -5.0 J Slovakia Hungary Bulgaria Poland Czech Rep. I Source: EBRD-WBBEEPS, 2005. 3.29. Nevertheless, streamlining o f regulatory regimes needs to continue, if Bulgaria is to align with best performers in the world. Further optimization o f licensing and permits may be needed, since about a quarter o f businesses indicate this still as a problem for doing business. Review o f the implementation o f the reform program that started in 2002 and evaluation o f its outcomes is needed to assess ifthe program has actually led to overall reduction o f licenses and permits issued by central government, and hence reduced the burden o f compliance. The streamlining needs to be expanded to include also municipalities and be accompanied by training to ensure that all issuingand enforcement bodies have adequate capacity to estimate the compliance cost and propose further improvement. The enforcement o f licensing and permits regimes could be further strengthened both at central government, and especially at local level. The introduction o f the "silence i s consent" rule for automatic licensing could also help in this regard. Further improvements in licensing regimes would reduce the compliance costs o f businesses, and also bring savings from lower administrative costs at central and local government levels. Monitoring o f progress in eliminating licensing, and increased reliance on consultation with private sector would be key for successful streamlining o f licensing and permits. 45OECD (2005). 40 3.31 Reducing administrative barriers to companies needs to continue to allow easier access o f new entrants to the market. As mentioned in the previous section, enhanced competition would force companies to reallocate resources to more productive activities and provide incentives to firms to innovate. According to Doing Business 2007 indicators, Bulgaria has made progress in easing the start- up o f corporations, although it still ranks quite low on that compared to many other countries (Figure 3.12). The indicator measuring "administrative burden for corporations" is based on the Doing Business data on number o f procedures and days needed to start a company, and the cost o f opening a company. Bulgaria had improved on this indicator by 6 ranks between 2005 and 2006, as a result o f eliminating two out o f eleven procedures needed to start a business, but still ranks quite low, scoring 85th out o f 175 countries. Figure3.12: Administrative barriers to start-ups, 2003 and 2006 Number of procedures Number of days to register Official cost of registeringa requiredto register a firm a firm firm (YOof GNI per capiata) 12 60 25 1 10 50 20 8 40 15 6 30 10 4 20 2 10 5 0 0 0 Bulgaria OECD EU4 Bulgaria OECD EU4 Bulgaria OECD EU4 3.32 To ease the administrative burden on firms, a number o f reforms have been initiated. In the beginning o f 2006, the National Revenue Agency (NRA) integrated the collection o f taxes and social contributions, with a view o f reducing the taxpayer compliance burden. There is an initiative to simplify and ease reporting requirements to taxpayers, and especially for start-ups. The new Tax and Social Insurance Procedural Code provides for reduced reporting requirements for companies and individuals- most o f the information required before from tax payers is now received electronically from other institutions, which eliminated the need for separate tax and social security registration. With the launch o f the NRA integrated information system in early 2007, benefits to businesses are expected to increase. In 2006, a Law on Commercial Registry was enacted, which transferred the responsibility for business registration from courts to a special enlistment agency, thus transforming business registration into an administrative process. The start-up o f the new agency was delayed by more than a year, and is expected to become operational in early 2008. 41 3.33 Despite progress in reducing administrative burden to corporations, Bulgaria needs to further the reforms to catch up with the best performing countries in Box 3.1: Reforms of BusinessStart-ups in Europe - terms o f starting a business- Canada, Australia, New Portugal is singled out as a top performer in businessentry in 2005/06. The reform took 5 months. The country managed to reduce the number of days Zealand, United States, and to register a company from 54 to 8 days within a year. This success was Ireland, where it takes 2 to 5 achievedby introducing a new fast-track registration service, which provides days to set up a business, and a choice of pre-approvednames at the registry's website. The registry deals involves fewer than 5 with tax, social security, and labor registration and publishes the procedures. The pay-off from incorporation notice website of the Ministry of Justice. Standard articles of such reforms is likely to be a association make the application fast and error-free-with no need for a substantial increase in the notary. Within a year, the number of companies using the new service rose number o f new businesses, from 12 to 75 per day. improved competition not least through innovation, lower Other countries in Europe have also focused on cutting costs or simplifying registration-eliminating stamp duties in Switzerland for the first opportunities for extracting EURl,000,000 of start-up capital; abolishing the registration fee and piloted bribes, and reduced online registration in Belgium; reducing minimum capital requirements by administrative costs to the 90 percent in Georgia; and creating a virtual one stop-shop for new business government. - As mentioned in start-upsinLithuania. previous section, the gains o f 3.34 Entry into sectors such as road freight and retail appears to be highly regulated in Bulgaria and needs to be reviewed and eased where necessary. These regulations refer to the need to register, notify and wait for approval or license for establishing and operating national road freight business, or engaging inselling clothing or food. D. State Control 3.35 Bulgaria is far advanced in reducing state control o f the economy, although benchmarking with OECD countries suggests that the reform agenda is still unfinished. The state control indicator refers to the state involvement in business operations o f enterprises either through various forms o f state ownership, price controls, or the use o f coercive rather than incentive-based regulation both in specific sectors and in general. In Bulgaria, privatization o f the financial sector has been completed, and most state-owned non-financial enterprises have been privatized, including in telecommunications and some o f the utility sectors. Thus, in 2005 state-owned enterprises in the non-financial sector generated only about seven percent o f GDP and e m p l ~ y m e n t ~ ~Prices have been liberalized and most price controls . eliminated, with the exception o f controls over some staples, tobacco4', and pharmaceuticals. Despite these important reforms, Bulgaria lags behind some EU4 countries, and is far behind the EU15 and OECD averages (Figure 3.13). The largest gaps in performance (Figure 3.14) appear to be due to the state's direct control over business and the use o f command and control regulation instead o f incentive based regulation. The size o f the public non-financial sector in Bulgaria remains comparatively large. 46Refers to employment in state-ownedenterprises only. 47Price controls on tobacco andtobacco productshavebeeneliminated since January 2007. 42 Figure 3.13: State Control Slovak EUlS Other Czech EU4 Bulgaria Hungary Poland Rep. M l C s Rep. Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay and Ilieva, World Bank, 2006. Note: the values are for 2006 for Bulgariaand for 2003 for all other countries. The indicator rangesfrom &least restrictive, to &-most restrictive. Figure 3.14: State Control by Type State Control Price controls Direct control over Size of public Scope of public Use o f command & businessenterprise enterprise sector enterprise sector control regulation Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay an Ilieva, World Bank, 2006. Note: the values are for 2006 for Bulgaria and for 2003 for all other countries. The indicator ranges from 0-least restrictive, to &most restrictive. 3.36 When it comes to direct state control over enterprises, Bulgaria is on par with EU4, although the Czech Republic and Poland have eliminated any constraints to the sale o f equity in state-owned enterprises. Comparison with OECD countries reveals even bigger divergence of Bulgaria from best practice in this area. The direct control over business enterprises indicator measures the existence of constraints on the sale of equity in state-owned enterprises; government's special voting rights in privately-owned firms, and the extent to which these special voting rights are being exercised to control strategic choices o f firms. The economic rationale for preserving such constraints needs to be reviewed and appropriate action taken. 3.37 The indicator that measures the extent o f the use o f coercive regulation rather than incentive- based regulation shows that Bulgaria is still far from best reformers in this area. The indicator measures both general and sector specific regulations in a number o f sectors. The divergence o f Bulgaria from best practice is due to the fact that alternative forms o f regulation have not yet been considered. Alternative forms o f regulations are increasingly being used in OECD countries-out o f the 30 member countries, only in seven countries regulators are not requiredto assess alternative policy instruments before adopting a new regulation. Examples o f alternative forms o f regulation are shown in Box 3.2. On a more 43 encouraging note, and in contrast to some o f the OECD countries, Bulgaria does not regulate shop opening hours in retail trade, restrict road freight on backhauling, contractual carriage, and inter-modal operation, or insist on transport only for own account. Box 3.2: Alternative Policy Instruments Performance-Based Regulations-specify required outcomes or objectives rather than the means by which they must be achieved. Thus firms and individuals can choose processes that are more efficient and less costly, which promotes the use of new technology on a broader scale. Such type of regulation is increasingly used in health, safety, consumer protection, and environmental regulation'. Drawbacks include measurement problems related to desired outcomes, higher administrative and monitoring costs, and greater responsibilities for small companies to develop appropriate compliance strategies, Most countries have resorted to the use of guidelines or "safe harbors" in conjunction with performance-basedregulation. Guidelines provide information on appropriate compliance strategies, while safe harbors allow the benefits of certainty of compliance associated with prescriptive regulation to be attained, while also allowingmore innovative firms to take advantage of the benefits of such regulation. Process Based Regulations-require businesses to develop processes that systematically control and minimize production risks. These processes are used in businesses with multiple and complex sources of risk, where ex post testing of the product is either ineffective or expensive. Process based regulation i s predominantly used in health, food safety, and environmentalregulation. Co-regulation-businesses take the lead in regulation through endorsement and adherence to codes of practice. This type of regulation is highly cost effective for the government. Drawbacks include the possibility for encouraginganti-competitive activities by business or professionalorganizations. Economic Instruments-taxes, subsidies, tradable permits, vouchers and the like. Economic instruments allow businesses to achieve regulatory goals in the least costly manner and provide market incentives which reward the use of innovation and technical change. Information and Education-most widely used approach to regulation in OECD member states; empower consumersto adopt actions or make informed choicesto change their behavior. Examplesinclude campaigns aimed at reducing speeding when driving, anti-litter behaviors; reducing the use of drinking water; and eco-labeling of products. Guidelines-issued by regulatory authorities, setting out processes or providing interpretationsto aid understanding of government objectives by businesses and citizens. Guidelines may accompany existing regulations, but also are increasingly used as stand-alone documents. Guidelines, for example, are widely used in the area of consumer protection in Denmark. Voluntary Approaches-initiated by industries, sometimes formally sanctionedor endorsed by government. They include voluntary initiatives, voluntary codes, voluntary agreements, and self-regulation. An example of avoluntary arrangement is the chemical industry's Responsible Care Program, used in 40 countries, which promotes the adoptionof rules for sound environmental management practice. Source: OECD (2002a), RegulatoryPolicies in OECD Countries: From Interventionism to Regulatory Governance Productmarket regulation indicators do not include environmental regulations. 111. REGULATIONAND QUALITY OFINSTITUTIONS 3.38 While the quality o f written rules and regulations matters for helping countries move closer to productivity levels o f the best performers, the quality o f institutions that enforce these regulations is equally important. Even if best practice rules and regulations exist in a country, divergence in implementation may favor one company or individual to another, and thus increase anti-competitive pressures inthe economy. Good regulations may exist only on paper, ifthere i s little effort in monitoring the enforcement o f these regulations. Differences in implementation may exist also between different levels o f government, or between different central government agencies, depending on the degree o f their administrative capacity, or propensity to extract rents from enforcing regulations. The adequate 44 functioning o f the judiciary system can also encourage or discourage such variation in regulation implementation. Private sector pressure groups could exert pressure on institutions to be more effective, or tolerate the status quo, ifbenefiting from low institutionalquality. 3.39 As shown in the previous section, Bulgaria is behind the best OECD performers and its EUpeers interms o fproductmarket regulations, which is measured exclusively by looking at the quality o fwritten rules and regulations. A number o f international comparisons point to the conclusion that Bulgaria does not score well in terms o f quality o f institutions either. The most recent Global Competitiveness Index4* released suggests that Bulgaria is far behind all OECD and EU8 countries. Moreover, at 72nd place in 2006/07, Bulgaria has even worsened its ranking compared to 2006/05 by 11 places, which is the third largest deterioration in country rankings. On market efficiency, Bulgaria ranks 90th, much behind countries with similar per capita income levels. The indicator o f market efficiency measures the degree o f distortions in the economy (agricultural policies costs; efficiency o f legal framework; extent and effect o f taxation; and ease o f starting a business), competition policy (extent o f barriers to foreign trade and investment, intensity and effects o f competition on the domestic market), and indicators o f trade integration. In terms o f quality o f institutions, the performance o f Bulgaria is even poorer-the country ranks at 109th out o f 125 countries included in the comparison. Indicator o f institutions measures the quality o f public institutions (property rights, ethics and corruption, judicial independence, government efficiency, and security-reliability o f police and costs to business o f crime) as well as private ones (corporate ethics and accountability). Table 3.3 summarizes the results. Table 3.2: Select Global Competitiveness Rankings Indicator (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) Bulgaria 72 109 65 35 39 62 90 68 84 87 Cyprus 46 35 34 72 22 41 55 38 50 55 Czech 29 60 33 42 58 27 41 26 29 28 Estonia 25 30 30 16 43 23 25 16 35 30 Hungary 41 46 48 98 66 30 37 35 49 31 Latvia 36 50 39 34 79 28 40 43 54 66 Lithuania 39 59 44 41 70 29 45 42 41 50 Malta 39 31 37 76 32 47 46 22 51 62 Poland 48 73 57 70 26 33 64 51 63 44 Romania 68 87 77 97 69 50 76 49 73 68 Slovak 37 53 47 68 74 38 34 30 45 42 Slovenia 33 43 32 29 19 26 63 29 36 34 Source: World Economic Forum (2006), The Global CompetitivenessReport 2006-2007 Notes: (1) global; (2) institutions; (3) infrastructure; (4) macro economy; (5) health and primary education; (6) higher education; (7) market efficiency; (8) technological readiness; (9) business sophistication; (10) innovation. m. SUMMARY AND DIRECTIONSFOR REFORM 3.40 Over the last years Bulgaria has improved the regulatory environment for doing business. In some areas o f product market regulation Bulgaria performs even better than the OECD average. Areas in which Bulgaria outperforms the OECD average (see Figure 3.15) are: antitrust exemptions, procedures that discriminate against foreign investment; legal barriers to entry; other regulatory barriers to trade and investment, and licenses and permits systems. Areas, in which Bulgaria is comparable to the OECD '*For more information on the coverage of indicators, rankings and score, see World Economic Forum (2006) The Global CompetitivenessReport 2006-2007. 45 average, or at least not seriously lagging, include: price controls; the scope of the public enterprise sector, and tariffs. Inall other areas Bulgaria significantly lags the OECD average (see Figure 3.16). And if one looks at Bulgaria's performance vis-a-vis OECD's best performers, Bulgaria lags significantly even in some areas in which it outperforms the OECD average such as licensing and permits and legal barriers. Figure 3.15: Convergenceto BestPerformers in Product Market Regulation: Areas of lulgaria's Relative Strength QDistancefrom OECD average Distancefrom OECD best performer -1 J Antitrust Discrim. Commun.& Legal Regulatory Licence and Price Scope of Tariffs exemptions procedures simplif. barriers barriers permits controls publicsector ource: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay ai I Ilieva, World Bank, 2006. Note: The values are for 2006 for Bulgaria and for 2003 for all other countries. Distances are calculated as the difference between Bulgaria's scores and those of the comparator group. Negative values show better performanceof Bulgaria, while positive values show worse performance relative to the comparatorgroups. Figure 3.16: Distancefrom Best Performers in Product Market Regulation: Areas of ulgaria's Relative Weakness 4.0 ODistance from OECD average .Distance from OECD best performer 7 DDistance from EU8 best performer 3.5 - 3.0 - 2.5 - 2.0 - 1.5 - 1.0 - 0.5 - 0.0 t 7- Size of public Ownership barriers Direct control over Use of command & Sector specific sector business control regulation admin. burdens purce: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay an I Ilieva, World Bank, 2006. Note: The values are for 2006 for Bulgaria and for 2003 for all other countries. Distances are calculated as the difference between Bulgaria's scores and those of the comparator group. Positive values show worse performancerelative to the comparatorgroups. 46 3.41 To align Bulgaria's product market policies with the best performers in OECD, a well defined, government-wide reform program, enjoying high-level political commitment and developed in close consultationwith the private sector, would be needed. Sizeable gaps with best performers exist in all but 4 of the 15 benchmarked policy domains (see Figures 3.15 and 3,16). To address them, both short and medium-termmeasureswould be warranted. 3-42 Inthe short term,the programshould aimat, inthe order of priority: Minimize administrative burden on business, including barriers to entry of firms: To promote competition and thereby productivity growth, it would be critical to make the starting and closing a business administratively easy and inexpensive. While Bulgaria has made significant progress in reducing the legal barriers to entry, starting and closing a business is still administratively cumbersome and costly, compared to the OECD average. For starting a business, nine procedures are required in Bulgaria compared to the OECD average of six. Opening a business in Bulgaria still takes on average 32 days, while the OECD average is 16 days, and the minimum capital requiredin Bulgaria is about 91 percent of the GNI per capita while it is 36 percent on average in OECD countries. Bulgaria should aim to reduce these requirements at least to the average OECD levels, but preferably below. Experience shows that the impact of taking a substantial step in this area is much more significant than that of a series of small steps. The fast-track business registration service introducedin Portugalwould be worth consideringalso in Bulgaria. Continueprivatization and abolish state's special voting rights inprivatized companies: To further lessen state's control over enterprises, the government should consider removingthe remainingownership barriers such as the sale of equity in state-owned firms, and the use of special voting rights to control strategic choices of firms. In addition, continuing with the privatizationprogram would help increase the efficiency in the economy, and improve labor productivity. Suchreforms would contributealso to the reductionofthe size and scope of the public enterprise sector, as well as to the creation of a leaner and more efficient public administration. Simpfifv further the licensing and permit system: Even though Bulgaria's licensing and permit system is broadly comparable to the OECD average, it still lags behind the best performers.Also, despite significant improvements, in a 2005 survey 27% of business still considered licensing and permit procedures to be cumbersome. The Bulgarian authorities may want to consider introducing the "silence is consent" rule for automatic licensing to simplify the system further and thereby facilitate business. This area of action could also includefurther progressinthe simplificationand communicationof rules and regulations. 3.43 In the medium-term, the following steps could be taken to improve the investment climate in Bulgaria: Rely more on the use of incentive-based regulation through the use of alternative instruments. Following the example of OECD countries, the government may consider requiring the regulators to assess alternative policy instruments before adopting a new regulation. The authorities could also consider implementing a "regulatory guillotine" to eliminateunnecessary regulations, which impose administrative burdenon business. Improve the enforcement of regulations: The quality of written norms and regulations is important for achieving government goals and objectives, and for encouraging competition and competitiveness of businesses. Little can be achieved, however, if it is not matched by adequate quality of the institutionsenforcingthese regulations, includingthe functioning of 47 the judiciary system in the country. Even if some regulations, or reduced forms of regulations exist on books, their actual implementationdepends on the enforcinginstitutions, which may further increase the costs of regulation, if processes and procedures are cumbersome, or if leading to corrupt practice and anti-competitive pressures on selected firms and individuals. Bulgaria does not fare well in international comparisons in the quality of its governance framework. It ranks low interms ofthe quality of institutionsin the GlobalCompetitiveness Index, Transparency Index, and BEEPS indicators. Therefore, improving regulation of product markets in Bulgaria and reapingthe benefits from this, would hinge upon reforms aimed at upgradingthe quality of institutions. Furtheringreforms in public administration andjudiciary would maximize the gains from better regulationof product markets in terms of higher productivity, innovationand technologicalupgrade of the economy, which are key for achievingthe goals ofthe LisbonAgenda. 3.44 Finally, being behind on the productivity ladder and behind best performers in product market regulation, implies that Bulgaria could reap high returns from reforms aimed at liberalizingthe business environmentboth interms of quality of regulationsand quality of regulatoryauthorities. These returnsto the society could be even higher, ifcombined with reformsthat increasethe flexibility of the labor market that allow firms and individualsto allocate resourcesto their most productiveuses. 48 4. IMPROVINGTHE FUNCTIONINGOF LABOR MARKETS 4.1. Recent cross-country empiricalanalysis for OECD countriesfinds that restrictive product market policies tend to go hand in hand with restrictionsin labor marketp~licies.~'Correlationbetween product and labor market reforms implies that these policies are complementary, and profound reforms in one policy domain might facilitate reforms in the other, or amplify the effects of the latter. This means that Bulgaria should proceed with reforms in product and labor markets in parallel in order to facilitate productivity growth and convergence. The previous chapter examined some of the constraints in Bulgaria's product markets. This chapter covers the issues in the labor market, taking into account the findings on productivitytrends inChapter 2. 4.2. The analysis in Chapter 2 suggests that while labor productivity and employment have been increasingstrongly during 2000-2002 and 2002-2005, respectively, inter-sector mobility of labor is still low. Lack of labor mobility suggests that sectors with high levels and/or high growth of labor productivity have not been growing sufficiently rapidly--whetherthrough the expansion of existing firms or the entry of new ones--to demand new workers. Strong growth in employment in the past fours years was instead mostly in less productive lower paying sectors. Even there, the relatively high minimum wage may have dampened the labor demand of the small vulnerable enterprises. At the same time some of the sectors are reporting shortages of relatively high skilled workers, which would suggest a supply side problem. Also, on the supply side there may exist an unemploymenttrap, wherein relatively high social benefits, when compared to the likely after-tax wage, discourage some workers from seeking employment. Constraintsthus exist on both product and labor market sides, and they needto be tackled inparallel. I. LABOR MARKET DYNAMICS 4.3. Labor markets in Bulgaria have gone through a profound and painful transition since the start of political, economic, and social reforms in the early 1990s. As a result, employmentwhich stood at about 4.1 million on the eve of the reforms in 1990, declined to just under 3 million in 2000.50 Thisjob loss reflects closure of many enterprises, and "defensive restructuring" by others-a process in which redundant labor is shed in order to increase productivity. This period of "job loss" growth was followed by aperiodof "jobless" growth. 4.4. Bulgaria's GDP began to grow again in 1998, but it was not until 2002 that the number of employed persons also began to rise. The employment increase since then has been substantial: about 400,000 new jobs were created during 2002-2006. Excluding the roughly 50,000 participants in the 49See Nicoletti and Scarpetta (2005). Inthis paper, a summary indicator of labor marketpolicies was estimatedfor OECD countries, which includes tax wedges, gross replacementrates, and employment protectionlegislation.The indicator of product market regulation includes barriers to entry, public ownership, market structure, vertical integration,andprice controlsinseven industries-gas, electricity,post,telecoms,air transport,andrailways. Based on the NSI establishment surveys and administrative recorddregister-basedstatistics. Comparable labor force survey data are available only since the beginning of 2003, at which point NSI aligned LFS to Eurostat methodologies. Data from previous years is not comparable. Subsidized employment refers primarily to the program "From Social Assistance to Employment." Other subsidized employment programs include, inter alia, "Beautiful Bulgaria", "JOBS", and"Social Assistant". subsidized employment program ("From Social Assistance to Employment"), the net gain in jobs was about 350,000, or 12percent ofthe labor force (see Table4.l)." 4.5. Almost two-thirds of the increase in employment, however, has been concentrated in low wage, low productivity industries,such as agriculture, forestry, sub-sectors of manufacturing,construction,and trade. Employmentin higherwage sectors, suchas mining, electricity supply, transport, communications, and financial intermediation remained relatively stagnant. In the public sector, employment in public administrationhas increased by 36,600 employees, but declined slightly in education, health and social work during 2002-2006. By sectors, the share ofjobs in the service sector rose from 43 percent in 1998 to 48 percent in 2005, while the share of industry fell from 31.6 percent to 27.5 percent, and that of agriculture stagnated at about 25 percent of total empl~yment.~~These numbers probably overstate the number of people actually working in agriculture as it probably includesmany who own some land and live in a rural area, but do not actually make a living from working in agriculture (for comparison, see Table 4.4 that uses the Labor Force Survey (LFS) estimates). Even discountingfor that the proportion is rather high even by EU8 standards. Also, private sector employment has risen significantly from 61 percent oftotal employment in 1998to 79 percent in2005.53 Table 4.1: Labor Force Participation(LFP),Employmentand UnemploymentRates (populationage 15 years and over) Labor Employe Unemploye LFP Empl. Unempl. Employe Incl. Registered force d (1000) d (1000) Rate Rate Rate (YO) d (1000) Subsidized Unemployed (1000) (YO) (YO) Empl. (1000) (1000) 2002 Na na na na na Na 2979.0 2003 3283.1 2834.0 449.1 49.2 42.4 13.7 3166.5 79.4 551.6 2004 3322.0 2922.2 399.8 49.7 43.7 12.0 3226.3 93.6 469.2 2005 3314.2 2980.0 334.2 49.7 44.7 10.1 3253.5 59.1 424.4 2006 3415.7 3110.0 305.7 51.3 46.7 9.0 3349.2 47.6 356.0** Source: Labor Force Survey (LFS), except employment data from the National StatisticalInstitute (NSI yearbook 2003- 2005, N S I 2006c), and data of registered unemployment and subsidized employment data from the National Employment Agency (MLSP/NEA 2006a). . **administrative data. A. Labor Force Participationand EmploymentRates 4.6. Limited job opportunities during the 1990s led to a massive withdrawal from the labor force, especiallyamongyounger and older cohorts and women. Accordingto the 2006 LFS data, the labor force participation(LFP) rate of the populationaged 15-64was only 64.5 percent, while the employment rate was 58.6 percent (51.3 percent and 46.7 percent, respectively, when measured as a proportion of all people age 15 and above).54 This is still low by any standard, but is a considerable achievement when compared to the situationinthe year 2000. Comparativestatisticsfor Bulgaria,select EU8 countries, and the EU15 average are presentedinTable 4.2. 51 Almost equal employment growth is recorded by the administrative data and the Labor Force Survey (LFS), which do not distinguish between formal and informal sectors, and thus the growth is not a statistical effect of shiftingemployment from the informalto the formal sector. 52 Based on data from establishment surveys and administrative records. According to the LFS data, only 8.9 percentof the employedworked in agriculture, hunting, forestry, and fishing. 53NSI(2000) and (2006~). 54The labor force participationrate refers here to the rate amongthe population aged 15-64, while Table 4.1 refers to the rate ina broaderpopulationgroupcovering 15 andabove. 50 B. Informal Employmentand Self-employment 4.7. The informal sector is still sizeable in Bulgaria. There are different estimates of the size of the informal sector. Data from the National Social Security Institute (NSSI) indicate that in 2005 social contributions were paid for about 2.5 million people. In the same year, there were on average 3.25 millionpeopleemployed, accordingto establishment surveys, and 2.98 million accordingto the LFS data. This suggests that about one-fifth to one-fourth of employment is informal, that is, working but not making social contributions. While informal employment provides a cushion for workers who cannot find ajob in the formal sector, it also leads to a loss in budget revenues. These features of the Bulgarian labor market point to various bureaucratic and regulatory rigidities, which hinder labor market adjustment, andjob creation. Even in the formal sector, accordingto the 2005 BEEPS survey, about six percent ofthe workforce, and 14percent of the wage bill was not registeredwith tax authorities. Table 4.2: GDP growthand labor force participationrates (population age 15-64 years), percentin 2006 Bulgaria - Romania Estonia Czech Hungary - . Poland Slovak EU15 Republic Republic GDP. average annual 5.6 5.5 9.1 4.0 4.8 3.6 4.6 1.8 growth in 2000-2006 Per capita GDP 9223 8785 16414 18341 16825 12994 16041 29332 * (dollars), at PPP, 2005 LFP rate 64.5 63.6 72.4 70.3 62.0 63.4 68.6 71.6 Employmentrate: 58.6 58.8 68.1 65.3 57.3 54.5 59.4 66.0 Male 62.8 64.6 71.0 73.7 63.8 60.9 67.0 73.5 Female 54.6 53.0 65.3 56.8 51.1 48.2 51.9 58.4 Youth (15-24) 23.2 24.0 31.6 27.7 21.7 24.0 25.9 40.1 Older workers(55-64) 39.6 41.7 58.5 45.2 33.6 28.1 33.1 45.3 Hours worked per 41.4 41.3 41.5 42.7 41.0 42.9 41.6 41.9 week o f employment* *full-time Average exit age from 60.2 63.0 61.7 60.6 59.8 59.5 59.2 61.1 (e) the labor force (years), 2005 Harmonized 9.0 7.7 5.9 7.1 7.5 13.8 13.4 7.4 unemploymentrate*** Male 8.6 6.5 6.2 5.8 7.2 13.0 12.3 6.5 Female 9.3 9.0 5.6 8.8 7.8 14.9 14.7 8.4 Youth (15-24) 19.5 16.3 12.0 17.5 19.1 29.8 26.6 16.1 Long-term 5.0 4.3 2.8 3.9 3.4 7.8 10.2 3.1 unemployment rate**** Notes: (e) - estimate;* unweighted average for EU15 countries; **spring 2006;*** aged 15-74;****population 15 + unemployed 12 monthsand over as a percentageof the total active population Source:Eurostatonline database; IMF online database; OECD 2006. 51 4.8. Among the EU countries, Bulgaria has the highest ratio o f Table 4.3: UndeclaredWork in select EUcountries,latest undeclared work (see Table 4.3). ' EU available datass uses the concept o f "undeclared EU8, Bulgaria, YOof GDP Select EU15 Yo of GDP work," referring to "any paid Romania Bulgaria 22-30 Austria activities that are lawful as regards 1.5 Czech 9-10 Belgium 3 their nature, but not declared to the Estonia 8-9 Denmark 5.5 public authorities" (EC 2004). This Hungary 18 Finland 4.2 definition excludes criminal activities, Latvia 18 France 6.5 and work that does not have to be Lithuania 15-19 Germany 6 declared. The main attraction o f the Poland 14 Greece 20+ undeclared economy i s financial. Romania 21 Italy 17 This type o f activity allows Slovak 13-15 Netherlands 2 employers, paid employees, and the Slovenia 17 Portugal 5 self-employed to increase their Sweden 3 earnings or reduce their costs by UK 2 Source: EC (2004) evading taxation and social contributions. This shifts the tax burden to registered workers, which therefore is much higher than would otherwise be the case inBulgaria. C. Participation Rates by Gender and Education 4.9. Labor force participation o f males i s higher than that o f females in Bulgaria. According to the LFS 2006 data, the labor force participation rate o f females aged 15-64 is 60.2 percent compared to 68.8 percent for males. Employment rate for females is 54.6 percent, and 62.8 percent for males (see Table 4.4). While the unemployment rate for females is slightly below that for males, women tend to be more active than men in their search for ajob through the National Employment Agency (NEA). In 2005, there were 237,400 females on the roster o f NEA, and "only" 187,000 males.56 Table 4.4: Labor market participation (populationof 15-64 years of age), and employment by gender, professionalstatus, and economic sectors, in percent in 2006 (employed population2005) Total Males Females Labor force participation rate 64.5 68.8 60.2 Employment rate 58.6 62.8 54.6 Unemployment rate 9.0 8.6 9.3 Employed population*: 100.0 100.0 100.0 Total employees 85.8 83.1 88.8 Employeesinprivate enterprises 56.7 57.8 55.5 Employers 3.8 5.2 2.3 Self-employed 8.6 10.5 6.5 Unpaid family workers 1.5 0.9 2.2 Agriculture and forestry 8.9 10.7 6.8 Industry 34.2 38.9 28.9 Services 56.8 50.3 64.2 Notes: employedpopulation 15 years of age and over; 0.3 % o f the total unknown. * Source: Eurostat online, NSI 2006 c. 55NSIestimatesthe proportion ofundeclaredwork at 22 percentofGDP. 56MLSPNEA 2006a. 52 outcomes. In the second quarter Flgure 8.1: Labor Force Particiption, Employment,and of 2006, able-bodied population UnemploymentRates (population aged15-64), YOin 2006 42 with higher education had employment rate of 83 percent 1 Labor force participation ratel 1 compared with 69 percent for 80 rn Employment rate those with upper secondary 60 schooling, and 33 percent with 40 lower secondary education (see Figure 4.1). The difference in 20 unemployment rates by the level 0 of education is also significant. In Total Higher Upper secondary Lower secondary Primary or lower 2006, the unemploymentrate was only 3.8 percent for those with higher education, but rose to 18 percent for individuals with lower secondary education, and to over 30 percent for those with primary or lower education. The gap in employmentand unemployment rates by education is significantfor all age groups. D. Trends inUnemployment 4.11. Bulgaria's labor market still has a fairly large gap between supply of and demand for labor, despite the notable improvements in the past four years. According to LFS data, the rate of unemploymentwas 8.4 percent inthe fourth quarter of2006. 4.12. The bulk of the unemployedare long-termunemployed, less educated, and young (see Table 4.5). In 2005, 60 Percent of all unemployed Table 4.5: Number of Long-termRegisteredUnemployed workers had been without work for at (average per month) least one year, and 34 percent for longer 2002 Januarv- than three years. Out of total September 2006 unemployed with higher education, 47 Totalnumber (1000) 332.5 209.5 percent were out of work for more than Of which (%): 12 months. Among job seekers with Females 52.8 57.1 secondary vocational education, the Males 47.2 42.9 ratio was 49 percent, while 60 percent Youth upto 24 10.9 9.0 of job seekers with lower secondary or Personsover 50 22.1 33.6 lower education had been jobless for By professionalqualification: more than a year (I1 quarter of 2006). With worker specialty 19.3 16.4 Forty-four percent of the long-term Specialists 10.7 10.0 unemployed had lower secondary, Without qualification 70.0 73.6 primary or lower education.57There are By education: indications that most of these numbers Higher 3.3 3.3 have improved a little in the last few Secondaryvocational 22.4 19.5 months. Secondarygeneral 5.8 5.5 Primaryandlower 68.5 71.7 Source: MoLSPNEA 2006b. 57N S I (2006a). 53 4.13. Unemploymentis high among certain ethnic groups, particularly the Roma. The Roma have the lowest employment rate at 29 percent, and the highest unemployment rate at about 70 percent.'* The Roma interviewedin the context of the JOBS (2003) program, which supports integrationof Roma into the labor markets in ten municipalities, revealed that 45 percent of them had never worked, and 16 percent participated in work activities for the first time in their life through the program "From Social Assistance to Ernpl~yment".'~ E. Youth Unemployment 4.14. As in other transition countries, the negative effect of high unemployment rates is especially serious and damaging for youth. On average, youth unemployment rates in Bulgariaare twice as high as overall unemployment rates (see Table 4.6), which is similar to other EU countries. Young uneducated people are in the worst situation in the labor market. This group, with no vocational education and experience, is so uncompetitive that even a considerable improvement in labor market conditions and employment growthmay not improvetheir situation. Table 4.6: Youth Unemployment,Employmentand Labor Force ParticipationRates, 2005 Youth Youthladult Youth Youth labor force unemployment unemployment employment rate, participation rate, rate, YO ratio YO YO EU15 16.5 2.0 39.7 47.6 Bulgaria 22.3 2.2 21.6 27.5 Czech R. 19.3 2.4 27.3 33.9 Hungary 19.4 2.7 21.8 27.1 Poland 37.8 2.1 20.9 33.5 Slovakia 29.9 1.8 25.6 36.5 Source: OECD (2006), LFS 2005 for Bulgaria 4.15. In addition to high youth unemployment rates, Bulgaria has low youth labor force participation rates. At 27.5 percent, Bulgaria's youth participation rate is fully 20 percentage points lower than the EU15 average. A significant portion of Bulgarian youth are neither working nor in school. In the age group 15-24, the rate ofjoblessness (the proportion of the populationneitherworking nor in school) was 21 percent in 2004, andthe rate of idleness (the proportionof the populationneither inthe labor force nor in school) was 14 percent. Compared to many EU8 countries, the share of early school leavers of 18 percent is quite high in Bulgaria. There are two mainreasons for this. First, about 35 percentofthe drop- outs cited family reasons associated with economic instability, unemployment, and poverty (inability of the family to providestudents with textbooks, clothes, or the needto helpearn the living) as the cause for dropping out. The secondmost important reason, cited by 29 percent of the drop-outs was unwillingness to study.60Bulgarianyouth are not alone in their plight. The World Bank's World Development Report 2007 on Youth notedthat an increasing share of young people is facing difficulties in transitioningfrom educationto the labor market. Primaryreasons for this are poverty, poor educational background, barriers to entry in the labor market, and getting stuck in low productivityjobs.6' As the LFS data reveal (see Table 4.7), labor force participation, employment and unemployment rates among young people strongly correlate with the levelof education. 58World Bank (2003). 59MLSP (2006). 6oMLSP (2006). 6'WorldBank (2006b). 54 Table 4.7: Labor Market ParticipationRatesat Age 15-24 and 25-34 and the Level of Educationin - 2005, Yo Level of education Activity rate Employment rate Unemployment rate 15-24 25-34 15-24 25-34 15-24 25-34 Higher 71.1 88.0 60.5 83.3 14.9 5.4 Upper secondary 48.7 80.8 40.2 73.8 17.4 8.7 Secondaryvocational 61.0 84.1 51.4 76.8 15.8 8.6 Secondarygeneral 36.8 74.2 29.0 67.6 20.0 8.9 Lower secondary 9.4 63.9 6.0 51.6 35.7 19.2 Primaryor lower 18.2 40.0 9.1 24.9 49.9 37.7 Source: LFS 2005 for Bulgaria. 4.16. Inthe rapidlychangingmarket economies of the transitioncountries, an individual'soccupational future is uncertain, and the risk of a mismatch between the skills of an individual and those required by the available jobs is high. Therefore, the World Development Report 2007 recommends that these countries provideyoung labor market entrants with general academic skills, which will makethem mobile across industries/sector and easier to employ. This is consistent with the proposed reform recommendations for the education sector in Chapters 6-7. The young are a particularly importantgroup inBulgaria,since they have a potentially longworking life ahead ofthem, andthe burdenoffinancingthe pensionsof the rapidly ageingpopulationwill to a great extent fall ontheir shoulders. F. RegionalDisparities 4.17. There is significant regional variation in participation, employment, and unemployment rates in Bulgaria. Table 4.8 shows labor market indicators by the urban, rural, and major regional groupings. Unemployment rates in urban areas are almost five percentage points lower, and participation and employment rates considerably higher than those in rural areas, suggesting that recent growth has been concentrated in urban areas as might be expected. The situation in the North-West region is the most difficult, althoughthe rate of unemployment is almost as bad inthe North-Eastregion. Table 4.8: Labor Market Indicators by GeographicalGroupings(population aged 15 years and over), in 2005 Planning regions North- North North- South- South South- Total Urban Rural West Central East East Central West LFP Rate 49.7 54.2 39.2 40.7 46.3 51.1 48.8 48.5 54.1 Employment 44.7 49.3 33.8 35.2 41.4 44.3 44.1 43.7 50.0 Rate Unemployment 10.1 9.0 13.7 13.6 10.7 13.3 9.6 10.0 7.6 Rate Source: MLSPINEA 2006a 4.18 Finer geographical disaggregation at district level show even more disparity. Variation in unemployment rates is between 2.2 percent in Blagoevgrad district (South-West), 3.3 percent in Gabrovo (North Central) and 5.4 percent in Stara Zagora (South Central), as the districts with the lowest unemployment levels, to 22.5 percent in Vidin (North-West) and 17.7 percent in Pazardzhik (South Central) as the districts with the highest unemployment levels. Although the capital city Sofia has one of the highest employment rates of 51.8 percent (second highest following Blagoevgrad district), the unemploymentrate in Sofia is relativelyhigh-7.6 percent (NSI 2006). 55 4.19 Wage levels seem to respondto the demand for labor. The correlationbetween regionalaverage wages, as reportedto the NSSI, and unemploymentrates is negative (-0.3744) and significant at the five percent level. (2005 data). Regions with low unemployment (higher demand for labor) tend to have higher wage levels. The finding is also consistent with often heard statement that wages in the private sector are rising rapidly in Sofia (south-west region) due to shortages of labor. However, there are no dataavailableto confirm that. G. LaborPotentialofthe CurrentlyInactivePopulation 4.20 Bulgariahasjust over 3.2 million people aged 15 years and above that are not in the labor force. Labor potential of this currently inactivepopulationshould not be ignored. Although a vast majority (85 percent) of this economically inactive population does not want to work, cannot work, or is unable to work (students, retirees, disabled, household members taking care of children or other dependants) according to the 2006 LFS, about 15 percent of the inactive population (268,000 individuals) could be consideredto be discouragedworkers. They would like to work and would be ready to start working, but for various reasons are not actively looking for ajob. In most cases such respondents report that they have lost any hope of finding work, or do not know where or howto search. 11. LABOR COSTS,WAGEDYNAMICS, ANDMINIMUM WAGES 4.21 Relativelycheap and well qualifiedworkforce continues to be one of Bulgaria'smaincompetitive advantages. Labor costs in Bulgariaare the lowest among EU countries, and are about one-tenth of the average hourly labor costs in EU27 countries (Table 4.9). They have also grown slowly compared to other EU countries. According to Eurostat data, Bulgaria is the only new EU member state where real labor costs decreased in 2006 compared to 2000 (see Table 4.9). Combining the low rate of growth in labor costs with the improvements in labor productivity in the last 5-6 years (see Chapter 2), unit costs of labor have grown muchless in Bulgariathan among its comparators. This has helpedpreserve Bulgaria's competitive edge, improved profitability and future prospects of many of Bulgaria's enterprises, and contributedto keepingdownthe rate of inflation. 4.22 There is a concern, however, that Bulgaria's competitiveness relies too heavily on low labor costs, and that Bulgaria may be locking-in into unskilled labor-intensiveactivities, and low productivity patterns of specialization. Low unit costs of labor are also a temporary and volatile advantage. As the labor markets in Bulgaria tighten, pressure to raise wages will mount. This could, in the future, create inflationarypressures, unless laborproductivityrises at least as rapidly as wages. 4.23 Since 1997 real (reported) wages have increased at about the same pace as real GDP. Private sector wages are reported at 72 percent of the public sector wage level; although this is open to doubt. There are indications that actual (rather than reported) wages in the private sector are considerably higher.62 Nevertheless, the public sector seems to have become an attractive option for many, which perhaps explains the growth in employment in public administration. Whatever the case, getting better dataon wages, productivity gains, and unit laborcosts shouldbe ahigh priority. `*This differential may reflect as well larger share of underreportingin the private sector than in the public sector. Accordingto the wage survey conductedin2006, actual averagemonthlywages were BGN840in Sofia, BGN700in Burgas,BGN600inPlovdiv, andBGN590inVarna (IndustryWatch2006). 56 Table 4.9: Labor Cost Index (2000=100)* 2005 2006 2005 2006 Hourly Nominalvalue Deflated labor costs. EUR,2005 EU27 119.9 123.4 106.1 106.7 ... CzechRepublic 141.8 150.5 128.3 33.5 6.56 Estonia 163.9 191.1 137.7 53.7 4.71 Latvia 163.4 201.5 133.7 54.7 2.91 Lithuania 127.5 151.0 121.7 38.9 3.62 Hungary -~ 161.2 175.4 121.4 26.8 6.57 Poland 136.8 144.2 119.5 124.4 5.78 Slovenia 143.5 152.5 109.6 113.5 11.49 Slovakia 157.6 170.4 118.6 123.0 4.59 Bulgaria 132.7 139.0 101.3 98.8 1.61 Romania 281.8 339.0 121.5 137.1 2.38 Notes: * Labor costs include gross wages and salaries, employers social contributions, and taxes net of subsidies connectedto employment;** 2003 Source: Eurostatonline 4.24 In Bulgaria, as in many other Central and EasternEuropeancountries, minimum wages are set at a relatively high level, amountingto about 47 percent of the average reportedwages in 2005, while for example in the United States they are at 27 percent (Table 4.10). According to the latest Eurostat data from early 2007, in relative terms Bulgaria, together with Malta, Luxembourg and Ireland, has the minimum wage above 49 percent of average gross monthly earnings. In absolute terms, however, Bulgaria has the lowest level of monthly minimum wage in EU at EUR92, and second lowest when applyingPurchasingPower Paritiesto households' final consumptionexpenditure. Nevertheless, in some low-wagesectors of the economy, such as in agricultureand forestry, minimum wage is about 65 percent of the averagewage. In trade, the ratio is 60 percent.63Such high ratios are typically more damaging for SMEs because these enterprises tend to be more labor intensive, and financially weaker. This likely contributesto keepingmany SMEs smaller than they might otherwisebe. It also gives them an incentive to stay in the informal sector. So, a well-intentionedpolicy (a high minimum wage) may well have the perverse effect of reducingthe tax base, and possiblythe overall level of empl~yment.~~The reason for high minimumwages in Bulgariaseems to be that, accordingto the Labor Code, their level is established administratively by a Decree of the Council of Ministers-it is set centrally and at a uniform rate.65 This decision is likely to be influenced most by insiders that are those who already have a job. It is also unlikely to reflect the varying conditions faced by enterprises in different sectors and regions, or be sensitive to the preferences of certain groups ofjob-seekers. The process of setting the minimum wage shouldthereforebe revisited. 63The draft 2007 budget law envisages a minimummonthly wage of BGN170, but the threshold might be raisedto BGN180duringthe discussionsinthe Parliament. 64WorldBank (2005b). " However, according to MLSP, the social partners are consulted within the framework of the Commission on incomes and living standards under the National Commission for Tripartite Cooperation but an Agreement on Economicand Social Developmentin the Republic of Bulgariauntil2009 (anational tripartite agreement) does not indicate the levels of the minimum wages. Article 10.12 of the Agreement only suggests that the minimum wage should be determinedafter negotiationswith the social partners taking into consideration the official poverty line andthe average wage for the country. 57 Table 4.10: Dynamicsof averagewages, minimumwages, and non-taxablemonthlyincomes, BGN Minimum Average Average Ratio of minimum Non-taxable monthly wages* monthly wages ** monthly wages ** wages to average monthly incomes*** wages 2002 100 258 267 0.338 100 2003 110 273 263 0.403 110 2004 120 292 295 0.411 120 2005 150 320 313 0.469 130 2006 160 343*** * 336**** 0.466**** Notes:* the minimum wage is set by the decree of the Council of Ministers; the PersonalIncomeTax Act;**** **employeesunder labor contract;**180 accordingto January-September Source: NSSI 4.25 High minimum wages have been found to have negative effects on employment. These effects may be small in the aggregate, but significant among workers injobs that have low productivity, since even a "minimum" wage may be higher than a particular worker's productivity,makingit unprofitableto employ him/her.66This is particularly true of many jobs held by young people. For more experienced workers the evidence is more mixed.67 4.26 Bulgarian authorities are reportedly thinking of linking the minimum wage to the poverty line. This is generally not advisable. OECD data indicatethat the relatively weak link between low pay and poverty is a rule rather than an exception.68 The main reason for this is that poverty is predominantly associated with non-employment (including unemployment), rather than with low wages. Many poor families have no one working and many minimum wage workers live in households with above average incomes. Therefore, and given that high minimum wages have negative effects on employment, linking the minimumwage to the poverty line may only exacerbate poverty and distort the labor markets. Rather than usingminimum wages as an instrument to reduce poverty, it should be the social assistance system that helpsthose belowthe poverty line. 111. EMPLOYMENT SOCIALINSURANCESYSTEM AND 4.27 Mandatoryregistrationof labor contracts with the National Social Security Institute(NSSI) as of 2003 has led to rapid growth in the number of registerednew labor contracts, and thus in revenues to the social security system (see Table 4.11). Initially, most of the increase was due to the registration of people employed in the informal sector. Later, most of the increase came from the creation of newjobs. As discussed in Chapter 1, Bulgaria is facing the challenge of a rapidly declining and aging population. This will eventually lead to an absolute decline in working age population, althoughfor a decade or two the inevitable fall may be staved off by higher labor force participationand employment rates and, ifthe right measures are taken, by a diminished number of people working in the informal sector. Thus, the ratio of pensioners to insured people, which is now falling, will eventually reverse course and the burden of dependency will rise. 66World Bank (2005a). 67See Kertesi and KBlliS (2002) for Hungary, and Gottvald et al (2002) and Eriksson and Pytlikova (2002) for the Czech Republic and Slovakia. OECD (1998). 58 Table 4.11: Employedand insuredpopulation,and the number of pensionersin 2000-2006 (million; average annual) Population Employed Pensioners Insured" Ratio of pensionersto insured persons* 2000 8.170 2.980 2.379 2.306 103.3 2001 7.913 2.968 2.371 2.311 102.6 2002 7.869 2.979 2.35 1 2.170 108.3 2003 7.824 3.166 2.337 2.394 97.6 2004 7.78 1 3.226 2.328 2.492 93.4 2005 7.740 3.276 2.314 2.597 89.1 2006 7.699 3.349 2.285 2.747 83.2 Source: NSSI; Notes: * Insuredinthe Mandatory Social Insurance System A. UnemploymentTraps 4.28 High levels of unemployment and other social benefits coupled with high taxes can create unemploymenttraps.69These are situations where unemployedpeople have financial disincentiveto seek employment since the level of social benefits as unemployed are higher than net earnings as employed after withdrawal of those benefits. They are "trapped" in unemploymentdue to perverse effects of the system of incentives. Low-wage traps may also occur, that is, situationswhere a relatively large part of thus making higher skill work Figure 8.2: "Tax" rate on LowWage Earners: unprofitable. UnemploymentTrap, YOin 2005 (source: Eurostaf) Slovakia 4.29 Comparative data from EU Hungary countries suggest that Bulgaria may Estonia suffer from an unemployment trap. When unemployedworkers in Bulgaria Czech R go back to work, they lose United Kingdom unemployment benefit, all or some of Romania the social assistance (Guaranteed Ireland Minimum Income; energy benefit, Germany income-based child allowance) and EU25 other benefits paid to the family of the EUl5 unemployed, while having to pay Bulgaria social security contributions and Lithuania income taxes. On average, the net Poland effect of all this amounts to an implicit Latvia "tax" totaling 76 percent of earnings for a prospective low-wage workers Slovenia 93 (see Figure4.2). 0 20 40 60 80 100 Source: Eurostat 69The unemployment trap measures the percentageof gross earnings, which is "taxed away" through higher tax and social security contributionsand the withdrawal o f unemployment and other benefits when an unemployed person returns to employment. This structural indicator covers single persons without children earning, when in work, 67 percent ofthe average earnings. See the data and methodology in: http://epp,eurostat.ec.europa,eu/portal/page?gageid=1073,46870091&-dad=portal&-schema=PORTAL&pqroduc t_code=EM042 59 4.30 Bulgaria ranks in the middle o f the scale in terms o f generosity o f unemployment benefit entitlements, but is well above Slovakia and Hungary which are the leading reformers in this area. According to the Law on Social Insurance, the duration o f benefit payments is from four months for beneficiaries with at least three years o f insurance records, to twelve months for those with over 25 years o f insurance records. Bulgaria is the only transition country that increased the maximum duration o f unemployment insurance payments from 6 to 12 months between the beginning and the end o f the 1990~.~'The size o fthe benefit is 60 percent o f the average monthly insurance income o f the beneficiary, and the minimum and maximum benefit levels are determined annually in the budget law."' For comparison, many EU countries are moving in the direction o f shortened maximum duration o f receiving a benefit. Others are decreasing the benefit with the length o f unemployment spell or, as i s the case in Denmark, even canceling it at some point. However, it should be noted that due to dominance o f long- term unemployment, relatively few registered job seekers--about one fifth-receive the benefit. Because o f the mandated minimumlevel o f the unemployment benefit (over 50 percent o f the maximum level); the current benefit formula creates adverse incentives for job search among the unemployed who were being paid low wages before losing their jobs. 4.31 In recent years, the Government has taken steps to Figure 4.3: Tax Rate on Low Wage Earners: Tax Wedge on reduce the dependency o f Labor Costs in 2005 unemployed as well as able-bodied but inactive population on social Figure 8.3: Tax Rate on LowWage Earners: Tax Wedge benefits. An increase in the level o f on Labor Costs in 2005 guaranteed minimum income and Ireland other social benefits has been Jnited Kingdom delayed, and eligibility rules made Bulgaria more stringent.72 Moreover, able- Slovakia bodied beneficiaries o f social assistance are asked to participate in Estonia "From Social Assistance to EU25 Employment" program to retain EU15 their access to income support. But Slovenia more could be done. Lithuania Romania 4.32 What about the low-wage Latvia trap?73 The tax rate on low wage earners at 35 percent in Bulgaria i s Czech R below the EUaverage o f 39 percent. Poland This is largely due to a relatively Hwary high level of non-taxable income Germany (Table 4.9). Therefore, once the worker enters the labor market, the 70World Bank (2005b). This was driven by the acceleratingprivatization and enterprise restructuring, which is now largely over. 7' Relatively high unemployment benefit tends to be associated with longer spells in unemployment, inter alia, because of the decline in the intensity of job search, although it may also potentially improve the quality and duration ofjob matches. 72In particular, the maximum duration of the guaranteed minimum income benefit for able-bodiedpeople who are not holdingdisability certificate was limitedto 18 months. This will be in effect as of January 1, 2008. 73The tax wedge on labor cost measuresthe relative tax burdenfor an employedpersonwith low earnings, 60 tax burden on labor is below the average in EU25. Thus, from the point of view of taxes, the Bulgarian labor market has built-in incentives for unemployedpeople to enter the labor market, althoughthere are instruments such as tax credits for low-wage workers that could help make the incentives for initial (re)entry into the labor force stronger, but that could be reduced as wages rose. Also, once the unemployedhave re-enteredthe labor market, it would be important for the system to encourage them to develop their skills and thus earningpotential. IV. LISBON STOCKHOLM EMPLOYMENT AND TARGETS 4.33 Even assuming that stronggrowth in GDP and employment will continuefor some years, the EU Lisbontargets are beyond reachfor Bulgariaby 2010. These targets call for the overall employment rate to rise to 70 percent, the employment rate for women to reach 60 percent, and the employment rate for older workers (55-64) to be at 50 percent by 2010 (see Table 4.12). However, the national target of reachingan employment rate of 61 percent by 2010 is achievable, providedthe GDP continues to grow at about five percent per year. Achieving it would imply addingjust over 40,000 newjobs in each year of the four year period 2007-10; a pace considerably slower than that observed since 2002. If one were to assume an employment elasticity with respect to GDP of 0.3-roughly the rate observed globally in the last 15 ~ears'~--andproject Bulgaria's GDP growth at 5-6 percent per year, employment would continue to grow at 1.5-2.0 percent per year. This would translate into about 50,000 additional jobs per year, leading to the Lisbon target goals being achieved around 2015. Under this projection, Bulgaria's employment will have grown by 450,000 people between 2006 and 2015. By 2015, total employment would be inthe range of 3.55-3.7 million (depending on the data source), and the employment rate would be 69-72 percent. The labor force in such a scenario would by then have absorbedall but the hardest core of unemployed, most of the quarter million discouraged workers, and would have started tapping into those underemployed inthe rural areas, or those employed in low-wageoccupations but looking for better opportunities. By 2015, the inter-sectorreallocationof labor, which is currently almost non-existent(see Chapter 2) could be well underway, if the various constraints in the product and labor markets were reducedor removed. Beyond2015, with the age group of 15-64year olds decliningat almost one percent per year and open unemploymentvirtually gone, the labor market would tighten considerably, and most of the further growth in GDP would have to come from rising total factor productivity. Under that scenario, provided the rate of growth of labor productivity increased to well above its recent pace of 2 percent per year, Bulgariawould continue to converge towards the average income level of EU25. Of course, this relatively rosy picturedepends a great deal on the policiespursued betweennow and then and to some extent on the developments beyondBulgaria's borders. Table 4.12: EUEmploymentTargets According to LisbonCriteria, and New Jobs Needed to Reach them In Bulgaria EULisbon Bulgaria Estimated number of new Estimated number of new targets - iobs needed to reach EU iobs neededto reach national targets in 2010 (1000) targets in 2010" (1000) 2005 2010 2005 Overall employmentrate 67 70 55.8 635 170 Employment rate for 57 60 51.7 165 women Emtdovment rate for - 50 34.7 178 older workers(55-64) Notes: * employment rate at age group 16-64 at 61 percent level; Pact on social and economic development of Bulgaria until 2009 signed by representative social partners and the Government. Source: Staff calculations. 74WorldEconomicForum(2006) 61 V. CHALLENGESFORLABOR MARKET POLICIES A. InstitutionalConstraints 4.34 Bulgaria has undertaken significant institutional reforms in the field of labor market policies in the last couple of years. The Labor Code was harmonized with EU Directives. The Law on Economic and Social Council adopted in March 2003 regulates the establishment of an Economic and Social Council, a consultative body on economic and social issues involving both social partners and civil society. A National Institute for Arbitration and Conciliation was established to focus on resolution of collective labor disputes. The Employment Promotion Act was amended to allow the provision of active job brokering services by the private and an agreement on Economic and Social Development in the Republic of Bulgaria until 2009 was signed among the employers' associations, trade unions, and the government in 2006. 4.35 Surveys of local employers suggest that the demand for labor is constrained primarily by the business environment, which is perceived as not particularly conducive to investment and job creation, although the situation has clearly improved since 2002 (Figure 4.4).76 In the 2005 survey, the most frequently heard complaints by local businessmen were related to factors such as uncertainty about regulatory policies; anti-competitive practices of their competitors; cost of financing; and tax rates. Issues such as macroeconomic instability and access to financing that were important in 2002 had receded by 2005. 75By early 2006, there were 432 private job brokerageagencies licensed in Bulgaria, of which 142 agencies were recruiting locally for work abroad (MLSP 2006). 76Based on the results of the EBRD-World Bank environment and enterprise performance survey (BEEPS) of 2002 and 2005. 62 Figure 4.4: Doing Business, percent of RespondingFirms Indicating a Problem in 2002 and 2005 7-- ~ _ _ _ _ ~ _ ~ _ ~ _ _ - _ _ ~ - I Access to land Title or leasingof land Customs and trade regulations L Labour regulations Business licensing and permits Skills and education of workers Tax administration Contract violations I Access to financing I Functioningofthejudiciary Corruption hlacroeconomic instabilit), Tax rates Cost of financing ~ Anti-conipctiti\ e practicesof dthcrs Uncertaint), about regulator),policics I 0 10 20 30 40 50 60 70 80 90 4.36 The surveyed businesses perceive skills and education of workers to have worsened between 2002 and 2005, and consider it as an increasingly binding constraint on job creation. It is the only indicator to have worsened since 2002. In 2005, almost 30 percent of managers indicated skills as an issue, including one-tenth as a major obstacle to expanding business. This constraint is likely to gain further prominence in the future, as the labor markets continue to tighten, and the competitive advantage of firms becomes increasingly based on innovation in products and processes. There are already some signs of this. Employers report difficulties in hiring certain types of high skilled workers, such as construction or IT specialists. Moreover, employers' current unwillingnessto spend much on upgrading of their labor force-through continuing vocational training, distance education, and other formal and informal methods-may have a negative impact on labor productivity, and the ability of labor to move from low-productivity to high-productivity jobs. Chapters 5-7 will cover different education sub-sectors and reforms neededinthose areas. B. ImprovingEmployment Services 4.3 7 The National Employment Agency (NEA), which is implementing government's labor market policies, is well resourced. Its activities are based on the National Employment Action Plan prepared by MLSPjointly with other ministries and social partners. The Action Plan serves as the operational tool for concrete actions and measures to attain the objectives laid down in the Bulgaria's Employment Strategy 2004-2010. For example, the 2006 action plan listed 63 different programs, measures, or projects. Many 63 o f these measures, however, covered only a small number o f beneficiaries. NEA i s relatively well staffed compared to similar agencies in other transition countries. In 2006, NEA had 2,825 staff, o f which 2,136 were front line counselors, who worked directly with job seekers. Thus, the staff caseload-the ratio of clients to employment counseling staff-was 130job seekers per one job counselor (see Figure 8.5).77 Figure 4.5: International Comparison of Public Employment Service Staff (2002 and 2003; _-. 2006 for Bulgaria)_ _ _ _____~___ ____ _ _ _ _ _ ~ _ _ _-________ ~ _ ~ ~ ~ ..._.._._ --. - .-. ..... ... .. , . . ... . 76 37 ~ Registeredunemployedper PE I i I , 1 r 0 200 400 600 800 1000 1200 1400 1600 1800 ~ 4.38 Public spending on employment programs in Bulgaria also compares favorably with EU8 and even EU15 countries. In 2005, Bulgaria spent about 0.44 percent o f GDP on active labor market programs (ALMP), compared to the EU15 average o f 0.55 percent o f GDP (see Table 4.13). However, what makes Bulgaria an outlier i s that more than 70 percent o f this amount was spent on direct job creation (through the program "From Social Assistance to Employment"). Since 2005, the A L M P policy has been changing. An increasing share o f funds has been spent on training and assistance to disabled individual^.^^ 77ILO online database, andNEA. 78InJanuary-September 2006, expenditures on ALMPs were BGN135.7 million, of which 52 percent was spent on directjob creation, 18 percenton assistance to disabledpeople, and 12percentontraining. 64 Table 4.13: Expendituresin active and passivelabor market measures, YOof GDP in 2005 Bulgaria Czech R. Hungary Romania Slovakia Denmark EU15 Active measures, % of GDP* 0.440 0.I22 0.197 0.097 0.170 1.433 0.545 Active measurestotal 100 100 100 100 100 100 100 Of which in %: Training 15.2 10.7 19.8 11.3 14.0 35.5 38.9 Job rotationand sharing 0.6 Employmentincentives 9..3 34.4 50.8 51.5 16.4 31.1 23.9 Integrationof disabled 2.0 28.7 5.3 33.4 16.6 Directjob creation 71.8 30.0 29.4 36.2 35.7 0.0 13.9 Start-up incentives 1.7 3.2 0.0 0.0 28.6 6.1 Passive measures, % of GDP 0.218 0.242 0.391 0.357 0.269 2.514 1.413 Passive measurestotal 100 100 100 100 100 100 100 Of which in %: Out-of-work income suuoort 1 . 100 100 98.0 100 64.7 72.9 94.4 Early retirement 2.0 35.3 26.1 5.6 Notes: excluding labor market servicesprovidedby the staff of PES * Source: Eurostatonline 4.39 However, ALMPs cannot substitute for structural labormarket reforms, which aimto improvethe functioning and efficiency of the labor market.79 While ALMPs are an important component of labor market policy, they mainly help disadvantaged groups, and often do not have a significant impact on unemployment or employment in general. Bulgariawould needto identifythe programsthat can improve future employment and earnings prospects in a cost-effective manner. Currently the funds are scattered across a multitude of programs and projects, the outcomes of which have not been assessed in recent years, Basedon internationalexperience, there is a general consensus that even under best circumstances, payoffs from ALMPs are modest, and it is difficult to address large scale unemployment through these programs. They may work for specific groups in specific circumstances, and therefore need to be carefully targeted. Table 4.14 summarizes the EU country experience with different types of ALMP (see also Betcherman et a12004). 4.40 The lessons learned from other countries, as summarized in Table 4.14, suggest that NEA should focus on helpingindividualsto findjobs themselvesthroughthe provisionofjob informationservices and job search assistance, includingjob search skills training, job search clubs, or job fairs. Workers often lack informationandconfidence about howto look for ajob. Also counseling can helpjob seekers obtain informationabout education, training, and alternativejob opportunities, make other employment services increasinglydemand-oriented, and thereby improve expenditure targeting. Employmentand professional orientationprograms for youth and adults are still limited in Bulgaria. Such services provideassistanceto the unemployed individuals, students, and other groups in determining appropriate work fields and employment opportunities.80 79There is an extensive literature on the impact of ALMPs on labor market outcomes. For example, see European Commission (2006a), Employment inEurope2006, Brussels. 80 In 2005, through the system of Professional Information Centers, 131,700 individuals received relevant counseling(MLSP/NEA 2006b). 65 Table 4.14: Impactsof ALMPs basedon experienceof EUcountries Intervention Summary of overall impact Comments Job-search assistance Significant positive impact on Improved outcomes when: (i) combined with monitoring and (job brokerage and the transition from welfare to enforcement of criteria, on which the receipt of unemployment counseling) work benefits is conditioned; and (ii)job search activities linked with participation inother programs, such as training. (Re)training for Effective for some target Following features enhance programs effectiveness: (i) small scale; unemployed groups (adult women), but not (ii) targeted at disadvantaged groups; (iii) close partnership with for others (adult men and local employers; (iv) training certified, and certificates recognized youth) and valued by the market. Youth measures Disappointingresults Interventions such as pre-school facilities, measures to reduce early school-leaving, and improve basic skills and the relevance of competencies provided by the education system seem to pay better dividends. Employment subsidies Positive effects on the Cost effective to target employment subsidies at specific groups probability of future (young men with high levels of education), and combined with unsubsidizedemployment counselingservices. Directjob creation Positive results rare Should be short duration and targeted at the most disadvantaged groups, ifused. Source: EC (2006a). 4.4 1 The Operational Program on Human Resources Development 2007-2013 calls for additional investmentsin early professionalorientationin schools, and the creationof career development centers in all universities. Providing informationto young people on labor market opportunities, and pay-offs to different levels and modalities of schooling would allow them to make educated guesses about their future returns, producing efficiency gains. Other programs for the unemployed youth could include the provision of employability and training plans, job and career counseling services, aptitude and vocational assessment tests, and assistance in developing profiling methods to identify profiles that are most susceptible to long-termunemployment. 4.42 NEA is already downsizing "From Social Assistance to Employment" program. Its primary objectivehas beento reintegrate the unemployedpeople on social assistance intothe labor market, restore their work habits and motivation, and reduce their dependency on the social safety net. The program covers the most disadvantaged and hardest-to-place groups-that is, those with a low level of education, the Roma, the long-term unemployed, and the social assistance recipients. The attractiveness of the program may be partly attributed to the fact it also covers pension and health insurance (including maternity benefits). It has provided employment for a group of unemployed that would otherwise have remained unemployed much longer and positively impacted their work discipline, habits, and qualifications.8' However, the results of the program's impact analysis (the only impact assessment carried out of the ALMPs) indicate that only eight percent of program participants have found employment at the end of the program, while in the control group this proportion was 16 percent. If gettingajob was their only goal, the participantswould have done better looking for work themselves. 4.43 As noted earlier, sizeable long-term unemployment is a serious issue in Bulgaria. Most of these jobless have no qualifications, andor a low level of education. They may have multiple employment barriers, including cognitive and health-relatedbarriers, and difficult home lives (for example, lack of transportation, many children, child care problems, domestic violence), which makes their employability Participants can enroll in a literacy course combined with part-time employment (five hours), and a daily four- hour study session. However, 67 percent of the employers involved in the program stated that they did not train their workers either beforeor duringthe project(de Koninget a1(2005)). 66 a problem.82 Assistance to the long-term unemployed should resort to a combination of temporary employment, on-the-job training, andjob-placement assistance (Egger 2003). Early interventionscould include profiling of job seekers to identify which one of the individuals or groups of unemployed are susceptible to long-termunemployment. The programs typically include the provision of employability and training plans, job and career counseling services, various aptitude tests, and vocational assessment tests. To reduce the probability of long-term unemployment among young workers, they should be providedwith effectivejob search assistance, or active labor market measureswithin the first 6 months of unemployment. 4.44 Given that many of the registered unemployed may not be genuinely unemployed, NEA should refocus all its efforts on activation policies.83Good activation policies involve: (i) improving personal, social, and vocational skills and competencies, and facilitating social integration; (ii) individually tailored ways to participate in ALMPs, taking into account such factors are the person's age, experience, needs and priorities; (iii)taking advantage of the resources and strengths of the beneficiary; (iv) networking with labor market services, social services, health services, housing sector, and communities; and (v) cooperation and interaction between the beneficiary and the agency in the planning, design, and implementationof individual actionplans. 4.45 Based on international experience, other measures might include: (a) frequent contacts with the responsible labor or social office (most OECD countries), and contract-based obligations (UK "New Deal"); (b) profiling ofjob searchers based on the amount of help needed to find a job (UK, Denmark); (c) matching available programs with different categories of job seekers (the Netherlands); and (d) intensive interviews to adjusthedesign the individual action plan at a certain stage of unemployment. These measures should be supported by incentives that push people to re-enter the labor force, for example, by reducingthe levelof benefits after a (shorter) time periodandor insistingthat, after a period, the unemployedtakejobs that they may not have considered"suitable" early intheir search. 4.46 Finally, the positive impact of labor market policiescannot be taken for granted. There should be continuous monitoring and evaluation of their outcomes. NEA should also establish a system for the evaluationof gross and net effects of programs and measures. C. EmploymentRegulations 4.47 On paper (dejure) Bulgarian labor market regulations may not seem particularly rigid, but in practice(defacto) they are considered to be a problem. Almost one-fifth of Bulgaria's firms indicatethat rigid labor market regulationsare a problemfor doing business (see Figure 4.4), and about eight percent of employers consider them a major obstacle. 4.48 Also, the rigidity of employment index suggests that Bulgaria's employment regulationsare still rather inflexible (see Table 4.15).84 The mainproblems seem to lie in the difficulty of hiring, rigidity of working hours, and the level of hiring costs. Flexibility in such parameters is especially important for small businesses, which tend to be labor intensive, and are therefore an important means of creatingnew 82For example, in2005 about five out of 100registeredunemployedhaddisabilities(MLSP (2006a)). 83Activation policies encourage certain unemployedindividuals to step up their job search after an initial spell of unemployment,with a later obligationto participateinvarious programs. Eventually,the activationprinciple makes the receiptofbenefitsconditionalonparticipationinprograms, inthe processshiftingthe balancebetween the rights andobligationsofthe unemployed. See EC2006. 84Rigidity-of-Employmentindex varies between0 and 100, with higher values indicatingmore rigidregulation.See http://www,doingbusiness.orgfor the methodology. 67 jobs. Also, flexible labor markets will become increasingly importantto the quest of raisingproductivity by allowing movement of labor from low to high productivity areas. As highlighted in Chapter 2, the immobility of factors of production is an issue in Bulgaria. This suggests that the implementationand administrationof the labor laws and regulationsmeritsattention. Table 4.15: Rigidityof Employment Indexes Rank Difficulty of Rigidity of Difficulty of Rigidity of Hiring Firing Costs Hiring Index Hours Index Firing Index Employment Costs (YOof (weeks of Index salary) wages) Europe and ... 34.2 50.7 37.1 40.8 26.7 26.2 Central Asia Bulgaria 100 50 80 10 47 30.1 8.7 Czech R. 45 33 20 30 28 35.0 21.7 Georgia 6 0 20 0 7 20.0 4.3 Hungary 90 11 80 I O 34 35.2 34.5 Poland 49 0 60 40 33 21.4 13.0 Romania 101 33 80 40 51 33.3 3.0 Slovakia 72 17 60 40 39 35.2 13.0 OECD ... 27.0 45.2 27.4 33.3 21.4 31.3 Australia 9 0 0 I O 3 21.3 4.0 New I O 11 0 I O 7 1.o 0 Zealand United 17 11 20 I O 14 11.0 22.1 Kingdom USA 1 0 0 0 0 8.5 0 Source; World Bank 2006b. 4.49 There are many indications that current labor regulations hinder flexible forms of employment contracting. Only abouttwo percent ofthe employed work fewer than 30 hours a week (that is, part-time) compared to about 18 percent on average in EU15 countries, while six percent of the employed hold temporary jobs (fixed term rather than open-ended contracts), as shown in Table 4.16. LFS indicatesthat the main reason for working part-time is lack of work, or the unavailabilityof full time jobs. While it may be true that employees cannot afford to work part-time because of Bulgaria's low wages, the main reason for employment on a fixed-term basis is that respondents cannot find a permanentjob (or they have a contract for the probationaryperiod). Inflexible working hours and workingtime arrangements are also a problem, with almost all workers working 40-49 hours per week.85 Overtime is restricted, andonly about six percent of employees work 50 or more hours per week.86 Seniority bonus paid to workers and employees depending on their job tenure creates disincentivesto labor mobility across firms, jobs, and regions.87 Recentlythe maximum length of the working hours under an employment contract was increased from 40 to 48 hours per week. The employer can increase the working hours per week in excess of 48 hours for a period of six months in case of a written consent of the employee. The Labor Code provides additional opportunities for the employers to introduce flexible arrangements for the working hours, for example owing to production considerations,butthe employer is obligedto informinadvancethe Labor Inspectorate. 86Within the EU, some 12 millionfull-time employees or nine percent, usually work more than 48 hours a week, which is the statutorymaximumnumber ofworkinghoursper week inmostEUMember States(EC (2006a)). 87The seniority bonus is establishedminimum 0.6 percent of the base wage due for each year of service with any employer,but couldbemore, depending onthe enterpriselevelCollective Agreement. 68 Table 4.16: Incidenceand Composition ofPart-timeEmployment,2005l Part-Time employment Women's share in part- as share of employment time employment Total Men Women Bulgaria 2.0 1.6 2.4 56.7 CzechRepublic 3.3 1.6 5.5 72.8 Hungary 3.2 1.8 5.0 70.5 Poland 11.7 7.1 17.4 66.5 Romania 9.7 9.3 10.2 ... Slovakia 2.6 1.4 4.1 69.2 EU15 18.1 7.0 32.3 78.3 Notes: 1 Part-Timers are those individuals,who work less than 30 hours a week in their mainjob (not only wage earners) Source: OECD (2006), LFS (2005) for Bulgariaand ILO (KILM4`h edition) for Romania 4.50 The impact of labor regulations on employment can Figure 4.6: Under employment due to Labor Regulations, % in be measuredthrough an indicator 2002 and 2005 measuring underemployment due to labor regulations. The 2005 BEEPS survey of local employers indicates that Hmgary employment in the formal sector Slovenia could be increased by almost Estonia eight percent, if labor regulations Czech R were eased, a notable increase Bulgaria from three percent in 2002 (see South Eastern Europe Figure 4.6). Despite some EU8 improvements in the Labor Code in recent years, most complaints Europe and Central Asia of employers are related to rigid Slovakia arrangements for fixed-term Poland contracts, seniority bonuses, Romania overtime provisions, and 0 2 4 6 8 I O 12 14 16 burdensome administrative arrangements for dismissals.88 Jurce: BEEPS The worsening between 2002 and 2005 may also indicatethat the constraints emanating from the Labor Code are becomingmore bindingas competition in Bulgaria's productmarkets intensifies. 4.5 1 Bulgaria's employment protection legislation (EPL) does not only discourage hiring and firing, but may also slow down adjustment to shocks and impede the reallocation of labor. The effects of employment protectionlegislation(EPL) on labor market performance remaincontro~ersial.~~Typically, EPL makes it harder for certain groups, includingyouth, women and displaced older workers, to enter or re-enter the labor market, at least on an open-ended contract; increases long-term unemployment, and seems likely to strengthen labor market "insiders". Regression analysis on pooleddata from OECD, and Centraland South Eastern European countries for the second half of the 1990s finds that the strictness of temporary EPL provisions is positively correlated with higher youth and female unemployment. Stricter EPL increases the risk of long-term unemployment; and stricter temporary EPL discourages labor 88For moredetaileddiscussionsof labor legislation, see World Bank(2005b). 89See, for example, OECD (2004~)and (2006); EC(2006a);Young. (2003). 69 supply.9oOn the other hand, countries with stringent EPL may have more durable or stablejobs. Recent studies also indicate that greater flexibility in the host country's labor market relative to that in the investor's home country is associated with larger foreign direct investment flows. This may be of relevance to Bulgaria; given the importanceof sustained high FDI inflows for the economy (see Chapter 3).91 4.52 Drafting and implementing a new set of labor regulations in Bulgaria may thus be called for. Bulgaria's current Labor Code dates back to 1985. It had major revisions in 1992, and, as noted earlier, the Code has been harmonizedwith EU Directives in the past few years. Nevertheless, there are good reasons, basedon the evidence presentedabove, for recommendingthe revisionof labor legislation. First, in the last decade the nature of jobs has changed, and the incidence of temporary and casual informal sectorjobs has increased. Second, there has been a shift from less skilled, blue-collarmanufacturingjobs towards more skilled, white-collarservice sectorjobs. Third, the share of employment in micro and small enterprises is rapidly increasing, and especially for this sector, promotionof more diversifiedemployment relationships would increase incentives to hire workers. Fourth, in general, bargaining on terms and conditions of employment should become more market driven in order to overcome rigidities of the current labor market. In terms of enhancing competitiveness of the country's business and investment climate it is beneficialto have less rigid labor relations, especially in comparison with other countries in the region. 4.53 Enhancingflexibility of labor markets-in parallelwith reducingbarriers in productmarkets-is also important from the macroeconomic point of view. Given the Currency Board Arrangement, the adverse consequences of a macroeconomic shock on growth and employment can only be minimized through labor and product market flexibility and adaptability. On the labor market side, measures to promote flexibility would need to be coupled with measures promotingworkforce adaptability through skills upgradingand increasinglabor market participation. Similarly, reducingregulatory complexity and improving the quality of the institutional framework to facilitate competition in the domestic markets would be neededto improvethe adaptabilityof product markets. Moreover, faster responses in labor and product markets to the changing external environment would facilitate greater diversification of the economy and would reduce output volatility. D. Adult Educationand Training 4.54 Upgrading of the labor force, or vertical mobility, is a precondition for rapid structural and technologicalchange in all countries, for competitiveness inthe world market, and for raisingthe share of high-value-added products and services in the markets. The world is moving towards a "lifelong learning" system, which means notjust improvingbasic skills of adults, but enablingthem to continue to develop a range of skills, andto enhance their employabilitythroughouttheir lives. 4.55 As the EmploymentStrategy 2004-2010of Bulgariastates, there is a deficit intraining ofworkers inthe modern basic and key skills. There are skill gaps inthe new types of professions, especiallyinthe area of advanced and new technologies in production and services, modern technologies in agriculture, and management and marketing. As will be discussedin Chapters 6 and 7, opportunitiesto upgrade skills through adult education and training and active labor market programs are limited. As stated in the European Commission's report "Employment in Europe 2003", an adaptable skilled workforce, with access to training, career development,job mobility, flexible work organization, and with a sense ofjob 90 WorldBank (2005a). 9'See Javorcik and Spatareanu(2004). 70 security is the key to increasing productivity within Europe, and encouraging job creation and higher employmentrates. Table 4.17: Participationof Adult Populationin 4.56 Adult education and training is LifelongLearning, YO* uncommon in Bulgaria. One of the EU25 2000 2005 7.5 (e) 10.1 Lisbon employment targets deals with EU15 8.0 (e) 11.1 lifelong learning and calls for the EU Czech Republic ... 5.6 average level of participation in lifelong Estonia 6.5 6.5 learning to be at least 12.5 percent of the Latvia ... 6.9 (e) adult working age population (25-64 year Lithuania 2.8 4.9 (e) age group) by 2010. According to the HUngaV 2.9 3.8 latest Eurostat labor force survey, ... 4.7 Bulgaria has the weakest performanceon Slovenia ... 15.0 this front among EU countries: only 1.3 Slovakia ... 4.3 Bulgaria ... 1.3 percent of surveyed workers stated that Romania 0.9 1.3 they had receivededucation or training in Denmark 19.4 29.2 the four weeks precedingthe survey (see Sweden 21.6 32.1 (2005) Table 4.17). United Kingdom 20.5 26.6 (e) Notes: * Life-long learning refers to persons aged 25 to 64 who stated 4.57 Only a small percentage of that they received education or training in the four weeks preceding the enterprises provide continuing survey out of the total population of the same age group. The training (CVT) to their (see information collected relates to all education or training whether or not relevant to the respondent'scurrent or possiblefuturejob. also Chapter 6) The most comprehensive e-estimate data on continuing vocational training Source: EULabor Force Survey. (CVT) in Bulgaria can be obtained from the latest 2004 survey of about 53,000 enterprises, of which 28 percent were in the public sector and 72 percent inthe privatesector (NSI 2006d). Stylized facts from the survey are as follows: Only 8.6 percent of enterprises introduced technologically new or improved products or services in 2004. This would require, as a rule, an upgradingof skills of at least some parts of workforce. However, only 25 percent of firms indicated that in 2000-2004 they had the needto obtain new skills for their workers. Only a fraction of enterprises, 6.6 percent, had a specific training plan; 4.6 percent of firms had a specific trainingbudget, and 1.3 percent of enterprises hadtheir owntraining center. Only around 30 percent ofenterprisesprovidedtrainingcourses in 2004. In 2004, 15 percent of employees in surveyed enterprises participatedin vocational training courses, and intotal 0.1percent paidworking time hourswere spent on it. Most courseswere of short duration: on average 17.2hours were spent per participantin CVT courses in 2004. In only 30 percent of enterprises providing CVT courses a formal procedure for evaluation was applied. Only 3.6 percent of enterprises providedinitial vocationaltraining, of which 69.2 percent was for pupils from professional schools and students; 17.1 percent for apprentices and newly employed with training contract; and 24.6 percent for unemployed persons sent by the employment agencyto undergo vocationaltraining and qualification. 71 Training costs per participantequaled BGN291, which is slightly below the average reported monthlywage inthe country. 4.58 Co-financing schemes, under which employers, employees and governments jointly finance training, are consideredto lie at the heart of a comprehensive strategy to foster CVT. The shift towards this policy approach is basedonthree general principles: in most societies, because of budget constraints, public authorities alone cannot provide the necessary financialresourcesfor lifelong learning; as lifelong learninggenerates considerable private returns, employers and employees should finance most of its costs; and 0 greater reliance on market forces could strengthen the incentives both for learners to seek more efficient learningoptionsand for providersto achieve higher levels of efficiency. 4.59 Recently, the Government has taken some steps to improve the situation. Issues associated with lifelong learning stand high in the Operational Program on Human Resources Development2007-2013. The program emphasizes the following main activities: (i)creation of a system for professional orientation and career development; (ii)development of vocational education; (iii)giving opportunities for a "second chance" for educationand training; (iv) giving opportunitiesfor makingadults literate; and (v) development of distance education. E. Improvementsin Labor Market Statistics 4.60 Although Bulgaria has been carrying out Labor Force Surveys according to the Eurostat methodology since 2003, and a census of all establishments is conducted regularly, the lack of comprehensive labor statistics hampers the assessment of developments in employment and wages, especially in the private sector. The main shortcomings include: (i) the under-reportingof private sector wages; (ii)the reporting of only average gross earnings, not wages for time worked nor wages by occupation; and (iii)the lack of coverage of the self-employed, and employment in small firms. At present, NSSI administrative data are used to estimate wages by occupation and the number of self- employed and employment in small firms, which is inadequate for many analytical purposes. Another shortcoming is the lack of a nation-wide system for assessing the current or likely future demand of employers for labor and various kinds of skills. VI. CONCLUSIONSANDPOLICYRECOMMENDATIONS 4.61 On the surface, Bulgaria's labor markets are doing well. Employmenthas increasedsignificantly in Bulgaria since 2002. Some 300,000 jobs were added during the period 2002-2005, bringing the number of employed to the three million range. Although this number includesthe workers covered by the subsidized employment program "From Social Assistance to Employment", the number of these workers has been cut in half since 2004. It now stands at about 50,000, and is expected to be reduced further during 2007. Preliminary data suggest that, the number of employed may have grown another 100,000 during 2006. As a result, employment rates have continued to rise not only for overall labor force, but also for women, youth, older workers and even long-termunemployed. 4.62 Nevertheless, major challenges lie ahead. Employment and participationrates remainamong the lowest in EU, and are still far from the Lisbon goals. Bulgaria also still has a substantial reserve of unused labor, both in terms of registeredunemployed and those who, for a variety of reasons, choose not to participateinthe labor force. Unemploymentremains high, in particular amongyouth and people with few skills and a low levelof education. Regionaldisparitiesin employment situationare significant. 72 4.63 But increasing employment is only one of the objectives of the reforms, although perhaps the most important one in the short run. The other objective is to increase the mobility of labor across sectors. Research reported in Chapter 2 points to a problem in this area. If it is not addressed, it will make it harder to increase the rate of growth of labor productivity which, in the longer term, also means slower GDP growth. It is for this reason that this chapter has taken a close look at policies and structural rigidities that contribute to the inflexibility of Bulgaria's labor market, and laid the basis for the recommendationsthat follow. Also in light of Bulgaria's Currency Board Arrangement promotinglabor market flexibility would be critical. 4.64 The 2006 EU Joint Employment Report highlights that a good balance between flexibility and security in the labor market, also referredto as "flexicurity", can be achieved by the interaction of four key elements: (i)sufficiently flexible contractual arrangements; (ii) effective active labor market policies; (iii)a credible lifelong learning system; and (iv) modern social security systems. Bulgaria faces challenges in all of these areas. EU guidelines for the employment policies suggest that member states should: (i)encouragejob creationby supportingentrepreneurship and a favorable business environment for enterprises; (ii)simplify andreducethe bureaucracy, regulationsand administrationgoverningstarting business, hiring staff, and accessing start-up capital; (iii)improve access to training and re-training by employees; (iv) reform overly restrictive employment legislationthat affects labor market dynamics; (v) promote flexible and diverse forms of labor agreements and working arrangements; and (vi) remove disincentives to work (for example, simplify regulations, provide incentives), and develop actions to eliminateundeclared employment. 4.65 Actions (i)and (ii)suggested above by the EU guidelinesfor employment policy are arguably the most importantin terms of creatinga strong demand for labor. They belongmore to the overall business climate, and some aspects of them were discussed in the previouschapter. Actions covered by (iii) will be discussed in more detail in the chapters on vocational and tertiary education (Chapters 6-7), although this chapter did look at the current situation with respect to lifelong learning. But the main focus of this chapter has been on the analysis which underpins potential actions in areas (iv)-(vi). The proposed reformsthat the government may wish to consider in these areas are listed below roughly in the order of priority and grouped into short and mediumterm actions. 4.66 Inthe short term, the authoritiesmay want to consider the following actions: Develop and encourage lifelong learning: Employers report that workers with the right skills are increasinglydifficult to find, despite the fact the Bulgarian labor force is relatively well educated. This problem is likely to only get worse, if the Bulgarian economy keeps expanding. Therefore, the culture of lifelong learning needs to be further developed, and education delivery systems modernized. As will be discussed in Chapter 6, this includes expandingthe networkof adulttrainingcenters, VET schools and privateproviders,andother alternative training opportunities. Also, their curricula need to be adjusted so that the certificates obtained by their graduates at the end of their training are recognized and valued by the employers. Many countries have established tax incentivesto encourage adult education. In Lithuania, the Law on Income Tax of Individuals envisions the possibility of receiving partial compensation of the cost of studies. In Hungary, employers pay a vocational training contribution equivalent to 1.5 percent of the wage. Employersthat spend the same amount on apprenticeships, the training of their own employees, or on the development of a vocational training school are exempted from this contribution. In-company training, training related to investments creating new jobs, and training aimed at improving the 73 competitiveness of SMEs, and the development of entrepreneurial skills are supported by grant schemes.92Although it may have budgetary implications, Bulgaria may also consider introductionof tax incentivesto stimulate lifelong learning. Meeting the training needs of employed individuals may require them to stop working for a period of time, which can be costly to both employers and employees. For this reason, Bulgaria may consider following the example of many OECD countries, which have introducedstatutory or contractualtraining leave schemes that guarantee employees the right to return to their jobs after completing the training course, as well as institutional arrangements facilitating access to trainingand education on a part-timebasis. Reinstatement rights help to reduce the risk element of human capital investment borne by the workers and imply some cost-sharingwith employers (who needto either replace the workers undertaking the trainingor makedo withoutthem on a temporary basis). Revise labor legislation and regulations, while complying with EU requirements: Drafting a new Labor Code and revising labor regulationsfurther is one of the actions that needto be taken. Although the Labor Code has been amended a number of times, it remains in some important ways too prescriptive for today's realities. Social partners-the employers and representatives ofthe employees-need to be given a greater role in determiningemployment relations. They are best positionedto assess the situation in their enterprises and industries and, through collective bargaining, develop rules that determine such important matters as wages, benefits, seniority bonus, and overtime and part-time work arrangements, without sacrificing an appropriate level of social protection. This would enable workers to benefit from defacto rather thanjust dejure employment protection because, by beingpartners in a negotiated settlement, their employers would have less incentive for non-compliance, and enforcement would be easier. At the same time, employers would have a chance to renegotiateregulations that are particularlycostlyto them, but of less value to workers. e Shyt the emphasis of active labor market programs (ALMP) to support job search and strengthen their monitoring and evaluation: NEA should retune the structure and content of ALMPs, and increasingly shift resources from the job creation program to other ALMPs deemedto be more cost effective. These include, first of all, activationpolicies, such asjob- search assistance, counseling, job brokerage, and career guidance. Job seekers should have stronger incentives to look for newjobs, even in other occupations and in other regions ofthe country. This would require a more intensivefollow-up of the individual cases by the front- line social workers than at present. A large-scale directjob creation program is justified at times of economic downturns, when aggregate demand is depressed and there are few vacancies. This is no longer the case in Bulgaria. On a limited scale it might be used as means of helping the most disadvantaged groups of unemployed to regain contact with the labor market. It should be possible, over the next couple of years, to carry out this reshuffling of resources from direct job creation programs to other, more cost effective, programs in a budget neutral way, since the direct job creation program still consumes a good chunk of ALMP resources. There should be a special focus on young workers so that they do not turn into long-rununemployed. However, there is a needto modernize and strengthenthe administrativecapacity of NEA for this shift to succeed. Also, ALMPs need to be accompanied by monitoring and impact evaluation, in order to fine-tune those of most relevance to the labor market situation in 92See:(hm://europa.eu.int/comdemplovment social/emplovment strategv/04 national en.htm). 74 Bulgaria. The net impact of most ALMPs has not been assessed since 199993 A net impact assessments is a rather expensive undertaking, and can be repeated say only once every five years, but there are less costly alternatives to evaluation of programs developed in other countries in the region, such as Performance Informationand Management Systems (PIMS). In the meantime, NEA can beginto shift emphasis to programs, which experience has shown in other countries to be the most effectivein reducingunemployment. Revisit the mechanismfor establishmentof the minimum wage and its level: Current levels of minimum wages are high in Bulgaria compared to other transition economies. This may be especially harmful in poorly paid industries, and in micro and small enterprises. Hence it would be important to make sure that the relatively high ratio of the minimum wage to the average wage is reduced over time. Currently, the minimum wages are set by the Council of Ministers. It may make better sense for the government to secure close involvementof social partners (employer and labor representatives) in the process, and have minimum wages determined sector by sector, in the context of collective bargaining agreements and in line with the ever-changing situation in each sector.94 Close involvement of social partners in fixing the level of minimum wages is consistent with the ILO Convention 130 on minimum wages, which suggeststhat social partners should be consulted (notjust informed), as well as the Pact on Economicand Social Development until 2009. Also, while evidence is mixed on the impactof minimum wages on employment, it is fairly clear inthe case of young workers. Creatingsub-minimumwages for young workers or in economically depressedregions, as is done in many EUcountries, would promotejob creationfor less productiveworkers, who are also the ones typically hardest hit by unemployment. For example, Poland recently introduceda youth sub-minimumwage (at 80 percent of the regular minimum wages) in an attempt to alleviateyouth unemployment. e Revisit the current eligibility and entitlement rules of the unemployment benefit: Bulgaria's unemployment benefit eligibility and entitlement rules do not per se currently create major labor supply disincentives. However, taken together with other schemes, they may give rise to an "unemployment trap", especially in lagging regions, where benefits account for a high proportion of the prevailingmarket wage of low skilled labor, or for job seekers who had low wages before losingajob thus giving less incentiveto the beneficiaries to go out and find a job. The current unemployment benefit entitlement rules, and mechanisms attached to their delivery, should therefore be revisited. The policies may include setting more efficient activation strategies, which better coordinate the level of unemployment benefitswith ALMPs. Inparticular, NEA could monitor more closelythejob search efforts of an unemployed person using individual action plans prepared for particular job seekers and, if their efforts are found wanting, impose sanctions rangingfrom partial to total withdrawal of the benefits. Although same performance criteria-such as "availability for work", or evidence of "active job search"-are used to decide who will be allowedto the register as unemployed, unemployment benefits of regressive scale and of limited duration, relatively strict job search requirements, monitoring of job search intensity efforts, and the qualityjob of brokerage services may help speeduptransitionsout of unemployment. 93The net impact of most ALMPs in Bulgaria has been evaluated only once. In 1999 the NetherlandsEconomic Institute (NEI) implementedthe project "Evaluation of the Net Impact of the Active Labor Market Policies". At that time all analyzed programs had positive net impact-participation in them improved the chances that the unemployedhaveonthe primary labor market. 94Currentlythe thresholds for minimum social security contributionsare negotiatedbetween social partnersandthe government bymostbranches andmainprofessionalgroups. 75 4.67 In the medium term, the key actions to consider for increasing labor productivity and employment would be as follows: Reduce labor taxesfurther in afiscally sustainablemanner: Accordingto the 2005 BEEPS survey, about six percent ofthe formal enterpriseworkforce and 13 percent ofthe wage bill is not reported. This combined with the still sizeable informal sector, meansthat the tax base is not as wide as it could be, and that taxes on those who pay them are higher than they otherwise might be. The Government is obviously aware of this since it, for example, lowered the social contribution levy by six percentage points in 2006. It may, however, following a careful assessment of the impact of recent tax cuts, wish to consider further reductions of disincentives to work embedded in the tax and benefit systems, including further reductions of the tax burden on wages. This would need to be done in a budget neutral manner. While lowering the tax wedge might partly finance itself through higher employment and output, additional revenue measures or preferably expenditure cuts would likely be required. Engage employers' associations: Involvementof employers' organizations is an important instrument for minimizing the emerging skills mismatch in the labor market. Occupational standards, or employment specifications, must be defined by employers using procedures agreed upon by all stakeholders, as will also be highlighted in Chapter 6 on vocational education and training. These standards can then be used to develop more relevant criteria for the curricula of training institutions. This process is in train but should be evaluated and adjusted in line with the outcome ofthe evaluation. 0 Strengthen labor market statistics: Bulgaria's labor market information system, especially wage statistics, needs further improvement. In addition, the government should consider developing other statistical instruments. Employer-based surveys of current and projected labor market conditions, for example, could focus on actual and plannedjob creation andjob destruction, and on key determinants of hiring and firing. The objective of such surveys would be to determine the degree of labor market flexibility, and to prepare projections of likely changes in employment and ~nemployment.~~A tracer survey of displaced workers would trace changes in labor market status (earnings, employment compared to unemployment, career developments), depending on the educational status of workers or unemployed individuals. It would be useful to keep track of graduates some years after graduation, as part of labor market monitoring. All these suggestions are in line with the Operational Program for Human Resources Development 2007-2013, which urges the promotion of cooperation between the education system, the vocational education and training system, the national economy, and EU through the development of systems for monitoring, analysis, andprojectionsof labordemandand supply. 95RecentlyNEA launchedan employersurvey to determinelabordemandby professionsand qualification levels. 76 5. GOVERNANCEAND FINANCE REFORMSINPRIMARY AND SECONDARY EDUCATION 5.1. An important step inpromotinglabor productivitywill be the development of a skilled, technically savvy, and adaptable labor force, which has knowledge and skills that match the demands of the labor market. As mentioned inthe previous chapters, rather than protectingexistingjobs, policies should aim at equippingworkers through education, on thejob training, and lifelonglearningfor inevitablechanges inthe demand for labor, andthereby promotetheir adaptabilityand mobility across industries and sectors. While Bulgariahas a highly educated populationfor its level of income, that education does often not translate to marketable skills. To raise labor productivity and mobility, Bulgaria would need to further upgrade its human capital by modernizingits education system. The next three Chapters of this report (Chapters 5-7) analyze the performance primary and general secondary education; vocationaleducation and training; and tertiary education, and identifyoptions for further strengtheningofeducationdelivery. 5.2. Bulgaria has recently embarked on an ambitious program to reform its primary and general secondary school system with the aim of increasing the quality and relevance of skills, raising participation rates and optimizing resource use.96 While there seems to be broad recognition and agreement on the challengesfacingthe Bulgarianschool system, there is no consensuson their magnitude and even less on the policiesneededto tackle them. 5.3. This chapter discusses the available evidence and presents reform options for finance and governance of primary and general secondary education." Vocational secondary and higher education will be covered inthe chapters to follow. This chapter argues that decentralizingthe school network and introducingreformsto the finance and governance system can improvethe way schools are managed, and help promote efficiency savings that can be redirectedto improvingthe quality of education, and raising participation rates. The underlying premise is that the current spending pattern is inefficient, and a lot more couldbe done within the existingbudgetary framework. I. THEREFORM CHALLENGES 5.4. Increasing the quality of education: Bulgariadoes not have a national system of externaltesting of student achievement. This makes it difficult to substantiate the widespread claim that quality of education is unacceptably low, and that it has been declining over the last decade. However, several indicators suggest that the problem is severe. For instance, in the OECD Program of International Student Assessment (PISA) 2000 survey, assessing proficiency in foundation skills for the knowledge society (reading, mathematics and scientific literacy), 40 percent of Bulgarian 15-year olds performedat or belowthe lowest level of proficiency in readingliteracy. This was twice the EUaverage and 2.6 time 96The reform agenda is laid out in the "National Program for the Development of School Education 2006-2015". For an in depth analysis of the challenges facing Bulgaria's primary and general secondary education system see Ministry of Finance (2005) "Public Expenditure Review-Education-Condition, Problems and Opportunities", and World Bank (2005c)"Bulgaria-Education and Skills for the Knowledge Economy", Policy Note. 97This chapter is based on prior analysis and work by the World Bank's Bulgaria education team comprising of Christian Bodewig, Lars Sondergaard, Steven Bakker, Boryana Gotcheva, Rebekka Grun, Anna Khachatryan, RosalindLevaEiC, Nickolay Mladenov, Juan ManuelMorenoand ReemaNayar. The authors express their gratitude to Stoyan Baev from the NationalStatisticalInstitutefor preparingextensivedatasets with school-level data. the Lisbon benchmark9', Equally, in the area o f mathematics, Bulgarian eight-graders participated in three rounds o f an international assessment Trends in International Mathematics and Sciences Study (TIMSS) in 1995, 1999,and 2003. Worrisomely, o f all the countries participating in the study, Bulgarian students had the steepest declines in mathematics and science achievement between 1995 and 2003 (see Figure 5.1). Clearly, international tests such as TIMSS and PISA scores alone are not sufficient evidence o f the poor (and declining) quality o f education, but they are the only external assessment of schools available for now. Figure 5.1: MathematicsPerformanceof BulgarianEighth Graders Fallen from Above to Below - the EU8Average Mathematics performance of eight gradem inTIMSS, 1995-2003 1995 2003 -- NMS(1995) 6 . -NMS(2003) 560 T I I Selected EU8 countries I 5.5, Raisingparticipation rates: Participation rates among the school age population have increased over the last decade (see Table 5.1). Net enrollment rates at pre-primary, basic, and upper secondary levels are all higher today than they were 10 years ago. Nevertheless, the net enrollment rate in lower secondary education-at 84 percent-is too low for a country where lower secondary education is c o m p u l ~ o r y .The sharp fall in net enrollment rates from primary to lower secondary, which i s a part o f ~ ~ compulsory basic education, is o f concern. Upper secondary shows impressive increases, although to some extent this reflects the recent increase in the duration o f some programs.'00 L o w participation rates affect mostly the poor and vulnerable, many o f whom fail to complete compulsory education. 98World Bank (200%). Bulgarian students are doing better at the lower level: in the 2001 Progress in International Reading Literacy Study (PIlUS) test of reading literacy of fourth graders Bulgaria ranked 4" among 35 countries. However, this advantage appears to disappear at the higher level. 99 Age enrolments, defined as participation of the relevant age group independently of the educational level, are higher, and close to universal levels, suggestingthat a significant fraction ofthe lower secondary age group may still be inprimary education, while others may have progressedto upper secondary. loo The duration of several (but not all) upper secondary programs was increased by one year to five years in 2002103, while the denominator refers to a four year age cohort. Nevertheless, absolute enrolments also increased by about 14 percentbetween2000101 and2003104, despitethe fall inthe population age cohort. 78 Table 5.1: Net School Enrolment Rates Growing, but Still Low in Secondary 1994195 2000101 2001102 2002103 2003104 2004105 2005106 Pre-primary (ICSED-0) 59.7 66.8 73.6 74.2 74.6 73.6 73.7 Primary (grades 1-4, 92.8 96.3 98.5 99.8 100.3 99.7 99.5 ICSED-1) Lower Secondary (grades 5- 79.0 82.4 83.1 84.0 84.2 84.2 84.9 8, ICSED-2A) Upper Secondary (grades 9- 61.4 64.7 68.3 74.9 77.1 77.3 78.0 12, ICSED 3A,3C) Source: National Statistical Institute (2006) Education in the Republic of Bulgaria 2006. Note; Upper secondary includes students enrolled in general (ISCED 3A) and vocational upper secondary schools (ISCED 3C). Box 5.1: Equity in Education Equity ineducation remains an issue, evident by low participation and achievementrates among children from poor and minority backgrounds. Regarding participation, Figure 5.2 shows that a large share of the poor and vulnerable groups fails to complete compulsory education. It is not possible to document the achievement of children from poor and vulnerablebackgrounds,given the lack of external assessment of student achievement, and the fact that no administrative data record the ethnic or socio-economic background of students. However, recent external pilot evaluations of fourth graders conducted by the Open Society Institute Bulgaria (OSIB 2006), which has been pioneering external assessment of students in the country, provide some concrete evidence of what is widely assumed in Bulgaria: there are large gaps in student scores betweenmany of the schools predominantly attended by Romaminority students and majority schools. These evaluations also show that inthe schools sampled, the average student in the "Roma schools" had not mastered half of the curricula taught, and that student performance fell well short of the performance in "non-Roma" schools. While no hard data exist, anecdotal evidence suggests that children from ethnic minorities, in particular Roma, are disproportionately representedin schools for children with special learning needs, perhaps driven by insufficient preparation (as evident in an insufficient command of the Bulgarian language). Also, the current segregated and selective system of secondary education is another source of inequality for the poor, vulnerable, andminority students. Figure 5.2: Years of schoolingby ethnicity ai I poorlnon-poor Years o f education completed by poor (20-28 yr Years o f education completed by ethnicity (20-28 olds) yr olds) 100 100 90 90 80 80 70 70 60 ,-. 60 S 50 5 50 v 40 40 30 30 20 20 10 I O 0 4 , , , , , , , , , , , , % , 0 1 2 3 4 5 6 7 8 9 1 0 1 1 1 2 1 3 1 4 I 2 3 4 5 6 7 8 9 1 0 1 1 1 2 1 3 1 4 Years o f completedschooling Years o f completed schooling Source: Staff calculations from Multi-Topic Household Survey (NSI, 2003). 5.6. Increasing efficiency of resource use: At first glance, the efficiency o f resource use looks reasonable when looking at readily available aggregate statistics. For example, overall spending on education as a share o f GDP is in line with other countries at similar level o f income (4.3 percent o f GDP 79 in 2005), and aggregate student-teacher ratios-the most commonly used summary measure in international comparisons o f efficiency-are lower than OECD averages in primary and general secondary, but not necessarily excessively so (see Table 5.2). Table 5.2: Student-Teacher RatiosinPrimary and GeneralSecondary Primary Lower Secondary Upper Secondary Public spending, % GDP OECDAverage 16.5 14.3 13.0 5.2 EU15 14.9 12.1 11.6 EU8 **** 15.1 12.2 12.3 Bulgaria * 16.7 12.8 12.1 4.3 Czech Republic 18.3 14.3 12.6 4.3 Estonia (01/02) 11.2 10.3 Hungary 10.6 10.6 13.2 5.5 Latvia 13.5 12.7 Lithuania 8.5 8.3 Poland 11.9 12.6 13.5 5.8 Slovenia 13 13.7 Slovak Republic 19.4 13.9 14 4.3 UnitedKingdom 20.0 17.4 12.6 5.1 Finland 16.6 9.8 15.9 6.0 France 19.4 13.7 10.6 5.8 Germany 18.7 15.6 13.7 4.4 Sweden 12.3 12.1 14.1 6.5 UnitedStates 15.5 15.5 15.6 5.4 Notes: *Bulgaria refers only to public education. The number of teachers based on NSI data (full-time equivalent public teachers). The number o f students in primary, lower and upper general secondary based on NSI school level data base. **Not weighted by population size (that is, the average of the countries' student-teacher ratios) Source: OECD, education at a glance 2005; and National Statistical Institute, expenditure data from 2003, Bulgaria 2005. 5.7. However, public spending per student has been increasing rapidly since 1997, mostly because student cohorts have declined faster than the number o f teachers (resulting in lower S/T ratios) and because o f rising teacher salaries. But aggregate figures conceal substantial variation in student-teacher ratios across schools: a large number o f schools (31 percent o f the municipal schools)--both in rural and urban areas-have exceptionally low student-teacher ratios (less than or equal to 11). Bulgaria's problem o f small schools with low student-teacher ratios is partly a result o f having a large number o f municipalities located in rural, mountainous areas with scattered settlements. However, there is also a large number o f schools with low student-teacher ratios located in urban areas (see Table 5.3), where optimization o f the school network should be considerably easier, given the short distances between schools. This problem is particularly visible in Sofia's 87 "urban" schools teaching only grades 1-8.'" The student-teacher ratio in these schools at 13.2 is lower than the national average o f 13.9 for similar type schools located in urban areas. There are a number o f schools with low student teacher ratios and very few schools which are operating with reasonably high ratios (that is, above 16) (see Figure 5.3). In addition, schools inBulgaria have a large non-teaching staff for every 100teachers inthe system, there is 43 non-teaching staff.'02 ``IEven large municipalities have schools classified as "rural". These schools are located in the periphery of the municipality. In Sofia, some o f these schools are located in the surrounding mountains, which make school consolidation more difficult. Therefore, inthe discussion o f Sofia above, focus is only on the LLurban''schools. Io'Annual Censusof Schools, the National Statistical Institute. 80 Figure 5.3: Student-teacher ratios in 87 urban schools in Sofia (grades 1-8) I 2 5 i 5 10 15 20 Student-teacher ratio Source: School level expenditure data base, NSIIMOFMESIWB 11. THEAGENDAFORFINANCEANDGOVERNANCEREFORM 5.8. Inmid-2006, the BulgarianNational Assembly approved an ambitious 10-yearreform agenda for its general school system in the National Program for the Development o f School Education 2006-2015. The strategy, which covers primary and general secondary education, has six broad objectives: Orienting school education towards the stimulation o f thinking, independence, formation of practical skills, and personality building; Establishing an efficient internal assessment system through the wide-scale use o f tests, and an introduction o f a national standardized external assessment system; Decreasing the number o f drop-outs and increasing enrollment rates o f children in the compulsory schooling age; Strengthening the authority and improving the social status o f the teacher; Decentralizing the school network through the gradual introduction o f delegated budgets for all schools, and providing increased flexibility to municipalities to appoint school directors; and Optimizing the school network by introducing a single standard (per capita) financing formula, and putting in place a system o f financial incentives for the closure o f ineffective schools. 5.9. While the Government is pursuingreforms across all six priorities, the decentralization, finance, and governance agenda is essential for promoting access and quality, and freeing up resources to be reinvested in the pursuit o f the overall reform agenda. The objectives o f the finance and governance reforms, as set out in the National Program, are as follows: (i)improved efficiency: better educational outcomes per BGN spent; (ii)equity: a fair educational system, which gives the right incentives and equal access to educational opportunities for all children, in particular marginal students; (iii)greater participation in decision making by local governments, school directors, school staff, parents, and the local community; and (iv) higher quality o f education for all students. The first three objectives will assist in the achievement o f the most important objective: higher quality education for all. Greater efficiency would allow higher quality to be achieved with a given amount o f expenditure on education. Equity would help to achieve equal access by all students to the available educational opportunities. 81 Greater participation would allow education decisions to be taken by those who have relevant knowledge o f local educational needs and conditions. A. The CurrentPrimary and GeneralSecondary Education System: Input-orientedand Centralized 5.10. The National Program describes the education system as excessively centralized, and the legal framework as complex and inconsistent. Also, the current system o f financing municipalities for the costs o f managing schools does not provide incentives for efficient school management. Detailed norms about teaching hours and class sizes determine the number o f teachers, and hence teacher salary costs, for which municipalities are then compensated. There is, therefore, little incentive or possibilities for municipalities to reduce costs by closing and consolidating small schools or by organizing larger classes, since both would result in reduced municipal revenues from the state. Until now, the bulk o f education related resources a municipality receives from the state has gone to pay staff, and these funds have been only loosely tied to the number o f students in the municipality. Specifically, a municipality can only hire a teacher if-according to official class size standards-there i s an appropriate number o f students to justify it. However, this relationship is weak, since there are upper and lower bounds for class sizes. Thus, a municipality could wait years before having to dismiss a teacher, as class sizes drop below the minimum. Moreover, the closing o f a school can be postponed for years, as municipal councils can simply choose to overrule the minimumclass size requirements, and provide the gap in funding from their own sources or postpone repair work. In this way, the system has left in place more schools than needed, sometimes in poor state, all suffering slow decline, with staff compensation consuming a rising share of total expenditures, and the resources available for teaching materials de~1ining.I'~ 5.11. As a consequence, the decline in student numbers has not been followed by the expected proportionate decline in the number o f teachers. This, along with rising teacher salaries, has helped push up real costs per students (see Figure 5.4). Studentand teacher numbers, index 1992-2005 Real expenditure per student, index 1997-2006 105 --Studcots (mdcx. 1992=100) Tcachcrr (indc?. 1992=100) 100 95 2I b 90 c 3 85 80 75 904 70 m u. W m m x N 2 2 s 0 0 N 0 N 0 N Source: National Statistical Institute and Ministry of Finance; Note: includes teachers and students from pre- primary to non-tertiary post-secondary level, including vocational (ISCEDO-4C). 103 Inability to explain the observed variation in student-teacherratios across municipalities with typical factors is consistent with this story: a crucial determinant in explaining student-teacher ratios i s unobserved, namely, the mayor's and municipal council's willingness to consolidate schools. 82 B. The New Primary and General Secondary Education System: Outcome-oriented with Self- managing Schools 5.12. The reformed general education system that is envisaged by the National Program i s one o f self- managing schools.'04 In the new education system, the Ministry o f Education and Science (MES) would focus on the results o f the education system rather than on detailed management o f the inputs, and defining the curriculum in terms o f content and student hours. This would require setting goals for student learning outcomes, and monitoring the achievement o f those goals at national, municipal, and school level. Further, school management and resources would be decentralized to the municipal and school levels. This would require strengthening o f regulatory and monitoring capacity o f MES, for example, through information systems to monitor the implementation o f school policy. The transition towards self-managed schools is planned to be done in three related steps: (i)by introducing a unified standard per student; (ii)by expanding the use o f delegated budgets,'05 and (iii)by relaxing MES regulations and establishing school-based management. Box 5.2 defines these terms. Among other EU countries, Sweden and the UK have been introducing similar reforms to enhance school-based management to various degrees over the past decade. 5.13. Introducing a unified per capita financing changes the incentive framework to promote efficient school management, and access to education. First, the unified standard provides incentives for school consolidation by tying all the funds a municipality receives for education directly to the number of students. Second, it gives municipalities and schools a clear incentive to attract and keep students. Thus, the unified standard is likely to help raise enrollment rates, and lower the drop out rates. In parallel, the Ministryo f Education and Science will needto step up oversight efforts through regional inspectorates to prevent municipalities and schools from reporting ghost students. A well known definition of this system by Caldwell (2002: p. 35) is: "A self-managing school is a school in a system of education to which there has been delegateda significant amount of authority to make decisionsrelated to the allocation of resources [resources defined broadly to include knowledge, technology, power, material, people, time, assessment, information, and finance] within a centrally determinedframework of goals, policies, standards and accountabilities. " 105 The term "delegated budget" has generated some confusion in Bulgaria, because the municipalities that have experimented with delegated budgets have introduced them in different ways. Similarly, given that there has already been some element of per student financing in Bulgaria for several years (for non-staff cost), it is often not understood that the unified standard per student is meant to cover all education expenditures. Bulgaria begun introducing delegated school budgets and school based management in the late 1990s (with EC support). By 2006, about 40 municipalities out of 264 had some form of delegatedschool budgets. Since each municipality developed its own system, there are substantial differences between them. However, a common feature is that budget delegation is limited in practice, and the school director has discretion only over all or parts of the non-staff budget. In the few instances where salaries are said to be delegated, it only means that the school manages the payment of salaries, not the determination of the number of staff or their salaries as these are determined by MES regulations. The shift to a delegated non-staff budget has been successful: municipalities and school directors consider their spending on the non-staff part of the budget more efficient than before. For further details on the evaluation of delegated school budgets in Bulgaria, see Club Ekonomika (ZOOS), Local Government Initiative (2005), Secondary EducationInformation Resource and Financial Management Center (2003), and EuropeanCommission (1998). 83 Box 5.2: School Finance and Governance Reforms: Understandingthe Terms Unified standardper student: The unified standard per student is unified because it includes funding for both staff salaries and non-staff expenditures. Since 2002, the Ministry of Finance has been allocating to municipalities a per student amount for non-staff expenses. To provide incentives to municipalities increase efficiency, salaries should be funded on aper student basis as well. For example, ifthe unified standard appliedto Municipality A is BGN800 per student per year and it has 20,000 students, it would receive a grant of BGN16 million per year from which to meet all the recurrent costs (that is, excluding capital costs) of education for grades 1 to 13. Municipalities could top up the BGN800 from its own revenues. However, the presumption is that the BGN800 per student would be sufficient to cover all recurrent costs associated with educating a child, and that a municipality would not receive any additional funds to cover education costs. That is, all current schemes of funding-such as, heating allowances, scholarships, traveling costs, clothes allowances-would be abandoned, and the municipalities would have to cover all costs from the per student unified standard. However, the uniJed standard is not uniform. That is, it will not be the same amount for all municipalities, but will vary depending on the type and municipality and structural factors that influence cost per student. The structural factors are beyond the control of the municipality, such as mountainousterrain, low population density, or higher than average percentagesof socially deprived students, which cause the cost per student to be high. Municipalities would not be given additional funds owing to small sizes of schools, since this would provide perverse incentivesand defeat the purposethe reform. Delegated school budgets: Under the unified standard per student, the school receives a single lump sum, with no indication of allocation between salaries and other expenses. This decision is left to school authorities. The school budget i s determinedby a formula, which applies to all schools inthe municipality. The main factor inthe formula, which determines the size of the school budget, is the number of students. The amount per student may be different for different grades, if the cost per student varies by grade due to differences in class sizes, teaching hours, or teacher pay rates. Examples of other factors included in the formula could be additional supplements for students with special learning needs, which may be due to their socio-economic background, lack of fluency in the language of instruction, or to disabilities. Some structural cost factors, such as an isolated location or having staff with higher salaries, could also be taken into account (for further details, see Ross and LevaEiC 1999). The main purpose of delegatingbudgets to schools (and accompanying it with school based management) is to delegate more decisions about educationto those who have knowledge about local educational needs and conditions. This, inturn, is likely to leadto more efficient use of resources and higher quality of education. School based management has different forms, but its main features are: (i) school director manages the school the budget, including determining the number of teachers and other staff, and selecting and appointing teaching and non-teaching staff; (ii)the school director is accountable for the honest and efficient management of the school budget and resources to a school council, which usually consists of representativesof parents, staff, and the local community (the council may have the power to appoint the school director and the ultimate authority to approve the budget decisions); and (iii)the school director can also be held accountable by the education authority (that is, the municipality). The school director and school council have to operate within the MES framework of education goals and standards-such as salary levels and working conditions for teachers and other staff. School-based managementhas been introduced insome OECD countries. 84 5.14. For a coherent and well functioning system of self-managing schools, all three key elements- unified standard, delegated school budgets, and Figure 5.5: The three aspects of a finance and school basedmanagement-need to be implemented governancereform (Figure 5.5). In Bulgaria, the reform process started on January 1, 2007 with the introduction of the unified per student financing standard, and School based management decentralization to municipalities. While this is an Delegated Budgets essential and important first step, the other two elements should also be implemented in due course to achieve the full effects of greater autonomy and accountability. Problems might arise if only partial reform was pursued. Rigid central class size and teaching hour norms in turn would prevent schools Unified standard to flexibly adjust to per student financing. Without further delegated budgets, municipalities might reallocate funds to schools on an uneven basis. Also, only further delegation of budgets to school will unleashthe full incentive effect fiom per student financing for attracting and retaining students. 111. INCREASINGEFFICIENCY PRIMARY AND GENERAL IN SECONDARY EDUCATION 5.15. Optimization of the primary and general secondary school network, and introduction of a per capita formula financing system for primary and general secondary education could save substantial resources for reinvestments in education quality. This is true even if the consolidation were limited to only large municipalities, where distances between schools are small. For example, there are 667 municipal schools located in urban areas within large municipalities (that is, with a population greater or equal to 60,000).'06 Out of these schools, only 320 operate with student-teacher ratios greater than or equal to 14, and a consolidation of these schools into schools with student-teacher ratios greater than 14 would yield savings. There are even larger savings to be generated, if policy makers were willing to tackle the problem of many small village schools. As reflected in Table 5.3, the vast majority of the 794 schools operating with student-teacher ratios less than or equal to 11 are located in villages.'07 Consolidating school in these areas would, however, be more challenging and require more planning and thorough analysis o f its impact on access to education. 5.16. There are also large possible savings resulting from the decline in Bulgaria's student-age population. As discussed in Chapter 1, the average enrolment in school at all grades from pre-school through upper secondary will have to adjust downwards to about 60,000 students per cohort over time, which i s 20-30 percent below current enrolments, depending on the grade. With fewer students to educate, the school network can be further consolidated, freeing up resources for the schools that remain inthe system. 5.17. International evidence suggests that per capita formula financing and school network optimization can lead to substantial savings without negatively affecting the quality of education. Neither would it negatively affect access to education, if mitigating measures are in place. It is well-established that marginal reductions in class size (especially below 30) have at best only a small, if any, impact on 106There are 29 municipalities(out of264) which have a populationgreater than 60,000. lo'The term village can refer to a small settlementinthe periphery of a larger municipality 85 student attainment. However, it has been argued that large reductions can have an impact on children in the early years o f schooling, and on those from socially deprived backgrounds.'08 Table 5.3: LargeVariation in Student-TeacherRatiosTranslatingintoVarying Per Student costs Location YOof student YOof municipal Average Average Number in municipal school student- expenditure of schools schools expenditure"' teacher ratio per student Student-teacherratios11 City 3.9 4.8 9.3 1,092 99 Village 7.1 10.6 8.9 1,176 695 Total 11.0 15.4 9.0 1,166 794 Student-teacherratio> 1I City 73.9 68.5 14.4 711 1,014 Village 15.1 16.1 14.3 838 769 Total 89.0 84.6 14.3 766 1,783 All municipal schools City 77.8 73.3 13.9 745 1,113 Village 22.2 26.7 11.8 999 1,464 Total 100.0 100.0 12.7 889 2,577 Of which: schools with student-teacher ratio214 City 41.4 36.1 15.8 665 529 Village 5.9 5.6 17.7 766 278 Total 47.3 41.8 16.4 700 807 Source: School level expenditure data base, NSIMinistry o f FinanceMinistry of Education and Science, and the World Bank. 5.18. Consistent with international experience, recent evidence from Bulgaria suggests that schools with lower student-teacher ratios do not automatically achieve better education outcomes (such as reduced drop out or repetition rates) than schools with higher ones."' To obtain a measure o f education outcomes, school-level information on drop-out and repetition rates is added to the school-level database. Figure 5.6 presents scatter plots showing the relationship between drop out, repetition, and student- teacher ratios."' The data reveal that schools with few students per teacher do not achieve better quality outcomes as measured by drop-out and repetition rates. The graphs reveal that there is neither a discernable relationship between the drop-out rate and the number o f teachers per student, nor the repetition rate and student-teacher ratios. Figure 5.6 also shows that there are a worrisomely large number o f schools with very high drop-out and/or repetition rates. Interestingly, schools with high drop- out rates do not necessarily also have high repetitions rates, ruling out the possibility that poor outcomes observed on aggregate can be attributed to a core o f schools, which fail in all dimensions. It goes beyond 108For example, WoRmann, (2003); OECD (2005b), and Hanushek (1999). IO9Municipal school expenditures accounted for about a third o f total public expenditure on education in 2005. 'loOECD (2004d) analyzed PISA 2003 results in OECD countries, and found no statistically significant relationship between the student-teacher ratio and student performance. 'I1There is data on both drop-out and repetition rates for 2,983 schools in 2005, suggesting that a large share of about 3,300 schools do not report one or the other. There are 58 schools performing poorly on either or both accounts-or have data o f questionable quality. These schools have repetition rates or drop-out rates above 22.4 percent (the cut-off point for the top one percent drop-out rates), or 26.4 percent repetition rates (the cut-off point for the top one percent repetition rate). The analysis in this chapter excludes these 58 schools because o f their data quality. 86 the scope o f this chapter to analyze the drivers o f drop-out and repetitionby school, but it i s a key area for future analysis. Figure 5.6: Student-Teacher Ratios and Drop-Out Rates (left chart) and RepetitionRates (right chart) by Schools, Bulgaria, 2004 w i * * * * . '1. v . * . . b r ,"..wo * .. . ...........- " ~ - -....... ... . Source: Staff calculations from school-level database and N S I data Iv. WHATH A SBEENACCOMPLISHEDSO FAR? 0 The new financing system effective from January 1, 2007 sets four different financing standards for four different types o f municipalities. Figure 5.7 presents the groups and per student standards. The first group consists o f the municipalities which have over (or equal to) 70,000 people in the municipal center. The remaining municipalities (which all have fewer than 70,000 inhabitants living in their municipal centers) are divided into three groups: (i)municipalities with the population density greater than (or equal to) 65 per square kilometer; (ii)municipalities with the population density less than 65 per square kilometer; and (iii)small mountainous municipalities (a subgroup o f (i)and (ii)) with more than three settlements, and less than 10,000 inhabitants in their municipal center. 0 Under the new financing system, there are 88 losing municipalities-that is, municipalities which will receive less (in nominal terms) under the per capita scheme than in 2006. In 2007, they are entitled to receiving a compensation equivalent to the difference between the allocation based on the new per student amount and their allocation in 2006."2 However, these municipalities have to present a school consolidation plan to MES and the Ministry o f Finance (MOF) by March 31, 2007 in order to receive the compensation. Current plans envisage that the compensation is limited to 2007 only, and that the per student financing rule will be fully implemented from January 1,2008 onwards, implying school consolidation needs to proceed in 2007. Losing municipalities will thus have multiple incentives to initiate school consolidation. With wages increasing by about 5-10 percent per year nominal terms, the only way for those municipalities to be financially viable under the per capita scheme is to consolidate their school network (assuming that non-wage costs are not cut instead, which i s a risk that should be taken into account in the plans). The implementation plans do not specify any ceiling on winning municipalities. 'Thus, the municipalities which have well-optimized school systems will experienceincreasesintheir educationbudgets. 87 Figure 5.7: Groupings of municipalities, along with baseline amounts and adjustment coefficients for 2007 Large municipalities: population 2 Underpopulated 70,000 in the municipal center municipalities: population < 40 municipalities: baseline amount x 70,000 in the municipal center and a population density 2 65 Per square meter 15 municipalities: baseline amount 139 municipalities: baseline amount x 1.12,or BGN894 Other municipalities: population < Small mountainous municipalities: 70,000 in the municipal center and population < 10,000 in the municipal population density < 65 persons per center and2 3 separatesettlements square meter 5.19. The Government has created mechanisms to support adjustment by municipalities to the new fundingsystem and school consolidation. The challenge o f introducingthe unified standard per student is that the municipalities which have failed to fully optimize their school network are likely to run into short-run financial difficulties (or have driven down their maintenance and material spending). While this should provide municipalities incentives to move ahead decisively, there may be transition problems. Therefore, MES has introduced support measures for school consolidation. This includes hands-on advice on managing the process o f school consolidation, and a budgetary facility to finance mitigating measures, such as parent outreach work, transport, and physical adjustments to school buildings to accommodate students from closed schools. 5.20. The introduction o f finance and governance reforms will necessarily span over a number o fyears, with municipalities consolidating the network and adjusting to the new financing parameters and delegated budgets being gradually rolled out.'13 It is essential for the Ministryo f Education and Science to monitor this process carefully, in particular through the regional inspectorates and external student assessments, to detect unduly negative effects on quality and access. Equally, under the new system it is important to monitor school budgets to prevent municipalities from financing municipal schools on an unequal basis. Under the intermediate system o f decentralized financing to municipalities, and not to schools through delegated budgets, there is a risk that municipalities provide beneficial financing to some schools at the expense o f others. This may lead to a worsening o f short-term outcomes in underfinanced 113In England, the introduction of school-based management and delegated budgets took seven years from the announcement ofthe reform in 1988to its full roll-out in 1994. Swedenfollowed a similar multi-year process. 88 schools. To offset this, the introduction of delegated budgets to schools should be accelerated, while carefully monitoring individual school budgets at the municipal levelto ensure equity. v. POSSIBLEFISCALIMPACT OF THEREFORM 5.21. The introduction of a unified standard, provided it leads to school consolidation, is set to yield substantial efficiency savings. These can be reinvested into the overall education system. Figure 5.8 provides preliminary estimates of the possible costs and potential savings of shifting to a per capita financing scheme in municipal schools. The graph on the left hand side of Figure 5.8 illustrates the additional costs and savings from the reform compared to current situation. The graph on the right-hand side traces the paths of education expenditures for two different reform scenarios. The underlying assumptions are explained below. Total savings and costs arising from the reform include (from left to right in Figure 5.8): (i)an efficiency gain (estimated by MoF when setting the initial funding rates); (ii) the "demographic dividend" (the saving associated with the fact that the student population is declining); and (iii)expenditures on mitigatingmeasures. Figure 5.8: Estimated Fiscal Impact of IntroducingPer Student Finance to Primary and General Secondary Schools Total spending on municipal schools with and without the funding reform Estimatesfor 2009 in `000 Leva Educationspending in K olGDP ~ 4 4 850,981 4 3 \ 4 2 a I E 4 1 & I 4 C e 3E ......Baselinem e -W pmpasai 3e Total spending EMciency gain Demographic Transpot, Total Wio funding estimatedby dividend refurbishing spending 37 reform MOF (cumuiatlve) and other with funding mnigation reform Source: Ministry of Finance, the World Bank school level expenditure data base for Bulgaria and World Bank educationteam simulations 5.22. School consolidation and adjustments to the number of non-teaching staff can achieve substantial savings. First, school level data shows that 794 schools in Bulgaria (that is about 30 percent) operate at student-teacher ratios below 11. Measuresto consolidate these schools, and to reducethe overall number to 400 schools operating at ratiosjust above 11, could yield savings of over BGN80 million per year over the next three years. Second, a parallel reduction of non-teaching staff by 30 percent (about 7,000 people) could yield additional savings of about BGN20 million. The total amount of possible and acceptable savings is a matter of judgment. The figure o f about BGN100 million shown in the graph contains the combined consolidation and non-teaching staff reduction savings. This scenario assumes that municipalities will respond to the incentives and support measures provided by the central level to consolidate schools. 5.23. There are also large possible savings resulting from the continued decline in the student-age population. The "demographic dividend" encompasses the savings that are made to the central government budget, since the new funding accrues per student and therefore accounts for declining student numbers. According to the UNpopulation projections, the student age population (that is, age 6- 19) will decline by about 40,000 during 2005-2010, and by another 20,000 by 2050. Assuming that Bulgaria manages to offset some of this decline by raising participation rates, the decline in students may be only about 27,000 in 2005-2010. The dividend arises from comparing the funding amount (under the 89 new per capita regime) without student decline with the funding amount with student decline. The demographic dividend grows each year, in line with the shrinkingschool-age population, and is estimated at BGN60 million by 2009. 5.24. Mitigating and support measures in school consolidation are in place to assist municipalities adjusting the school network. Figure 5.8 also factors in any mitigating and support measures during the transition period. These would include a program to cover material improvement o f school buildings, a bus transportation scheme, parent-involvement strategies, and municipal capacity support. The annual expenditure for this i s estimatedto be BGN35 million. 5.25. The medium-term budget framework for 2007-2009 projects a freeze in total education spending as a share o f GDP at the 2006 current 1 e ~ e l . l 'The fiscal projections on the right hand side o f Figure 5.8 ~ integrate all elements o f the reform agreed so far by different ministries. The baseline scenario assumes that spending grows at the rate o f growth o f GDP in 2007-2009. The line below the baseline scenario indicates expenditure under per-student financing as percentage o f GDP, if there is full transition to the new per capita funding rates, and losing schools are compensated for two years. The savings generated (illustrated by the vertical arrow) will be reallocated to the education system. The reduction in allocations to municipalities based on per student formula would be compensated with increased program spending (by part o f the savings). In 2007, program spending is planned to be allocated to policies aimed at mitigating the impact o f school consolidation, investments in strengthening staff qualification, modernization o fthe school base, education quality enhancements, and external student assessment. VI. POLICYRECOMMENDATIONS 5.26. The initiation o f the school governance and finance reform in primary and general secondary education opens an opportunity for the government to promote long-term reforms improving access and the quality o f education. First, the reform agenda, if sustained, would lead to a more efficiently managed school system with greater focus on quality than before, in particular if coupled with the introduction o f internal and external assessments o f learning outcomes to promote achievement o f national education standards. Second, efficiency savings would open the possibility to finance in a sustainable manner measures aimed at achieving improved education outcomes, and needs in other parts o f the education system. 5.27. While the government has already shifted to per student financing on January 1,2007 for primary and general secondary schools, further policy steps on governance and finance sides would still need to be taken. The remaining short and medium-term policy steps and recommendations can be grouped as follows. 5.28. The four key short-run policy steps and recommendations would be: Establish a clear and credible timeline for reform implementation to facilitate school consolidation: The efficiency savings will only materialize, if the per student financing formula leads to a further consolidation o f the school network. Therefore, ensuring that school consolidation happens is critical. The government would need to announce a credible timeline for the roll-out o f the reforms (and their sequencing) across all municipalities, covering 2007 and subsequent years. At the same time, the government should continue supporting the consolidation process through targeted advice- and financial assistance to '14 Ministry ofFinance(2006) Reportonthe Three-YearBudgetary Forecastfor the Period2007-2009. 90 those municipalities which proceed with the consolidation o f their school systems. In addition, hands-on advice to municipalities on how to manage consolidation would be helpful. Several municipalities have gained experience on school consolidation over the past years, and MES could promote peer learning activities among municipal authorities jointly with the National Association o f Municipalities. This support and advice would need to be available throughout the reform period. 9 Monitor the impact of reforms, and introduce external evaluation of learning outcomes: It i s essential that the roll out o f the reforms and their impacts are closely monitored and, based on the results, plans are adjusted as needed. The first stock taking in municipalities and schools would need to be conducted early on to detect any problems and allow early course correction. In addition, it would be important to monitor that municipalities treat all schools equally and fairly in their funding allocations, in particular prior to the roll-out o f delegated budgets to schools. In parallel, the Ministry o f Education and Science's (MES's) capacity to monitor education outcomes would need to be strengthened through the introduction o f nationwide external testing to determine learning outcomes, and through its management information system. MES has already conducted pilot student assessments and is scheduled to phase in systematic external testing over the coming years. Relax central regulations on teaching hours and class sizes: The per student formula funding, and rigid top-down regulations regarding teacher working hours or class sizes are mutually inconsistent and could lead to a fiscal crisis in municipalities (or for schools, once the formula reaches them through delegated budgets). With the shift to per student funding, schools would need considerable flexibility in determining how they allocate students to classes and how many classes they establish. Therefore, it is recommended that MES leaves the class sizes for municipalitiesto decide, and relaxes regulations on teaching hours. Implement school-based management and delegated budgets: Per student financing enhances efficiency and quality only if it is accompanied by an expansion o f school-based management and further delegation o f budgets to schools. Hence, it is important that the school-based management is rolled out in the next few years, as the school consolidation proceeds, which requires preparation now. In the context o f the shift to school-based management, capacity buildingfor school directors and municipal education department staff will be needed, including on budgetary issues and determination o f the delegated budget formula. MES has recently established an Institute of School Directors for this purpose, and a number o f school principals have already been trained. In the meantime, however, MES should not hold o f f delegating responsibilities to directors, as the most important learning will happen on the job. When shifting to school-based management, introducing performance- related pay schemes to teachers might also be contemplated: school principals, who are accountable for quality, would need means to evaluate teacher and influence teaching quality. MES is also promoting the establishment of school councils comprised o f parents and local stakeholders, such as community associations and private businesses. While the experience with such councils is mixed in OECD countries, they may enhance parent and stakeholder involvement in the school, and thereby help hold schools and municipalities accountable for school performance and budgeting,provided they are empowered and given full information. 5.29. The key medium-term policy step would be: 9 Reinvest savings in measures aimed at promoting quality of education and access: The introduction o f per student formula financing, if it leads to the consolidation o f the school network, can yield substantial savings. Since consolidated spending on education as a share 91 of GDP is projected to remain constant in the 2007-2009 medium-term fiscal framework, this implies that a growing share of the education budget can be reinvested in other education system needs, includingpolicies to enhance education access and quality. In addition to the needs on the vocational and tertiary education side, this could include teacher training, external assessments of schools to promote school and teacher ac~ountability"~,and pre- primary education to promote school readiness and reduce subsequentdrop outs'16. 115 The Center for Control and Assessment of the Quality of Education (CKOKO) has been tasked with the institutionalizationof the goals for an outcome-oriented education system. Similar agencies exist in every EU country, and they have emerged as one of the key players in the education sector. The government is planning to strengthen CKOKO's technical capacity to implement testing programs, which include: (i)a new placementtest at the end of 7th grade, which has the potential to radically overhaul current patterns of student access to upper secondary school; (ii)designing and piloting a new Matura, that is, secondary school-leaving examination; (iii)new tests (sample or census-based) to be used strictly as system-wide evaluationof education quality; and (iv) managing Bulgaria'sparticipationin internationalachievement tests. This includes internationaltests such as TIMSS, PISA, and PIRLS.Bulgariahas already participatedin some internationalassessment studies but without sustained interest and funding from MES, which prevents it from taking full advantage of the benefits associated with these internationalendeavors. For example, Bulgariahas not participatedinPISA since 2002. Household survey data suggest that children from poor and marginalizedcommunities are under-representedin pre-primaryeducation, and are particularly likely to drop out from primary school. Adopting measures to promote access to pre-primary education for children from vulnerable groups-for example, through waiving the kindergarten fees for low income families, and facilitating establishment of communitychild care providers-might be a cost-effective way to promote school readinessand reduce drop-out rates. Years later, such measures may have an importantpay-offinterms of loweringyouth unemployment(see Chapter4). 92 6. IMPROVINGVOCATIONAL EDUCATIONAND TRAINING 6.1 The major economic and social changes that have taken place in Bulgaria since 1989 have had an impact on the role o f the vocational education and training (VET) system and its institutions, especially the public vocational secondary schools. These schools were established to serve the needs o f centrally planned economic sectors o f production, such as mining, ore processing, chemical and oil products, and heavy machinery-that is, sectors that have suffered major downturns in their share o f production in the past fifteen years. The old VET system was also designed to serve the needs o f large state-owned enterprises, with their training centers providing avenue for vocational training for students in the VET systems, as was also the case in current EU8 countries. These centers are now closed down, and opportunities for practical training have become limited. Vocational secondary schools still focus on programs designed to serve the old economic sectors, such as forestry, wood processing, and chemical, metallurgical, and machine technology. However, the new emerging economy i s dominated by private small and medium enterprises (SMEs) in light industries and service sectors, and the needs o f these enterprises are quite different from those that prevailed inthe old one. 6.2 Duringthe transition period, the labor market has experienced disequilibrium, and there is general consensus among officials, and representatives of employers association^"^ that the knowledge and skills o f the graduates o f vocational secondary schools do not match the skill set required for the emerging job vacancies, despite the relatively low unemployment rates among its recent graduates (Table 4.7). The situation is further aggravated by negative population growth rate and emigration. 6.3 With this inmind, the Council of Ministers approved in2001 the Employment PromotionAct (EPA 2001), which introduced incentives for employers to train their employees and maintain and improve their qualifications."* The Vocational Education and Training Act (VETA 1999) in turn defined the regulatory mechanisms for initial and continuing vocational education and training. Its major goal is to "match the quality of the vocational education and trainingprovidedfor the needs of the labor market, and in accord with the trends in the European Union"."g Since then a National Agency for Vocational Education and Training (NAVET) has been established, which is in charge o f licensing VET providers and the classification o f occupations. Amendments to the VET Act were introduced in 2003 and 2005 to approve a new list o f professions and framework programs regulating the acquisition o f vocational qualifications. The Bulgarian approach in defining qualification levels and professional competencies is consistent with the approach developed by the European Qualification Framework and based on knowledge, skills and personal qualities required for the profession. In 2005, consistent with European directives, progress was made in the mutual recognition o f vocational qualifications. These developments notwithstanding, there i s still significant room for improvement in the system as a whole. 6.4 This chapter provides first an overview o f the VET structure and its governance in Bulgaria, highlightingthe enrolment trends. This is followed by a look at continuing VET and how it compares with the EU8 countries. Finally, the chapter explores the cost-effectiveness o f VET, as well as its links to the labor markets. The chapter ends with a presentation o f some options for reform. 1I 7 Such as the Bulgarian Chamber of Commerce and Industries, the Bulgarian Industrial Association, and the Bulgarian Smalland MediumEnterprisesAgency. 118 EPA regulatesthe types of continuingVET organizedby the NationalEmployment Agency, and the conditions of its delivery. 119 CouncilofMinisters(2005) "National Strategy for ContinuingVocationalTraining, 2005-2010". I.THESTRUCTUREANDORGANIZATIONOFTHEVETSYSTEM 6.5 The structure o f the Bulgarian VET system is complex and includes several different types of schools. The typology and organization o f the Bulgarian education system as a whole and vocational schools in particular is shown in Figure 6.1, Further, to put into perspective the size of the VET network, the types andthe number of schools providing general education are summarized in Table 6.1. The Figure and the Table together indicate that in terms of number o f schools the VET system is about a sixth o f the size o f the secondary education system. Figure 6.1: The Education System in Bulgaria 7 (Higher) 6 Doctorate Education Bachelor 5 4 4 3 3 3 Masters 2 Age 20 19 18 17 16 15 14 13 12 11 10 9 8 7 A C E2 Leaend A: Elementary School, 8:Lower Secondary School, C: Primary School, D: Upper Secondary School E l & E2: Comprehensive School, F, GBH:Vocational Training School, I,J&H:Vocational Secondary School, L: Vocational College Table 6.1: School Types in General Education (2005) School Type Number of School Urban Rural Private Total Primary (Grades I-IV) A 118 155 4 277 Lower Secondary (Grades V-VIII) B 10 10 3 23 Basic ( Grades I-VIII) C 516 1,244 22 1,782 Upper Secondary (V-XII) D 166 2 26 194 ComprehensiveSchools(V-XII) and (I-XII) E l,E2 350 60 4 414 Total 1,160 1,471 59 2,690 Source: National Statistical Institute (2006e). 6.6 Vocational education is provided in three categories and seven types of vocational schools and colleges. The numbers of schools, teachers, enrollment, and student-teacher ratios by categories and types of school are summarized inTable 6.2. The categories are as follows: 94 Vocational TrainingSchools: These schools provide avenues for students, who wish to pursue vocational studies as early as Grade VII (Type F), Grade VI11(Type G), or Grade IX (Type H). That is, students can shift to a vocational school prior to the completion o f compulsory education. Successful completion o f VET programs in these schools provides for semi-skilled occupations (level 1 qualification), with competencies in the targeted trades emphasizing routine activities, and repetitive tasks. Vocational Secondav Schools: These schools provide specialized vocational courses in selected occupations, and academic courses similar to those offered in general secondary education. Some o f them (type I,J, K) provide for manual skills and occupations (level 2 qualifications), with competencies in the targeted trades involving the execution o f complex activities. Others (type J and K) provide for skilled occupations (level 3 qualification), with competencies in the targeted trades involving the execution o f complex activities, including responsibilities for the work o f other people. Vocational Colleges: These colleges established under Article 18 o f the Vocational Education and Training Act (VETA) provide the highest VET award sanctioned (level 4). They prepare for skilled occupations with middle-management supervisory responsibilities, with competencies in the targeted trades involving the execution o f complex activities, including responsibilities for the work o f other people, and for the allocation o f resources as required. Table 6.2: Types ofVocational Secondary Schoolsin Bulgaria (2006) School VET School Duration of Number Enrolment Number of Student- Category Award Type Studies in of Schools Teachers Teacher Years Ratio Vocational Level 1 Training FIGM 2-3 na 2627 72 36.5 Schools Vocational Level2 I 4 85 38429 2120 18.1 Secondary Level3 JK 5 - 6 397 149665 16178 9.3 Schools Vocational Level4 L 2 23 3984 405 9.8 -Colleges Total 505 194,705 18,775 10.4 Sources: 1. National Statistical Institute (2006e) 2. National Agency for Vocational Education and Training (NAVET) 6.7 The Ministry o f Education and Science (MES), with support from NAVET, has defined a list o f approximately 275-300 occupations for which VET is provided. The characteristics o fthe qualifications for the existing VET scheme in Bulgaria are summarized in Annex 1. The scheme defines the duration and form of training, the admission requirements, the graduation procedures, and certification secured upon graduation as well as the continued education opportunities for graduates. 6.8 The quality and labor market relevance varies substantially across the vocational schools. Some o f them are among the elite schools in the country, while others are o f much lower caliber academically and in terms o fthe quality o ftheir facilities. 6.9 The VET system in Bulgaria streams students before the end o f the compulsory education (as early as grade VII) into vocational schools and designated occupational areas. The experience o f other 95 countries'*' indicates that students streamed narrowly early in their Figure 6.2: Distribution of Enrolment in VET Programs by education are harder to reorient than Type and Level their contemporaries in general I secondary education when they .. -. ....._.. .... .. .. _. . ... . .. - . . . . become unemployed, because o f their weak educational background. They also often have difficulty accessing tertiary education, and lifelong learning opportunities. In other EU and OECD countries, the streaming into VET typically takes place only at the end o f compulsory general education, roughly at age 16. Many j Level 1 Level 2 Level 3 Level 4 OECD countries have been also exploring the development o f flexible educational pathways in upper secondary education, which allows the integration o f relevant generic vocational skills in all secondary schools to respond to the needs o f a diverse student population, and changes in the nature o f work. This is what the EU Bologna process is also aiming for (see more o f the Bologna process in Chapter 7 on tertiary education).12' To achieve that typically requires reducing the number o f vocational education programs by broadening the definition o f vocational areas; creating linkages between general and vocational secondary schools; developing a combination o f school and work-based learning; and building bridges between vocational secondary education and tertiary education.I2* 6.10 Over 60 percent of vocational students are enrolled in technology programs at levels 1, 2 and 3, as shown in Figure 6.2 and Table 6.3. This still largely reflects an old style VET mandated to prepare workers for construction and heavy industries. 120World Bank (2006), "Fiscal Efficiency and Vocational Education inthe EU8 Countries." 12'EU launched in 1999 the Bologna process, which supports a series of reforms to make European Higher Education more compatible, comparable, competitive, and attractive for EU citizens and citizens and scholars from other continents. The aim of the European Higher Education Area, which EU hopes to establish by 2010, is to provide citizens with choices from a wide and transparent range of courses, and benefit from smooth recognition procedures. 122OECD (I994), Vocational Education and Trainingfor the 21"` Century: Opening Pathways and Strengthening Professionalism. 96 Table 6.3: Distribution of Student Enrolment in Vocational Schools by Vocational Discipline and Level, percent (2006) Vocational Area Level 1 Level 2 Level3 Level 4 Arts and Humanities: A r t s 0 0 3.6 4.7 Humanities 0 0 0.4 1.6 Business & IT: Business & Administration 0 8.1 18.7 68.5 Computing 0 0 2.7 0 Technology: Technics 13.4 38.6 36.0 6.2 ManufacturingandProcessingTechnology 59.7 18.4 12.7 0.1 Architecture& Building Construction 2.4 6.4 6.4 4.8 Agriculture, Forestryand Fishery 7.4 9.7 7.5 1.8 Veterinary ScienceITechnology 0 0 1.6 0 Services: Social Services 0 0.3 0.0 0 PersonalServices 17.1 17.8 8.2 8.5 Transportation 0 0.2 1.1 0.4 Other Services 0 0.1 0.9 3'5 Total 100 100 100 100 Sources: 1. National Statistical Institute (2006e) 2. National Agency for Vocational Education and Training (NAVET) 6.11 New enrolment in vocational secondary Figure 6.3: Enrolment Trends in Vocational Secondary Education education has been in decline in the past few years. Enrolment trends in VET programs offered in the vocational secondary schools are summarized in Figure 6.3 and Table 6.4. The data show that total enrolment increased from 2001, peaked at 2003 and declined by 7 percent from that peak by 2006. 2001 2002 2003 2004 2005 However, there has been a steady decline in the new Total Female 0 New Entrants1 entrants by 21 percent in the five year period from 2001 to 2006. Also, unlike enrolment in general secondary education where female enrolment exceeds male enrolment, the pattern in vocational secondary schools is the opposite: female enrolment is less than 40 percent o f total enrolment. The declining VET enrolment is consistent with the experience o f EUS countries. Since 1990, the share o f vocational secondary in total secondary enrolment has fallen significantly in all EUS countries, except the Czech Republic, as students have opted for the general secondary education.123 123World Bank (2006e), "Fiscal Efficiency and Vocational Educationinthe EU8 Countries". 97 Table 6.4: Enrolment Trends in Vocational Secondary Education, 2001-2006 Year Enrolment New Entrants Number Student- Male Female Total Male Female Total of Teacher Teachers Ratio 2001 116420 74908 191328 33876 21141 55017 18129 10.6 2002 123710 78802 202512 31591 19693 51284 18809 10.8 2003 130538 80848 211386 31763 18948 50711 19362 10.9 2004 128456 78939 207395 30602 18340 48942 19352 10.7 2005 123791 77154 200945 28041 18078 46119 19064 10.5 2006 120147 74558 194705 26453 17067 43520 18775 10.4 Source: NSI(2006e). 11. GOVERNANCE THEVET SYSTEM OF 6.12 Several government and private sector bodies are involved in the governance of the VET system. These are the following: 0 TheMinistry of Educationand Science (MES): MES manages and controls the implementation of national VET policies. It regulates and controls the provision of VET programs through a systemof public and private VET secondary schools, art schools, and vocational colleges. The Minister approves national occupational standards, the list of approved VET occupations, and programs for preparation ofVET graduates inthe M E S affiliated schools. 0 TheMinistry of Labor andSocialPolicy (MLSP): MLSP develops, and coordinatesthe national policies for the professional qualifications of the workforce. It is also responsible for the development ofthe annual national plan for employment, and the determination of the needs for vocational training based on labor market analysis. Further, MLSP is responsible for the maintenanceofthe National Classification of Occupations and Positions. 0 The National EmploymentAgency (NEA): NEA is an agency of MLSP, which implements the national policy for employment promotion and labor market protection, and organizes professional information and counseling, vocational and motivational training for both the employed and unemployed, and mediatory employment-related services. 0 TheNationalAgencyfor VocationalEducationand Training (NAVET):NAVET, establishedin 1999, is a specialized body under the Council of Ministers mandatedto license VET activities and coordinate the institutions involved in VET. It develops the national VET education requirements, the list of VET-related occupations, and oversees and regulates the provision of VET inthe licensedVET centers. Government Ministries and Municipalities: The Ministry of Culture implements the VET policies in the Art Schools, and participates in the development and coordination of VET programs in these schools, and in securing certification in the related occupations. The Ministry of Health determines the list of chronic disease and physical injury that are incompatible with VET programs and relatedoccupations Employers Associations: Various employers associations participate in the development, coordination, and maintenanceof the national VET educational requirements for the acquisition of occupational qualifications. They have representativesinthe NAVET Boardof Management and expert commissions, and participate in the examination process to certify candidates for occupationsrelevant to them. 98 Labor Unions: Labor unions designate representatives to the NAVET Board of Management and participate inthe development, coordination, and maintenance o f the list o f occupations. 111. CONTINUINGVOCATIONALEDUCATION ANDTRAINING 6.13 Continuing vocational training in Bulgaria is delivered by formal education, training, and VET institutions, and by a variety o f non-formal institutions. The formal institutions are the various types o f vocational secondary schools and colleges discussed earlier, and Vocational Training Centers (VTC). In 2005, there were 490 such institutions, including 440 states, 15 municipal and 35 private schools. Continuing education was provided by 182 o f these schools. NAVET licenses the VTCs and monitors their operations. All VTCs licensed since 2002 offer VET Figure6.4: Percentage of EnterprisesProvidingContinuingVET, programs for the first, second, 2004 (Source: Eurostat,CVTS2) and third levels o f vocational qualifications. Currently there are 146 licensed VTCs, and 169 affiliates. Most universities and higher education institutions also provide continuing education certificates and diplomas, many o f them in vocational subjects in continuing education divisions and units. Some enterprises &* .$* 8 .bi B 3 $9 *.f.*9h offer informal continuing VET G2e"-9q.? and is significantly below the E215 average, ~i~~~~~ 6.4 Figure 6.5: Percentage of Employees Participating in Continuing and 6.5 showsthe levelsVET, of 2004 (Source: Eurostat, CVTSZ) continuing VET in Bulgarian , enterprises in comparison with the EU8 countries, Romania, and the EU15 average. 6.15 According to NAVET,'24 the key challenges for CVT are lack o f adequate learning resources; inadequate training o f teachers in adult education and training methodology; I I and insufficient dialogue with and support from employers, who have so far not shown meaningful support for CVT activities. The participating schools also consider the centralized financial management o f revenues generated from continuing education activities to be a problem. lZ4 Council of Ministers (2005), National Strategy for Continuing Vocational Training 2005-2010. 99 Iv. EXPENDITURESVOCATIONAL EDUCATION ON 6.16 Early introduction o f VET at the secondary school level is costly, as Table 6.5 shows. Comparison of public spending per student in general and vocational secondary schools indicates that the average per student expenditures in vocational secondary education were 20 percent higher than the corresponding expenditures in general secondary during 2001-2005 (see Figure 6.6). This is true also in all EU8 countries. There are two reasons for this: (i)student-teacher ratios tend to be lower in vocational schools; and (ii)the cost of Figure 6.6: Per Student Public Spending on General and Vocational equipping, upgrading, and Education, BGN maintaining workshops in a I large number o f relatively run-down vocational schools is costly. These additional costs might be justified, if the VET graduates were more employable than the graduates o f general secondary education: that is, posses skills that are in high demand inthe market. Whether that is 2001 2002 2003 2004 2005 the case, will be explored next. Table 6.5: Expenditureson General (Upper) and Vocational Secondary Schools 2001 2002 2003 2004 2005 General Upper Secondary Schools Students in general upper secondary 148,581 160,871 166,995 170,482 170,462 education Expenditures on general upper secondary 96,585 123,639 152,759 195,716 245,346 education(thousands of BGN) Expenditures per student in general upper 650 769 915 1,148 1,439 secondary school (BGN) Vocational Secondary Schools Students in vocational secondary schools 181,595 192,759 202,274 197,818 191,649 Expenditures on vocational secondary 152,136 178,983 205,339 263,919 340,456 education(thousands of BGN) Expenditures per student in vocational 838 929 1,015 1,334 1,776 secondary education(BGN) Source: Ministryof Finance. v. EMPLOYMENTGRADUATES OF 6.17 Graduates of secondary vocational schools have unemployment rates that have been consistently 1-2 percentage points lower than those of their general secondary school counterparts (see Table 6.6). So, they seem to be more employable. However, one has to weigh that against a number of considerations. The education o f each of the vocational graduates is 23 percent more expensive. They also are about 50 percent more likely to be among the long-term unemployed, which suggest that, in the longer run, general secondary education might have served them better. Furthermore, studies on returns to investment in education in OECD countries show substantial wage premia for graduates of alternative occupational tertiary institutions over secondary school graduates o f either type. Those skills are increasingly in 100 demand in advanced economies. But to get there, the students are best served by a broad-based general education at the secondary level. On balance, the evidence points in favor o f general secondary schools, accompanied by a broadening o f curricula inthe remaining vocational schools at the secondary level. Table 6.6: Unemployment Rates for Secondary (Vocational and Upper General) Graduates 2001 2002 2003 2004 2005 2006 Number of unemployed: upper 112,800 98,800 72,500 62,800 52,300 47,100 generalsecondary Number of unemployed: vocational 228,000 223,300 157,700 144,900 117,400 103,400 secondary Unemployment rate of upper general 19.4 17.3 13.5 11.4 10.2 8.2 secondary graduates Unemployment rate of vocational 17.5 17.1 12.1 11.0 8.6 7.5 secondary graduates Source: National Statistical Institute, Bulgaria. VI. THELINKToTHELABOR MARKET 6.18 An earlier World Bank study presented evidence that there was a mismatch between the skills of graduates and the needs o f employer^.'^^ To get further information on this issue, a small survey o f the Bulgarian enterprises was carried out for this study by the Bulgarian Chamber o f Commerce and Industry. The aim was to gauge employers' satisfaction with skills o f their employees. The survey covered 300 enterprises employing a total of Figure6.7: Distributionof Employees by Type of Education 34,424 employees. The enterprises were o f four sizes ranging from micro to large.'26 In the surveyed enterprises, irrespective o f their size, the largest category o f employees was the graduates o f vocational schools (Figure 6.7). 6.19 Employees with tertiary education received the highest combined score for the satisfaction categories (very satisfied, or satisfied), and the lowest combined score for dissatisfaction categories (unsatisfied or very unsatisfied), when the surveyed enterprises were asked to indicate their level o f satisfaction with their employees in relation to their educational attainment. Employees with tertiary education were followed by graduates o f vocational secondary schools, the graduates o f general secondary schools, and the others. The implied preference o f employers for tertiary education graduates is consistent with results o f similar surveys in OECD countries. It is also not surprising that the employers prefer people with vocational World Bank (2005b). 126The surveyedenterprises were from the following sectors: agriculture, forestry, and mining-6.4 percent; energy and process industries45.7 percent; construction and related business-24.6 percent; services-1 9.3 percent; and others4 percent. Ofthe surveyedenterprises, 24 percent were micro (upto 10 employees; 35 percent small (11-50 employees); 30 percent of medium size (51-250 employees); and 33 percent large (over 250 employees).. While the sample size is too small for the results to be statistically valid, the results still provide a snapshot of views of employers. 101 skills to those with more general (secondary level) backgrounds. But as discussed earlier, the provision o f such skills at the secondary level is costlier than the provision o f general education. It also increases the risk that if the skills are not needed at some point in time, the lack o f a broader general education will make it harder for such individuals to adjust to the demands o f the labor market. A number o f countries have come to the conclusion that the way forward is some sort o f a hybrid-a general secondary education for (nearly) all, followed by a variety o f non-university skill-building options at the tertiary level. 6.20 Overall, the link o f the VET institutions to labor market is weak. The challenges facing VET in Bulgaria as identified by NAVET'27 include: (i)improving market intelligence and information availability to potential clients and stakeholders; (ii)developing effective communication and information dissemination framework; (iii)continuously updatingthe occupational standards in line with the needs o f employers; (iv) devising effective continuing VET programs to close the competency gap with EU; (v) creating incentive mechanisms to motivate the employers and workers to appreciate the need for and effectively participate in continuing VET; and (vi) mobilize and coordinate the efforts o f all social partners, local authorities, NGOs and other to actively participate in the process. VII.OCCUPATIONALLY-ORIENTEDALTERNATIVE SECTOROFTERTIARYEDUCATION 6.2 1 Bulgaria has a fairly small and ineffective alternative sector o f tertiary education, which may partly explain the low overall tertiary enrolments in Bulgaria compared to other EU countries. The sector consists o f two public and nine private colleges, which enrolled fewer than 7,000 students o f the total o f 221,400 students-a 3.1 percent-in 2005. In addition, Bulgaria has a large number o f post-compulsory, specialized and costly vocational colleges. 6.22 This is in stark contrast with other EU and OECD countries, most o f which have significant and strong alternative sectors o f tertiary education, with Table 6.7: Alternative Sector in Select Countries (2004) enrolments ranging from a count^ Gross Percentageof Enrolment in: minimum of 16.4 percent of Enrolment Rate University Sector Alternative Sector total tertiary enrolment in Australia 46.4 59.9 40.1 Finland to about 40 percent in Canada 49.2 60.5 39.5 Australia, Canada, Ireland, and Finland 64.6 82.6 16.4 40.0 72.0 28.0 Norway (see Table 6.8). All beland 42.2 62.7 37.3 EUS countries and Romania N~~~~ 40.7 78.1 21.9 have alternative tertiary Spain 31.1 56.9 43.1 institutions and colleges with Bulgaria 25.7 96.9 3.1 larger relative enrolments than Source: OECD Statistics 2004. Tables C6.1 and A3.0 Bulgaria.'28 6.23 Academic programs offered by these institutions are typically vocationally and occupationally oriented, which differentiates them from universities. For this reason they are covered under the VET chapter. The alternative sector institutions can also provide innovative degree-level programs, such as the Foundation Degrees in the UK, the Engineering Technology Degrees in the United States, and the NAVET has nojurisdiction over the more than 490 vocational secondary schools and collegesthat constitute the VET system. While it is mandatedto coordinatethe VET system by developingthe framework and the occupational standards governing the four levels o f certification, and also mandated to ensure the integrity of the certification examination system and the participation of employers in it, NAVET does not have any say inthe development and delivery of the VET curricula at the four levels, or in the training required for teachers, especially in emerging technologies. A summary ofthe organizationoftertiary educationand its institutionsinthe EUS countriesis provided inAnnex 2. 102 Applied Degrees in Canada. Examples o f the well established generic areas o f studies in such institutions include business managementI2', information and communication technology (ICT)I3', applied scienceI3', te~hnology'~~,agriculture and natural resources133,trades'34, applied arts and design'35,health studies'36, and social service^.'^' VIII. OPTIONSFORREFORMOFVOCATIONAL SECONDARYEDUCATION 6.24 As mentioned earlier, high quality vocational education is needed to promote adoption o f existing technologies and promotion o f labor productivity. However, this chapter has shown that the skills provided do not sufficiently match the current and evolving labor market needs. In addition, the system does not seem to be particularly cost-effective. To move the Bulgarian VET system closer to the best practice examples in EU and OECD countries, and ensure that vocational education students have an appropriate basis for lifelong learning to promote their adaptability and mobility across sectors and industries, the government may want consider five short and medium-run reform options. 6.25 In the short run, the government would be advised to pursue the following financing reform to promote the efficiency o f VET: Introduce per student financing to VET: To provide incentives for improvements in relevance and for cost control, the ongoing governance and finance reforms at the primary and general secondary levels could be extended to vocational secondary schools. This would include the shift to per student financing and delegated budgets to schools. The process o f the reform extension, and revisions that might be required compared to primary and general secondary schools would need to be worked out and require further analysis. 6.26 To promote labor adaptability and mobility in response to market needs, it is critical that all students are equipped with basic general education, and the education system provides options for continued lifelong learning. To shift the Bulgarian VET system into that direction calls for broader Including business management, office and organizational management, retail operations, accounting, marketing, human resources, e-business, supply chain operations, banking and financial services transportation operations, and hospitality and tourism studies. 130Computer systems software systems, computer networks, computer games, animation, multimedia design, Website design, and Internet services. 13'For example, biotechnology, pharmaceuticalstudies, environmental studies, nutrition studies, veterinary science, naturalresources, industrial chemistry and laboratory studies 13*Such as, mechanical systems, manufacturing technology, automation, transportation and heavy machinery, electrical distribution, electronics, energy systems, computers and ICT, telecomm, construction and building technology, architecture, and surveying 133For example, field crops and processing, agribusiness, agriculture technology, dairy animals, milk production, and horticulture, forestry, and forest management. 134For example, constructiontrades, automotive and transportationtrades, heavy machinery, and industrial trades. 135For example, interior design, graphic design, fashion design, multi media,journalism studies, and theatre design. 136Nursing, paramedical studies, spa therapy, medical laboratory studies, dental hygiene, optometry, biomedical technology, assistive devices technology, medical rehabilitation studies, geriatric care studies. 137New programs are also being developed in fields such as avionics, digital media, financial services, small businessenterprises, marketing, disability studies, early childhood education, leisure studies, animal husbandry, and optometry. 103 structural reforms in the medium term. The four key medium-term reform options the authorities may want to consider are the following: Start vocational secondary education only afrer the completion of compulsory education: Following the example o f other EU countries, Bulgaria would be well advised to delay the streaming o f students into VET until the completion o f compulsory education. Students streamed early in education are hard to reorient when they become unemployed, because o f their weak general education. Ifthis reform is implemented, the vocational schools presently offering the early programs would need to be closed and the students directed to schools offering lower general secondary education. 9 I n parallel, develop curriculafor the remaining vocationalsecondary schools that balance vocational and general studies. The curricula would need to emphasize occupationally- oriented skills and competencies as well as strengthening the core o f natural and social science, mathematics, foreign language, and the applied dimensions o f this knowledge. This would imply increased integration o f the curricula of the vocational'38and general secondary schools. The aim would be to ensure strong general education o f vocational students, which would enhance their adaptability and readiness for continued learning. 9 Establish Occupationally-Oriented Regional Colleges: In today's world, increasingly sophisticated skills are required even in many vocational occupations. As Bulgaria climbs up the technology ladder, the demand for people with occupational skills and education beyond the vocational secondary can be expected to rise. To strengthen the existingalternative education sector so that it can respond to this demand, the government may want to consider initially clusteringlmerging and upgrading select existing vocational secondary schools (types J and K in Figure 6.1) as well vocational colleges (type L) into occupationally-oriented regional colleges. The selection criteria for clustering and upgrading would include the reputation o f the institution, quality o f its human and physical resources, and relevance of its programs to the needs o f the local economy. The curricula offered by each college should be tailored to match the demand in the region (for example, programs geared towards tourism in regions close to the Black Sea). These new comprehensive occupationally-oriented colleges would be similar to those in other EUand OECD countries, and would satisfy the demand for access to tertiary education by a more diverse student population. This would include students with acceptable level o f academic preparation, students from vocational secondary schools with possibly lower academic preparation, students seeking tertiary education qualifications, and students from disadvantaged groups. Therefore, the establishment o f these colleges can be expected to increase tertiary education enrolment in Bulgaria. The new sector would establish important bridges between vocational secondary education and tertiary education on the one hand, and between the two sectors o f tertiary education on the other. Students from both upper general and vocational secondary schools with, and in some cases without, the matura exam will be eligible to enter the new colleges. Graduates o f these institutions can, after a period o f employment, or immediately after completing their sub-degree studies, continue their studies towards a university degree. Figures 6.9 and 6.10 show two alternative models for the new institutions with the earlier mentioned bridges, and Table 6.11 summarizes the characteristics o f each. Figure 6.11 shows in turn an example o f the relationship among the various occupations in the construction sector in terms o f the type and duration of studies at the secondary and the tertiary levels, and the corresponding occupational categories. 13'Vocational school types J and K in Figure 5.2. 104 Figure 6.8: Organization of the Vocational Programs in the Proposed New Tertiary Institutions- Model 1 --.- New Applied Degree Programs Professionalsfor Knowledge- Intensive Occupations ___, NIiddle-Level Programs - .Technicians Middle Level Practitioners -- Tevel4 Apprenticeship Programs -* 3 Level Skilled Workers and Licensed Tradesmen T - -Level 2 -Semi-skilled Workers Level 1 /x Figure 6.9: Organization of the Vocational Programs in the Proposed New Tertiary Institutions- Model2 University Programs -Professionals for Knowledge- Intensive Occunations - Middle-Level Programs .Technicians Middle Level Practitioners el 4 Apprenticeship Programs el 3 - * Skilled Workers and Licensed Tradesmen Semi-Skilled Workers 105 Figure6.10: Exampleof OrganizationofPrograms in the Construction Sector E E Occunational Specialists: .-e cs) P Construction Manager a .-> f 3c - Construction Trades: -- Plumber Electricians Cabinet Makers si ----Roofer Carpenter Mason Dry Waller * Brick layer Heavy equipment operator Cable installer Establish a National Qualification Framework and Authority to Strengthen Life Long Learning: If the proposed vocationally-oriented tertiary colleges and institutions were established, it would be important that a National Qualification Framework (NQF) also be developed. NQF would allow recognition o f qualifications earned at various levels and stages o f education and training to ensure that mobility, access, and life long learning opportunities are available. In addition, it would be worthwhile to consider establishment o f a National Qualifications Authority (NQA), based on other similar existingsuccessful agencies, such as NQA of Ireland. NQA would have three tasks: (i)the establishment and maintenance of NQF for all educational awards in Bulgaria; (ii)the establishment, promotion, and maintenance o f the standards for education and training awards in all institutions (secondary, alternative tertiary, universities); (iii)the promotion and facilitation o f access, transfer, and progression through the education and training system. It should be mentioned here that substantial consultations have taken place in Bulgaria since 2005 concerning the establishment o f such a framework that adopts the guiding principles o f the European Qualification Framework. 106 Table 6.8: Characteristics of the two proposedmodels Aspect Model 1 Model 2 International The Colleges for Further Education in the UK, and The InstitutUniversitairede Technologie IUT, - Example the Technical Institutes in Ireland France Bridges to Both models provide bridgesto vocational secondary education allowing students in vocational schools Secondaly to continue their studies towards higher occupational awards without obtaining their end of secondary - Education educationcertificates. Bridges to Program-specific articulation because the colleges are Systemic articulation. The institutes are Universities separate from universities. university-basedinstitutions. Program Level Post compulsory and tertiary programs offered in the Mostly tertiary short-cycle programs. Post- same institution. At the tertiary level short cycle and compulsory programscan be offered. three-year innovative degree level programs are offered. Admission Open access for post compulsory programs Requirements Matura for tertiary programs Academic Awards Certificates and advanced certificate of VET Certificates of VET qualifications qualifications 2-year diplomas 2-year diplomas 3-year new applied degrees Strengths The new institutionscan be easily, quickly and The institutionscan be linked to existing cost-effectively established from selected public and private universities, and existing vocational gymnasiaand collegesthat benefit from their management and meet certain criteriafor capacity and quality. academic capacity. The new institutionscan be vehicles for regional The link to university implies the economic development. developmentof systemic articulation The new 3-year applied degree can allow between the short cycle programsand Bulgaria to meet the Bologna objective of a 3- their university counter part, and mobility year Bachelor degree. for students Weaknesses The new "applied" degrees would have to be The short cycle two- year program hasto formally recognizedby MES andthe National be fully recognized and transferableto Qualification Agency, and included inthe Higher university programs through a reasonably Education Act. accessibleand short bridging program. The innovation would meet resistance from the The stronger link to university can also academically conservative established be a disadvantage stifling the spirit of universities, andthus would require political will . . innovation inthe new institution and and leadership. creating a"poor cousin" syndrome. 107 Annex 1:Typology ofVET Qualification inBulgaria Aspect of VET Level 1 Level2 Level3 Level4 Skills and Predominantly Predominantly Skilled Skilled Occupational basic semi-skilled manual skills and occupational occupational Levels occupations occupations categories categories with middle- management supervisory responsibilities Duration of 1 or 2 years after 2 or 3 years after 4 years after basic 5 or 6 years after Studies basic education in basic education in education in basic education in technical schools technical schools vocational vocational secondary schools secondary school or in a vocational college Typeof Studies Formal in institutionalsetting as well as in Formal in institutional setting vocational centers and on-line training Admission Completion of Basic Education Certificate Basic Education requirement GradeVI or VI1 Certificate + Admission Exam Graduation Qualification State Examination+ Qualification Examination Procedures Examination Certijication Vocational Qualification Certification + Vocational Qualification Certification + Documentation of Completion of Specific Secondary School Diploma Grade Access to Secondary Schools Vocational College University Continuing or University Education 108 Institutions o f professional higher education (rakenduskorgharidus) Non Universty 5B 3,4,5 and second level professional higher education programs) Non University 4 3 3 2,334 Is, Medical Academies, Maritime Schools, emies o f Physical Education, Artistic Schools, logical Schools, Military Schools and Internal r s Schools: Higher Vocational Schools (just Institution InstitutionType ISCED Level Length University Colleges (colegii universitare) Non University 5B 2,3,4 bniversities, Institutes or Academies bniversity 15A,6 /4,5,6 109 bniversitiesType (Universities andAcademies) /university Source: European Commission, (2006)National Summary Sheets on Education Systems in Europe and Ongoing Reforms, Eurydice http://www.eurydice.org/portal/page/portal/Eurydice/ShowPresentationND?pubid=047EN&country=nulI&countryreg=null 110 7. STRENGTHENING TERTIARY(HIGHER)EDUCATION 7.1 Tertiary education institutions are facing the challenge o f adapting themselves to the multiple demands from stakeholders: students for the high quality education, employers for the relevance o f education to their needs, and the government for accountability o f the public resources allocated to the tertiary institutions. Higher education usually refers to the system o f universities, or university-type institutions, which offer undergraduate and graduate studies leading to Bachelor, Master, and Ph.D. degrees. By contrast, tertiary education is a more comprehensive designation that includes most forms and levels of post-secondary educational provision in both the conventional university sector, and in non-university institutions forming an alternative sector. 7.2 Institutions o f tertiary education are no longer seen as remote places where students acquire academic knowledge and professional qualifications, but instead as a major force in the ongoing economic development, and the advancement o f knowledge. Tertiary education is an important determinant o f individuals' earning capacity and employment prospects, and therefore plays an important role in determining the level and distribution o f income in society. In most developed and transition economies, the wage premium earned by the graduates o f tertiary education compared to the graduates o f upper secondary education are substantial and increasing with work experience. The graduates o f tertiary education also face a lower risk o f unemployment than those without tertiary education. I. TYPOLOGY TERTIARY OF EDUCATION 7.3 To put the Bulgarian tertiary education system in context and to highlight the link with the discussion o f VET in the previous chapter, the evolution of tertiary education systems in select other countries is first briefly summarized. The development o f a typology o f modern tertiary education faces two challenges: (i)defining the identity, role, and an appropriate place for the new alternative sector institutions (that is, the type o f occupationally-oriented colleges proposed in the previous Chapter 6) in systems dominated by the universities; and (ii)branding or labeling o f the institutions that do not belong to the traditional university sector. The early work o f the OECD, and the European Association for the Study o f Higher Education called them tertiary short-cycle institutions. However, some o f these institutions provide degrees requiring 3-4 years of study, which could not be considered to be short cycle. The 1991 OECD report called them alternatives to universities, and some authors referred to them as the non-university sector o ftertiary education. 7.4 A better approach is to define the tertiary education system as a tripartite system composed o f three tiers o f institution^.'^^ Tier Iconsisting o f the elite research and comprehensive universities; Tier 11 o f lower level universities, and some degree granting tertiary colleges and institutes; and Tier I11 o f institutions offering mostly short-cycle programs/occupationally-orientedprograms. Figure 7.1 outlines the evolution o f tertiary education in OECD countries during 1960-2005. The hierarchy o f institutions in Tiers Iand I1 is established by the nature o f the degrees offered, by the selectivity o f their admission criteria, and by the resources allocated per student, which are almost universally greater in Tier I universities than in Tier I1or 111institutions. For example, in the UK Tier Icover Oxford, Cambridge, and the rest o f the so-called Russell group o f high-status universities; Tier I1consists o f universities o f lower status, research orientation, and selectivity, including the former polytechnics; and on Tier I11are the Further Education (FE) colleges, which are occupationally-oriented colleges. In the United States, 13'Grubb, W.N (2003). The Roles of Tertiary Colleges and Institutes: Trade-offs in Restructuring Postsecondary Education, OECDPublications. Tier Iis composed o f the ivy league and other research universities; Tier I1 consists o f less-selective universities, which offer a wide array o f occupational programs; and Tier I11has the community colleges, and technical institutes. France also has a tri-partite system, in which the Grandes Ecoles form Tier I with selective admission and high spending per student; the universities form Tier 11; and the Institut Universitaire de Technologie (IUTs), and the Sections de Technicians Superieurs (which award the Brevet de Technicien Superieur) operated by secondary schools constitute Tier 111. See Table 7.1 for further examples. 7.5 The boundaries between the Figure 7.1: Evolution of Tertiary Education: 1960 to 2005 three tiers are fuzzy, and typically The Universtty Sector of I hotly disputed by many o f the Tertiary Educatlon institutions in the lower tiers. In the The BinarvSvstem U.K., there are institutions that Tw;t;;cJo;r;;;v~;eU;;of provide higher education degrees and Tertiary Education further education courses, and are (lg60- lgE5) therefore hybrid institutions. Canada has university colleges that cooperate with local universities in providing Bachelor'sinstitutions Australia has degrees. The Tn-Partite Svstem dual-tier that include Tier II Tier 111 Hybrid-ner 11 lnstltutlonsand the universities, and Technical and Shifl in The BoundariesBehveen Sectors (1985 - 2005) Further Education colleges co-located with shared infrastructure, and some U.S. universities are allowed to grant 2-year associate degrees commonly offered by community colleges. However, these complications and fuzzy boundaries should not obscure the conclusion that the tripartite model reflects the reality o f tertiary education in most OECD countries in 2006. The alternative sector of tertiary education includes all the institutions of Tier 111, and some o f the institutions in Tier 11, which are not considered, within a national context, to be part o f the university sector. Table 7.1: The Tripartite System of Tertiary Education in Select Countries Country Tier I Tier I1 Tier 111 Australia 8 researchuniversities 32 universities and some TAFE 68 TAFE Colleges colleges Canada 30 research and comprehensive 56 universities, university colleges, 145 community colleges and universities polytechnics, ITALs* technical institutes Finland 20 universities 3 1 polytechnics Short cycle programs in polytechnics France 37 Grandes Ecoles 86 universities 123 IUTs** Germany 78 technical and 182FachhochschulenFHS Dualtraininginstitutes comprehensiveuniversities 43 Berufsakadeinien Ireland 8 universities 13 technical institutes trainingcenters Norway 4 universities 26 state colleges adult educationinstitutes Spain Escuelas Tecnicas Superiores y Facultadesy EscuelasUniversitarias Formaci6n Profesional de FacultadesUniversitarias Grado Superior (FPGS) UK 20 Oxbridge and the "Russel" 53 newer and polytechnicuniversities 340 further education (FE) universities colleges USA 690 Ivy League and public and 1760 polytechnics, colleges, and 1075 community colleges and privateresearchuniversities smaller state universities institutes oftechnology Bulgaria 2 comprehensive universities 40 mediumand small universities 11 small vocational colleges with meaningful research capacity Notes: * InstitutesofTechnology and Applied Learningin Ontario; ** InstituteUniversitairede Technologie 112 11. THESTRUCTUREAND ORGANIZATION OFTERTIARYEDUCATION BULGARIA IN 7.6 Tertiary education was established in Bulgaria after the country's liberation at the end o f the 19th century, with the establishment o f the University o f Sofia. The evolution o f tertiary education in the 1920s and 1930s was influenced by the Humboldtian ideal o f the university. The nature and structure o f tertiary education changed drastically after the Second World War. In 1947, the first law on higher education was adopted, and it emphasized the role o f universities and institutions o f higher education as agents for the transformation o f the Bulgarian economy into an industrial economy. The mission o f the universities was seen as to primarily prepare graduates with the knowledge and skills to facilitate such transformation. The structure o f the system, which still prevails today, is specialized and characterized by single-discipline institutions serving a particular sector. Examples include the universities o f forestry, chemical technology, and metallurgy. 7.7 After the collapse o f communism, and the transformation o f the Bulgarian economy and society into a market economy, a number o f changes have taken place in the tertiary education system, including renaming o f some institutions to reflect the paradigm shift in the philosophy and values o f society. An important development has been the emergence o f private universities, and the establishment o f colleges of tertiary education, mostly in the private sector. Tertiary education in Bulgaria today consists o f three categories o f institutions: (i)comprehensive and technical universities; (ii)specialized institutions o f higher education; and (iii) colleges. These three categories of institutions are both in the public and private sector (see Table 7.2). A complete list o ftertiary education institutions in Bulgaria is inAnnex 1. Table 7.2: Tertiary EducationInstitutions in Bulgaria, 2006 Institutional Category Number of Enrolment Average Number of Student- Institutions Size Faculty Faculty Ratio Public Universities 10 78,500 7,850 7,784 10.1 Private Universities 4 37,424 9,356 1,977 18.9 Public SpecializedInstitutions 26 118,820 9,850 13,648 8.7 Private SpecializedInstitutions 2 2,250 1,125 161 14.0 Public (Short-Cycle) Colleges 2 1,000 500 102 9.8 Private (Short-Cycle) Colleges 9 5,470 608 453 12.1 Total 53 243,464 4,594 24,125 10.1 Source: BulgarianHigherEducationSystem-HumanResourceDevelopmentCentreBulgaria 7.8 Table 7.2 shows that there is a large number o f small specialized institutions, and only a small number o f comprehensive universities (only seven universities have more than 10,000 students). This is a concern from the quality, fiscal, and effectiveness o f R&D points o f view. Small narrowly specialized institutions, such as the University o f Transportation (1,000 students), or the University o f Mining and Geology (2,600 students) carry a relatively high overhead cost. As a result, they are likely to have fewer resources to spend on research, and student support, thus raising quality concerns. Also, proliferation o f small universities reduces the benefits to be gained from scale and scope, and hinders the increase in student-faculty ratios from the current low levels. Further, as will be discussed later in Chapter 8, it hinders R&D in universities, since a critical mass o f scientists and researchers is usually needed for that. At the same time, the alternative sector o ftertiary education-the colleges-is small compared to EU8 and EU15 countries, as was discussed inthe previous chapter inthe context ofVET reform. 7.9 Further, the overall student-faculty ratio in the system is below 11, and in the specialized institutions it is below 9, which is significantly lower than the norm o f 16 in OECD countries. If private universities, which employ many o f the faculty o f public universities (see paragraphs 7.32-7.34 for discussion o f faculty issues), are excluded, the ratio is even lower. This is a concern, since it highlightsthat resources are not efficiently allocated. These characteristics suggest that there are opportunities for reform 113 o f the system, consolidation o f institutions achieving more cost-effective use o f resources, and improving the quality o f learningand student services. 7.10 Private provision o f tertiary education is uneven in Bulgaria. Of the six private universities and eight private colleges, three are among the top ten o f all institutions by size. All the others, except one, are small with less than 1,000 students. The demand for private universities in Bulgaria-as in EU8 countries-is high, and still growing, while the demand for public universities is leveling off. The advantages o f private universities include: (i)they act as a catalyst for reform in tertiary education, increasing private investment, and providing competition and innovation; (ii)they provide an avenue to respond to some o f the unsatisfied demand by the public sector for tertiary education; and (ii)owing to their flexible management and staffing arrangements, they are able to respond flexibly and efficiently to market and student demand. 7.1 1 However, the private universities also raise concerns, Table 7.3: Types of Tertiary Education Institutions in Bulgaria, mostly related to the quality o f Romania, EU8,and EU15 education provided and indirect Country University Non University Public Private access to public finance. There Czech Republic 28 36 26 38 is concern that owing to the Estonia 11 29 20 20 small size o f most o f these Hungary 24 47 31 40 institutions, they are unlikely to be able to provide broad and Poland 209 218 126 301 comprehensive curricula. Many Latvia 36 20 36 20 o f the small institutions focus Lithuania 19 51 48 22 on business management, social Slovakia 22 2 20 4 studies, and other disciplines, Slovenia 48 31 62 17 which do not require large Average EU 8 50 54 46 58 investment in capital equipment Average EU 15 59 82 98 31 or infrastructure. However, this Bulgaria 42 9 37 14 concern applies as well to Romania 122 55 67 public universities, which are Source: Eurydice-Eurybase--UNESCO-CEPES--Bologna-Bergen2005. also predominantly small. There is also a widespread concern that private universities admit students who do not have the required qualifications for higher education. In addition, there is a strong belief that by hiringpart time faculty, who are moonlighting professors from public institutions, private universities are indirectly subsidized by the taxpayer, and give little in return. 7.12 Compared to most EU8 countries, Bulgaria has (i)a relatively large number o f small specialized universities; (ii)small share o f privately run tertiary institutions; and (iii)a small number o f alternative tertiary institutions. These are weaknesses that would merit attention. The comparative analysis o f the types o f tertiary education institutions in Bulgaria, Romania, EU8, and EU15 countries is shown in Table 7.3. Of the EU8 countries, the comparison with Czech Republic and Hungary is most relevant, since they have comparable population and demographics; both countries have smaller number o f universities and much larger alternative sector o f tertiary education. 111. ACCESSTo TERTIARYEDUCATION 7.13 A modern knowledge-based economy needs an adequate supply o f skilled educated workers, and the majority o f these workers are expected to have tertiary education. Table 7.4 shows that Bulgaria compares unfavorably with EU8 countries in two important factors influencing participation in tertiary education: (i)the percentage o f 18 years old still in the education system; and (ii)the percentage o f 22 years old that have completed upper secondary education. Bulgaria scores lower than all EU8 countries 114 in these two importantpredictorsof potentialparticipationintertiary education. A recent study'40suggests that this is both a challenge and an opportunity. The challenge is that participation rates in tertiary education depend on high-schoolgraduation, and without improvementsin performanceat the secondary school level, student numbers intertiary education are unlikely to increase. The opportunity inturn is that if school performance improves to the levelof the EUScountries, appropriatesupply side policies could translate this latent demand into actualdemandfor tertiary education. Country Participation rate Percentage of 20-24-year Percentage of 22-year of 18-year old in old with at least upper old with upper education (ISCED I secondary education secondary education 1-6) Icompleted 1completed Czech Republic 90.8 91.4 90.5 Estonia 80.5 80.3 83.9 Latvia 83.3 79.5 75.6 Lithuania 88.9 85.0 78.4 Hungary 76.4 83.5 85.5 Poland 86.9 90.9 91.2 Slovenia 87.2 90.5 90.2 Slovakia 82.1 91.7 93.0 Bulgaria 73.6 76.1 74.8 Romania 58.3 75.3 Na Average EU8 84.5 86.6 86.0 Average EU15 76.3 74.2 Na Source: Eurostat Data (2004) 7.14 The participationrate in tertiary education in Bulgaria is lagging behind the EUS countries, and the from Tableaverage. participation rate 7.5, the As can be Seen Table 7.5: Tertiary Education Participation Rates in ~~1 aria,E U and ~ ~ ~ 1 5 in tertiary education is not only Cou:try 2000 2001 2002 2003 2004 2005 substantiallyand consistently lower in Czech Republic 30.2 30.5 34.3 34.8 35.2 35.6 Bulgaria than in EUS and EU15 Estonia 60.8 60.5 66.2 66.7 67.1 67.4 countries, but the gap has also Hungary 40.1 40.7 49.9 52.2 54.1 54.6 widened during 2000-2005. Table 7.6 Latvia 64.1 63.8 71.9 72.2 73.9 74.1 shows a troubling trend in the Lithuania 59.9 59.9 67.8 68 68.4 68.9 enrolment in tertiary education in 54.1 56.7 59.9 60.7 61.5 61.8 Bulgaria: during 2000-2004, Bulgaria 29.8 30.5 32.3 33.1 33.9 34.2 was the only country among EUS and Slovenia 60.8 61.2 67.9 68.4 69.6 69.9 that had a EU8 50.0 50.5 56.3 57.0 58.0 58.3 Of about l3Average EU15 Average 53.9 57.6 57.8 58.0 percent 52.6 53.6 in tertiary education Bul aria 24.3 25.7 25.9 26.4 26.8 26.9 enrolment. During the Same period, Souke: UNESCOInstitute o f Statistics all the other countries had robust growth in tertiary enrolmentranging from 14 percent in the Czech Republicto 51.5 percent in Romania. Table 7.7 showsthat this same troubling trendwas for a while happeninginthe enrolment ofnew entrants to the system. However, preliminarydatafor 2005 and 2006 suggests a reversalofthis decline alongwith a strongpick-up in net enrolmentrates. I40Bekhradnia, B. (2004). Higher Education in Bulgaria: A Review for the Ministry of Education and Science, Higher Education Policy Institute. 115 Table 7.6: Total Enrolmentin Tertiary Educationin Bulgaria, Romania, EU8 and EU15 Country Enrolment in Thousands 2000 2001 2002 2003 2004 O h Change Czech Republic 253.7 260.0 284.5 287.0 318.9 26% Estonia 53.6 57.8 60.6 63.6 65.7 23% Latvia 91.2 102.8 110.5 118.9 127.7 40% Lithuania 121.9 135.9 148.8 167.6 182.7 50% Hungary 307.1 330.5 354.4 390.5 422.2 37% Poland 1579.6 1775.0 1906.3 1983.4 2044.3 29% Slovenia 83.8 91.5 99.2 101.5 104.4 25% Slovakia 135.9 143.9 152.2 158.1 164.7 21% Bulgaria 261.3 247.0 228.4 230.5 228.5 -13% Romania 452.6 533.2 582.2 643.9 685.7 52% Average EU8 2626.8 2897.4 3116.5 3270.6 3430.6 31% Average EU15 12563.3 12820.3 13191.0 13589.6 13859.7 10% Source: UNESCO Institute of Statistics Table 7.7: Enrolment of New Entrants in Tertiary Education in Bulgaria, Romania, EU8 and EU15 Country Enrolment in Thousands 2000 2001 2002 2003 2004 O h Change CzechRepublic 51.845 56.81 56.261 61.026 71.957 39% Estonia 13.055 14.749 14.01 18.162 18.855 44% Hungary 99.152 88.001 94.343 106.645 110.524 11% Latvia 34.788 33.295 36.986 40.659 43.037 24% Lithuania 34.154 37.464 39.94 40.332 42.145 23% Poland 419.308 435.648 458.339 458.108 465.674 11% Slovenia 15.363 20.927 23.27 23.353 23.782 55% Slovakia 36.037 38.72 41.6 38.725 46.054 28% Total EU8 703.702 725.614 764.749 787.01 822.028 17% Total EU15 1922.25 2518.08 2587.837 2739.958 2297.933 20% Total OECD 6052.14 6184.42 7302.342 7336.492 7258.515 20% Bulgaria 49.767 41.901 42.434 43.564 46.101 -7% Romania 129.237 170.974 158.094 147.537 195.408 51% Source: UNESCO Institute of Statistics 7.15 The imbalance that exists at present between male and female enrolment in secondary education, a Table 7.8: GeneralUpper Secondary phenomenon that is common in EU countries, suggests SchoolEnrolment in Bulgaria that the demand for tertiary education could be Year Males Females Total increased. In Bulgaria, female participation in general 200112002 55,920 92,661 148,581 upper secondary education is over 50 percent higher 2002/2003 61,502 99,369 160,871 than male participation, as shown in Table 7.8 (this ratio i s almost reverse in VET schools). While this situation 200312004 65,149 101,846 166,995 i s potentially serious owing to the shorter participation 200412005 67,891 102,591 170,482 o f females in the labor market, it also means that 200512006 68,745 101,727 170,472 policies to encourage male participation in secondary Source: National Statistical Institute, Bulgaria (2006) 116 education, rather than being siphoned off into the VET sector, could lead to increased participation in tertiary education. The establishment o f occupationally-oriented colleges, as proposed in the previous chapter, could helpto address this. 7.16 Inequities in access to education have limited school participation rates in Bulgaria. At present the highest birthrates are among the poorest and least well educated segments o f society-the Roma and Turkish minorities-whose children are least likely to continue their education. However, with the EU accession, and growth o f the economy, the demand for tertiary education among disadvantaged groups should grow as it has in the EU8 countries. The limited institutional diversity o f tertiary education in Bulgaria is likely limiting the participation o f disadvantaged minorities. Most of the institutions are traditional institutions belonging to the university sector, and there are few colleges offering occupationally-oriented programs. The occupationally-oriented colleges discussed and proposed in the previous chapter would often be better suited to the academic qualifications, needs, and aspirations of disadvantaged groups as well, and more responsive to the needs o f the labor market. 7.17 The present disjointed admission process involving university or institution-based examination is seen as an obstacle to improved access to higher education. Currently, each university sets up its own standards, entrance examinations, and criteria for admission. Experience suggests that for a country the size o f Bulgaria, a nation-wide system o f the end-of-secondary school examination would be the best approach to ensure fairness and transparency, and simplify the entrance examination process. w. RELEVANCETHEACADEMIC PROGRAMORIENTATIONTO THENEEDS LABOR OF OF MARKETS 7.18 The distribution of students across academic subjects in Bulgaria differs significantly from the rest o f EU countries, and may not match the needs o f the modern economy. Table 7.9 shows some discrepancies between the pattern in Bulgaria and the rest o f EU: (i)a high proportion o f students (47 percent) studying social sciences, compared to 26 percent in the rest o f the EU; (ii)a small percentage (six percent) enrolled in service-related programs compared to 17 percent on average in the EU; and (iii) only four percent compared to 12 percent in the rest o f EU study mathematics, science, and information and communication technology, subjects essential to achieve competitiveness in the knowledge economy environment. Table 7.9: Distributionof Studentsin Tertiary Educationby Academic Discipline Academic Discipline Percentage of Total Students Enrolled EUAverage Bulgaria Social Science, Business and L a w 26 47 Services 17 6 Health Sciences and Related Studies 12 9 Engineering 14 12 Humanities and Liberal Arts 10 9 Science M a t h and IC'T 12 4 Education 8 10 Agriculture and Veterinary Science I 3 Total 100 100 Source: Bekhradnia,B. (2004) 7.19 In an attempt to encourage universities to offer programs that are relevant to the needs of the market, MES has responded with mostly supply-side measures involving the allocation o f approved enrolment numbers, and associated grants to each university on the basis o f the perceived needs o f the market. This approach does not take into account the willingness, or the ability o f universities to provide instruction in the targeted areas, nor the readiness o f the students to enroll in those programs. An 117 alternative, demand-side approach that has been discussed, but not yet implemented is one in which MES provides incentives in the form o f subsidies to institutions, and scholarships to students in the disciplines it considers a priority. However, this approach, while attractive, has a number o f implementation problems. First, MES would need to identify the subjects which it wished to encourage, and would need to establish appropriate networks o f public and private sector stakeholders to provide input about the market needs. Second, MES would need to ensure that the universities and other tertiary institutions have the capacity and resources to offer the approved programs. Third, MES would need to monitor the outcome o f the initiative closely to ensure that the supply o f incoming students and the demand for graduates in those targeted areas indeed meets. Finally, MES would have to establish a strong alternative sector o f tertiary education offering occupationally-oriented programs strongly tied to identified needs o f the labor market. V. THEBOLOGNA PROCESS 7.20 Prior to 1991, the degree structure in Bulgarian universities followed the traditional European two-stage model with the Masters degree over total o f five years o f study, followed by the Doctorate stage over three additional years. Bulgaria has since taken the necessary steps to adopt the Bologna three-cycle (Bachelor/Master/Doctorate) structure. However, the change was more in form than in practice: the Bachelors degree qualification is not regarded as a valid qualification by the majority o f students and their families. Two thirds o f the graduates with the Bachelors degree go on immediately to a Masters program, and study for five years consecutively before seeking employment. Such a high proportion is contrary to the goal of the Bologna process, which aims to promote employability o f Bachelor degree holders, and also represents a burden on public finances, even if many o f the students in the Masters phase are self- financed and not subsidized by the state. It may also involve opportunity costs in terms o f the students staying out o f the labor force longer than necessary. 7.21 Countries that have joined the Bologna process have restructured their higher education degree system according to the 31.2 and less frequently to the 4+1 model o f the first two cycle^.'^' Bulgaria, has adopted the 4+1 model in its universities, The Bologna process intended the Bachelors degree to be a viable qualification for entry into the workforce. One advantage o f a 3-year Bachelors degree is that, if it is accepted by the labor market and society at large, the financial resources that could be released for use elsewhere in the tertiary education system would be substantial. 7.22 The current "specialist in" qualification, which is readily awarded in a small number o f colleges and in branches and departments o f universities, does not fit the Bologna framework, because it i s neither a college award nor an accepted Bachelors degree, As such, it is somewhat o f an anomaly in the Bulgariantertiary education. It is intended to provide access to tertiary education for students who do not have the appropriate academic qualifications from secondary school to enter a Bachelors degree, but despite the implication o f "specialist" in its title, it does not appear to be particularly valued in the job market. Therefore, the majority o f students with the "specialist in" qualification seek advanced-standing admission to Bachelor degree programs; some in the second and others in the third year o f the program, taking in total 5-6 years to complete the degree. As such, these programs provide the "university transfer" function that community colleges in the United States and Canada, and the Institute Universitairede Technologie in France provide. 7.23 The results o f the latest stocktaking on progress show that Bulgaria still faces a number o f challenges with regard to the implementation o f the Bologna action lines (see Table 7.10). Every two years, prior to a ministerial conference, a major stocktaking exercise is undertaken in each country to 14'England, Wales, and Northern Ireland are exceptionsand follow a model where athree year Bachelor is followed by a one year Master. Some institutions inthe Netherlands also offer this possibility. 118 assess the progress o f reform along the so called Bologna action lines. The last stocktaking was done in 2005 for the Bergen Ministerial Meeting (the results o f 2007 exercise are expected to be available in May 2007). The results suggest that Bulgaria is doing relatively well when it comes to the implementation o f the two cycle structure, although, as stated above, the employability o f Bachelor degree holders has not been fully realized and there remain issues to be resolved with regard to the access to the second cycle. Bulgarian universities have implemented the European Credit Transfer and Accumulation System and the Diploma Supplement, but some obstacles still hamper mobility. A major challenge remains on the quality assurance front. Bulgaria is ranked in the lowest category for participation o f students in the quality assurance process, and also scores low on international participation in the quality assessment procedures. Table 7.10: Bologna Scorecard for Selected Countries, 2005 Quality 2-cycle Recognition Total score Assurance Albania *** ** **** *** Croatia *** *** **** *** Macedonia **** ** **** *** Montenegro ** *** ***** *** Serbia ** ** *** ** Bulgaria ** **** **** *** Romania *** *** ** ***** *** Slovenia ***** ***** **** Notes: (1) The maximum score is 5 stars--the scorecard is expressedin `traffic light' colors (from redto dark green) but stars have been assigned here for clarity. (2) Since the 2005 conference, the Bologna Process has moved to a 3-cycle system (Le., BA, MA, and PhD) Source: Bologna Scorecard 2005. VI. GOVERNANCE AUTONOMY AND 7.24 Several reviews o f higher education have been carried out in Bulgaria since 1989, and these have led to some reforms o f university governance through the introductiono f two Higher Education Acts along with numerous amendments. Until 1989, the university system in Bulgaria was closely controlled and regulated by the government. The Autonomy Act o f 1989 removed most o f the controls, and succeeding legislationchanged the balance between autonomy and control close to another extreme. 7.25 The reforms gave university academics too much autonomy, and did not adequately satisfy the government's need for accountability. The governance framework is characterized by a number o f contradictions: (i)public universities can own assets, but they do not own the majority o f their buildings; (ii)the universities can appoint their own rectors through elections without interference, but the government-until the reforms o f 2002-required that all academic programs be approved and registered in the state register; and (iii)universities enjoy freedom in the allocation o f the financial resources they receive from the government, and can carry money forward from one year to the next, while the Ministry o f Education and Science (MES) dictates the number o f students that they can recruit. The ultimate authority o f the university resides in the University Council; a body comprised largely o f the faculty o f the university, and presided over by a Rector, elected by the same faculty. This system o f governance ensures that universities are run primarily for the benefit o f their faculty. The Rector is effectively the Chief Executive, but instead o f being accountable to all stakeholders (the tax payers, their elected representatives, the students, the faculty, staff, and employers) the Rector is currently accountable to only the faculty o f the university. Furthermore, management experience o f the rectors, when first elected, is 119 often limited, and is generally not used as a criterion for their appointment. Major reforms to tertiary education are unlikelyto succeed unless the governance framework is changed. 7.26 The accountability o f universities has several dimensions. First, universities receive substantial funds from the government, and should be expected to show that the money has been properly and cost- effectively used.142 Second, they are also to be accountable for the quality and relevance o f their programs, and at least in theory be subjected to the scrutiny of the National Evaluation and Accreditation Agency (NEAA). Third, to ensure reliance on the market rather than detailed MES control, the universities are expected to produce relevant information to ensure that all stakeholders can make informed choices. mI. FINANCING TERTIARYEDUCATION OF 7.27 Public spending on tertiary education in Bulgaria compares favorably with EU8 and EU15. At first glance it may appear that Bulgaria's overall tertiary education expenditures compare slightly poorly with EU8 countries (see Table 7.11). The proportion o f GDP devoted to tertiary education declined through the 1990s, was reversed in the late 1990s, but at 0.9 percent o f GDP in 2004 was just slightly below the EU8 average level o f one percent o f GDP. However, a closer look at the expenditures on tertiary education per student and as percentage o f the per capita GDP reveals that public spending per student compares favorably, and in fact exceeds, the levels in EU8 countries and the EU15 average (see Figure 7.2). The relatively high level o f spending per student is explained by the low student-teacher ratio mentioned earlier, and resultinglarge spending on faculty salaries. Figure 7.2: Public Spending per Full-time Tertiary Student in 2005, percent of GDP per capita (source: Eurostat) 54 5 - 7.28 Most European countries have come to accept that the beneficiaries o f tertiary education have to contribute a fair share o f the cost o f their education through tuition fees, and not expect tertiary education to be fully subsidized by the state. This is viewed to increase the accountability o f universities to students while also reducing the burden on the state budget. Having beneficiaries pay for a meaningful part o f the education costs tends to increase the vigilance o f students and their parents when it comes to the quality o f education delivered. To ensure that the tuition fees will not adversely affect access to university 14'Bulgarian universities are auditedby MES, and are expectedto account for the use of their funds. 120 education, in parallel student loan schemes have been e~tablished,'~~or tax benefits.'44 Further, to ensure equal access to tertiary education, grants and scholarships as a form o f non-repayable aid are provided to the talented students from poor families. 7.29 The idea o f tuition fees has been accepted in Bulgaria with little opposition. At present, students pay a fee which can be as high as 30 percent o f the cost o f provision o f education per student, according to the Higher Education Act. However, in practice the fees charged are significantly less. They range from BGN200-300 for Bachelor's programs, to BGN300-400 for a Masters program. The universities admit students beyond their state quota on the condition that they pay full cost. An estimated 25 percent o f all students in 2005 were admitted on that basis. Universities may charge the full cost for Master's degree programs, and about 35 percent o f Master's degree students indeed pay the full cost. This seems to indicate that the cost o f education is not, at least at the present levels, a deterrent in Bulgaria. Table 7.11: PublicExpenditureson Tertiary Education,percent of GDP Country 2000 2001 2002 2003 2004 Czech Republic 0.8 0.8 0.9 0.9 1.o Estonia 1.1 1.1 1.1 1.1 1.1 Latvia 0.9 0.9 0.9 0.7 0.7 Lithuania 1.3 1.4 1.1 1.o 1.o 1.o Hungary 1.1 1.2 1.o 1.2 1.3 Poland 0.7 1.O 1.1 1.1 Slovenia 1.3 1.3 1.3 1.4 Slovakia 0.7 0.8 0.9 0.9 0.9 Bulgaria 0.9 0.8 0.8 0.8 0.9 Romania 0.4 0.8 0.7 0.7 0.7 Average EU8 0.9 1.0 1.1 1.0 1.0 Average EU15 1.1 1.1 1.1 1.2 1.2 Source: Eurostat VIII.FUNDING MECHANISMS 7.30 The present funding mechanism provides little incentive for universities to develop relevant programs, improve the quality o f the learning environment or provide better services to students. Until recently, Bulgarian institutions o f higher education have been funded using a framework o f "deficit financing": budget allocation for the current fiscal year being based on the previous year's budget, but taking into account the cost o f universities' additional inputs, and approved enrolment targets. In 2003, the funding mechanism was amended to include the following reforms: (a) the provision o f enrolment- based subsidy usingthe enrolment targets approved by MES; and (b) a subject-specific weight to reflect the actual costs incurred by the universities in teaching costly subjects, such as medicine, engineering, or defense studies. MES provides funding to the universities using a program-weighted funding formula, which is summarized in Table 7.12. In sum, what this amounts to is that the government simply divides the number o f student places among universities irrespective o f their reputation and quality o f their programs. `43 Salmi and Hauptman (2006) Innovation in Tertiary Education Financing: A Comparative Evaluation of Allocation Mechanisms,The World Bank. Student loan scheme are provided in over 60 countries aroundthe world. They vary along a number of dimensions: the source of capital, the type of expenses covered, student eligibility criteria, and institutions eligibility criteria. `44 Tax benefits have been introduced in Europe and North America. They are intended to help families offset a portion ofthe tuition fees paid for a son or daughter attendingauniversity or tertiary institution. 121 Table 7.12: FundingFormula for Tertiary EducationinBulgaria Discipline Weight Funding/Student in BGN PedagogicalScience and Education 1 696 Social Science 1.6 1,136 Natural Science and Engineering 2.3 1,600 Veterinary Medicine 4.3 2,993 Medicine 5.0 3,480 Security and Police Studies 7.8 5,435 Defense Studies 10.6 7,357 Source: Ministry of Education and Science- Datasheet (2006) 7.3 1 To provide appropriate incentives to universities, the government should consider adjusting the formula slightly: instead o f enrolment targets, linkingthe enrolment-based subsidy to actual enrolments. While this would only be a minor change in the formula, its impact in terms o f incentives would likely be significant. Belgium for example i s allocating funds based an actual enrolment with positive results. 7.32 In the medium term, to supplement the actual enrolment-based subsidy, a partial shift to performance-based funding could be considered. Although a number o f university vice rectors interviewed indicated their readiness to consider the introduction o f performance-based funding to improve the quality, relevance, and responsiveness o f university programs to the needs o f students and employers, arguments have been made by others that performance-based funding has disadvantages. First, the attempt to link funding to the desired outcomes, such as the employment rate o f graduates, or greater responsiveness to market signals requires that the universities build the capacity to collect, analyze, and document data and relevant indicators to validate their claim. This capacity is said not to exist in Bulgaria. Second, the shift may have unintended consequences, as happened in Ontario, Canada, where the incentive to prove the occupational relevance o f college programs gave rise to an unwelcome explosion in difficult-to-validate testimonials by employers. Third, many rectors o f small specialized institutions and universities expressed concern that performance-based funding will reward the larger more powerful institutions at their expense. However, evidence from many OECD countries, including Denmark, New Zealand, Australia, and many U.S. States and Canadian Provinces, overwhelmingly indicates that there have been benefits outweighing the disadvantages from the introduction o f a performance-based component in fimding mechanisms. Its strengths are the f ~ l l o w i n g : ' ~(i) ~ : it is transparent compared to many other funding mechanisms, if the data for calculating the performance indicators are publicly available, (ii)it provides a strong link between funding and public policy objectives; and (iii)it encourages accountability in the use o f public funds by linking results to funding levels. IX. FACULTY ISSUES 7.33 The autonomy o f Bulgarian universities is reflected in their policies and practices with faculty employment and work conditions. The university hires and employs faculty, and has complete autonomy over their progress through the ranks, work load, and retirement. The retirement issue is a serious problem, because many faculty members remain on staff past the retirement age. This is contributing to the overstaffing in Bulgarian higher education, and the associated low student to staff ratio with two negative consequences: (i)a substantial portion o f the financial resources are used to employ disproportionately large numbers o f faculty, and as a result faculty salaries remain low and diminished 145Salmi. J, and Hauptman.A (2006). Innovations in Tertiary Education Financing: A Comparative Evaluation of Allocation Mechanisms.The World Bank. Washington, D.C. 122 funds are available for equipment, facilities, and learningresources; and (ii)there are little incentives for faculty to develop new courses, and apply modern learner-centered teaching methods. 7.34 Bulgarian academics are not well-paid and are ageing, a phenomenon witnessed in many countries, but one that needs to be addressed in an EU member country. This phenomenon is creating a number o f concerns. First, the low income discourages the best graduate students from pursuing an academic career, given that they can earn substantially more working in the private sector. Second, the poorly paid faculty members are forced to "moonlight" by accepting teaching assignments in other institutions, especially the newly formed private universities, as mentioned earlier. The resulting lack o f commitment o f these professors to their parent university, and the additional draw on their time when teaching elsewhere, probably affects the quality o f their teaching, and surely the time that they devote to doing research. Third, the salary distribution in Bulgarian universities is skewed in favor o f senior professors, who are paid more than three times the salary o fjunior lecturers, adding another impediment to the ability to attract young faculty. Finally, the ageing o f faculty coupled with the lack o f resources leads to stagnation o f academic program development and scholarly activities. Given all o f this, as the first step towards the reform, it would be essential to enforce the retirement rules to make room in the system. 7.35 The high staffing levels have adverse consequences in terms o f teaching processes, and program hours. First, high staffing levels in Bulgarian universities have led to a teacher-centered learning process-the teachers teaching, and the learners passively taking notes-instead of a learner-centered process, which encourages a spirit o f enquiry, independent thinking, and autonomous study. Second, to justify the large number o fteachers intheir departments, academic managers approve structured programs that often exceed 30 contact hours per week. This preoccupation with student contact hours and the excessive in-class learning focus is not necessarily conducive to free enquiry that a learner-centered approach requires. Endemic over teaching is often defended on the grounds that contact with the teachers is the only way that students can learn in an environment where access to libraries, learning resources, and the Internet is limited. X. QUALITY ASSURANCE 7.36 The expansion o f tertiary education in Bulgaria since 1989 and its slow, and sometimes painful, conversion from an elite system o f higher education to a more open and diverse system o f tertiary education, which includes both public and new private institutions, has given rise to a concern about quality. Quality in tertiary education has been traditionally viewed as an institution and/or program-based attribute. To ensure quality, governments typically make funding o f public institutions and authorizing o f private institutions conditional on their securing accreditation from an accrediting body. 7.37 In Bulgaria, the government established the National Evaluation and Accreditation Agency (NEAA) in 2004, with a mandate that includes both institutional and program accreditation. NEAA regulates rather than controls the quality o f universities. It also ensures that information is provided to students and to all stakeholders to reassure them about the quality o f provision, and to enable them to make informed choices about programs and institutions. NEAA has eight standing committees covering the following major disciplines: educational sciences, humanities and arts, social sciences and law, economic sciences and management, natural sciences, mathematics and computers, technical and military sciences, agrarian sciences andveterinary medicine, and healthcare and sports. These committees define the criteria for institutional accreditation in three major dimensions: (i)the educational dimension, which includes the goals and activities o f the institutions, the policies and procedures governing the activities, the framework for monitoring, evaluation, and quality assurance, and student services; (ii)the research, development, and scholarly dimension, which includes the scientific research and creative initiatives, student participation, and outcomes o f these activities; and (iii)the institutional management dimension, 123 which includes the overall organization o f the institution, its human resources and intangible assets, the educational resources and infrastructure, and domestic, and international cooperation initiatives. 7.38 While based on best practices in the European quality assurance agencies, the NEAA framework have two major drawbacks. First, it focuses on evaluating inputs, and to a limited extent learning processes, but rarely outputs and outcomes using tools, such as student and graduate satisfaction surveys, and indicators. Second, the NEAA evaluation teams are staffed only by full-time university faculty, who are assigned to evaluate programs in other universities delivered by fellow faculty members. No external professionals representing the private sector are included in these committees. This i s exacerbating the governance problems in universities. NEAA needs to identify outcome indicators, and develop mechanisms for collecting and evaluating them. NEAA should also include self-evaluation by institutions and program faculty, and integrate it in its processes. Further, NEAA should make information sharing and dissemination an integral part o f its mission. The success o f the agency depends on the integrity o f its standards, and the confidence that the tertiary institutions have in the integrity o f these standards and procedures. All institutions and their staff, students and their families will rely on the integrity o f the agency's published informationfor making informed choices. XI. OPTIONS FORREFORM TERTIARYEDUCATION OF 7.39 A modern knowledge-economy needs an adequate supply o f skilled educated workers, and the bulk o f workers are expected to have tertiary education. There is extensive evidence that effective tertiary education investment increases a country's ability to make leading-edge innovations. Highly skilled people are also usually adaptable in the face o f changing labor market needs. Further, tertiary education and research are among the key elements to promote European integration: through provision o f skills and knowledge that promote labor mobility, and through participation in the European Higher Education Area (the Bologna process) and the European Research Area. Bulgaria should follow these trends and take measures to increase the quality, efficiency and effectiveness o f its tertiary education to promote productivity growth. 7.40 Compared to other EU countries, Bulgaria's tertiary education system is currently characterized by a relatively large number o f small and specialized universities, relatively low participation rates, lack o f program relevance, and weak accountability o f universities. The often heard complaint about the lack o f relevance o f programs and the knowledge and skills they impart to graduates, reflects the current divide between universities and their external environment. 7.41 To address these issues and to strengthen the overall performance o f the tertiary education sector and facilitate R&D (as will be discussed in Chapter S), Bulgarian authorities are in the process of preparing a new higher education strategy. The aim o f the strategy will be to improve the quality of tertiary education, expand access, and leverage public and private resources. The reforms are expected to focus on governance and financing systems, quality assurance, student admission policies, and expansion o f university R&D. Initial steps have already been taken in establishing the Matura as the university entrance examination. In finalization o f the strategy, the government may want to consider a set o f short and medium-term reform options. There is no single measure that alone would fix the system. 7.42 In the short term, the following four reform options may be considered, in the order o f priority. Of these recommendations, the first two options would be the most critical ones for improvement o f the performance o f universities : Base thefunding on actual student enrolments:To promote competition among universities and thereby provide them with incentives to improve quality and efficiency, as thefirst step the current funding formula could be adjusted so that instead o f enrolment targets, the subsidy is based on actual enrolments. This change in the formula is critical to promote 124 competition and influence incentives. However, over time this kind o f a formula could lead to distortions such as enrolment beyond optimum levels, delays in student completion, and a bias towards low-cost programs. Therefore, other complementary reforms should be considered inthe medium term, as outlined below. Strengthen university governance through the establishment of Boards of Trustees and a Tertiary Education Council: To enhance accountability o f universities in terms o f quality, relevance o f programs, and use o f resources, the Bulgarian authorities may consider institutinga contemporary governance structure for tertiary education, embodying many the reforms adopted in other EU or OECD countries. The governance reform would have two parts: First, change the role of government in tertiary educationfFom directing and managing the system to that of "steeringj-om a distance". This change would require the establishment o f a Council o f Tertiary Education for the whole system, and perhaps two separate lower level councils for its two sectors-the university sector, and the alternative (or non-university) sector o f tertiary institutions and colleges. These two councils would develop the appropriate policies relevant to their sectors. See Figure 7.3, which highlights the proposed revised governance framework. The Council o f Tertiary Education would replace the existing Council o f Rectors. It would be an independent body mandated to develop and implement a national strategy-and related policies-in tertiary education, and ensure that the practices o f tertiary institutions comply with them and serve the public interest.'46 The proposed two-tier framework is essential to ensure that the proposed new alternative tertiary sector (see Chapter 6) has a distinct and significant voice in the development o f tertiary education policies in Bulgaria. Lessons learned from the experience o f OECD countries that have introduced similar reforms over the past decades show the importance o f such a two-tier governance str~cture.'~~The linkages between the councils and other tertiary education bodies would needto be determined duringthe preparation stage. `46The Council's mandate would include: (i)development of a national tertiary education strategy for Bulgaria; (ii) development of plans to support R&D tertiary education institutions; (iii)forecasting the number of students necessary for the country, and developing plans to rationalize enrolment in institutions; (iv) developing plans for continuous upgrading and improvement o f the capacity and resources of all publicly hnded tertiary institutions; (v) developing policies on public expenditures and funding of tertiary institutions; (vi) establishing the norms for employment intertiary institutions; (vii) overseeingand approving the work of NEAA (viii) overseeingthe work of the two other councils-the university council, and tertiary institutions council; (ix) submitting annual reportsto the Minister of Educationand Science, and to the Council of Ministers on the status of tertiary education Bulgaria; and (x) maintaining contacts with counterparts in Europe and in other countries. In other countries, a typical Council consists of 15 members; 9 (5 senior public sector and 4 private sector representatives)appointedby the Government, and 6 members representing the university council and the tertiary education council. In most countries, the Chair ofthe Council is a private sector representativeappointedby the Government. `47The introduction of community colleges in Ontario in the mid-l960s, and the reform of higher education governance in California inthe 1980s. 125 . Figure 7.3: Proposed Governance Structure for Tertiary Education NationalEvaluation (L Accreditation Agency NEAA NationalQualification Universities 1 Councilof Universities lnstitutlons InstitutionBoardof Trustees Institution Second, establish a Board of Trusteesfor each university/tertiary institution and have them appoint the heads of institutions. The Board o f Trustees would govern the affairs o f the universityhertiary institution by: (a) developing broad administrative and management policies for the institution; (b) providing broad direction and coordination to the development o f academic programs; (c) overseeing the efficient management o f funds, property, facilities, and investments; (d) appointing the rector, as a chief executive o f the institution; and (d) determining the representation o f the institution on the Council o f UniversitiedTertiary ~nstitutions.'~~ MES has recently proposed to establish Boards o f Trustees, but only with an advisory function and with membership consisting primarily o f faculty members. The implied (and continued) lack o f authority, because o f the composition o f membership, is a concern. While these Boards, once in place, might be upgraded and provide proper authority, the concern is that until then they would simply further entrench the existing interests. This could tarnish the whole Board concept and make further adjustments unfeasible. 0 Strengthen links with labor markets: The relevance o f tertiary programs could be enhanced by strengthening the links to employers. In many countries such links include work placement o f students with private and public sector employers during the studies, and setting up strong professional orientation programs and services. These measures give the employers an opportunity to assess the knowledge, skills, and competencies o f students, and the incentive to actively provide input and advice on academic program relevance. MES could also consider providing incentives to institutions to establish Program Advisory Committees (PACs) for all programs, and include employer representatives in sectors such as engineering, engineering technology, business, or medicine. The mandate o f the proposed PACs would include: (i)validating market intelligence about the existing and future demand for graduates o f various disciplines; and (ii)providing advice on the knowledge and skills 14'In other countries, the Board of Trustees is typically composed of 15-20 members, depending on the size of the institution. Two thirds of the trustees are typically appointed by the government to represent key external stakeholders, including the government, employers, civil society, and labor unions. One third is elected members who represent the key internal stakeholders of the institution: faculty, students, academic managers, staff, and alumni. The chair ofthe board is usually appointedby the government from the roster of appointedmembers. 126 needed by employers. PACs and similar committees are used successfully in many EU countries, United States, provinces in Canada, Australia, and New Zealand. Institute the Matura as access examination: To simplify the university application process and thereby improve access to tertiary education, the government may want to consider making the Matura a nation-wide end-of-secondary school examination and the basis for university admission. As a side benefit, a nation-wide exit (school-leavers) examination would also provide an objective basis for school evaluation. MES has already taken the initial steps of this reform, and expanded the mandate o f the Center for Control and Assessment o f the Quality o f Education(CKOKO) to manage the Matura. 7.43 In the medium-run, the following reform options, which would require preparation and some structural changes, would be worth considering. The reform options are listed in a descending order o f priority. Increase tuition fees, establish a student loan scheme, and review scholarship programs: As the second step o f financing reform, to provide incentives both to universities and students to perform, it i s recommended that the tuition fees are raised to the maximum level o f 30 percent o f the actual tuition cost per student, i.e. to the maximum permitted by law. In parallel, to ensure that the access to universities will not be unduly affected by the increased fees, a means-tested and/or income-contingent student loan system would need to be rolled out together with a revised policy o f existing scholarship programs to target qualified low income students and to encourage enrolment in public or private tertiary institutions. Taken together, these reforms would: (i) augment sector financing and potentially expand access and make it more equal; (ii)provide incentives for students and their parents to demand value for their money, and press for quality improvements; and (iii)improve graduation rates and throughput, since students who pay or borrow money are likely to be more vigilant about their studies. 0 Introduce a performance-based componentto tertiary institutionfunding: As theJinal step o f financing reform, the authorities may want to consider introducing a performance-based component to tertiary funding, initially equivalent to 10 percent o f the total state funding to an institution, but increasing it to 20-30 percent over five years. The performance-based component would be transparent, based on well understood set o f indicators, and dependent on the performance o f the institution in the previous year, or the moving average o f the two most recent years. Performance could be assessed using key performance indicators (KPIs), which would measure the success o f the institution in achieving the agreed outcomes, including cost-effectiveness o f education de1ive1-y.'~' This step would provide further incentives to universities to improve quality, and avoid delaying student completion or focus on low cost programs, ifK P I s are appropriately selected. Consolidate universities and tertiary institutions: As discussed in this chapter, the large number o f small, single discipline universities is a concern not just from the fiscal point o f view, but above all for quality and R&D reasons. The large number o f small universities `49Examples of KPIs include: (i)a student satisfaction indicator (based on student surveys) measuringthe quality of the learning process, learning resources, environment, and student services; (ii)a graduate satisfaction indicator assessing the graduates' satisfaction with the institution and its programs, including the relevance and utility of the education received; (iii)employers' satisfaction indicator (based on surveys of employers of graduates of the institution) assessingthe occupationalrelevanceof the educationreceived; (iv) the employment rate of graduates six months after graduation, which would measure the relevance of the program content for labor markets (taking into account graduates who are pursuing fiu-ther education instead of employment); and (v) a graduation rate indicator assessingacademic programs' efficiency and throughput. 127 means that a large share o f university funding goes to overhead costs finance administration, which implies that less is available for equipment and materials, with adverse implicationsfor quality. Further, from the R&D point of view, a critical mass o f researchers, usually across disciplines, would be required, which could not be assembled in such small institutions. Australia and Hungary provide examples o f successful mergers by bold government action, despite considerable opposition from the universities. The Hungarian reform focused on the consolidation of 100 specialized institutions into about 30 larger comprehensive institutions. In Bulgaria, the government may consider merging some universities to create a smaller number o f comprehensive universities with larger average enrolment than at present. The aim would be to reduce the number o f small, specialized universities, and increase the student-faculty ratio to about 16:1 in all universities. An example o f this kind o f consolidation would be the establishment o f a second comprehensive multi-campus technical university in Sofia by clustering the specialized small institutions o f architecture, civil engineering and geodesy; chemical technology and metallurgy; forestry; mining and geology; transportation; and civil engineering. The consolidation or merger o f universities is a classic example o f change management involving strong vested interest. Hence, it would need to be managed by capable change managers usingfair and transparent criteria. The benefits o f the consolidation or mergers would need to be articulated to all affected parties, especially to the university faculty and rectors. e Strengthen accreditation and quality assurance of universities and their programs: The government may want to consider separating the institutional accreditation from the program accreditation. NEAA should continue its work on institutional accreditation using the framework developed. However, program accreditation would require the involvement o f international experts and professional organizations, which can add value in assessing the quality o f programs and in ensuring that the employers or employers' associations are included in the assessment process. An assessment by an external body would also have a better chance o f ensuring that program accreditation is rigorous, and that university faculty members are not directly involved in the evaluation o f their peers. In addition, it is recommended that internal quality assurance units and procedures are established in each tertiary institution to promote a culture o f quality and ownership o f quality assurance reforms. 0 Continued teacher and faculty training: For the above mentioned reforms to produce maximum results, they would need to be complemented with capacity building. While the proposed reforms in governance would need to be accompanied with leadership training for university faculty, in-career teacher development, and initial teacher education for newcomers would also be warranted. For these purposes, MES may want to consider establishing a Leadership and Faculty Development Institute (LFDI). The institute could be established inone o f the leadinguniversities, based on a competitive biddingprocess. 128 Annex 1:Bulgarian Institutionsof Tertiary (Higher) Education NoUniversity Location Students Faculty S/F Group I:Public Comprehensive and Technical Universities IUniversity of Sofia (St Kliment Ohrdiski) Sofia 22,000 1,650 13.3 2%. Cyril & St. Methodius University Veliko Tamovo 10,500 550 19.1 3Rousse University (Angel Kanchev) Rousse 8,000 500 16.0 4University of Plovdiv ( Paisii Hildendarski) Plovdiv 13,000 55023.6 5Prof. Assen Zlatarov University Bourgas 4,000 320 12.5 6University of Shoumen ( Konstantin Preslavsky) Shoumen 7,200 36020.0 7SouthWest University (Neofit Rilski) Balgoevgrad 11,000 50022.0 8TechnicalUniversity Sofia Sofia 12,000 1,300 9.2 9TechnicalUniversity Gabrovo Gabrovo 8,000 225 35.6 1OTechnical Universitv of Varna Varna 6.000 450 13.3 Subtotal Group I 101,700 6,405 15.9 Group 1I:Public Specialized Universities and Institutions of Higher Learning 1luniversity ofNationa1 & World Economy Sofia 20,000 55036.4 12University of Architecture, Civil Engineering & Geodesy Sofia 3,800 420 9.0 13University of Chemical Technology and Metallurgy Sofia 3,500 380 9.2 14NationalAcademy of Music "Pancho Vladigerov" Sofia 600 65 9.2 15University of Forestry Sofia 3,500 250 14.0 16University ofMining & Geology ( St. Ivan Rilski) Sofia 2,600 230 11.3 17HigherSchool of Transport (Todor Kableshkov) Sofia 1,000 157 6.4 18LiubenKaravelov Civil EngineeringHigher School Sofia 700 75 9.3 19MedicalUniversity of Sofia Sofia 4,000 1,970 2.0 2ONationalAcademy of Theatre & Film Arts (Krastio Sarafov) Sofia 540 106 5.1 21National Academy of Fine Arts Sofia 900 130 6.9 22National Sports Academy ( Vasil Levski) Sofia 3,000 260 11.5 23Rakovski Defense & Staff College Sofia 100 138 0.7 24Ministry ofthe Interior Academy Sofia/ Vama 550 160 3.4 25Higher School of Libarary & Information Science Sofia 200 60 3.3 26Trakia University StaraZagora 4,000 490 8.2 27Vasil Levski Military University Veliko Tamovo 550 250 2.2 28Demitar Tsenov Academy of Economics Svishtov 10,000 25040.0 29Medical University of Pleven Pleven 750 320 2.3 3OMedicalUniversity of Plovdiv Plovdiv 6,300 240 26.3 3 1Agricultural University of Plovdiv Plovdiv 2,500 205 12.2 32The University of FoodTechnologies Plovdiv 4,000 200 20.0 33Academy of Music, Dance& Fine Arts Plovdiv 1,000 108 9.3 34University of Economics Vama 8,700 270 32.2 35Naval Academy (Nikola Vaptsarov) Varna 1,100 121 9.1 36Medical University of Vama Varna 800 360 2.2 Subtotal Group 11 84,690 7,765 10.9 ~ 1 1 _ _ 1 _ _ _ Group 111: Public Short Cycle Colleges 37Collegefor Islamic Studies Sofia 400 50 8.0 38Collegeof Telecommunication & Posts Sofia 600 52 11.5 Subtotal Group Ill 1,000 102 9.8 Group IV: Private Comprehensive Universities 39New Bulgarian University Sofia 8,000 24033.3 129 40American University Blagoevgrad 825 66 12.5 4lBourgas Free University Bourgas 6,500 11656.0 42Vama Free University (Chemorizets Hrabar) Vama 12,000 60020.0 Subtotal Group I V 27,325 1,02226-7 Group V: Private SpecializedInstitutions of Higher Learning 43EuropeanCollege o fEconomicsand Management Plovdiv 600 30 20.0 44International Business School Botevgrad 650 25 26.0 Subtotal Group V 1,250 55 22.7 Group VI: Private Short Cycle Colleges __ 45Intemational College of Albena Albena 150 30 5.0 46Higher Schoolof Agriculture Plovdiv 700 20 35.0 47College of Management, Trade & Marketing Sofia 400 45 8.9 48College of Tourism Blagoevgrad 780 60 13.0 49College of Theatre "LyubenGrois" Sofia 350 40 8.8 5OHristoDanov College of Commerce P1ovdiv 750 28 26.8 5 1EuropeanCollege o f Business & Management Plovdiv 1,100 42 26.2 52Collegeof Economy & Administration Plovdiv 800 29 27.6 53Collegeof Telematica StaraZagora 440 25 17.6 Subtotal Group V I 5,470 319 17.1 130 8. TOWARDSRESEARCHAND DEVELOPMENT(R&D) STRUCTURESAND POLICIESSUPPORTINGINNOVATION 8.1 The final piece o f the productivity puzzle covered in this report deals with the R&D policies. As mentioned at the beginning o f this report, the available empirical evidence indicates that R&D investments have a positive impact on productivity growth, among other things by enhancing technology transfer. While the other factors already discussed-improving functioning o f product and labor markets, and strengthening the education delivery-are likely to have the largest impacts on productivity growth in the short and medium term, Bulgaria will need to start paying increasing attention as well to its R&D policies to sustain highproductivity growth over time. 8.2 Scientific research, technological development and the ability to convert research results into economic and social benefits play an increasingly important role in determining economic development and international competitiveness o f countries. Globalization and rapid distribution and transfer o f knowledge by information and telecommunication technologies have also made investments in knowledge increasingly pertinent. This includes the generation and adoption o f new knowledge created by scientific research and technological development, investments in education and research, adoption o f best practices, and openness to social, economic, and cultural innovations. 8.3 Bulgarian R&D system faces many challenges and opportunities. The country's recent entry into EU has brought along new competitive pressures, but also new windows o f opportunity for improving R&D performance, and its operational and financial structures and instruments. Bulgariajoined EU at a time when R&D activities are gaining momentum in EU strategies. The Lisbon Agenda formulated in March 2000 sets the ambitious goal o f making EU by 2010 ''the most competitive and dynamic knowledge-based economy in the world, capable of sustainable economic growth with more and better jobs and greater social cohesion". In Lisbon, and two years later in Barcelona, a number o f concrete objectives in terms o f research quantity and quality were formulated. Box 8.1 summarizes these objectives/targets, which are part o f the so called Lisbon goals. Lisbon goals apply primarily at the national level, since the bulk o f R&D investments are made at that level. EU research programs account only for about five percent o f the total R&D investments by the member states. 8.4 Lisbon goals call for all EU member states to increase their R&D investment to three percent o f GDP by 2010, o f which two-thirds-two percent o f GDP-is expected to be financed by the private sector. To achieve these goals, member states are to improve the environment for private research investment, R&D partnerships, and high-technology start-ups. However, as can be expected, the quantity and quality o f R&D investment varies significantly across EU countries. As will be discussed in this chapter, achieving these goals-in particular, the private sector investment goal-will be a significant challenge for Bulgaria, and unrealistic to achieve by 2010. But Bulgaria may wish to quicken its pace o f progress inthat direction. 8.5 This chapter will review the Bulgarian R&D and innovation system, assess its performance, and identify options for its strengthening. To put Bulgaria's performance on the R&D and innovation front in perspective, Bulgaria will first be benchmarked against other countries in this area. This will help to identify Bulgaria's relative strengths and weaknesses in the field o f innovation. After benchmarking, the chapter will review select aspects o f the Bulgarian R&D and innovation system, and highlight options to strengthen it. Box 8.1: Lisbon StrategyTargetdObjectives in R&D I. Increase R&D spending to 3 percent of GDP by 2010. Thesharefinanced by business should rise to two-thirds of that total (target set at Barcelona). 2. Network national and joint research programs on a voluntary basis around freely chosen objectives and develop an open method of coordinationfor national researchpolicies. 3. Improve the environment for private research investment, R&D partnerships, and high- technology start-ups. 4. Harness new andfrontier technologies, notably biotechnology and environmental technologies. 5. Introduce a cost-effective communitypatent. 6. Remove obstacles to the mobility of researchers, attract and retain high-quality research talent in Europe. 7. Roll out a world-class research communications infrastructure. I. BENCHMARKINGOFBULGARIAINR&DAND INNOVATION 8.6 To assess Bulgaria's performance in R&D and innovation and to identify the country's relative strengths and weaknesses, Bulgaria is benchmarked first against the other European countries using the European Innovation Scoreboard, and then against a broader set o f international comparators using the Knowledge Assessment Methodology. In addition, to get a sense o f potential gaps in the Bulgarian innovation environment, the structure o f the Bulgarian innovation environment is roughly mapped out and compared with the structure in Finland, which is one o f the Europe's and world's leaders in innovation. A. European Innovation Scoreboard 8.7 The European Commission publishes annually a European Innovation Scoreboard (EIS), which evaluates and compares innovation performance o f EU member states as well as Turkey, Iceland, Norway, Switzerland, the US and Japan. EIS tracks 26 innovation indicators focusing on innovation inputs and outputs. Innovation inputs refer to indicators measuring: (i)structural conditions for innovation (which cover science and engineering graduates, population with tertiary education, life-long learning, youth education, broadband penetration); (ii)investment in R&D (which covers public and private investment, share o f enterprises receiving public funding for innovation, share o f university R&D expenditures financed by businesses); and (iii)innovation eflorts at the firm level (which refer to innovation by SMEs, early-stage venture capital, ICT expenditures). Innovation outputs in turn cover indicators measuring: (i)application (which cover employment in high-tech services and in medium-high and high-tech manufacturing, exports o f high technology products, sales o f new-to-market products); (ii) the achieved results in terms o f patents, trademarks, and designs. Based on these indicators a Summary Innovation Index (SII) is compiled. 8.8 The 2005 SI1 results indicate that Bulgaria not only has a sizeable innovation gap to the average EU25, but is also losing ground relative to the European innovation leaders. SI1 ranks Bulgaria 26`h in a sample o f 33 countries (including a few outside the EU) in terms o f innovation performance. Further, Figure 8.1, which shows SI1 on the vertical axis and average growth rate o f SI1 on the horizontal axis, suggests that Bulgaria is falling farther behindthe leaders. Countries above the horizontal dotted line had innovation performance above the average EU25; and countries to the right o f the vertical dotted line experienced a larger than the EU25 average increase in their SI1 value. Based on this, Switzerland, 132 Finland, Sweden, Denmark, and Germany were the innovation leaders in Europe in 2005'50, while Bulgaria, Estonia, Romania, and Spain were notjust trailing behind, but actually losing ground. Figure 8.1: European Innovation Scoreboard2005 and Bulgaria 010 8.9 The results also suggest that Bulgaria has performed worse on innovation outputs than on inputs, indicating poor transformation o f inputs to outputs. This suggests that Bulgaria would be well advised to focus its efforts on strengthening the gaps on the output side, instead o f further strengthening the areas where it is already relatively well rated. Table 8.1 below reports Bulgaria's performance by indicator relative to the EU25 average. The table indicates that Bulgaria is doing better on structural conditions and investment indicators than on the others. According to EIS, strengthening the intellectual property regime and transformation o f R&D investments into marketable goods and services would be the areas requiring urgent attention by the government. 150However, the SI1results show that the US and Japan are still significantly ahead of EU25. While the innovation gap betweenEU25 and the US has remainedrelatively stable, the gap between EU25 and Japan has been increasing. Inthe US and Japan the number of different types of patents and the share of population with tertiary educationare higher, anduniversities better integratedinto the innovation processthan in EU25. 133 Table 8.1: Bulgaria's performance relative to EU25 by indicator Indicator YOof EU25average INPL'T Structural Conditionsfor Innovation: Science and engineeringgraduatcs 68 Population \\ith tenia? education 99 Broadbandpenetration rate -_ Participationin life-long learning 13 Youth educationattainment level 99 Investment in R&D: Public R&D expenditures 57 BusinessR&D expenditures 8 Share of medium-highhigh-techR&D 96 Enterprisesreceivingpublic funding 12 Businessfinanced university R&D 506 Innovation efforts at the firm level: SMEs innovatingin-house 36 InnovativeSMEs co-operatingwith others 25 Innovationexpenditures 38 Early-stageventure capital -_ ICTexpenditure 137 SMEs usingnon-technologicalchange 20 OUTPUT Amlication: Employmentin high-techservices 84 Exportsof high-technologyproducts 16 Sales new-to-marketproducts 35 Sales new-to-firmnot new-to-marketproducts 32 Med-hihigh-tech manufacturingemployment 71 Achieve results/Intellecfual urouertv: New EPO patents 3 New USPTOpatents 1 NewTriad patents New communitytrademarks 0 New communitydesigns 1 Summary Innovation Index, SI1 (2005) 56 Source: European Innovation Progress Report, Trend Chart 2006. B. Knowledge Assessment Methodology 8.10 The World Bank's Knowledge Assessment Methodology (KAM) can be used to benchmark Bulgaria inthe area of innovationon a world-wide basis. KAMprovides a quick assessment of countries' readiness for the knowledge economy, and helps to identify areas needing attention. It covers 132 countries, and uses more than 80 structural and qualitative indicators to measure countries' performance in four areas: economic incentive and institutional regime; education; innovation; and information and communications technologies. Investments in all of these areas are considered necessary for sustained 134 creation, adoption, adaptation, and use o f knowledge in economic activities and production. Based on these indicators, a Knowledge Economy Index (KEI) is then con~tructed.'~' 8.11 The most recent KEIranks Bulgaria 4Istamong the 132 countries that were rated (while Romania ranks 54th and Hungary 32nd). Denmark, Sweden, and Finland hold the top positions in KEI. Comparisons over time-comparing Bulgaria relative to other countries in 1995 and today-suggests that Bulgaria has been falling behind the world's innovation leaders in the past decade. This reinforces the EIS results presented inthe previous section. 8.12 Comparison o f Bulgaria with other European and Central Asian countries on innovation indicators only (see Figure 8.2) highlights that Bulgaria is performing relatively poorly, in particular in the areas of royalty and license fee receipts and payments, science enrollment, numbers o f researchers involved in R&D, total expenditure on R&D as a share o f GDP (especially private sector investment in R&D), university-company research collaboration, and firm level technology absorption. According to the KAMmethodology, these are the areas that would require attention to improve Bulgaria's innovation performance. On the other hand, the comparison suggests that FDI inflows as a share o f GDP, science and engineering enrollment, and manufacturing trade as a share o f GDP are relative strengths of Bulgaria's innovation system. Figure8.2: Relative strengths and weaknessesof the Bulgarian innovationsystem'52 6uigaria, FDIOutflows as % of GDP Value ChainPresence 10 FDIInflowsas % of GDP Firm-LevelTechnologyAbsorption Royaity and License Fees Payments(US$ mil ) PrivateSector Spendingon RBD Royaltyand License Fees Payments(US$@op) High-TechExportsas % of Manuf Exports Royaityand License Fees Receipts(US$ mil ) PatentsGrantedby USPTOI Mil People Royaity and License Fees Receipts(US$@op) Patents Grantedby USPTO Science and EngineeringEnrolment Ratio (%) Availabilrty of Venture CapRal Science EnrolmentRatio(%) Scientificand TechnicalJournalArticles I Mil People Researchers in RBD Scientific and TechnicalJournalArticles Researchers in RBD I Mil People Unwersrty-CompanyResearch Collaboration Total Expenddurefor R8Das % of GDP Manuf Trade as % of GDP Normalization Group: Europe and Central Asia; Year: most recent Source: KAM, World Bank (2006d). C. Innovation Environment in Bulgaria versus Finland 8.13 Comparing the Bulgarian innovation environment-in terms o f relative importance of various resources, funding, and focus o f R&D-with one of the European innovation leaders can be illuminating and help identify the gaps in the system. Hence, Bulgaria is compared with Finland, and Figure 8.3 15'Variables are normalized on a scale of zero to ten relative to other countries inthe comparisongroup. lS2The indicators are normalized from 0 (the worst) to ten (the best). Hence, the closer to the perimeter the spiderweb is, the better positioned the country is relative to the comparisongroup. 135 roughly maps out the situation in these two countries. The horizontal axis describes the innovation chain starting with basic research at one end and the research moved to the markets at the other. The vertical axis in turn reflects a continuum from public to private funding. The size o f different elements (different color bubbles) indicates their financial weights in the system. `igure8.3: Innovation environmentinFinland and Bulgaria153 t FINLAND BULGARIA I Busmess angels Private Private Universities Public Public I I Basic Aoolied .. Business Business I Basic Aoolied Business Business I Research Research R&D Development Research Rdskarch R&D Development Source (left panel): Dahlman, Routti, and Yla-Anttila(2006) 8.14 Figure 8.3 suggests that R&D in Finland is predominantly applied, business driven, and carried out and financed by the private sector. In Bulgaria R&D is heavily focused on basic research, financed largely by public funds, and carried out mainly by public research institutes and universities. R&D carried out by businesses is quite modest in B~1garia.I'~This isjust the opposite o f the Lisbon goals, and thus presentingBulgaria with a significant challenge. 8.15 R&D done with public funding at universities and research institutes, and R&D with private funding incompanies form the basic elements of an innovation system, butthey are not sufficient for high performance. For innovation performance, these need to be complemented with public-private partnerships, national and international technology transfer, incubators and science parks for starting and growing research-based companies, and venture capital for financing start-up companies especially in hightechnology areas. InBulgariaventure funds and business funding by individuals are largely lacking, and there is a disconnect between public and private efforts. 153Note that in the case of Finland, "research councils" refers to funds allocatedthrough the Academy of Finland, (see paragraph8.48), while in the case of Bulgaria it refers to the National Science Fund (see paragraph8.33) `54 Table 8.1 highlights that business financed university R&D is high a share of total university R&D in Bulgaria. However, this reflects the extremely low volume oftotal R&D carried out by universities. Centuries ago traders exploring the world called the merchants financially backing their efforts as business angels. The term was later used in the theatre in the context of financial backers who invested in a theatrical production. Today, the terms is used to refer to individuals who invest their capital (and sometimes also business skills) ina range of new and developing commercial ventures. 136 8.16 Funding structures in Finland emphasize the competitive elements in both basic and applied research, and foster public-private partnership inapplied research. For instance, the share o f direct budget fundingo f universities accounts for less than halfo fthe total (that is, more than halfo fthe funds received by universities are allocated on a competitive basis). This is a result o f about two decades o f intensive restructuring o f the system, often accompanied with debates among the stakeholders. In contrast, the share o f competitive R&D funding in Bulgaria i s still minor. 8.17 Further, compared to Finland, the different elements in the Bulgarian innovation system are disjointed: basic and sectoral research is largely detached from R&D carried out by the private sector. It would be important that the different elements in the innovation system link seamlessly but at the same time have clear and distinct roles. In terms o f Figure 8.3, this would mean the various "bubbles" remaining distinct in their various remits, but growing much bigger in the case o f Bulgaria and overlapping (indicating collaboration). 8.18 It is important to note that there are large differences in the funding systems o f different countries. In United States, public funding is directed mostly to basic research, but also to defense goals. In France, funding of the Centre National de Research Scientific, and to a lesser extent in Germany with Max Planck Institutes, has been institutional, with competitive funding and public-private partnership funding having emerged only lately. One would thus expect Bulgaria to evolve its own distinct system that serves the country's objectives, although the process o f reaching them would be conceptually similar. D. How to Catch Up? 8.19 While Bulgaria may currently be trailing in rankings, rapid catching up i s possible. The cases o f Finland, Chile and Korea are a proof o f that, as well as some o f the EU8 countries, which have increased their rankings in the past couple o f years. Many o f these improvements in rankings were based on the countries increasing R&D investments and renewing the related structures. Bulgaria has that opportunity as well. 8.20 Taken together, the results o f the above benchmarking and comparisons suggest that the key challenge facing Bulgaria is to increase private sector investments and involvement in R&D and innovation. In parallel, there is a need to make R&D efforts increasingly geared towards business and industry needs so that their results are likely to translate into economic benefits-that is, to be commercialized-through increased research collaboration between academia and business. Further, to make that happen, the enforcement o f the intellectual property rights regime would need to be strengthened, number o f researchers involved in R&D increased, and science enrolment expanded. What measures should the Government take to address these issues and to encourage increased private sector R&D expenditures and move them closer to the Lisbon targets? The next sections will explore select aspects o f the Bulgarian R&D and innovation system, and highlight options to improve their performance. 11. INSTITUTIONAL ANDINNOVATION FRAMEWORK R&D FOR 8.21 The Bulgarian R&D and innovation system is in a period o f transition, and new strategies, laws, and instruments have been introduced in the past years. There are, however, still several old structures dating from the earlier era o f Bulgarian scientific research, which have not been reformed. To get the maximum benefit from the new structures that have been introduced, it i s essential that the reform o f the R&Dand innovation system is continued and old structures renewed. With the recent EUaccession, the EUframework program for research can be expected to further shape the system, and the availability of EUgrants provides a unique opportunity to help finance the needed reforms. 137 8.22 Figure 8.4 depicts the current institutional structure o f the Bulgarian R&D and innovation system. This section will review its main components-the key policymaking bodies, financing instruments, actors, as well as the overall strategies that are being pursued. Figure 8.4: Institutional structure of the R&D and innovation system in Bulgaria NatictnalAssenihly C`rtmmftrrre 011 fiiucarion and Science I I Councilof Ministcrs andForesmn I NationalCouncilon . . .... .. . . .... ..... . ... ..... .., . ., .. . . ...... . ...... . ... .,..,. . ...... ..... lnnornion , i NationiilCouncil for i i., Scientific Kescarch - i I I NationalCentrefor Agrwian Scieticcs Note: Enterprises, BAS, universities and other government researchinstitutions. Have beenplaced in the diagram to give a more complete picture of the innovationsystem in Bulgaria. These entities are not subordinate to the Council of Ministers; no lines connectthem to the rest ofthe structure. A. National R&Dand Innovation Strategies 8.23 Bulgaria has two key strategie~''~that lay out government's policy in the area o f R&D and innovation. These are the National Strategy for Research and Development, and the National Innovation ~trategy.'" 8.24 The National Strategy for Research and Development (NSRD), approved by the Council o f Ministers in May 2005 but not yet reviewed by the National Assembly, aims to help the integration into the European Research Area. The document highlights the low level o f R&D funding, inparticular by the 1560ther relevant national strategies that partially cover R&D and innovation include the National Strategy for Small and Medium-sized Enterprises Development and Promotion; the National Strategy for Life-long Learning in ProfessionalEducation for the period 2005-2010; Human Resource Development Strategy 2000-2006; Information Society Development Strategy of the Republic of Bulgaria; Strategy for the Establishment of e-Government; Strategy and Action Plan for Bulgaria's Competitiveness on World ICT Markets; and the National Strategy for Regional Developmentuntil2015. These documents can be accessed at (www.government.bg) 157In addition, the Bulgarian Parliament adopted a law on scientific research promotion in October 2003, which stipulates that priorities for research need to be related to solving economic, social and human issues, national identity and culture, the development ofthe engineeringscience, innovations, and new knowledge. 138 private sector; insufficient research infrastructure; low productivity o f research; and the shortage o f managerial skills as the main challenges and issues to address. It maps out concrete mechanisms and measures, which aim at strengthening the administrative capacity for forming a national policy towards science; R&D funding; raising the profile o f the scientific potential; creation o f new knowledge in areas that are traditionally strong and have won national and international recognition; increasing the market demand for research products; and innovations on the domestic and world markets. 8.25 The National Innovation Strategy (NIS) was adopted in September 2004. Its objective is to increase the productivity and value added created by the Bulgarian industry through creation o f new knowledge, transfer and implementation o f contemporary technologies, provision o f financial resources for innovative products, and development o f markets. The strategy envisages a series o f financial and non-financial measures for creation o f a framework for a proper innovation policy. Of these, the main financial measure to encourage innovation-the establishment o f a National Innovation Fund-has already been implemented. The key non-financial measures include the employment o f young specialist in SMEs, cluster development, attracting FDIinR&D activities, and establishment oftechnology parks. B. Coordination of R&DPolicies 8.26 The Ministry o f Education and Science, and the Ministry o f Economy and Energy are the key ministries responsible for the implementation o f the above-mentioned two strategies and R&D and innovation policy in general. As shown in Figure 8.4, other relevant ministries, which address R&D and innovation issues, are the Ministry o f Transport and Communications, and the Ministry o f Agriculture and Forestry. 8.27 The Ministry o f Education and Science is responsible for the national policy in the field o f research, and the National Councilfor Scientijk Research (NCSR) is the key coordinating body for the research policy. It is chaired by the Minister o f Education and Science, has 19 members, including representatives o f other ministries, umbrella organizations o f employers, scientists, and universities. The council approves all major research policy documents, including the NSRD, and funding priorities and programs o f the National Science Fund. 8.28 In parallel, the Ministry o f Economy and Energy is responsible for the development and implementation o f the national innovation policy, which contains several elements closely related to R&D. The National Councilfor Innovation (NCJ is the central coordinating body for innovation issues. However, unlike NCSR, N C I has less decision-making power and serves only as an advisory body to the Minister o f Economy and Energy. 8.29 This dual structure-two parallel strategies, two responsible ministries, and two coordinating councils-raises concerns, since research and innovation are strongly related, and links between them need to be strong. Although there are some links between the two advisory councils (namely, each ministryis represented in them), a unified structure would arguably better support horizontal cooperation among the various bodies. For example, in Finland, like in Bulgaria, two ministries (Ministry o f Education, Ministry o f Trade and Industry) have the main responsibility for the implementation o f R&D and innovation policies, but there is only a single council (Science and Technology Policy Council) in charge o f strategic development and the coordination o f the overall effort. This council is not under any particular ministry, but functions as an advisory body to the Government, and is chaired by the Prime Minister to underpin its importance and cross-cutting nat~re.'~' Is* The members ofthe council are from the government, academia, industry, and labor organizations. 139 8.30 Also, leaving the R&D and innovation policies to individual ministries would merit reconsideration. While in Bulgaria the Council o f Ministers oversees the activities o f ministries, coordination and policy issues are largely left to the ministries. Given their importance, the policy questions related to R&D and innovation would need to be agreed at the level o f the whole government rather than at the level o f individual ministries. Experience from other countries suggests that successful implementation o f R&D and innovation policies calls for consensus and support from the highest political level, as well as from other public and private actors inthe Bulgarian innovation system. 8.3 1 R&Dand innovationare issues that require a long-term vision. The pursuit o fthis vision needsto be based on societal consensus, and must hence involve all key actors and especially the politicians. To educate these actors about the issues on which consensus is needed, a number o f countries have developed a continuous process o f education for their politicians, high level policy makers, academia, industry, labor organizations, and the media (see Box 8.2 on Finland as an example). These courses and workshops have resulted in a better appreciation o f the need o f for substantial structural R&D investments that pay o f f only inthe long run. This is often difficult for politicians, who are elected for short periods o f time and are under pressure to deliver quickly. Nevertheless, the issue is so important that it must be 1addressed. Potential availability o f EUgrant funds should make it easier to tackle it. Box 8.2: Training of Policymakerson EconomicPolicy Managementin Finland I Since 1977 programson economic policy management and national strategies have been organizedto policy makers inFinland. More than 1,500 policy makers so far have attended them. The participants include most members of the Parliamentduring their first terms, other decision makers inthe public sector, as well as industry, labor market and medialeaders. The program lasts about two weeks, including visits to relevant organizations. Programs are structured to define policy objectives and choose the policy instruments, such as taxation structures, allocation of resources in different sectors, investments and incentives, and interest rate policies. About 20-30 lectures are given by the best domestic and international experts, and followed by thorough discussions. The lecture series commences with fiscal and monetary policies, proceeds to structural questions in different sectors, and concludes with long-term development options. The most important part ofthe program is the exercise defining the policy objectives and the budgetary and other instruments to reach them. This exercise takes the form of simulating the work of government, with the workshop participantsplaying the role of key decision makers. The exercise is supported by competent economists and simulation models of the national economy, typically the same models used by the Ministry of Finance and the Bank of Finland. Source: Dahlman, Routti, Yla-Anttila, eds, "Finland as a Knowledge Economy: Elements of Success and Lessons Learned. WorldBank Institute, 2006. ' I C. FinancingInstruments 8.32 In addition to private sector financing and direct budget financing, which primarily goes to finance the established research institutes, there are two potentially important public instruments to finance R&D investments in Bulgaria. These are the National Science Fund overseen by the Ministry o f Education and Science, and the National hnovation Fund overseen by the Ministry o f Economy and Energy (see Figure 8.4). These two funds are noteworthy because they operate and allocate funds on a competitive basis, which is still relatively new in Bulgaria. 8.33 The government finances R&D at universities through the National Science Fund (NSF), which provides funding on a competitive basis through seven instruments/programs: (i)a thematic project call; (ii)ageneralprojectcall; (iii)supporttotheyoungscientists andresearchers,(iv) promotionofresearch at universities (and between universities and the Bulgaria Academy o f Science); (v) bilateral international 140 cooperation; (vi) fostering cooperation between science and academia; and (vii) scientific publications. NSF's flagship program is the annual call for Scientific Research, which accepts research proposals from any field o f science by both public and private institutions. 8.34 The National Innovation Fund (NIF) i s the first proactive and purely innovation-related policy measure in Bulgaria in the past few years. NIF finances on a competitive basis innovative projects inthe pre-market phase o f product development, as well as some advisory services for enterprises. It is managed by the Bulgarian Small and Medium-Size Enterprise PromotionAgency in the Ministry o f Economy and Energy. 8.35 While NIF is an important step forward in policy making and implementation, its initial budget o f EUR2.5 million is still too small to contribute significantly to the Bulgarian innovation performance. However, its annual budget is projected to increase to about EUR5O million by 2013, which could be expected to make a difference. D. Key Actors 8.36 The key entities carrying out the bulk o f R&D in Bulgaria are universities, the Bulgarian Academy o f Science, and the National Center for Agrarian Sciences. Both the Bulgarian Academy o f Science and the National Center for Agrarian Sciences are government-funded, and are currently by far the most dominant actors inthe R&D field. There are also other government research institutes, but they are relatively minor. Also, as mentioned earlier, R&D conducted by private sector enterprises is still limited. 8.3 7 Research ut the universities: Research and university (including university hospitals) collaboration with industry have slowly started to gain prominence in the agenda o f universities. This is consistent with NSRD. The 1995 law for higher education stipulates that universities are to carry out basic and applied research in addition to educational activities. Traditionally, Bulgarian universities have concentrated on their educational tasks. 8.38 However, universities face several challenges in trying to fulfill their mandate o f having to improve the quality o f research and forge strong partnerships with the industry in R&D. According to international evaluation^,'^^ the quality o f higher education has been in decline in the past decade. Inevitably this has also had an impact on the quality o f research. In addition, Bulgaria is facing other, internationally shared, challenges such as unattractiveness o f scientific careers among the younger population, ageing o f scientific professionals, and increasing pressure for the universities to actively contribute to the overall economic and societal development. 8.39 The 1995 law stipulates that at least 10 percent o f the funds allocated to universities should be devoted to research. While there are no detailed data on investment in research by universities, the universities are generally considered to spend less than that. According to the National Statistical Institute, the total higher education sector investment in R&D was about EURlO million. Research activities o f universities are often assigned to the Rector or Vice-Rector, or to specific research units at the larger universities. According to the estimates by the Ministry o f Education and Science, roughly half o f the university research is conducted on a collaborative basis and includes external funding. lS9 OECD (2004b) Bulgaria: Research, Science and Technology and OECD (2003) Trends in Mathematic and Science Studies (TIMSS). 141 8.40 The large number o f small universities in BulgariaI6'--that is, the fragmentation o f the university system-in relation to the size o f the economy i s also an issue, since it is not conducive to research activities for which a critical mass would be required. Indeed, most university research is currently conducted by the largest ones (for example, the Sofia University, Technical University, and the University for the National and World Economy). These are the same universities that also actively collaborate with industry and participate in EU research projects. It would make sense to have some consolidation o f the university system to improve the quality o f research, in addition to the benefits that this is likely to bringto the quality o feducation (see Chapter 7). 8.4 1 Bulgarian Academy of Sciences (BAS): BAS is the leading and dominant research organization in Bulgaria, and is responsible for the implementation of the large part o f Bulgarian R&D policies. Its central role is highlighted by the fact that it i s the recipient o f close to 70 percent o f total government R&D funding in Bulgaria. This central role in Bulgarian R&D is further amplified by the fact that the private sector investment inR&D is so small. 8.42 BAS is a national autonomous association for scientific research, which includes 87 academic institutes, laboratories, and other independent research units in natural sciences, humanities, social sciences, and technical sciences. BAS has a Board o f Directors, an Executive Board, and a General Assembly as its governing bodies. 8.43 BAS currently employs about 8,200 people. Of these, 3,600 are trained scientists and 2,600 experts with higher education degrees. At its largest, BAS had a staff o f about 16,000 professionals and held virtual monopoly in Bulgarian science. After the collapse o f the central planning system, BAS has been shrinkingin size. The staff has been reduced by 45 percent and the number o f units by 27 percent. 8.44 Being the largest research establishment in Bulgaria BAS accounts for more than half o f the scientific output o f Bulgaria. It has the largest number o f research contracts both from Bulgarian organizations and from abroad, and has received favorable appraisals in international rankings o f scientific organizations. However, it can not alone respond to the R&D needs o f the country. Bulgaria's modest innovation performance is probably due to four major factors: (i)significant downsizing and reorientation o f BAS as a result o f transition to the market system; (ii)Bulgaria's still underdeveloped business sector; (iii)weaknesses in the way R&D is funded; and (iv) weaknesses in the performance o f the university sector. Experiences o f other countries suggest that additional funding and new funding instruments can create R&D activities that better match the society's needs and can improve the overall innovation performance. Increased university research produces graduates with research experience that will increase competence and interest in R&D activities in corporations. In addition, increased corporate R&D, driven by the forces o f competition, and aided by government fundingcreates clientele for research contracts that will also benefit BAS. 8.45 BAS conducts basic and applied research in a large number o f disciplines. Inboth areas they will face increasing international and global competition. This would require focused basic researchefforts on a more limited number o f most promising areas, with strong international partners. This development is manifested in most advanced countries by the establishment and focus o f centers o f excellence and the increased funding for highly competitive frontier research in the EU programs. For educational reasons, university research tends to cover a greater number o f disciplines. Yet, in many countries, universities too are increasingly focusing on their best units. In applied research and development work the leading role should be given to the clients and industrial partners, in order to give more emphasis to the demand side. Both wide strategic programs and product and process development projects are needed. To enhance market potential and returns to investments inresearch, increased collaboration with and contract I6OIn2006, there were altogether42 universities and 10 colleges inBulgaria. 142 research from the private sector are the way forward. This can be facilitated by strong technology research funding agencies, as has been the case inmany countries Many European research organizations would serve as good operational models to this end, such as Fraunhofer Gesellschaft in Germany, TNO in the Netherlands, Sintef in Norway, or the Technical Research Center o f Finland (VTT). These organizations work in close cooperation with industries, service companies, and specialized government agencies. They carry out joint research projects with domestic and foreign companies, provide advanced technical services to companies, and exchange with them information and experiences on a regular basis. Over two-thirds o f their financing comes from external sources-from companies, public funding agencies, and from EU research programs. Apart from strong industrial orientation, these institutes continue to perform cutting edge basic research in certain fields, in order to maintain their competitiveness in future technologies. 8.46 Today there are too many small institutions within BAS, and only some o f them can be internationally competitive. There is a wide range o f performance outcomes, relevance, and scope across the 87 research institutes. Some o f the equipment in these entities is obsolete, and not conducive to contemporary research methods. Some units are doing research in areas and sectors which are no longer viable in Bulgaria. At the same time, some o f the best ones have already received international recognition, such as the status o f a Centre o f Excellence under EU FP6, but these are few. Overall, however, resources are not necessarily optimally allocated and there is room for efficiency gains. 8.47 The institutional status o f BAS is quite unusual when compared to its counterparts in other European countries o f Bulgaria's size. Many countries have a network o f government research institutes, which have some similarities with BAS, but these institutes focus on applied research, and report to various ministries according to the type o f work being carried out by the institute. In other words, the government research institutes are research arms o f government sectors (such as, industry, agriculture, forestry, environment), with the aim o f producing data and knowledge o f relevance to the strategic and operational development o fthe sector. 8.48 Most European countries have a well-established research council system that provides competitive funding for basic research. For example, Finland has an agency called the Academy of Finland, but despite its misleading name, it is in fact a research council. It is a planning and funding agency for basic research carried out mainly by universities, and it does not have research institutes o f its own. Of the Bulgarian organizations, it is NSF that resembles the Academy o f Finland, not BAS. 8.49 Further, in other relatively small European countries including Finland, it is the universities that are mainly responsible for basic research. These countries do not have separate research institutes for basic research, such as BAS. This structure has been working well in these countries, and locating the strongest basic research units in universities is a rather universal trend in the world. 8.50 In order to identify the needed structural reforms and a refocusing o f BAS activities, a thorough impact evaluation and functional review o f all BAS institutes and functions would need to be carried out by an independent evaluator. N o such evaluation o f BAS exists currently. Through a carefully planned and implemented refocusing process, BAS could become more competitive, the quality o f its research could be raised to an even higher level, and its impact on the Bulgarian economy and society could increase. 8.51 The Government would be well advised to increasingly shift to competitive R&D funding with incentives for collaboration, and make BAS also increasingly compete for funds. Directing funding increases to highly performing institutions on a competitive basis would provide incentives for reform also from inside, and encourage collaboration and institutional mergers. 143 8.52 The National Centerfor Agrarian Studies (NCAS): There is also a need to review the role o f the National Center for Agrarian Studies (NCAS), and prepare an appropriate reform program for it. NCAS i s the other major government research institute in Bulgaria. However, unlike BAS, it is not autonomous, but under the Ministry o f Agriculture and Forestry. It conducts scientific and applied research on agricultural issues in its 21 research institutes, and has a staff o f over 3,600 people. NCAS also provides consulting services and training. In addition to the Ministry o f Agriculture and Forestry, NCAS receives funding from its consulting and training activities.161 The Strategyfor Development of the Science in the Agruriun Sector envisages that the share o f competitive research hnding will be increased. To this end, the Ministry o f Agriculture and Forestry has initiated 18 programs for the development o f integrated scientific projects. 111. FUNDING AND TYPEOFR&DAND INNOVATION INVESTMENTS A. InvestmentinR&D and Innovation 8.53 Total investment in R&D amounted to about 0.5 percent o f GDP in 2005. This was significantly below the EU15 average o f 1.91 percent o f GDP and lower than the EU8 average o f 0.82 percent of GDP. Figure 8.5 below depicts the investment levels in select EU countries in 2005. As can be seen from the figure, only Cyprus and Romania recorded lower total R&D spending than Bulgaria. Investment in R&D in Bulgaria as well as in all the EU8 countries is substantially below the Lisbon target ofthree percent of GDP. Total R&D investment as a share o f GDP has remained largely unchanged since 2001in Bulgaria. Figure8.5: Total R&DInvestment by Sector in 2005, YOof GDP EUlS Bulgana Czech Estonia Cypplus Lat\!a Lnhuanla Hungar). Maka Poland Romania Sloyenia Slotakia average Repubk 0 government industry 0 higher education 0 private non-profit - 8.54 The bulk o f R&D investment is financed by the government and only a relatively small share by the industry (see Table 8.2). This i s opposite to what is observed in most EU15 countries and what the Lisbon targets are striving for. In 2005, about 66 percent of total R&D Table 8.2: Investment inR&D in Bulgaria, percent of GDP investment (0.33 percent of GDP) was 2001 2002 2003 2004 2005 financed by the government, which a Total 0.47 0.49 0.50 0.51 0.50 was significantly above the shares in Government 0.31 0.35 0.35 0.34 0.33 any EU8 country and the EU15 Industry 0.10 0.09 0.10 0.12 0.11 average o f 10 percent (or about 30 0.06 0.05 0.05 0.05 0.05 percent, if government financed R&D Privatenon-profit 0.00 0.00 0.00 0.00 0.01 channeled through universities is Source: Eurostat included). This is shown in Figure 8.6. In parallel, only about 22 percent (0.11 percent o f GDP) o f R&D 161In 2004, NCAS carried out 255 scientific and researchprojects financed by the institute, 48 by the Ministry of Education and Science, 43 by other organizations, and 153 contractsunder international andbilateral cooperation. 144 expenditurewas financed by industry,whichwas substantially lowerthanthe EU15 average of 64 percent and the share in any EU8 country, except Lithuania (see Figure 8.7). R&D investment by higher educationinstitutionsaccountedonly for aboutten percent ofthe total. Figure8.6: Shareof R&DFinancedby Governmentin 2005, YOof total R&Dinvestment ______ . . . . . . . . . . . . . __. .... . . "" ........... _I_ .. ... _ _........... _.. __ __ Bulgarla Poland Romania CWNS Slovakia Uhuanla Hungary Latvla Czech Slovenla EUE Estonla Maha Repubhc average Figure8.7: ShareofR&DFinancedby Industry in2005, YOof total R&D investment I Slovenia Malta Czech EUE Romania Slovakia Estonia Hungary Latvia Poland C ~ N S Bulgaria Ljthuania Republic average 145 8.55 This pattern o f R&D financing-two-thirds funded by the government and the rest by industry and higher education institutions-has remained broadly unchanged during the period 2001-2005 (see Figure 8.8).'62 Further, over 90 percent o f R&D investment is used to cover current expenditures, and less than ten percent goes towards investment in capital. Figure 8.8: R&D Investment by Sector, YOof total investment This implies that minimal (Source: National Statistical Institute) scientific infrastructure j investments have been made at 100% universities or research 90% institutions, which limits the 80% 70% type o f research that can be 60% carried out. In other EU 50% countries, capital investments 40% 30% represent typically 20-30 percent 20% o f total public R&D investment. 10% For example, in Finland, 27 0% percent o f government R&D 2001 2002 2003 2004 2005 1 expenditures were spent on research infrastructure and material investment. While Bulgaria's pattern o f investment may be consistent with its stage in the transition process and level o f income, to facilitate the country's shift to the next level o f development and to raise productivity, increased private sector R&Dwould be called for. 8.56 Almost 70 percent o f government R&D funds Figure 8.9: Allocation of Government R&D Investment in 2001-2005 , go to BAS. As can be I seen from Figure 8.9,16' the share o f government funding going to BAS has increased from about 51 percent in 2001 to 67 percent in 2005. Since the overall level of R&D has also increased during the period. it means that the budget o f BAS has been 2002 2003 2004 2005 ~ 2001 increasing strongly in the past years, (see Table 8.3). Well over 90 percent o f the BAS budget finances current spending, that is, staff salaries. 8.57 About one-third o f government R&D funds go to the ministries. The Ministry o f Agriculture receives about 27 percent o f total funds, of which a large share goes to finance NCAS. The rest-about four percent-goes to the Ministry o f Education and Science and the Ministry o f Economy and Energy. Inadditionto NSF, the Ministryo fEducation and Science invests about the same amount o f money as on 16* However, the situation used to be different in early 1990s. The 1996-1997 crisis adversely impactedBulgarian businesses,and the share of industry-financed R&D fell from about 50 percentof total R&D expenditure to less than one fifth. 163InFigure3.9, extrabudgetaryfinds refer to internationalprograms and grants not channelledthroughthe budget. 146 the NSF budget on what is called evaluation, development, and preservation o f the Bulgarian science potential. In the case of the Ministry o f Economy and Energy, the funds finance primarily NIF. However, the shares going to ministries have declined steadily in the past few years, while the share going to BAS has increased. Table 8.3: Allocationof Government R&DInvestment 2001 2002 2003 2004 2005 Total government R&D investment (BGN 97,617 118,993 119,620 129,696 133,799 thousand) Of which, % allocated to: Ministry of Educationand Science 4.5 4.7 3.5 Ministry of Economy and Energy 1.9 1.o 0.4 Ministry ofAgriculture 30.2 29.0 26.8 BAS 50.9 55.3 59.8 62.5 67.0 Other 3.7 2.8 2.3 Source: ililinistry of Finance, Staff calculations 8.58 The allocation o f a major part of government R&D financing as institutional funding (that is, as subsidies to maintain existing staff, facilities and equipment) suggests that the quality o f government R&D investment has not yet adapted to the needs ofBulgaria's market economy. Only a small fraction of government financing has been allocated to support what the government itself has defined as its priority objectives, and o f that only a small share is currently distributed on the basis o f competitive selection procedures. B. Type ofR&DFinanced 8.59 Inthe last ten years, the share o f R&D funding allocated to basic research has increased steadily at the expense o f - applied research and experimental de~elopment'~~(see Table 8.4). Table 8.4: Allocation of R&D Funds by Type of This trend is disconcerting, and opposite of the Research, % of total investment trends in most EU countries. In recent years, 1995 2003 most EU countries have increasingly shifted Experimental development 20.4 15.5 Applied research 54.7 46.7 public funding to application-oriented activities Basic research 24.9 37.8 and innovation, instead o f basic research. Source: NSI Bulgaria would be well advised to follow this trend. Obviously, there will still be need for public investments in basic research as well, but the main emphasis should be on applied work. The objectives o f basic research should thus be carefully reconsidered. C. EnhancingIndustryEngagementinR&Dand Applied R&D 8.60 To increase industry's participation in R&D, while also shifting the R&D focus increasingly to applied research will be a formidable challenge for Bulgaria. In order to reach the Lisbon goal o f R&D investment of one percent o f GDP financed by the public sector (one-third o f total spending), a three-fold increase in government R&D investment would be required, even if GDP remained constant. To reach the goal o f private sector R&D investment o f two percent o f GDP (two-thirds o f total R&D spending), a twenty-fold increase in spending by industry would be needed. It is obvious that the private sector will not achieve this sort o f an increase by 2010. It will take increased competition to provide firms the incentives to invest innew technologies, and that will take years. Hence the public sector can be expected 164Experimental developmentis the most applied form of research. 147 to dominate Bulgarian R&D for a while. To shift the course so that the Lisbon goals can eventually be met, a radical change inpolicy i s probably needed. 8.61 Governments around the world have experimented with various ways o f enhancing private sector R&D. Some governments have had the public sector undertake industrial R&D activities directly, but the results have been discouraging in most cases. Government i s rarely in a position to judge what type o f research would help firms and have market potential. Nor does it have the right incentives. Public R&D also tends to crowd out private R&D, unless public efforts are carefully designed to complement private activities. Some governments provide tax incentives, in-kindgrants (for example, land), or cash grants to encourage private R&D efforts. However, since inthe case o f subsidies, except cash grants, it is difficult to estimate the costs involved, the process i s effectively hidden from the public view, and becomes subject to abuse. 8.62 As shown earlier, in OECD and EU15 countries, the private sector finances the bulk o f applied research and product development, even though public-private partnerships for R&D and knowledge creation remain important. It is worthwhile to note that Finland and Sweden, which were among the highest ranked in the EIS 2005, have high levels o f private R&D and governments o f these countries do not provide substantial direct government or tax support to the private sector for these purposes. How was this achieved? Much o f the answer lies in the creation o f an environment that makes it easy to start and grow a business. 8.63 The challenge posed by the Bulgarian industrial structure: The current industrial structure in Bulgaria, which is rather low-te~hnology'~~,adds another dimension to the challenge o f increasing industry financed R&D. According to the Bulgarian Association o f Industries, the R&D capacity o f Bulgarian industry is weak due to this industrial structure, in which low-tech SMEs and micro enterprises dominate and their R&D capacities are limited, Most large companies are foreign-owned. Hence their connections to Bulgarian universities or research institutions are only occasional, and their R&D i s conducted abroad. The machine-building sector has little domestic product development, and is largely manufacturing for foreign companies. The same applies for other light industries in Bulgaria. There are no large domestic chains in the tourism sector that could benefit from R&D. In trade and commerce, large foreign chains dominate the market, with little development work in Bulgaria. Agriculture is a large sector, but suffers from fragmentation into many small units. In short, there are few Bulgarian global export products, and at the moment a limited number o f companies have the capacity to carry out R&D work, though they all could benefit from it. 8.64 The EU Trend Chart on Innovation 2004-2005 report on Bulgaria (EC 2006d) lists many of the same factors as obstacles to innovation by Bulgarian enterprises: (i) low-technology product specialization and export structure o f the economy; (ii) predominantly low-technology employment; (iii) short-term planning horizon o f enterprises; (iv) poor human resources management system within enterprises; (v) lack o f venture capital schemes; and (vi) lack o f policy schemes for high-tech employment. 8.65 Experiences o f advanced EUcountries inthe field o f innovation yields the following lessons: 0 competitive markets and the accelerating pace o f scientific and technological change force firms to innovate more rapidly; 0 innovation increasingly relies on effective interaction between the science base and the business sector; `65Less than five percentof the manufacturing sector i s high-tech. 148 0 networking and collaboration among firms are now more important than in the past and increasingly involve knowledge-intensive services; 0 SMEs, and especially those based on new technology play an important role in the development and diffusion o f new technologies; and globalizationis making countries' innovation systems more interdependent. 8.66 These lessons suggest that the large SME base in Bulgaria is not necessarily a problem. What may be the problem, rather, are some aspects o f the business environment. As was discussed in Chapter 3 there are a number o f weaknesses in the quality o f the regulatory environment that, by not fostering competition, reduce the pressure for innovating and raising productivity, Earlier sections o f this chapter discussed the weak links between the science base and the business sector. Other parts o f this report focused on measures needed to raise the quantity and quality o f human capital. Much o f the economy can be efficiently run by using people with medium-level skills o f the type learned in general secondary and/or vocational schools. This includes to some extent the adoption o f existing technologies. However, development o f new technologies or moving the country closer to the world technology frontier depends on a large pool o f people with higher education. A large proportion (at least 30 percent) o f the labor force o f the most innovative and competitive economies have a tertiary-level education. Chapters 5-7 covered the key reforms needed to raise Bulgaria's quality o f human capital, and Chapter 4 discussed the policies needed in the labor market to make the continuous reallocation o f labor from lower to higher productivity levels as smooth and rapid as possible. When taken together, these measures would help create a business environment that would attract private investment, both foreign and domestic, in the process intensifying competition and thus creating incentives to innovate and raise productivity. Those will be the key policies that, in the long run, will lift the level o f industry-financed R&D towards the Lisbon targets. However, there are areas in which the government may be able to assist in speeding up the processvne o f them is through the retargeting o f existing funding. 8.67 Initiating a shvt through government funding instruments: The government has recently introduced incentives for private financing o f R&D through the establishment o f NIF and NSF discussed earlier. These funds provide opportunities for public-private partnership in R&D by providing up to 50 percent o f R&D project financing on a competitive basis. In the case o f an applied research project, NIF could finance upto 50 percent o f R&D expenses (at most EUR250,OOO) over a period o f three years. 8.68 The sizes o f these funds would, however, need to be increased to have an impact on R&D and innovation and the government would be well-advised to reallocate part o f the current institutional fundingto these competitive funds. NSF still has insufficient volume to make a true impact on university research. A national target with appropriate incentives would need to be set to increase the level of competitive funding to about 30 percent o f total university research expenditure. The purpose o f this would be not so much to raise the volume o f research, but rather to raise its quality and hence impact by increasing competition and thereby directing resources to high-performing units. 8.69 The establishment o f NF has been a significant step forward in boosting innovation in Bulgarian enterprises but it needs to be developed further. As inthe case o fNSF, the funding volume o f NIFwould need to be increased for it to have an impact. Also, in order to ensure that the funds are properly spent, it would be important to strengthen the capacities to manage these funds. Professional assessment, selection, monitoring and follow-up o f R&D and innovation projects is o f crucial importance. Further, NIF planning would need to be strengthened. There is a need for broader strategic programming than exists today to respond to the key industrial needs. The National Technology Programs o f Tekes in 149 Finland'66provide one example o f such programming, which might be useful as a successful example when NLF is developed further. The promotion o f public-private partnerships in R&D can be expected to enhance the chances o f commercialization o f research results, which is a problem in Bulgaria. Industry involvement i s likely to steer the R&Dprocess inthe direction o f serving the business interests. 8.70 Additional innovation funding instruments to complement R&D grants could also be experimented with. NIF is still young and the available set o f funding instruments limited. The funding instruments that could increase the chances o f proper follow-up and commercialization include guarantee schemes/collaterals, or equity loans. These instruments should be designed ina way that would encourage collaborationbetween large and small companies, as well as between universities and industry. D. OpportunitiesProvidedby EUResearchPrograms and Grants 8.71 Research, innovation and competitiveness are high on EU's agenda. The EU grant funds, both research and structural, provide a unique opportunity for Bulgaria to reform and develop its R&D and innovation system. Bulgaria should take advantage o fthese. 8.72 EU Research Programs: At the EU level, the R&D allocations have been significantly increased. The seventh Framework Program for R&D (FP7) for the period 2007-2013 has a budget of over EURSO billion, which is almost double the earlier program (see Table 8.5). FP7 has also a renewed structure, including competitive basic research funding, increased international academic-industry exchange o f scientists and researchers, and building o f research capacities in member states and at the level o f EU, and an increased collaborative research component. Bulgaria has participated in the prior programs, and should continue doing so. 8.73 In 2004, about six percent Table 8.5: Budgetof the EUseventhFramework Program (EUR6 million) o f the total R&D for Research, 2007-2013 expenditure in Bulgaria was financed FP7 Specific Programs EUR54,587 million through different EUprograms. Though Cooperafion-Collaborative Re~arch EUR32,292 million relatively low, EU funding plays an Ihs-Frontier search EUR7,460 million important role in B ~ 1 g a r i a . lIf ~ ~salaries Curie Actions EUR4,727 million and infrastructure support are excluded +Capacities-ResearchCapacity EUR4,291million JRC non-nuclearresearch EURl,75 1million and Only research projects and + Euratom-nuclear fusionand fission EUR4,061million financing might have exceeded the are taken into research In + Euratom-nuclear fusion and fission EUR4,061 million government R&D funding, given that the bulk o f government fundinggoes to cover current costs. 8.74 EUgrantfunds: EUgrant funds should be harnessed to advance Bulgaria's R&D and innovation agenda. The country's National Strategic Reference Framework (NSRF) is operationalized through six thematic Operational Programs (OP), o f which three are linked to R&D and innovation: the OPs for human resource development; regional development; and for the development o f competitiveness. Through these OPS, about six percent o f all structural funds available to Bulgaria are proposed to be allocated to R&D and innovation. In comparison, during the 2000-2006 program period Objective 1 regions invested up to 15 percent o f their grant funds into R&D and innovation, and Objective 2 regions 166For more information, see www.tekes.fi. 16'EC (2006) ERAWATCHResearch Inventory Report: Bulgaria. 150 up to 43 percent.I6' Most EU8 countries allocated 2-10 percent. Since the emphasis in the current program period is on R&D and innovation, these shares can be expected to increase. 8.75 The OPfor human resource development covers the proposed allocation o f available European Social Funds, and treats R&D and innovation as a horizontal policy, which is supported in each priority area. These include labor market policy (flexibility, innovative joint actions, start-ups), and education policy (community initiatives in education and training to promote collaboration between education institutes and the public, and quality o f service delivery, ICT use, business-education system collaboration, mechanisms to foster international collaboration in research, loan instruments to facilitate research projects). The OP for regional development, which covers all development topics from the regional perspective, focuses primarily on infrastructure objectives but also covers R&D and innovation. About 30 percent o f its budget is to be devoted to the Lisbon priority entitled "Establishing European Area o f Research and Innovation". The OPfor competitiveness is the main vehicle for direct support to R&D and innovation, and several measures are proposed in that area. The program proposes to provide financial resources to implement the goals o f the National Innovation Strategy, and shift Bulgariatowards a knowledge-based economy. This is to be done through: (i)promotion of R&D activities and commercialization o f innovations in enterprises (for example, through provision o f equity capital); (ii) protection o f the intellectual property rights in Bulgarian enterprises and research institutions; and (iii) development o f pro-innovative environment supporting enterprises. In total, about BGN155 million is to be allocated to these objectives. In addition, under the OP, cluster development activities are proposed to be launched, which can also be expected to have an impact on R&D and innovation. 8.76 All these proposed measures are highly relevant and much needed. A recently publishedstrategic e v a l ~ a t i o n 'o~f~structural funds in Bulgaria suggests the following actions to maximize the impact of innovation and knowledge interventions: (i)facilitate project preparation capacity for example through public-private partnerships, and targeted vouchers; and (ii)define clearly the innovation actions, and establish a proper process o f monitoring them. Above all, with the simultaneous introduction o f many new instruments and structures, attention should be paid to (i)competent management o f resources, and whether they adequately respond to needs o f industries, and (ii)whether they support structural change and economic progress of the country inthe long run. Objective 1 promotesdevelopment and structural adjustment of regions, whose development is lagging behind- that is, average per capita GDP is less than 75 percent ofthe EU average. Objective 2 supports economic and social conversionofregions in structural difficulties, but other than those eligible for Objective 1. 16'EC (2006~)Strategic Evaluation of Innovation and the Knowledge-basedEconomy in relation to the Structural and CohesionFundsfor the Programming Period2007-2013, Bulgaria. . 151 IV. HUMAN RESOURCES R&DANDINNOVATION AND A. Availability of Researchers 8.77 Availability o f well-trained researchers, scientists, and engineers i s critical for innovation but, as highlighted by the benchmarking at the beginning o f this chapter, this is an area, where Bulgaria is trailing behind. Having funds for R&D investments alone is not Figure8.10: Employmentof Researchers by Sector,2004 sufficient. As in other countries o f Central and Eastern Europe, the deep social and economic transformation o f Bulgaria during Higher the 1990s led to a significant education shrinking and restructuring o f the Bulgarian scientific system. Lifting restrictions on emigration resulted in a substantial brain drain from Government Bulgaria towards the US, Germany, 59% the United Kingdom, and 1 13% Scandinavian countries. Scientific activities and employment dropped significantly. During 1995-2004, the total number o f researchers in Bulgaria dropped by about 30 Source: Eurosta) percent, even though the share o f basic research funding increased over the same period. Most significant drop was experienced in the higher education sector, where the number o f researchers decreased by more than 50 percent (from 4,905 to 2,362). 8.78 The share o f science and technology graduates in Bulgaria, at 8.5 per 1,000 people (in 2004), is significantly below the EU25 average o f 12.6, Ireland at 23 and the United Kingdom at 18.17' Among the EU8 countries, only Hungary (5.1), and the Czech Republic (7.4) are below that. Also, the number o f doctoral degree holders in science and engineering is small in Bulgaria, and fewer than half o f those studyingfor a doctoral degree ever defend a dissertation and complete the degree. 8.79 Further, the bulk o f scientists-59 percent in 2004-is employed by government research institutes, above all BAS (see Figure 8.10). About 28 percent were in universities in 2004. The share o f scientists in Bulgarian enterprises is lowest among the EU countries: only 13 percent o f them were employed by industry in 2004 compared to the EU15 average o f 55 percent. As highlighted in the benchmarking, the low number o f researchers involved in R&D, and the declining pipeline o f scientists in light o f a decline inthe number o f science enrolment inuniversities are concerns in the case o f Bulgaria. 8.80 Apprenticeship system could be an effective way to encourage research work in enterprises, particularly in SMEs. Currently, the industrial training periods tend to be a formality instead o f being a properly planned and implemented learning process. It also appears that the law on scientific titles and degrees o f 1972 should be revised to enhance flexibility and improve career opportunities for young scientists. For example, the current law defines approval procedures for professorships, which are long, burdensome, and do not encourage new scientific directions or multi-disciplinary approaches. I 7 OEurostat, 2005. 152 8.81 Overall, the issue o f availability o f researchers and scientists is closely tied to the Bulgarian university system. The reforms recommended for the university system in the previous chapter (Chapter 7) would help to address some o f the R&D needs as well. B. DevelopingLinkswith the International ResearchCommunity 8.82 Although the best performing research institutions o f BAS and Bulgarian universities have already developed international connections, the majority o f Bulgarian research units are still operating largely on a domestic basis. Science does not recognize borders. Internationalization i s thus an essential element in improving the quality and relevance o f research. There are many areas o f research, such as climate change and other environmental issues, mapping genomic structures and functions, designing telecom and traffic instrumentation standards, where international collaboration is the only avenue for successful research. 8.83 Bulgaria could take the advantage o f various EUprograms to develop and further strengthen links with the international research community. Key instruments would be the EU Research Framework programs and other international co-operation mechanisms, such as Eureka. To this end, there would be a need to raise the general awareness of available EU instruments and their funding possibilities among the Bulgarian research institutions. To ensure a reasonable success in gaining funding, some investment in the preparation o f competitive proposals would be required, though. 8.84 Inaddition, there is European collaboration ina number of science fields where research facilities typically cost billions o f euros. The following separate organizations have been created: (i)in particle physics the European Organization for Nuclear Research (CERN); (ii)in space research the European Space Agency (ESA); (iii)in astronomy the European Southern Observatory (ESO); (iv) in molecular biology the European Molecular Biology Laboratory (EMBL); and (v) in synchrotron radiation the European Synchrotron Radiation Facility (ESFW). While Bulgaria has been a member o f CERN since 1999, it may want to considerjoining some o f the other organizations as well in the future. V. INTELLECTUAL PROPERTYRIGHTSANDINNOVATION A. LegislativeFramework 8.85 The Bulgarian legislative framework for ensuring the protection o f intellectual properties is reasonably comprehensive, up-to-date, and consistent with the EU directives. In 2000, as the Bulgarian intellectual property rights regime was renewed, the Government ratified treaties o f the World Organization o f Intellectual Property, covering among other things software and the rights o f artists. In 2002, Bulgaria joined the European Patent Convention, and obtained an observer status in the Administrative Council of the European Patent Organization. During the same year further legislative changes were introduced to address latest developments in ICT, digital technologies, and internet. Further, new legislation to provide better protection on the development o f pharmaceutical products was adopted in 2003. Bulgaria has also been part o f the Innovation Relay Center (IRC) Network since 1997. 153 8.86 Ineffective enforcement o f the intellectual property rights Figure 8.11: To what degree do you agree that the legal system regime is a concern, however, and will uphold contract and property rights? considered to be a barrier to foreign investment and innovation. This was also highlighted as an issue to address by the benchmarking exercise. A large scale EBRD-World Bank business environment and enterprise performance survey (BEEPS) o f 2005 suggests that problems remain with the enforcement o f contract and fully agreeagreein tend to tend to disagree in strongly most cases agee disagree most cases disagree . . . property rights in general, with only half of the surveyed firms considering the current legal system upholding those rights (see Figure 8.1 1). Inaddition to strengthening enforcement, increased emphasis should also be put on raising general awareness about the importance o f the protectiono f intellectual property rights. B. Patents and Scientific Outputs 8.87 Ingeneral, the Bulgarian culture is positive towards inventors-their social status has always been high, although commercial benefits to inventors have been rare. According to the Bulgarian Union o f Inventors, there are about 10,000 inventors in Bulgaria. However, the economic impact o f Bulgarian patenting, both domestic and international, is limited compared to the impact o f absorbed foreign technologies through imported investment goods and/or foreign direct in~estment."~ 8.88 Interms of the number of patent applications and the number o f patents issued by the two major international patent offices-the European Patent Office (EPO) and the United States Patent and Trade Mark Office (USPT0)-Bulgaria lags behind EU8 countries. Following the 1997 crisis, the patenting activity in Bulgaria began to recover in 2001 and has remained relatively stable for the last five years. During2001-2004, 18 patents were granted by USPTO to Bulgarian applicants (twice the number granted in 1997-2000), and Bulgarian USPTO patent applications returned to the two-digit zone and marked a historical record o f 105 in 2004 (compared to the average o f 40 per year in the 1970s and 1980s). Similarly, the number o f Bulgarian EPO patent applications increased from three in 2002 to 16 in 2004. Yet Bulgaria clearly lags behind the average EU8 level in high-tech patenting. Most o f the patenting activity is generated by the government research institutions and universities. 8.89 The number o f scientific publications per million inhabitants is also low in Bulgaria at 182 compared to the EU15 average o f 673 (see Figure 8.12). Further, the numbers fell during 1996-2002 Slovakiawas the only other European country that experienced a decline duringthe period. ARC Fund2006. 154 Figure8.12: Number of Scientific Publicationsper millionInhabitants,2002 0 500 1000 1500 2000 Switzerland Sweden Israel Denmark Finland Netherlands Island UK Norway Belgium Austria USA Germany Slovenia France EU15 Ireland Spaln Japan Italy Greece Czech Rep Estonia Hungary Portugal Slovak Rep Poland Cyprus Luxembourg Bulgaria Lithuania Latvia Turkey Romania Malta Source: Key Figures2003-2004, EuropeanCommission VI. ROLEOFFDIINPROMOTINGR&DAND INNOVATION 8.90 Large foreign direct investments (FDI) in Bulgaria provide an opportunity for importing foreign knowledge and technologies, and may have a positive effect on domestic R&D intensity. FDI stock in Bulgaria increased more than three-fold between 2000 and 2005 in absolute terms, and more than doubled relative to the country's GDP (see Figure 8.13). The biggest recipients o f FDIwere the services sectors, such as financial intermediation, communication, trade, real estate, and business services. These sectors are usually the largest users o f information and communication technology (ICT), and hence contribute to increased technology diffusion in the country, and increased demand for high-skilled labor. In industry, FDI was concentrated in non-ICT using sectors. Construction attracted most FDI, while FDI in manufacturing was concentrated mainly in basic metals and metal products; coke, refined petroleum products, and nuclear fuel; food, beverages, and tobacco; other non-metal mineral products; and, textiles and textile products. While investments in ICT have been found to have positive effect on growth and productivity, it is difficult to estimate their impact on the capacity o f firms to innovate and to increase the level o f domestic R&D investment. 8.91 Data limitations do not allow analysis o f the size and scope of foreign R&D stock in Bulgaria, but the experience o f some OECD countries suggests that the share of R&D funded and performed by 155 foreign-owned companies is increasing.172 This has contributed to increased R&D o f domestic firms especially in countries where domestic policies create environment conducive to innovation-liberal product market regulation, protection o f intellectual property igure 8.13: Inward FDIStock rights, and education and labor market policies that improve the Figure 7.13: Inward FDI Stock availability o f skilled labor force. 10000 in million Euro 50 9000 -%of GDP(RHS) VII. CONCLUSIONANDPOLICY 15 RECOMMENDATIONS 8000 40 7000 35 8.92 Despite major changes in 30 the Bulgarian R&D and innovation e! . 0 6000 system in the last decade, WOO 25 n 0 I- assessments and rankings o f 4000 20 innovation performance across 3000 75 countries suggest that Bulgaria has started to fall farther behind the 2000 10 European and world leaders in 1000 5 innovation. Unless decisive action 0 0 is taken to rethink these systems in 2000 2001 2002 2003 2004 2005 Bulgaria, this gap may well continue to widen. This chapter has tried to do some o f that rethinking, and has come up with a number o f reform options that the Government may wish to consider. The options are grouped into those that should get priority attention ("short-run") and those that are o f a more medium-term nature. 8.93 Five areas would need attention inthe short term: Increase the share of competitive R&D funding: Bulgarian R&D funding, above all by the industry,remains small and is below the targets set bythe Lisbon agenda. Over time it would need to be increased aiming at a better balance between public and private funding as well as between institutional and competitive funding. Bulgaria has recently established instruments for competitive R&D funding (such as NIF and NSF), but their share o f budget allocations is still small and dwarfed by funding that maintains existing institutions (e.g. BAS and NCAS). Competitive funding has a number o f advantages. It allows funds to be allocated directly to new research areas, rather than having to achieve desired changes through existing research programs o f research institutions. It is likely to identify the best research proposals, and it rewards active teams, who are likely to use the additional resources effectively. Also, increasing the share o f competitive funding would allow increased industry engagement in the R&D process. Except for the funding o f big science facilities, all international funding i s competitive, so why not establish and follow that practice at the national level. Competitive funding is better executed by independent agencies than by ministries. Strategic technology programs could also be planned and executed for key industries by pulling together the stakeholders from both industry and research. The strategic planning and direction o f such programs should be in the hands o f industry, which best knows the challenges and opportunities it is facing and for whom success may be a matter o f survival. 17'Jaumotte and Pain, Innovation in the Business Sector, Economics Department Working Paper No. 459, OECD, Dec-02-2005. 156 These programs could then be partly funded through the competitive processes. They could also be linked with the EU technology platform programs, which aim to provide industries with the best information about new enabling and generic technologies. Encouragepublic-privatepartnerships in R&D: Public-private partnerships in R&D would help ensure that R&D carried out is relevant to business, and hence likely to have an economic impact through increased chances for commercialization. The government could promote public-private partnerships by making teaming up with industry increasingly a requirement for public R&D funding-both for competitively allocated and for institutional funding. R&D projects between companies, and universities and research centers would be particularly important for SMEs that can ill-afford research departments and facilities o f their own. Also, to ensure that R&D results yield economic benefits, applied research projects should routinely have corporate partners. Re-evaluate the role of theBulgarian Academy of Science: All Bulgarian research institutes would benefit from a functional and impact evaluation, but the Bulgarian Academy o f Science, because o f its size and potential, needs it most urgently. The size o f BAS, with its 87 research centers, is massive-one o f the largest in Europe-and does not appear particularly well justified in the current economic and industrial context o f Bulgaria. It also suggests that there is room for improving efficiency and effectiveness o f government resources. Some o f the equipment and facilities in these entities is obsolete and not conducive to contemporary research methods, and some units are doing research in areas and sectors, which are no longer viable. Thus, a significant, but careful, reorientation o f BAS is recommended, along with a concerted effort to shift the research conducted by BAS increasingly towards applied R&D, in order to respond to the needs o f clients, including industrial corporations. By a carefully planned and executed reform process, BAS could become more competitive, the quality o f its research could be raised to an even higher level and its impact on the Bulgarian economy and society could increase. In addition to the proposed re-evaluation o f the role o f BAS, efficiency gains might be achieved also by reviewing the roles and responsibilities o f NCAS and other existing research entities under line ministries, which spend close to one-third o f the government R&D budget. The role o f NCAS could be important given Bulgaria's agro-industrial potential. Introduce systematic evaluation of R&D policies, institutions, and programs: There is an urgent need to establish systematic, regular and independent evaluations o f R&D policies, institutions, and programs in order to assess their functioning and impact, and to identify the needed adjustments and reforms. So far no evaluations seem to have been carried out. Also, regular periodic evaluations would need to be carried out o f all funding mechanisms (such as NIFandNSF), to assesstheir instruments, operationalmethods, impact, and funding levels. Rethink the institutional R&D set-up. To keep up with the world and to become world-class in some niches, Bulgaria would be well-advised to rethink its institutional R&D set-up. The current dual structure-two parallel strategies, two responsible ministries, and two coordinating councils-raises concerns, since research and innovation are closely related, and links between them need to be strong. To promote horizontal coordination, the authorities may want to consider shifting to a more unified structure and elevating the coordination to a higher level o f Government to give the issues greater prominence. R&D and innovation issues and activities are connected to the country's economic performance and will continue to grow in importance as Bulgaria's economy catches up with other EU economies, and approaches the technological frontier in an increasing number o f sectors. 157 8.94 Inthe medium term, the following issueswould needto be considered: Enhance industry-financed RhD: Enhancing industry investments in R&D offers the best way to improve the performance and economic impact of the Bulgarian R&D. Currently, R&D funding is unbalanced, with the government financing about two-thirds of all R&D investments. This is exactly the reverse of the EU15 average, if one group together direct funding of R&D from the budget with the indirect funding going through the universities. While Bulgaria's pattern of investment in R&D may be consistent with its stage in the transition process and level of income, to facilitate the country's shift to the next level of development andto raise productivity, increasedprivate sector R&D would be called for over time. The challenge is how to get the Bulgarianindustry to find it in its interest to raise its R&D expenditures. Given Bulgaria's current industrial structure, a rapid increase in industry financed R&D is highly unlikely. It will take time. The government can best promote industry-financedR&D by providing an enablingenvironment that encourages it to increase over time. As discussed in previous chapters, this will include above all ensuring that the regulatory environment promotes competition and does not prevent entry and exit of firms, including those from abroad, since contestedmarketsforce firms to innovate and raise their productivityin order to stay afloat. There must be effectiveenforcement of intellectualpropertyrights, and access to input markets such as capital, materials, and information needs to be unhindered. Finally, labor markets need to be flexible so that people can easily move from lower to higher productivityactivities. Encourage university research: The reform options presented in the previous Chapter for the tertiary education system would not only improve education delivery, but also facilitate R&D. In addition, university research could be boosted by linking the educational curricula with research activities. This would help to introduce students to research methods, and increase their interest and competence in professionalwork after graduation. Also, thesis projects addressing development needs of companies should be actively encouraged. In addition to promoting a shift to more applied research and practical problem-solving, this would provide a recruitment channel for students and companies. As was discussed in Chapters 4-7, strengthening the links betweenthe higher education system and labor markets is a priority. Introduce new competitivefunding instruments: A portfolio of further competitive funding instruments best suited for particular needs could be developed over time. Universities, research institutes, and perhaps SMEs would benefit primarily from grants (such as NIF and NSF), perhaps in the form of vouchers, larger corporationsmay benefit from risk loans, and high technology companies may need risk and profit-sharingventure capital. However, if and when this is done, caveats presented under the recommendation to "enhance industry- financed R&D" should be kept inmind. 158 9. BUDGET AND CAPACITY IMPLICATIONS 9.1 All the reform options suggested in this report could be carried out within Bulgaria's currently projected budget envelopes for 2007-09. Investment costs could largely be covered by various grant funds available from EU. This would require some co-financing from Bulgaria's budget, but the total amount might be on the order o f EUR15-20 million, which is roughly 0.06-0.08 percent o f GDP. Even these amounts can likely be fitted into preliminary budget allocations for current Operational Programs (OP), since they are all compatible with the OP goals. Additional current running costs o f the options taken together are miniscule comparedto the potential savings. This leaves room for a good portion o f savings to be kept by the ministries concerned to give them incentive to carry out the reforms rapidly and efficiently. The savings could be redeployedfor other reform and quality enhancement measures. This impliesthe need for leadership to make the case for the proposed reforms and build consensus. Since Bulgarian leaders have already been thinkingabout and planning a number o fthese reforms, this should be feasible. This report has tried to estimate some o f the pay-offs to the reforms, which can be substantial, and thus help with the process o f setting priorities. I. COSTSANDBENEFITSOFTHEPROPOSEDREFORMS A. Product Market Regulation 9.2 Costs o f improvements in product market regulation (Chapter 3) were not calculated. However, they are all mostly improvements inthe way the relevant ministries and agencies think about the problems, and implement the regulations. These can be handled through shifts in focus and budget allocations, but within existing budget envelopes. There may even be some savings, for example, through reductions in permits and licenses, since these require personnel for enforcement, who may no longer be needed. Pay-offs to the proposed reforms are potentially substantial. By one set o f estimates-assuming Bulgaria would catch up with some o f the best performers in the OECD-the ratio o f private investment to GDP could increase by up to two percentage points o f GDP, and help raise labor productivity growth by 1.5-2 percent per year. This would imply higher real earnings, as well as morejobs for the Bulgarian work force. B. Improving the Functioningof Labor Markets 9.3 Proposed reform actions in the labor markets area (see Chapter 4) that would have any fiscal implications have largely to do with A L M P activities. However, these can easily be expanded as the direct employment program is cut back, and accommodated within the existing budget envelope. C. Governanceand FinanceReformsin Primary and GeneralSecondary Education 9.4 The already on-going reforms in the primary and secondary education are estimated to be self- financed through efficiency gains. Chapter 5 (see Figure 5.8) presents estimates that suggest that cost savings fiom the reforms would be on the order o f 0.1 percent o f GDP in the first year, rising to the 0.3 percent o f GDP range over the next few years. These funds can be re-invested into quality improvements in that sector, including teacher training, improvements in facilities and teaching aids, reducing drop-out and repetition rates, and higher teacher salaries. D. VET and Tertiary Education 9.5 The thirteen reform options in VET and tertiary education presented in Chapters 6 and 7 forms a comprehensive reform program around four themes: (i)increasing access to vocational and tertiary education; (ii)improving the internal efficiency o f the system; (iii)strengthening the capacity o f the system: and (iv) improving the quality and external efficiency o f the system. Figure 9.1 presents the four themes and the thirteen reform measures. The measures/options are numbered according to their sequence in Table 9.1, which provides a summary o f the proposed investments, and anticipated annual savings and/or projected annual current expenditures. The first four reform options in Table 9.1 refer to the VET system. The rest refer to the tertiary education system and are listed in rough order o f priority, ranging from short to medium term actions (see Chapters 6 and 7 in this volume and/or Table 9.1 o f the Overview volume) Further details o f approximate costs o f the reform options are presented in Tables 9.2-9.8. Some o f the thirteen options have no financial implications or their financial implications cannot be determined at this point. It is important to emphasize that these are rough estimates, and are presented here not as exact numbersbut rather as "orders o f magnitude". They do not include many expensesthat may happen, but are not now known. However, the big picture is not likely to change. The investments are presented in euros because they could be mostly covered by EU funds under the appropriate OP. They are assumed to be carried out between mid-2007 and mid-2010. Savings and/or recurrent expenditures are calculated in BGN and are assumed to start in 2011. Although they would in principle continue indefinitely into the future, they are likely to be important for only a few years. 9.6 Taken together, net savings (savings minus projected current expenditures) o f the proposed reforms-even under their "minimal" variant-are expected to pay for the investments in well under two years. Even ifthe estimates o f investments, additional costs and savings are off by a factor o f two, the rate o f return o fthe proposed reform package is still high. Increasing Access and improving Internal Efficiency Strengthening Capacity improvingQuality and Eauitv I . . I ` I I I / External Efficiencu I 4. Establish 1. Introduce per student 7. Strengthenuniversity 3. Develop curriculafor WET occupationally. oriented financing to VET governance that strikesa balance betwen regiotialcolleges vocational aad genemlstudies 2, Relay the introduction af 14. Continuedteacher and 9. Institute Natura as VET until completion of faculty training 5. Estabrish a national access examination cornpulsary education Qualific~~ionFramework and Authorlfyto rdmngthen life- 6. Base funding on actual long learning student enrolments in tertiary institutions 8. Strengthenlinkswith labor markets I O . fncrease tuition fees, establish a student loan 53. Strengthenaccreditation scheme, and w i e w and quaiifyassurance of scholarship programs univemiticssand their programs 11. Introduce performance. based componetitto tertiary funding 12. Consolidate universities and tertlaiyinstihitions 160 Table 9.1: RoughEstimated Costs (in 2007-2010) and ProjectedAnnual Savings and Additional Operating Costs ofthe ProposedVET and Tertiary EducationReform Program ProposedReMrms Proposed Anticipated Annual Savings (BGN) Projected Investment Min Average Max Annual (Euros) Expenditures 1. Introduce student -- -- -- _- _- financing to VET 2. Rationalize vocational 6,650,000 12,960,000 25,920,000 38,880,000 0 secondary schools (Table 9.2) 3 . Establishoccupationally- 42,700.000 3,750,000 7,500,000 11.250,OOO 0 orientedregional colleges (Table 9.3) 4. Establish a National 500,000 0 0 0 100,000 Qualifications Framework andAuthority 5. Base tertiary institution -- -- -- -_ -- hnding on actual student enrolments 6. Strengthen university 360,000 0 0 0 150,000 governance (Table 9.4) 7. Strengthen links with 0 0 0 0 0 labor markets 8. Institute the Matura as 0 0 0 0 0 access examination 9. Increase university tuition 100,000 50,000,000 100,000,000 150,000,000 0 fees and establish a student loan scheme (Table 9.5) 10. Introduce a performance- 100,000 30,000,000 30,000,000 30,000,000 0 based component to tertiary institution funding (Table 9.6) 11.Consolidate universities 0 30,600,000 67,800,000 105,000,000 0 and tertiary institutions (Table 9.7) 12. Strengthen evaluation 0 0 0 0 0 and accreditationof universities andtheir programs 13. Continuedteacher and 500,000 0 0 0 200,000 faculty training (Table 9.8) Total 50,910,000 127,300.000 231,220,000 335,130,000 450,000 161 VET 9.7 Introduce per student financing to VET: To provide incentives for cost control, it was recommended in Chapter 6 that as the first step o f VET reform, the ongoing governance and finance reforms in primary and general secondary would be extended to VET. Since further analysis on this would be required, no cost and savings estimates were prepared. 9.8 Start vocational education only after the completion of compulsory education, and develop curricula for VET that strike a balance betweenvocational and general studies: The rough estimated cost o f delaying the introduction o f VET until the completion o f compulsory education, which would imply closing the vocational schools currently offering the early programs, and developing for the remaining VET schools curricula that strikes a balance between vocational and general studies would be about 6.65 million in 2007-20 10. Projected annual savings from increasing the student-teacher ratio- by closing some o f the existing vocational schools, keeping students in compulsory education, and expanding the size o f the existing general secondary and remaining vocational schools-from its present level o f 1O:l to 15:l are estimated to reach on average BGN27 million. They would range from a minimum o f BGN12.96 million to a maximum o f BGN38.88 million; depending on the reduction in the net number o f teachers (see Table 9.2). The shift in the allocation o f resources would be expected to result in a more cost-effective operation o f vocational secondary schools, with potential cost reduction of about 10-20 percent per student. Table 9.2: Rough Estimated Investment Costs (2007-10) and Savings (starting in 2011) associated with the Rationalization of Vocational SecondarySchools Item Investment in the Period 2007-2010 (Euros): Identify, develop and test 10key newjoint course streams 100,000 Procure equipment for new curricula for 250 schools 6,250,000 Training of Teachers 300,000 TotalInvestment Cost 6,650,000 Projected Annual Operational Savings (BGN) starting in 2011: Scenario 1: 30 percent reduction in number of teachers 38,880,000 Scenario 2: 10percentreduction innumber ofteachers 12,960,000 9.9 Establish Occupationally-Oriented Regional Colleges: The rough estimated cost o f merging select existing vocational schools and colleges into seven occupationally-oriented regional colleges would be about 43 million for the period 2007-2010 (see Table 9.3), and is based on the following assumptions: (i)15 sq. metedstudent for classroom, laboratory andworkshop space; (ii)the occupancy rateofthese spaces about 65 percent; and (iii)the average refurbishing cost o f 75/sq.meter. It i s assumed that these colleges would occupy already existing, but refurbished educational buildings. The assumed number o f the proposed regional colleges (7) is arbitrary and would be adjusted to reflect the facts on the ground at the time o f implementation, but their size (5000 or more students) is based on international experience. 9.10 The reform o f higher education for example in Ireland and Ontario, Canada in the 1970s and 1980s show that, once established, these institutions can absorb 30-40 percent o f the tertiary education students. Most o f these students would otherwise have gone to the regular universities. The expenditures per student inthe technical colleges average about 65-75 percent o f the corresponding expenditures in the university sector. In Ireland and Canada, teachers in these institutions are not required to have a Ph.D.-a Masters degree with relevant work experience is usually sufficient-and as a result the cost o f teaching is lower than in the university sector. Further savings in public expenditures can also be achieved once the quality and relevance o f the new programs are ascertained and accepted by employers, because the graduates can have access to employment after 2-3 years of education, instead o f the 4-5 years (at least) 162 taken by a typical university student to graduate. To be conservative, the initial savings from this reform option were assumed to be in the range o f 5-15 percent o f current average student unit costs, and it was assumed that about 25,000 students currently heading for universities would, instead, choose to attend a technical college. It is also assumed that the teachers needed for the new colleges would come from the existing pool o f teachers, and/or fresh recruits where necessary, but at no additional cost. Table 9.3: RoughEstimatesof Investment Costs and Annual OperationalSavings Item Investment in the Period 2007 to 2010 ( Euros): Refurbishing Facilities for 7 Regional Institutions of 28,000,000 5000 students each Equipment and ICT Infrastructure 14,000,000 Other 700,000 Total Investment Cost 42,700,000 Projected Annual Operational Savings starting in 2011 (BGN) : 10% reduction in expenditures per student in new 7,500,000 tertiary institutions (25,000 students) Net ProjectedAnnual Operational Savings 7,500,000 9.11 Establish a National Qualifications Framework and Authority to strengthen lifelong learning: The investment cost o f setting up the framework and the authority are assumed to be on the order o f Euros 500,000. The runningcosts are assumed to be around BGN 100,000 annually. Tertiary Education 9.12 Base tertiary institutionfunding on actual student enrolments: Basing the funding on actual student enrolments would be expected to generate savings, and have negligible costs. However, further analysis would be needed to determine the fiscal impact. 9.13 Strengthen university governance: Chapter 7 proposed a strengthened governance framework for universities. The cost o f establishing the proposed governance structure would be roughly 380,000 for the period 2007-2010 (see Table 9.4). This assumes that the universities have been consolidated to 25 inthe first five years, and that each Board o f Trustees will have eight external private sector members, each devoting about 10 days per year. Once established, the expected annual operating budget for these Boards o f Trustees is roughly estimated at BGN150, 000 starting in 2011. 163 Table 9.4: RoughEstimatedCost ofReform of the University Governance Structure Item Investment in the Period 2007-2010 (Euros): Governance Coordinator and support staff 60,000 ICT Infrastructure 100,000 Board induction training, plus cost of Boards of 220,000 Trustees and Boards of Governors Total Investment Cost 380,000 Projected Annual Operating Costs2011 (BGN) : GovernanceCoordinator and support staff 30,000 Boardsof Trustees and Boards of Governors 120,000 Annual OperatingBudget (BGN) 150,000 9.14 Strengthen links with labor markets: The proposal would be to strengthen links with employers by establishing Program Advisory Committees (PACs) for all university programs. PACs would include employer representatives in sectors such as engineering, technology, business, or medicine, following the practice in other EU countries. The mandate o f PACs would be to validate market intelligence about the existing and future level o f demand for graduates o f various disciplines, and to provide advice on the knowledge and skills likely to be needed by future employers. It should be possible to accommodate the cost o f this process within the existing university budgets. 9.15 Institute the Matura as access examination: The proposed reform o f instituting the Matura exam as a basis for entrance into the university would be consistent with the goal o f facilitating access to tertiary education, and increasing participation rates. N o cost calculations were carried out, since the authorities already have plans to pilot the examination, and based on those annual costs o f the nation-wide examination and its management could be estimated. 9.16 Increase universitytuition fees, establish a student loan scheme, and review the scholarship programs: To increase the accountability o f universities to students and to reduce the burden on the state budget, it was proposed in Chapter 7 that tuition fees be increased in practice, and a student loan scheme be established in parallel to ensure access will not be adversely affected. A rough estimate o f additional revenues from this measure would be about BGN100 million. The assumptions made in calculating this amount are: (i)that the student portion o f tuition costs would be 30 percent o f the average per student cost, or BGN900 per student; (ii)that at present, students pay only half o f that amount-that is, about BGN450; and (iii)that there are roughly 220,000 students attending the university. The student loan scheme would, therefore, fund the extra BGN450 per student, which comes to roughly BGNlOO million (see Table 9.5). 9.17 The loans could be distributed according to a variety o f criteria that would need to be decided. But if access to higher education is to be maximized the criteria would need to include some sort of means-testing, with the poorest students obtaining larger amounts than the students whose parents' income i s higher. It may also be decided that the level o f tuition to be paid should be lower than 30 percent o f the average cost. Further, the management o f the student loan scheme would have a cost (presumably it would be put out to bid to commercial banks that already have the infrastructure to administer loans), as would the interest rate subsidy, if any, and the risk o f non-repayment. However, until the broad parameters o f the scheme have been settled, they cannot be estimated. For all these reasons, the ultimate savings from a student loan scheme are uncertain, and a range o f BGN5O million to BGN150 million was assumed, representing low and high variants, respectively. Nevertheless, regardless 164 of the criteria and the size of the scheme, there could be substantial savings from shifting the burden of tertiary education financing partly onto students and away from the public purse, in additionto improved accountability of universitiesto its clients. Table 9.5: Rough Estimated Costs and Revenues (Savings) from Increased Tuition Fees and the Student Loan Scheme Ttem Investment in the Period 2007-2010 (Euros): Student Loan Expert and Committee to decide on recommended 100,000 approach TotalInvestment 100,000 Projected Annual Savings from Student Loan Schemestarting in 2011 (BGN) : Additionalrevenuescollectedfrom students 100.000.000 9.18 Introduce a performance-based component to tertiary institution funding: To provide incentives for universities to improve quality and efficiency of resource utilization, it was proposed in Chapter 7 that a performance-based component be introducedto university funding in the medium-term. The rough estimated cost of setting up the performance-based funding framework would be 100,000. The projectedannual savings would be accruedas a resultof anticipated: (i)faster progressionof students throughthe system; (ii)reducedprogram and teacher contact hours; (iii)improvedoperationalefficiency, and increased student-teacher ratios. Assuming these led to savings of 2-5 percent of the annual budget, the annual savings would be BGN30 million (see Table 9.6). The fiscal impact of adjustingthe current funding formula so that it is basedon actual rather than enrolment targets is not calculated, owingto lack of data on enrolment targets used. Table 9.6: Rough Estimated Costs and Savings from Introduction of Performance- based Funding Item Cost/Saving Investmentin the Period 2007-2010 (Euros): FundingExpertandCommitteeto decide on the recommendedapproach 100,000 TotalInvestment in Euros 100,000 Projected Annual Savings starting in 2011 (BGN): Projectedimprovementinthroughput or rate ofgraduation 6,000,000 YO of graduatingclass) Reductioninteachinghoursby one contact hour per weekistudent 24,000,000 TotalProjectedAnnual Savings 30,000,000 9.19 Consolidate universities and tertiary institutions: The consolidation of universities through mergers or clustering of existing institutions could produce substantial savings in the operational costs. For example, merging universities into 20-25 large comprehensive universities operating at a cost- effective student faculty ratio of about 16:1 could reduce the size of the faculty by about 8,000 through retirement and other incentives. This would bring the total size of the university faculty down from 24,000 to a more sustainable level of about 16,000. Estimatedreductions in the annual operatingcosts would vary from a conservative BGN31 million to an optimistic BGNIOS million annually (see Table 9.7). 165 Table 9.7: Estimated OperatingCostReductionsfrom UniversityConsolidation Projected Annual Savings starting in 2011 (BGN) Total Cost Scenario 1: Staff Reduction by 33%: Faculty 96,000,000 Administrators 9,000,000 Total Scenario I 105,000,000 Scenario 2: Staff Reduction by 10%: Faculty 28,800,000 Administrators 1,800,000 TotalScenario 2 30,600,000 9.20 Strengthen evaluation and accreditation and quality assurance of universities and their programs: To improve the existing processes and standards o f university accreditation it was proposed inChapter 7 that the NationalEvaluation and AccreditationAgency (NEAA)would be strengthened. The proposed reforms could be accommodated within the existing budgets o f NEAA or MES, since the reform concerns largely guidingprinciples and the process o f program assessment and accreditation. 9.21 Continued teacher and faculty training: To ensure the quality o f teaching, continued teacher and faculty training was proposed to be established. Training would be carried out by the newly established Leadership and Faculty Development Institute (LFDI). The estimated cost of setting up the LFDIduring 2007-2010 would be about 500,000. Subsequent annual operating budget is estimated at BGN200 00 (see Table 9.8). Table 9.8: RoughEstimated Cost of Continued Teacher and FacultyTraining Item Investment in the Period 2007-2010 (Euros): LFDI Director, managers, staff and consultants 150,000 ICT Infrastructure 200,000 Developmentof LFDIPrograms/Courses 50,000 Delivery and Evaluation of LFDI Training Sessions 100,000 Total Investment 500,000 Projected Annual Operating Costs starting in 2011 (BGN): LFDIDirector, managers, staff and consultants 100,000 LFDI ProgramDelivery 100,000 Annual Budget (BGN) 200,oo E. R&D 9.22 Bulgaria has a long way to go to reach the Lisbon target o f having the public and private sector spendjointly three percent o f GDP on R&Dand innovation. The shortfall is particularly acute inthe case o f the private sector. The problem is that private sector expenditures in this area come out o f a process o f competition. They cannot be willed by the public sector. Chapter 8 considered what could reasonably be done to provide incentives for enterprises to increasingly invest in R&D. 9.23 Most o f the actions proposed can be undertaken within the currently proposed budgets for R&D (these would grow slightly faster than projected GDP) with reallocations across activities. The only action that could cost more is funds that would match efforts by the private sector to innovate, but these must be proposed and driven by the private sector. This will take time, so there are no or minimal fiscal 166 implications for the next few years. However, should the private sector come up with a pleasant surprise, the issue can easily be revisited. 11. CONSISTENCYOF THEPROPOSEDREFORMS WITH THEOPERATIONAL PROGRAMS 9.24 The proposed reforms in this report are directly linked to two o f the OPs under the National Strategic Framework for 2007-2013. These programs are: (i)Development o f the Competitiveness o f the Bulgarian Economy, and (ii) Human Resources Development. While some o f the proposed reforms are already included in the two OPs, others may be included subsequently or just reinforce the reforms envisaged inthe OPs. 9.25 The Competitiveness OP is consistent with the reforms outlined in Chapter 8 aimed at creating incentives to firms to innovate and invest in R&D. The objective o f the Competitiveness OP is to create business environment conducive to higher productivity and efficiency o f production. Specifically, it aims at: (i)development o f a knowledge-based economy and innovation activities; (ii)increasing efficiency o f enterprises and promoting supportive business environment; (iii)providing financial resources for developing enterprises; (iv) strengthening the international market position o f the Bulgarian economy; and (v) providing technical assistance. EUR1.2 million has been allocated to cover the activities in this OP over the period 2007-13, o f which EUR988 million is from the European Regional Development Fund, and EUR247 million o fthe state budget. 9.26 Out o f the total amount, EUR156 million is allocated to activities aimed at developing a knowledge-based economy and innovation activities. These include support for establishment and commercialization o f innovations in enterprises, protectiono f intellectualproperty rights, and investments in innovation infrastructure-technology transfer centers, technology incubators, technology platforms, and technology parks-or investment in equipment in research organizations. These activities are in line with the reforms proposed in Chapter 8 for enhancing industry-financed R&D through subsidies, grant schemes, and the encouragement o f public-private partnerships. 9.27 The largest portion o f the Competitiveness OP funding, EUR775 million, is allocated to efforts to modernize technologies and management o f firms, reduce energy intensity, information and consultancy services to business, and business networking and clustering. These efforts are to focus on firms purchasing or introducing innovative technologies, and introducing international market standards. Special financial instruments for SMEs have also been envisaged under this OP, totaling EUR180 million. These instruments include guarantee funds, micro-loan funds, venture capital funds, and establishment and/or upgrade o f existing business angel's networks. 9.28 The Human Resources Development OP is mostly consistent with the policies proposed in Chapters 4-7 labor markets and education. The objective o f the Human Resources Development OP is to improve the quality o f life through enhancing human capital, achieving higher levels o f employment, increasing productivity, and enhancing social inclusion. Specific objectives o f this OP are: (i)promotion o f sustainable employment and development o f inclusive labor market; (ii)increasing productivity and adaptability o f the employed persons; (iii)improving the quality o f education and training and its alignment with labor market needs; (iv) better access and integration to education and training; (v) social inclusion; (vi) improving the efficiency o f labor market institutions and social and healthcare services; (vii) transnational cooperation; and (viii) support for human resources OP management. EURl.2 million has been allocated to finance the activities under this program over the period 2007-13, with EURl.0 financed out o f the European Social Fund, and EURl82 financed out o f the state budget. 9.29 However, the impact o f these activities would be further strengthened, if the proposed activities were extended to cover policies and reforms suggested in Chapter 4. Close to 60 percent o f the financing 167 i s currently slated to direct at activities promoting labor market development, institutions, and outcomes. It would be a pity if the effectiveness o f those funds was compromised by the omission o f some key reforms. The rest o f the financing o f the Human Resources Development OP is allocated to activities aimed at improving the quality and access to education and training. 9.30 Also, to improve the efficiency and effectiveness o f the education system and to align it with the requirements o f a knowledge-based economy, the activities envisaged under this OP could be complemented with education reforms suggested in this report. These include the extension o f per student financing to all levels o f education, consolidation o f secondary, vocational, and tertiary education institutions; reforms in the governance o f these institutions; and establishment o f occupationally-oriented regional colleges. These reforms would help further improve the access to education, improve the quality, relevance, and external and internal efficiency o f the education system inBulgaria. 111. IMPLEMENTATION CAPACITY 9.31 Much o f the success o f the reforms proposed in this report will depend on the capacity o f Bulgaria's institutions. Many o f the reforms are complicated, and have to deal with vested interests. No matter how high the eventual pay-off to the proposed reforms might be, the short-term losers from the reforms are likely to resist them. Hence one needs leadership to explain the value o f reforms and reduce resistance, and determined follow-through on implementation. That will involve many institutions and many individuals at all levels o f government. 9.32 Available evidence suggests that in a number o f ways the capacity o f Bulgaria's institutions relative to that o f other countries is lagging. It i s thus implementation capacity rather than the cost o f reforms that i s a cause for concern. However, even that is a relative matter. Various indexes o f governance and implementation capacity are typically highly correlated with per capita GDP, so it is likely just a matter o f time before the capacity o f Bulgaria's institutions catches up with its per capital GDP. The problem for Bulgaria is that, because o f its convergence and demographic challenges, it has to overachieve on the productivity growth front, and thus also in terms o f its institutional framework that would make the rapid catching up possible. 9.33 Perhaps the most complete source o f evidence on Bulgaria's institutional capacity is the Global Competitiveness Report (World Economic Forum 2006). The 2006 GCR ranks the competitiveness o f 125 countries around the world along dozens o f dimensions, grouped into nine pillars (see also Chapter 3). Those in turn are divided into three broad groups: (i)basic requirements (that is, institutions, infrastructure, macro economy, health, and primary education); (ii)efficiency enhancers (that is, higher education and training, market efficiency, and technological readiness); and (iii)innovation factors (that is, business sophistication, and innovation). Countries are also divided into five groups, covering the various "stages o f development" from "factor driven" through "efficiency driven" to finally "innovation driven". 9.34 Bulgaria is considered now to be in the "efficiency driven" stage (stage 3). Its world ranking in 2006 was 72, down from 61 in 2005. In the same sample o f 125 countries, it was ranked as 56" in its GDP per capita using the purchasing power parity method. The main factors dragging down its global competitiveness ranking fall under four pillars: (i) institutions (pillar 1); (ii)market efficiency (pillar 6); (iii)businesssophistication(pillar 8); and(iv) innovation(pillar9). Thisreporthascoveredanumberof the issues concerning market efficiency and innovation in other chapters. 9.35 Bulgaria's institutions received the weakest ranking o f all nine pillars (109`h out o f 125 countries). Of the 29 indicators on which the relative ranking o f Bulgaria's institutions is based, the ten that GCR ranks as the most serious "disadvantages" (institutions being one o f only two pillars that list no 168 "advantages" in the case o f Bulgaria) are: (i)organized crime (ranking 118); (ii)reliability o f police services (ranking 117); (iii)favoritism in decisions o f government officials (ranking 112); (iv) diversion o f public funds (ranking 108); (v) public trust in politicians (ranking 105); (vi) wastefulness o f government spending (ranking 101); (v) judicial independence (ranking 100); (vi) business costs o f crime and violence (ranking 97); (vii) burden o f government compliance (ranking 92); and (viii) property rights (ranking 91). The factors concerning organized crime, reliability o f police services, and judicial independence have been so prominent that they are already being attended to as urgent matters at the highest levels. 9.36 In terms o f implementation o f the recommendations o f this report, it is issues such as wastefulness o f public spending, burden o f government compliance, and the diversion o f public funds that matter, and could be the focus o f the Ministries o f Finance, and Economy and Energy. Interestingly, plain corruption is not a major issue. For example, responses to questions about "irregular payments" demanded by officials in customs, public utilities, and/or tax offices all gave Bulgaria a relatively good ranking o f about 40. 9.37 Afonso et a1(2006) analyzed public sector efficiency in new EU member states, using GCR 2003 data. The analysis covered 24 countries-EU8, Bulgaria, Romania, Cyprus, Malta, Greece, Ireland, Portugal, and 10 emerging market countries (Brazil, Chile, Korea, Mauritius, Mexico, Singapore, South Africa, Thailand and Turkey). Of these countries, all except Korea and Singapore are not far from Bulgaria's current stage o f development. The analysis covered a set o f indicators expected to reflect how well the public sector has performed in different areas in which the countries spent public funds. The broad areas covered were administration, human capital, health, income distribution, economic stability, and economic performance. 9.38 Bulgaria ranked the lowest on the aggregate public sector efficiency among the countries included. However, the sample period covered the ten year period preceding 2003. If data for only the years since 2000 were used, Bulgaria's performance in the economic, human capital, health, and income distribution areas would have been at least average compared to other countries. This would leave only the administration area ranked below the sample average. In that area, measured by aspects such as corruption, red tape, quality o f the judiciary, and the size o f the shadow economy, Bulgaria ranked behind all the other countries, except Turkey and Romania. On the corruption index, Bulgaria ranked above average. The picture i s much the same with the performance indicators related to the public resources spent in each o f the areas: Bulgaria again ranks at or above average in most areas. The only exception is again the administration area, inwhich Bulgaria ranks lowest, on par with Romania and Brazil. 9.39 In terms of cost-effectiveness o f resource use, Bulgaria could do much better. According to the analysis, it could either achieve the same performance with only 50-60 percent o f the resources, or it could produce 30-25 percent more output with the same resources. This is consistent with the results o f PFPR o f 2006 (WB 2006a), which argued that major efficiency gains should be possible in the use of public resources. A number o f countries inthe Afonso et a1study have been able to grow at rates as rapid as Bulgaria's in the past 7-8 years with public expenditures as proportion o f GDP well below Bulgaria's levels. Much o fthis shortfall, o f course, cannot bejust due to deficiencies in administrative capacity, but it does suggest that it is a problem. 9.40 The Government i s aware o f the administrative capacity problem, and i s taking it seriously. There is a law that covers administrative reform, as well as a strategy and an action plan. Also, binding standards have been adopted for the quality o f administrative services-these include, for example, what the clients can expect, ranging from specifying the working hours for the delivery o f services, how fast the mail has to be answered, and obligation for civil servants to identify themselves in phone calls. Every administrative unit has to adopt a Client Charter that specifies what is expected, and every six months the 169 various units are to report their progress in the delivery o f services in an internet-based System for Self- Assessment o f Administrative Services. Further, plans for laying a basis for an e-Government are well underway, which should raise the efficiency, transparency, and accountability of the process. 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