Twenty years ago…The last eighteen months have brought peace and a start to political, economic and social recovery in war- ravaged Bosnia and Herzegovina. With a massive internationally supported construction effort, schools and health clinics have reopened; commercial flights land at the Sarajevo airport; repairs to infrastructure, essential to economic revival, are underway; and commerce has picked up. Growth last year reached 50 percent, and unemployment, though still unsustainably high at 50 percent, has fallen dramatically from its war-time levels. Following the first national elections in September, BiH’s State Council of Ministers and the Federation and Republika Srpska (RS) Entity governments were established – important milestones on the road to a more stable political future for the country. (World Bank Country Assistance Strategy FY98-FY99, World Bank 1997) Today…The country has been at peace for the past twenty years, and despite a complex political setup has been able to achieve significant results. Much of infrastructure destroyed in the war has been rebuilt, and institutions have been established to govern the country at all levels of authority. A framework for economic and fiscal management has been established that has brought lasting macroeconomic stability. Multiple reform efforts have improved economic links between the Federation of Bosnia and Herzegovina and Republika Srpska, and some progress has been made in creating a better environment for private sector development and job creation. Much more now needs to be done if Bosnia and Herzegovina is to achieve sustainable prosperity for its citizens and join the ranks of the European Union. … A consensus is emerging at different levels of society that the time has come for the country to change course and unleash its growth potential. (World Bank Country Partnership Framework FY16-FY20, World Bank 2015a) The human and economic cost of the ethnic conflict in institutions for economic management; C) Managing the Bosnia and Herzegovina (BH) between 1992 and 1995 transition to a market economy. The scale of these challenges was enormous. Conflict in BH emerged soon after the was immense: republic became independent during the dissolution of the former Socialist Federal Republic of Yugoslavia (SFRY). It is In this new environment, economic reconstruction and recovery estimated that more than 100,000 people were killed in BH have become the focal point for both policy makers and the and 2 million were displaced or became refugees—over public: the outcome could cement or shatter the ongoing peace half the pre-war population.1 The economy all but collapsed process. The challenge is of immense proportions: history shows with a decline in output estimated at 80 percent (World Bank that it is always difficult to rebuild after a prolonged war. It is 1996). Employment plummeted and physical infrastructure doubly difficult to undertake the task when it involves setting up was decimated, severely impacting social services provision. new governance structures and institutions. Undertaking such a task with a socialist legacy and major unresolved problems in The Dayton Agreement (DA) set the framework for a industry, banking and economic management – as in the case peace agreement that was signed in Paris in December of Bosnia and Herzegovina – is truly heroic. (World Bank 1996, 1995.2 The immediate DA priority was to establish and p. viii) maintain peace. However, the institutional structure created at that time resulted in significant fragmentation of public Two decades later, how much progress has been made? institutions and decision-making, which, when added to the What have been the drivers of progress and the areas of political legacy of the war and the transition from the former more or less success? What lessons can be learned for the socialist republic, has affected development progress in the sustainability of development progress in BH and in other following two decades. The DA maintained the territorial post-conflict countries faced with similar challenges now and integrity of BH and put in place a decentralized structure, in the future? establishing a state or “Institutions of BH” level of government and two entities (the Federation of Bosnia and Herzegovina Significant progress has been made, although the (FBH) and Republika Srpska (RS)).3 A Peace Implementation institutional frameworks established by the DA have had Council (PIC) was established of countries and international long-reaching economic consequences. Peace and macro agencies supporting the peace process with an Office of the stability have been maintained, although building political High Representative (OHR) set up as an ad hoc international cooperation and support for reforms across governments institution to oversee implementation of the civilian aspects has been challenging. The post-conflict reconstruction – of the peace agreement, with a mandate to facilitate supported by domestic efforts and high levels of international resolution of difficulties arising in pursuit of this goal. assistance - and immediate recovery in economic activity boosted incomes and contributed to lower rates of poverty. At the time of the peace agreement, BH had to confront However, growth diminished in the second decade of the three major economic challenges: A) Implementing a post- recovery as structural weaknesses were exposed following conflict reconstruction program – the most pressing near- the 2008 global financial crisis. Policies and incentives have term priority; B) Developing new governance structures and been skewed toward the public sector rather than the private 1 According to the International Criminal Court. 2 For the Dayton Agreement text see http://www.ohr.int/?page_id=1252. 3 Brcko District (BD), which the Dayton Agreement did not agree on the allocation of entity control, was established in 1999 following an arbitration process. Its constitutional position is defined in Amendment 1 of the BH Constitution, adopted in 2009. 3 sector, and toward consumption rather than investment. The remainder of this overview of a forthcoming World Similarly, institutional fragmentation has contributed to Bank book is structured according to the main challenges inefficient public service delivery in many areas. The extensive faced by post-Dayton BH: Achieving Reconstruction system of social transfers, such as pensions and veterans and Recovery; Building Economic Institutions; Promoting benefits, has contributed to social stability, but is expensive Enterprises and Transitioning to a Market Economy; and insufficiently targeted to the poor. Unemployment rates Investing in People for the New Economy; and Conclusion: have fallen from post-conflict levels but remain high, and Achievements and Challenges. activity rates are low, with formal employment discouraged by a weak business environment and high social contribution rates. The social inclusion and cohesion agenda remains ACHIEVING RECONSTRUCTION AND RECOVERY unfinished. Reforms have been initiated in social services and, more recently, in labor markets, but deeper reforms are needed to create jobs and improve the quality and equity of At the end of the conflict the economy was devastated, social services. with massive unemployment and low utilization of physical capital. In addition to the human and physical losses Recognizing these challenges, a shared understanding associated with the conflict, production and commercial is emerging on the imperative to move forward with channels were dislocated as the socialist economy structural reforms. With impetus for better implementation disintegrated and markets had only begun to develop. Prior than in the past, the Council of Ministers and entity-level to the conflict, the economy was quite diversified with a governments adopted a medium-term Reform Agenda in significant industrial sector, accounting for more than half July 2015. Its implementation is supported by international of output and employment, particularly in energy and raw partners including the International Monetary Fund (IMF), materials, textiles, leather, footwear, machinery and electrical the European Union (EU) and the World Bank Group (WBG). equipment (World Bank 1996). Civilian engineering was An application for EU membership was submitted in February strong in the services sector. Following the conflict, many of 2016, for consideration within the year. Despite this progress, the main state-owned enterprises (SOEs) lost the role they political risks remain ever-present and–while the accession had in the protected market of the Socialist Federal Republic process will be an important anchor for reforms–mobilizing of Yugoslavia (SFRY), trade channels and commercial contacts internal demand for reforms will be crucial if progress is to be had been lost and the economy had shrunk dramatically. sustained. 4 Physical reconstruction in the immediate post-Dayton years, as in many other post-conflict situations, initial resource period was supported by domestic commitments and inflows were highly import-oriented, given the devastation of large-scale official development assistance from external productive capacity and process of re-establishing domestic partners. As key infrastructure services were restored, these economic relationships. As a result, the multiplier effect of efforts were generally viewed as successful, but less progress this development assistance and remittances appears to occurred on institution building and policy reform. Notable have been low. variability was also seen in progress by area, entity, canton, and municipality. For example, rehabilitation of community The second stage of the recovery, from 2000 to 2008, and social sectors was more advanced in urban than in rural saw favorable external conditions and domestic areas and in FBIH than RS, where reconstruction started later. developments supporting steady, consumption-driven growth. In this phase of the recovery the multiplier effect of Growth recovered quickly during the first years of the resource inflows increased as the BH economy recuperated. recovery from 1996-1999. This growth was from a low Strong real export growth was supported by global economic base, and stimulated by the significant flows of development trends and strong investment by a rapid rise in private credit assistance and personal worker remittances. In the first few and capital inflows including FDI. Domestic reforms saw Figure 1. After robust growth in the 2000s, the post-2008 Figure 2. Growth has been good for the poor downturn was marked in BH Real growth in consumption, 2004-2011, Percent Real GDP growth, annual average, percent 37.1 4 1996-1999 2000-2008 Bottom 40 Top 60 All 10 2009-2013 2014- 3 8 2 6 1 4 0 2 -1 -2 0 2004-2007 2007-2011 2004-2011 BIH Other FYR (median) ECA MIC Note: FYR is countries of the former Socialist Federal Republic of Note: Bottom 40 (top 60) are the bottom 40 (top 60) percentile of Yugoslavia; ECA is developing Europe and Central Asia; MIC is middle households by consumption level. income countries. Source: World Bank 2014; Household Budget Survey 2004–11 data. Source: World Bank World Development Indicators (WDI). 5 the establishment of the Indirect Taxation Authority and inherent in accomplishing reforms, such as laying off excess introduction of the VAT. The first nationwide medium-term public sector workers at a time in which few private sector development strategy was adopted in 2004 and negotiations jobs were being created to absorb them. with the EU on a Stabilization and Association Agreement opened in 2005. An attempt to reform the constitution in The impact of this external shock was significant. The April 2006 was not successful, and the fragile consensus for effects of the global financial crises on BH were, arguably, reform broke down. The steady economic growth of 2000- magnified by the BH currency board that constrained the use 08 was good for the poor, increasing labor income, which of monetary policy to alleviate the impact of reduced inflows contributed one-third to the rise in incomes of the bottom and made it impossible to facilitate a change in domestic 40 percent (B40) of households. About 50 percent of income adjustment by devaluing the exchange rate. Public spending gains due to social assistance transfers (World Bank 2015b). did rise post-crisis, cushioning the impact of the downturn through social spending and the maintenance of public Public spending also began to pick up again. Public sector employment. The economic adjustment - the burden spending, which was around 50 percent of GDP from 1996 to of which was on the private sector - was also hampered by 2002, initially fell to around 46 percent of GDP between 2004 domestic structural weaknesses, particularly in the labor and 2006. Spending then rose from 2007 onward, particularly market. With labor income growth adversely impacted by on public sector salaries and pensions. While the rise in the crisis, pensions and social assistance were left as the main spending was enabled by higher revenues after the VAT was contributors to income growth of the poorest 40 percent of introduced, it led to a fiscally unsustainable position within households during the crisis-affected period. several years (World Bank 2012). Most recently, in what appears to be a fourth stage of The third stage of the recovery from 2009 to 2013 recovery, growth has picked up, reaching 3 percent in was dominated by the global financial crisis and its 2015. Growth rebounded in 2015 following the floods of consequences. The repercussions of the global financial 2014. However, sustained growth will require addressing the crisis of 2008 on Europe’s banks and the emergence of serious structural weaknesses of the pre-crisis model that have been weaknesses in the Euro area had a deep impact on the BH exposed, as discussed further below, especially the excessive economy and all of South Eastern Europe (SEE) through size and inefficiency of the public sector and the bottlenecks multiple transmission channels. For example, in 2008 55 to private investment and export performance. percent of BH goods exports were to the EU and the EU was the source of 43 percent of inward FDI stocks in 2009. The In terms of the drivers of growth, consumption has been EU accounted for an estimated 45 percent of remittances in dominant across the past two decades. Even though the 2010. Financial linkages are also high with Euro area banks share of consumption in GDP has been declining gradually providing almost all the cross-border claims and local claims since 2003, it remains high, at close to 100 percent, and, of foreign affiliate banks to BH, as recorded by the Bank for fueled by remittances and public wages and transfers, International Settlements (BIS). As part of the deleveraging supported the high growth rates seen up to the global of Euro area banks, total “foreign claims” on BH declined by crisis. Remittances dropped after the crisis, largely offsetting nearly 40 percent from their average 2008 value through 2015 the impact of higher public wages and social transfers and Q3, down from 66 percent of GDP to 51 percent. The global depressing consumption and economic growth. Investment financial and euro crises also exacerbated the difficulties has also not yet recovered from the steep decline caused by 6 the global crisis. Similarly, between 2004 and 2008 export BUILDING ECONOMIC INSTITUTIONS growth was among the fastest in the region, with the export share rising steadily (although from a relatively low base) Building effective economic institutions, in some cases but this trend was interrupted when the crisis occurred and from scratch and in other cases on the legacy of former the EU economy faltered. Exports have since rebounded arrangements, was a considerable challenge. Although somewhat but are still relatively low. On the production side, the DA prescribed arrangements for the conduct of monetary services now account for two-thirds of GDP and have been a policy, it left the necessary fiscal structures ambiguous. The key driver of recent growth. Retail and wholesale trade has DA devolved most government responsibilities and control played an important role in the post-crisis period but also over revenues to the constituent entities. Within RS and finance, communications and public administration. FBH, the constitutional structures support further local self- Following a substantial recovery in relative incomes, the government and devolution of public service functions rate of convergence with EU income levels has stagnated and responsibilities to municipalities in RS and to cantons since the global financial crisis. Looking across the four and municipalities/cities in FBH. This structure followed the phases of recovery, and with a caveat on the quality of data traditional decentralized structure of the former SFRY. in the reconstruction period, real GDP per capita (in constant 2010 USD) in BH increased nearly threefold from 1996 to While the level of decentralization served a political 2015. This was equivalent to an annual average growth rate purpose, the high level of fragmentation within the public of 5.8 percent compared with 1.4 percent for the EU in this 20 sector has contributed to inefficient service delivery in year period. Leaving out the rapid reconstruction period, BH many areas. The objectives of the Dayton architects were real GDP per capita grew by average of 3.2 percent per year to reach a peace settlement and to reduce the scope for versus 1.0 percent for the EU from 2000 to 2015. However, ethnic tensions. In this they succeeded: clearly decentralized with the gap in growth rates narrowing post-2008 the rate governance, if aligned with political or ethnic population of convergence in incomes has slowed. The gross national structures, is more likely to reduce tensions at the local income per capita of BH, in purchasing power parity terms, level than centralized governance. However, because the was estimated at just above 10 percent of the EU average decentralization has contributed to the fragmentation and in 1996. Relative income levels doubled through the duplication of public services and decision-making, it may reconstruction period to 1998 and then gradually rose from have led to inefficiency when a function assigned to a lower 22 percent in 2003 to around 28 percent in 2008, the level at level of government could have benefited from economies which they remain in 2015. of scale. The entity constitutions do not necessarily obligate 7 such duplications, for example, in FBH, where separate The DA arrangements have created challenges in moving ministries of health were created at the level of cantons, but forward with reforming the public sector. Most spending political considerations dominated. authority and service delivery responsibilities are at the levels of the RS and the FBH and its cantons and, in many cases, Multi-layered administrations have also created a this responsibility may not be aligned with the incentives complex legal and regulatory framework for companies. to carry out reforms. This ambiguity is at the heart of many The multitude of state, entity, cantonal, and municipal of BH’s reform challenges including, for the public sector, administrations – each with the power to regulate business (a) accumulation of arrears, (b) lack of resolution in the and arbitrate disputes – creates a heavily bureaucratic restructuring of SOEs, (c) uncontrolled spending by extra- and non-transparent system. Businesses consider judicial budgetary funds such as pension funds, (d) rising public proceedings slow, complex and ineffective. Enforcement sector wage bill, both in terms of number of employees of judicial decisions is also viewed as intermittent and and relative salaries and (e) the outsize fiscal burden on the unpredictable. private sector. Figure 3. Revenues to GDP in BH are well above norms by Figure 4. High government spending levels are dominated by national income level wages and social benefits Revenues as percent of GDP, Average 2011-2014 General government expenditures to GDP, percent 60 Compensation of emplotees Goods & services Social benefits 50 Net acquistion of non-financial assets BIH 60 Total expenditures 40 MNE SRB 30 40 MKD 11.5 12.1 KSV ALB 20 10.1 7.8 20 13.7 17.3 10 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 0 6 7 8 9 10 11 Ln GDP per capita 2011 (PPP international dollars) Note: The solid line indicates non-parametric nearest neighbor Source: CBBH; World Bank calculations. smoothing, with dashed lines showing confidence intervals at +/- 2 standard deviations. Y-axis is truncated at 60 percent. Source: WDI, IMF WEO April 2016. 8 The DA assigned one important economic policy function was important for supporting development of a single to the State level—keeping prices stable. While the State economic space within the country and reducing differential also had responsibility for foreign trade and customs policy, entity policies and administration of indirect taxes. administration of customs and taxation was assigned to the entities. In contrast, the DA had an explicit article (VII) making the central bank the sole authority for issuing currency PROMOTING ENTERPRISES AND ACCELERATING and conducting monetary policy throughout Bosnia and THE TRANSITION TO A MARKET ECONOMY Herzegovina. It specified that for at least the first six years, monetary policy would be outsourced through adoption of a currency board and the central bank governor would be Since 1996, the BH economy—and the enterprises external and, after consultation with the president, appointed operating therein—had to deal with a dual transition. by the IMF. The agreement put the management of monetary The immediate transition was from war to peace. As policy beyond the realm of political discussion, and so far this mentioned, the war destroyed almost all economic activity. has worked well. Reconstruction and recovery encouraged small-scale service and construction industries, shifting away from agriculture, A further crucial later development was the Law on yet not many export industries flourished. Immediately Indirect Taxation. This moved the administration of after the war, both the country and businesses had to indirect taxation, given to the entities, to the State level, to adjust their operations to transition from a socialist (self- be administered by the Indirect Taxation Authority (ITA). governed) planned economy to a market-led economy. Early Under the DA, the entities had authority over tax policy and interventions focused on efforts to improve the environment over tax and customs administration but in 2003 a state law for private investment at the BH and entity levels, such provided for the establishment of the ITA. Setting up the ITA, as passage of a liberal BH Foreign Investment Policy Law, and introducing the VAT in 2006, constituted a major reform introduction of a common currency, and adoption of a requiring a shift in the constitutional powers for indirect uniform trade and customs policy across the entities (World taxation policy from the entity to the state level, establishing Bank 2001). the new institution and accounting system, defining the allocation of indirect revenues and harmonizing indirect tax Following initial progress and growth, the transition to a legislation. The move to a single system of indirect taxation market economy lost ground. Privatization and corporate 9 restructuring ground to a halt, leaving a number of enterprises which typically are the companies that boost employment. unable to fully restructure and prosper, while improvement Compared to countries with higher numbers of companies in the business environment and alignment between in this group, the BH economy is based primarily on large governance levels slowed, leading to uneven treatment of SOEs and a sizable group of small enterprises that employ no businesses across BH and creating overlaps and space for more than 9 employees. Lack of standards and norms deters rent-seeking. The halt in SOE transformation, restructuring, exports and increases the cost of production in areas where and sales at times generated political tension. Nevertheless, BH could successfully compete externally and grow, such as some critical reforms and adjustments succeeded, leading food production, light metals, textiles, and wood processing. to an imperfect but somewhat more open environment, in which enterprises operate today. BH has a number of advantages it could leverage to rebalance its economic model and re-energize the Incomplete transition to a market economy has depressed business sector, if bottlenecks in the business environment growth of a vibrant private sector. Productivity grew rapidly are addressed. Next door to the EU, it is well located to during the initial reconstruction phase and then steadily from leverage international markets and trade with EU. Current 2000 to 2008; it has stagnated since. This is in parallel with plans for reforming the SOE sector through privatization, patterns in other countries in the region, illustrating the deep restructuring, or bankruptcy are a good starting point for impact on the region of the global financial crisis and the reducing the role of SOEs and opening space for medium- weakening of Euro area economies. Progress on indicators sized private companies to thrive. However, as the 2016 Doing of economic transition has followed a similar pattern. BH’s Business report underscores, the BH business environment average score across the EBRD transition indicators, which lags behind regional peers, its labor market remains rigid, and its inadequate infrastructure discourages international had trended upwards from 2000 to 2008, has since remained and domestic transport and trading networks. High tax rates around three, roughly in between the score of 1 where there are a serious deterrent for the private sector and shortages is little or no change from a rigid centrally planned economy of skills sought by export-oriented and import-competing and 4+ for the standards of an industrialized market economy. industries are also substantial. The result is weak investor confidence, both foreign and domestic. Major adjustment Small scale businesses and large SOEs dominate, creating to the business environment set out in the Reform Agenda a “missing middle” of private sector firms. The complex will aim to address many of these prominent impediments business environment, coupled with inadequate economic to the operation and growth of the private sector and enable infrastructure and services, has not been conducive to access to markets by addressing deficiencies in norms and bringing in substantial FDI despite BH’s proximity to the EU standards, and facilitating trade between BH entities and and its traditional trading linkages with some EU countries. The economy is still based on small-scale service operations and the SOEs, which even today employ large numbers of employees. Except for several in electricity and telecoms, SOEs are largely inefficient and only minimally productive, adding to the general stagnation of manufacturing. Few companies are large enough to be part of international value chains that allow for successful competition in external markets. BH has few enterprises employing 25 or more employees, 10 between BH and nearby markets. Efforts are needed to encourage innovative approaches to supporting business, especially engaging the private sector in supporting nascent technologies or businesses. BH businesses also need long- term stability and predictability in the policy environment to attract and foster long-term investment. INVESTING IN PEOPLE still below replacement rates. Net outward migration is also down from the peak levels of the 1990s. These demographic Since 1990, the combined effects of low birth rates and shifts have, and will continue to have, deep impacts on the high emigration, particularly by the young, have resulted economic and political landscape. in a declining and aging population. BH lost nearly an estimated quarter of its population during the war, mostly Like regional and income-level peers, life expectancy in due to emigration and displacement. Though some returned BH has been improving, but significant health challenges after the war, the population decline has continued. The 2013 are faced. Average life expectancy at birth rose from 72 in Census results putting the population of citizens permanently 1995 to 74 in 2000 and then went up gradually to 76 in 2014, residing in BH at 3.5 million, approximately eight percent less above middle income peers. However, the gap with the EU, than in the pre-war 1991 Census. The population impact of where in 1995 life expectancy was about four years higher, increased longevity has been offset by a gradual decline in was unchanged in 2014, despite a slight dip in the 2000s. birth rates and significant emigration in the 1990s. Birth rates, Smoking and inadequate diet and exercise are though long- which plunged in the 1980s, have stabilized since 2000, but are term risks for the health of Bosnians. Bosnians are among Table 1. Selected Human Development Indicators Other FYR BH ECA MIC (median) 2000–08 74.9 73.2 69.8 67.9 Life expectancy at birth, total (years) 2009–14 76.0 74.8 72.0 70.0 Adult literacy rate, population 15+ years, 2000–08 96.7 83.8 95.7 78.6 both sexes (%) 2009–13 98.3 92.2 98.2 83.4 Improved water source 2000–08 98.2 98.6 92.3 84.2 (% of population with access) 2009–14 99.5 99.2 95.3 89.7 Prevalence of overweight, weight for height 2000–08 21.0 11.8 8.7 4.8 (% of children under 5) 2009–13 17.4 15.6 11.3 5.3 Prevalence of stunting, height for age 2000–08 12.0 9.8 16.9 33.6 (% of children under 5) 2009–013 8.9 6.6 12.1 27.4 Note: FYR is countries of the former Socialist Federal Republic of Yugoslavia; ECA is developing Europe and Central Asia; MIC is middle income countries. Source: World Bank WDI. 11 the heaviest smokers in the world; in 2009–13 the average poor and unemployed also have more difficulty accessing smoking rate was 49.5 percent for males versus 38 percent in jobs, services, and other state benefits. middle-income countries. Chronic child malnutrition is also a major health burden. Nearly 10 percent of children experience Rates of unemployment have been structurally high. In chronic malnutrition (stunting), a relatively high level among the reconstruction period jobs were created through public peers in the Western Balkans. Child obesity rates are also sector employment and reconstruction efforts; few new surging in all income quintiles but exceed 20 percent for the private sector jobs were created. Two decades later only a wealthiest. Undernutrition can have lifelong consequences small percentage of Bosnians have jobs, few have formal jobs, for a child’s cognitive development, while childhood obesity and even fewer have private sector jobs. The 2015 Labor Force significantly increases risks of non-communicable diseases in Survey figures suggest that the labor force participation rate adulthood. Both measures of malnutrition disproportionately of those of working age (>15) was 44 percent, and of those in impact the poor, especially in rural areas. the labor force, 27.7 percent were unemployed. That means only a third of Bosnians over age 15 are employed. High rates Within the aggregate poverty trends, many households or of unemployment - with over 80 percent of the unemployed groups are particularly vulnerable to falling into poverty remaining jobless for over a year- and high rates of inactivity or have more difficulty accessing services or economic are a problem for the economy and society: they contribute opportunities. Between 2004 and 2007 poverty fell and to poverty and jeopardize long-term stability. Youth, women, incomes of the bottom 40 percent of the population grew and older workers are particularly affected by inactivity and rapidly. Poverty (measured against a 205 KM daily threshold) unemployment. Informality in the labor market is also high. fell from 17.7 percent of the population to 14 percent between 2004 and 2007 (World Bank 2015b). The onset of the financial Outcomes for many human development indicators have crisis, slowing growth and leading to a rise in unemployment, improved but should be better given BH’s level of income stopped poverty reduction. At 15 percent of the population and high government social spending. In terms of human in 2011, poverty was slightly higher than the pre-crisis 2007 development outcomes, people in BH are better off on estimate. Within these aggregate figures, children are more average than those in many developing and middle-income likely to be poor, and child poverty has increased since 2007. countries in terms of life expectancy, literacy, and access to People with jobs and better education are also less likely to water—indicators that have improved slightly in the past two be poor. In contrast, people with primary education or less decades. But the level of human development is lower than are much more likely to be poor; and in 2007–11 their poverty it should be given the average BH income and government increased. Inequality is also among the highest in the Western spending on social services. Balkans, based on World Bank estimates. With the social inclusion agenda unfinished, many are still marginalized or Fragmented and inefficient social service delivery is vulnerable. This is particularly true for groups like the Roma one of the reasons human development indicators are (which are estimated to represent approximately 2.0 percent below expectation. This inefficiency not only undermines of the population, World Bank 2015a). Over 40 percent human capital development but also heightens the cost of of Roma are estimated to be poor, with one in five adult government and adds to the tax burden on workers. Though Roma considered to be illiterate (compared with close to the extensive system of social transfers, such as pensions full literacy among the rest of the population) and over half and veterans benefits, has contributed to social stability, it malnourished (World Bank 2015b). Other groups such as the is expensive and not well-targeted to the poor. High social 12 Figure 5. The BH Demographic Challenge Figure 6. Youth unemployment is particularly high in BH Thousands of Population, 1980–2050 Percent of the Labor Force, 2014 Total population 70 Population aged 0-14 Population aged 15-64 5,000 Population aged 65 and over 60 4,000 50 3,000 40 2,000 30 1,000 20 0 10 1980 1985 1990 1995 2000 2005 2010 2015 2015 2020 2025 2030 2035 2040 2045 2050 0 BIH MKD SRB HRV MNE ALB SVN EU Note: UN population projections. Note: Modeled ILO estimates. Unemployment as percent of total labor Source: UN 2015a. force aged 15-24. BIH: Bosnia and Herzegovina; MKD: FYR Macedonia; SRB: Serbia; HRV: Croatia; MNE: Montenegro; ALB: Albania; SVN: Slovenia. Source: World Bank WDI. contributions also discourage formal employment. Social to demographic changes. The low coverage and quality services like health and education inherited positive legacies of early childhood development programs have enormous from the former Yugoslavia, but reforming them has proven consequences for the future learning, income, and welfare to be more difficult than rebuilding them after the war. The of Bosnia’s children and productivity of the economy. broader governance environment has had a significant What explains this situation? First, because children don’t influence on the cost and effectiveness of services, including vote or protest on the street, programs that benefit them politically motivated hiring of managers and staff, fragmented can be neglected. Second, the social transfer system procurement systems, and inadequate monitoring and disproportionately benefits politically influential groups, accountability systems, among other problems. such as veterans and pensioners, and neglects children, particularly poor children. High spending on pensions, social With its population declining and aging, BH needs to transfers, and inefficient hospitals is crowding out better invest more in its most important resource -- children long-run investments in human capital, particularly children. and youth – and adapt its pension and health systems 13 Reforms to create more jobs, and to encourage labor and increasing use of pooled financing and procurement force participation, are needed. High and persistent and (3) enhancing mechanisms for citizen engagement and unemployment, particularly among the young, and high the accountability of service providers. BH currently lacks all inactivity, particularly among women, are major economic three, but they could be realized in the next five to ten years. and social concerns. Recent labor law reforms are among the steps being taken to address some of these issues. However, A prerequisite for better performance, and its monitoring, the fiscal regime also results in disincentives to work, for is establishing policies and data standards at the entity, example, through high marginal contribution and tax rates, and preferably the state, level. Services provision could and the design of such social transfers as pensions. Many remain decentralized as long as data are shared more widely workers are exceedingly attracted to public employment, and and reported. A relatively strong health information system those still working in nonviable SOEs may not be equipped for primary care already exists, but it needs to be better to transition to new employment opportunities. Prospects networked, linked to hospitals and institutes of public health, for the young entering the labor market or for unemployed and the data systematically reported. More work is needed workers looking for a formal job are also dimmed by poorly to establish basic data standards and infrastructure for adapted education and employment support services, and education, and performance-based financing for both health the scarcity of information about the labor market. The and education services could be introduced at the entity and consequence is persistent informality, and the departure of canton level. Establishing a centralized mechanism to make young people from the country. financing more equitable may be more challenging, but could be built up from an already existing basis in the FBH Solidarity Reforming service delivery is possible but requires greater Fund. Finally, more needs to be done to make service delivery attention to performance monitoring, financing systems, more accountable, through performance scorecards and and citizen accountability. As noted, the DA created a greater involvement of parents in monitoring school quality fragmented and unwieldy system for organizing services and and patients in monitoring health service quality. making policy. But the current constitutional arrangements allow for improving the quality, efficiency, and equity of social services by (1) reinforcing systems for monitoring their quality and efficiency; (2) introducing performance-based financing, 14 CONCLUSION: ACHIEVEMENTS AND of respondents in BH thought the economy was going in the CHALLENGES right direction, the same number as in 2009, down from 42 percent in 2006. Almost 40 percent of respondents would In the past two decades BH has undergone profound like to move to another country, reaching 60 percent for changes and significant progress has been made. It those aged 15 to 29. Levels of confidence in government has gone from conflict to peace; economic collapse to are relatively low (less than 20 percent of respondents) and recovery; centralized socialist institutions to markets and concern over corruption high. decentralized institutions; an economy largely dominated by SOEs and economic planning to a more mixed economy; A shift to a more sustainable growth model for BH is from disrupted trade linkages to gradual re-integration and needed. The post-crisis experience has focused attention on recent submission of its EU membership application. The the economic sustainability of BH’s growth model. The strong DA established a system of political institutions to govern role of consumption in driving growth in the immediate post- and economic institutions to stabilize the economy and conflict years is understandable given the level of destruction transition from socialism to markets. These institutional and of physical capital and productive capacity during the conflict. policy changes catalyzed a significant economic recovery in However, over a longer period, the domestic economy is small terms of higher per capita GDP and a narrowing of the gap enough that it is unlikely that household- and government- between per capita GDP in BH and the EU average, although led consumption alone could support enough economic interrupted by the global financial crisis, and progress in the growth to narrow the income gap between BH and the EU. transition, though incomplete, towards a market economy. More sustainable sources of economic recovery and long- Today reinvigorating growth in an inclusive manner must run growth are likely to be exports and investment (World be the highest priority.4 Poverty reduction has stalled and Bank 2015b). However, both were hit by the recession in the unemployment rates are high, particularly among the young. euro area and are discouraged by high marginal tax rates and In 2015, according to the Gallup World Poll, only 8 percent inefficient government services. Improving competitiveness 4 For an analysis and prioritization of the challenges faced in reducing prosperity and achieving shared prosperity in BH see the World Bank’s 2015 Systematic Country Diagnostics (World Bank, 2015b). 15 of export-oriented businesses, and supporting the sector reforms in BH are subject to common challenges seen attractiveness of FDI would also help mitigate risks to external in other countries, including the distribution of winners and sustainability given BH’s sizeable current account deficit and losers and financing of transition costs. Local level reforms external financing needs. In terms of fiscal sustainability, are less constrained by the need to develop consensus at a in the baseline outlook of limited fiscal deficits, ongoing national level that comes with major, cross-cutting reforms, reforms and improved growth performance, the debt-to- and potentially more responsive to demand-driven initiatives. GDP trajectory appears sustainable. Important progress has Improved monitoring of service delivery performance and also been made on improving debt management. Potentially benchmarks can support demand-side accountability for important fiscal liabilities remain which could have a reforms and improved service delivery from the public. significant impact on future financing and debt dynamics and on which more analysis is needed. These include public sector In order to secure a more prosperous future for the people arrears and liabilities associated with remaining SOEs. Finally, of BH, the consensus to reinvigorate economic reforms and crucially, improved job creation, productivity growth and must be maintained and deepened, and the coordination enhanced public service delivery are keys to ensuring the challenges that slow implementation must be alleviated. social sustainability of BH’s growth going forward. Over the past two decades, the people of BH have had to address not only the economic challenges faced immediately Reforms that would support such a rebalancing of growth after the conflict, but to navigate the economic impact of are well-recognized, but remain challenging within external shocks, most notably the global financial crisis BH’s decentralized governance structure. Decentralized and also natural disasters. Significant progress has indeed governance increases coordination costs for formulating and been made, but with income growth and poverty reduction weakening since the 2008 global financial crisis, the need is implementing reforms and gives different agents potential clear to move forward with the broad set of measures laid out veto powers. Overlapping authority to control decisions and in the country’s Reform Agenda. Growth requires deepening misalignment of responsibilities and incentives also means of labor market reforms, improving social protection delivery that decisions tend to have high transaction costs. and reducing the cost of labor; improving competitiveness, entrepreneurship and the investment climate; reducing the Political commitment of all governments is a critical size of the public sector while ensuring fiscal sustainability building block for reform, but that alone is not enough and improving public service delivery; and investing in key to make changes happen. Achieving consensus to move transport and energy infrastructure. These are all significant forward on major reforms is clearly difficult given the domestic reform areas, each with its own vested interests. In order to political environment. The main challenge is to mobilize and fulfill the aspirations of both young and old in Bosnia and harness internal demand for reforms and to hold governments Herzegovina, governments will need to work together now accountable for their implementation. The adoption of the to achieve common goals, delivering on a reform agenda that Reform Agenda agreed by the different governments in 2015 expands economic opportunities, creates high-quality jobs highlights how application for EU membership and the EU and advances the country’s path into the European Union. accession process can support such an internal demand for reform. This process is clearly not without its own challenges, as seen in the recent political debate on adoption of the EU Coordination Mechanism and adaptation of the EU-BH Stabilization and Association Agreement. Furthermore, public 16 Bibliography: World Bank. (1996). Bosnia and Herzegovina: Toward Economic Recovery - Report prepared by the World Bank, the European Commission, the European Bank for Reconstruction and Development for the Second Donor’s Conference April 1996. Washington, D.C.: The World Bank Group. World Bank. (1997). Country Assistance Strategy of The World Bank Group for Bosnia and Herzegovina: Report No. 16866-BiH. Washington, D.C.: The World Bank Group. World Bank. (2000). Country Assistance Strategy of The World Bank Group for Bosnia and Herzegovina Report No.: 20592. Washington, D.C.: The World Bank. World Bank. (2001). “Bosnia and Herzegovina: Commercial Legal Framework and Administrative Barriers to Investment.” Washington, D.C.: World Bank Group. World Bank. 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