Report No. 38570-BG Bulgaria Accelerating Bulgaria's Convergence The Challenge of Raising Productivity (In Two Volumes) Volume I: Overview July 2007 Poverty Reduction and Economic Management Unit Europe and Central Asia Region Document of the World Bank Office MES MinistryofEducation and Science Vocational Educationand Training MLSP MinistryofLabor and SocialPolicy VETA Vocational Educationand Training Act MOF MinistryofFinance Vocational Training Centers NAVET National Agency for Vocational World Trade Organization Education and Training Country Director: Anand K. Seth, ECCUS Sector Director: Cheryl Gray, ECSPE Sector Manager: BernardFunck, ECSPE Task Team Leaders: Satu Kahkonen, ECSPE Peter Miovic Table of Contents ACKNOWLEDGEMENTS EXECUTIVE SUMMARY .......................................................................................................................... i The ChallengeOf IncreasingProductivity ................................................................................................. i ObjectivesOfThe Report .......................................................................................................................... i Tackling The Challenge Of IncreasingProductivity: Top Ten Reforms .................................................. 11 .. 1 THE CHALLENGE OFINCREASINGPRODUCTIVITY . ........................................................... 1 I. ............................................................................................................. 1 I1. Magnitude of the Challenge .............................................................................................................. ........................................................................................................................ 3 2 IV. Objectives ofthe Report.................................................................................................................. I11. Demographic Trends RecentProductivity Trends 5 2. TACKLING THE CHALLENGE OF INCREASING PRODUCTIVITY .................................... 7 3. IMPROVINGPRODUCTMARKETREGULATION ................................................................. 11 I. Benefits of Reform ......................................................................................................................... 12 I1 . Options for Reform ........................................................................................................................ 13 4. IMPROVING THE FUNCTIONING OF LABOR MARKETS ................................................... 15 I. Benefits of Reforms ....................................................................................................................... 16 I1. Options for Reform ........................................................................................................................ 16 5. GOVERNANCEAND FINANCE REFORMINPRIMARY AND SECONDARY EDUCATION ............................................................................................................................................ 21 I. Benefits of Reform ......................................................................................................................... 22 22 6.11IMPROVINGVOCATIONAL . Options for Reform ........................................................................................................................ EDUCATIONAND TRAINING ................................................ 25 I. Benefits of Reform ......................................................................................................................... 26 I1. Options for Reform ........................................................................................................................ 27 7. STRENGTHENINGTERTIARY (HIGHER) EDUCATION ...................................................... 29 I. Benefits of Ref0rm ......................................................................................................................... 30 8.I1TOWARDSRESEARCHAND . Optionsfor Reform........................................................................................................................ 30 SUPPORT OF INNOVATION ................................................................................................................ DEVELOPMENT (R&D) STRUCTURESAND POLICIES IN 35 I. ......................................................................................................................... 36 I1. Benefits of Reform Options for Reform ........................................................................................................................ 36 9 39 10 BUDGETAND CAPACITY IMPLICATIONS .. SUMMING UP BY COREMESSAGES ......................................................................................... ............................................................................. 41 I. ...................................................................................................................... -41 I1. Budget Implications Capacity Implications .................................................................................................................... 41 Tables Table 6.1:AlternativeSector in SelectCountries(2004) ............................................................................. 27 Table 9.1:Mappingof ReformOptions by Core Messages........................................................................ 40 Figures Figure 1.1: Bulgaria'sConvergence Challenge ............................................................................................ Figure 1.2: Shift-Share Analysis of Labor ProductivityGrowthfor Bulgaria2000-2005, % ...................... 2 2 Figure 1.3: MedianPopulationProjections by Age Group, 2005-2050........................................................ 4 Figure 3.1: Convergence to Best Performers in Product Market Regulation:Areas of Bulgaria's Relative Strength....................................................................................................................................................... 11 Figure3.2: Distancefrom Best PerformersinProductMarketRegulation:Areas of ................................ 12 Figure7.1: ProposedGovernanceStructurefor TertiaryEducation ........................................................... 31 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 benefited from 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 Reviewers were Andrew Burns, Andreas Worgotter and Simeon Djankov. The report was produced in close collaboration with the Bulgarian authorities. Mr. Lyubomir Datsov, Deputy Minister, Ministry of Finance was the immediatecounterpart, and his support and comments were invaluable. However, he is not responsible for the recommendations offered. The cooperationwith the rest ofthe BulgarianGovernment was also excellent, and the team is gratefulto officials at all levels, who took the time to meet with the team, and provided information in a competent and timely manner. Same applies to the private sector entities, NGOs, universities, schools, research centers, and employers' associations visited. The report greatlybenefitedfrom these exchanges, andthe team wants to thank them for their time and shared insights. EXECUTIVESUMMARY THECHALLENGE OFINCREASINGPRODUCTIVITY 1. On January 1, 2007 Bulgaria and Romania became the newest members of the European Union (EU). Inthe run-up to this momentous event, the Bulgarianeconomy and institutions had gone through a major transformation. After an initial collapse in output and employmentas 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, Bulgariastill 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 EU8,' respectively. 2. Closingthe income gap and facilitating convergencewith other EU countries is, and has been for some years, an overriding priority for Bulgaria. However, the country is embarking on this road to convergence with two disadvantages: the sheer distance that it hopes to traverse, and its rapidly declining working age population. For atime, this can be offset by increasingthe labor force participationrate, but this has a limit. Beyondthat, output will inevitablydecline, unlessoffset by productivity growth. 3. To close the income gap and converge, Bulgaria needs to raise notjust labor force participation and employment, but above all productivity. Convergence is not beyond Bulgaria's reach, butthe country faces long odds. Bulgaria's labor productivity has been rising at about 4 percent per year on average since 2000. However, the split of strong GDP growth between growth in productivity and growth in employment has shifted during this period. Also, labor has been relatively immobile during the whole period, which is a concern. Early on most of the GDP growth came from a rise in labor productivity, using the existing labor force or even shedding some of it. From 2003 onwards, growth came mainly from a strong expansion in employment with labor productivity rising at only about 2 percent per year. This trend has been good for putting people back to work, but may spell trouble for the goal of convergence if, once much of the remainingunemployed or underemployed labor force is absorbed, the rate of growth of labor productivity fails to increase substantiallyfrom its recentpace. To avoidthat kind of situation-that is, ensuring that the rate of growth of labor productivity picks up-requires boldpolicy reforms. Marginalmeasureswill not be enough to makethe country converge. OBJECTIVES OFTHEREPORT 4. The report aims to assist the Bulgarian authorities in identifying options for policies and reforms that would help to boost productivity and employment and thereby economic growth and income convergence. To achieve this, the report looks at Bulgaria's product and labor markets, human resource development, and R&D and innovationsystem. The reform options are arranged alonga time dimension, rangingfrom short to mediumterm. The implicationsof the proposed policy optionsfor the government's budgetare also briefly explored, includingthe utilization of EUgrant funds. 5. The report concentrates mostly on the supply-side aspects of Bulgaria's product and labor markets, its education (primary and general secondary, VET, tertiary) delivery, and its R&D and innovationsystem. A companionpiece, the Investment Climate Assessment, which is beingprepared in ' EU8 refers throughout the report to the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, the Slovak Republic,and Slovenia. i parallel, deals with the demand side and, usingfirm data, identifies the binding constraints to productivity growth from the firm perspective. While there is necessarily some overlap, the two reportstogether are designed to provide a more comprehensive view of the options to tackle the challenge of boosting productivity. TACKLINGTHECHALLENGE OFINCREASINGPRODUCTIVITY: TOP TENREFORMS 6. InnovationAefined 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 formulato promote innovationandthereby productivity growth. 7. 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 incentives. This will include above all the provision of incentives for increased labor mobility, which the report shows is currently weak, but essential for strong growth in the longer run. Incentivesfor investingin R&D and human capitalwould also be central. 8. Fromthe analysis inthe report emerge four core areas for action: a. Increaseemployment; b. Enhancelabormobility; c. Narrow the skill gap; and d. Strengthen R&D. 9. Bulgaria is doing well on the employment front (the first core message), but this is not yet true of the other three core messages-enhancing labor mobility, narrowing the skill gap, and strengthening R&D-which are all ways to increase productivity growth. Having a mobile labor force that moves from lowerto higher productivityjobs and sectors as opportunities emerge is a core buildingblock in the quest to raise productivity. Bothproductand labor market policiesand regulations impact the mobility, and are thus the key levers to effect a change. Havinga skilled and technically sawy labor force is in turn essentialto effective adoption and adaptation of technologies, whereas R&D enhances technology transfer by helping firms to learn abouttechnologicaladvances. 10. The top ten reform options for the short and medium term to raise employment and productivity through enhancing labor mobility, narrowing the skill gap, and strengthening R&D are summarized in Table 1. The first four short-termreformoptions would be the key measures for increasingemployment and labor mobility, while options 5-6 would address the skill gap and the remaining three would strengthen R&D. Of the medium-term reform options, the first two would enhance employment and labormobility, andthe rest would focus on the narrowingofthe skill gap and strengthening of R&D. .. 11 Table 1. Top 10+ Short-term Reforms Top 10 Medium-term Reforms 1 1 Minimize administrative burden on business, including Improve the enforcement of regulations in product barriers to entry of firms I markets 2 Continue privatizationand abolish state's special voting Reduce labor taxes further in a fiscally sustainable rights in privatizedcompanies manner 3 Developand encourage lifelong learning Start vocational secondary education only after the completionof compulsory education 4 Revise labor legislation and regulations while Develop curricula for vocational secondary schools complyingwith EU requirements that balance vocationalandgeneral studies 5 Shift the emphasis of active labor market programs EstablishOccupationally-OrientedRegionalColleges (ALMPs) to support job search and strengthen their monitoringand evaluation 6 Introduceper student financing to VET Increase university tuition fees and establish a student loan scheme 7 Base tertiary institution funding on actual student Introducea performance-basedcomponent to tertiary enrolments institutionfunding 8 Strengthen university governance through the Consolidateuniversitiesandtertiary institutions establishment of Boards of Trustees and a Tertiary EducationCouncil 9 Increase the share ofcompetitiveR&D funding Enhance industry-financedR&D 10 Encouragepublic-privatepartnershipsin R&D Encourage university research 11 Re-evaluate the role of the Bulgarian Academy of Science 11. All these reforms could be carried out within Bulgaria's currently projected budget envelopes for 2007-09. Investmentcosts could largely be covered by grant funds available from EU. This would require some co-financingfromBulgaria's budget, butthe totalamount mightbe on the order ofEURl5-20 million, which is roughly 0.06-0.08 percentofGDP. Eventhese amountscan likely be fitted intopreliminarybudget allocations for current Operational Programs (OP), since they are all compatible with the OP goals. Additional current running costs of the options taken together are miniscule compared to the potential savings. This leavesroomfor a good portionof savings to be kept by the ministriesconcernedto give them incentive to carry out the reforms rapidly and efficiently. This impliesthe need for leadership to make the case for the proposed reforms and build consensus. Since Bulgarian leaders have already been thinking about andplanninga number ofthese reforms, this should be feasible. 12. Attention to issues of implementation is likely to be particularlyimportant in Bulgaria. Evidence presented in the main report (Chapter 9) suggests that the performance of Bulgaria's institutions lags in most dimensions, when compared to countries at a similar level of development. There is a strong case for Bulgaria to develop a comprehensive mechanism that tracks performance across the entire administration. Specifying performance targets may be difficult, but the exercise of producing them, tracking them, and identifying corrective actions where performance gaps emerge, would help improve performance. It would be an iterative process, first piloted in some critical areas, and as experience is gathered, widened in scope and quality. Also, the power of making the information on performance publicly availableshould not be underestimated. iii iv 1. THE CHALLENGEOF INCREASINGPRODUCTIVITY I. MAGNITUDEOFTHECHALLENGE 1,l. On January 1, 2007 Bulgaria and Romania became the newest members of the European Union (EU). Inthe run-upto this momentous event, the Bulgarianeconomy and institutions hadgone through a major transformation. After an initial collapse in output and employmentas 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 EU8,2respectively. 1.2. Closingthe income gap and facilitating convergence with other EU countries is, and has been for some years, an overriding priority for Bulgaria. However, the country is embarking on this road to convergence with two disadvantages: the sheer distance that it hopes to traverse, and its rapidly declining working age p~pulation.~For a time, the decliningworking age population can be offset by increasing the labor force participation rate, but this has a limit. Beyondthat, output will inevitably decline, unless offset by productivity growth. 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,l presents scenarios of Bulgaria's GDP per capita through 2040 under two sets of assumptions. 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 growing at 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 assumed that labor productivity will 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, Bulgariawill 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 reforms, giventhe magnitude ofthe challenge. 2EU8 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 precent per year. See discussion on demographic trends later in this chapter. Figure 1.1: Bulgaria's Convergence Challenge EU25-average productivity growth (2% p.a.) Bulgaria--low productivity growth scenario (2% pea.) ---- Bulgaria-high productivity growth scenario (2% until2015, 5% p.a. thereafter) 11. RECENT PRODUCTIVITY TRENDS 1.5. During 2000-2005 labor productivity increased a total of 24.1 percent, or at an annual rate of roughly 4 percent, as marked in Figure 1.2 by a diamond. However, this was composed of annual labor productivity growth of almost 6 percent during the first three years (2000-2002), followed by productivity growth of under 2 percent per year during the latter part of the period (2003-2005). With GDP growing by 5-6 percent per year, this meant that employment was stagnant or even declining slightly during the first three years of the period (a period of "jobless" growth), followed by strongly expandingemployment at a rate of 3-4 percent per year during the second three year period. The objective is, of course, to have strong growth in both employment and labor productivity, but that implies extremely high GDP growth. This may be difficult to achieve for extendedperiodsoftime. Figure 1.2: Shift-ShareAnalysis of Labor Productivity Growth for Bubaria 2000-2005, YO 10.2 0 I Static shlft effect [LP(base)'d(S)] II Dynamic shift effect [d(lP)'d(S)] 111 Wthin growth effect [d(LP)'S(base)] 1 +Labor productivitygrwoth 2000-2005 2000-2002 2002-2005 Note; The effects 1-111 may 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. 2 1.6. Figure 1.2 also shows something else. Productivity growth can be decomposed into effects arising from reallocationof productionfactors across sectors, and those comingfrom within the sector. In the case of aggregate labor productivity, one candecomposethe overallchange into three separateeffects: (i)astaticshift effect--the effectof reallocationoflabortowardssectorswithabove-averageinitiallevel 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 effect-gains in labor productivity achieved through means other than reallocation of labor, including increases in the capital-labor ratio within the same sector. This type of decompositionis also referredto as "shift-share analysis". 1.7. The decompositionof productivity growth reveals that labor was relatively immobile in Bulgaria in 2000-2005. Productivity growth due to reallocationof labor from sector to sector (that is, the sum of the two "shift effects") accounted for almost 2 percentage points of labor productivity growth duringthe first three years (2000-2002), but for virtually none during the second half of the period (2003-2005), as can be seen from Figure 1.2. Most of the productivity growth came from simply raisingthe productivity of workers already working in any given branch of the economy. Similar results were obtained using a different decompositionmethod, but that case revealed that both capital as well as labor mobility across sectors were low (see Chapter 4 ofthe mainreport). 1.8. The relative immobility of factors of production raises concerns about the medium to long term growth potential of the Bulgarian enterprise sector. In the most dynamic economies, in particular in economies undergoing a transition like Bulgaria, growth takes place through the Schumpeterian process of "creative destruction", in which firms either actively invest in new technologies and/or organizational change, inthe process challengingtheir competitorsto do the same, or face the threat of exit.4 This fierce competition leads to an allocation of factors to their most productive uses, and thus keeps shifting the factors from less to more productivesectors. Further analysis at the firm level will be neededto ascertain the facts in the case of Bulgaria, but the "shift-share" analysis suggests that the process of "creative destruction" in Bulgariais still in its infancy. 1.9. What do these results imply for Bulgaria's convergence? They suggest that convergence is not beyond Bulgaria's reach, but that the country faces long odds. Bulgaria's labor productivity has been rising at about 4 percent per year on average since 2000, which does not seem to be that far from the 5 percent per year pace assumed in the convergence scenario in Figure 1.1 above. However, the split of strong GDP growth between growth in productivity and growth in employment has shifted during this period. Early on most of the GDP growth came from a rise in labor productivity, usingthe existing labor force or even shedding some of it. From2003 onwards, growth came mainly from a strong expansion in employmentwith labor productivity rising at only about 2 percent per year. This trend has been good for putting people back to work, but may spell trouble for the goal of convergence if, once much of the remainingunemployedor underemployedlabor force is absorbed, the rate of growth of labor productivity fails to increase substantially from its recent pace. To avoid that kind of a situation-that is, ensuring that the rate of growth of labor productivity picks up-requires policies and bold reforms that will allow all the effects identified through the different decompositions to play a role in raising labor and total factor productivity in Bulgaria. Marginalmeasures will not be enoughto make the country converge. 111. DEMOGRAPHIC TRENDS 1.10. Bulgaria's productivity challenge is made even tougher by its demographics. Bulgariahas one of the fastest decliningpopulations in the EU. In early 2006, Bulgariahad 7.8 million peoplea5However, See for example, Aghion and Howitt (2005). Eurostat(2005) basedon Bulgaria's NSI data. 3 according to Eurostat, by 2025 the population will have dwindled to 6.5 million, and by 2050 to 5.2 million. Projections carried out by the UN (2007) are similar, with the lowhigh scenarios of 4.2-6.0 million people by 2050. This represents a 0.7 percent decline in population per year. The demographic patterns are similar, but more moderate in all EU8 countries.6 In contrast, total population of EU15 is projected to stabilize, although the share of old people will rise, and that of children and working age population decline. 1.11. Bulgaria's working age population (people of ages 15-64) will decrease. According to projections, it will decline by about one percent per year after 2010. As a result, the working age population is 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 populationwould 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 available each year during 2010-2030, tapering off to an annual decline of 20-25,000 workers by 2040-2050 (Figure 1.3). While this may eliminate the current unemployment problem in Bulgaria, it also implies that the labor force will have to go through a major upgrading of its education and skill levels, accompanied by large capital investments, to raise its productivity and bring Bulgaria's living standards to the average of those inother EUcountries. Figure1.3: MedianPopulationProjectionsby Age Group, 2005-2050 6oooooo ~ 5000000 4000000 m0-14 3000000 0 1 5 - 6 4 m65 + 2000000 1000000 0 2005 2010 2020 2030 2040 2050 Source: DemographicInstituteof BAS, Eurostat (2005) and UN(2007) 1.12. At the same time, the share of those aged 65 and above in Bulgaria will rise from 17 percent in 2004 to 26 percent in2050. Because the 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 ofthe current old people, but eventually themselves. They will not be able to expect generationsyounger than themselvesto take care ofthem, since younger generationswill be declining innumbers. EU8 refers throughout the report to the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, the Slovak Republic, and Slovenia. 4 1.13. The number of babies born each year is projected to 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 the low fertility rate reflects the unfavorable economic conditions of the transition, which are not expectedto last. However, even ifthe birth rate were to recoverto the population-stabilizingrate of 2.1-2.2 births per woman, makingit the highestin Europe, it would imply only getting back to the current number of babies born each year. Well before it affects the size of the labor force, this "baby bust" will have important implications for the school system. The numbers of children in primary and lower secondary schools are already declining and it is just a matter of a few years before upper secondary enrolments will be affected. Tertiary enrolments may escape the decline if access to tertiary level can be improvedthus raisingparticipationrates. Iv. OBJECTIVESOFTHE REPORT 1.14. This report aims to assist the Bulgarianauthorities in identifying options for policiesand reforms that would help to boost productivity and employment and thereby economic growth and income convergence. To achieve this, the report looks at Bulgaria's product and labor markets, human resource development, and R&D and innovationsystem. The reform options are arranged along a time dimension, rangingfrom short to mediumterm. The implicationsof the proposedpolicy options for the government's budget are also briefly explored, includingthe utilization of EUgrant funds. 1.15. This report concentrates mostly on the supply-side aspects of Bulgaria's product and labor markets, its education delivery, and its R&D and innovationsystem. A companionpiece, the Investment Climate Assessment, which is being carried out in parallel, deals with the demand side and, using firm data, identifiesthe binding constraintsto productivity growth from the firm perspective. While there is necessarily some overlap, the two reportstogether are designedto providea more comprehensive view of the optionsto tackle the challenge of boostingproductivity. 1.16. 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 Memorandumof 2005 and the Public FinancePolicy Review of 2006'. This study is also closely linked to the World Bank study that benchmarked Bulgaria's product market regulations using the OECD methodology.8 The benchmarkingresults have been partly utilized in this report, alongwith some of the prior work carriedout by the World Bank on education. Inadditionto the areas covered in this report, other factors, such as adequate provision of infrastructure,are important for the quest to raise productivity. However, since they were already covered at least partly in earlier reports, they are not includedinthe currentreport. 'World Bank (2005b), Bulgaria:The Roadto SuccessfulEUIntegration-The Policy Agenda, ReportNo. 34233- BG., and World Bank (2006) Bulgaria Public Finance Policy Review: LeveragingEU Funds for Productivity and Growth. De Rosa, Fay, and Ilieva (2006), "Product Market RegulationinBulgaria:A Comparisonwith OECD Countries." The World Bank. 5 6 2. TACKLING THE CHALLENGE OF INCREASING PRODUCTIVITY 2.1. As stated in the previous chapter, to close the income gap and converge, Bulgaria needs to raise both employmentandproductivity growth. While employment has grown strongly in the past few years, its expansion has a limit, in particular as the working age populationkeeps shrinking. For some years there is still significant roomto raise the labor force participationand employment rates, and that indeed should be done. However, once the remaining labor reserves have been mobilized, further growth in GDP can be sustained only through growth in productivity. Therefore, tacklingthe challenge of increasing productivity is becomingurgent. 2.2. Sincethe onset of the new millennium,transitioneconomies likeBulgariahave faced a significantly changedglobalenvironment. The dimensions of change includeglobalization,the emergenceof knowledge as the driver of economic growth, andthe "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 competitivecapacity 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 of these trends. To keep up, it must adapt, and inthe processraise the rate ofgrowthof productivity. 2.3. Innovation-defined 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^.^ This will include above all the provisionof incentivesfor increased labor mobility, which is currently weak, but would be essential for the growth process. Incentives for investing in R&D and human capitalwould also be central. 2.4. The areas central to productivity growth and on which Bulgaria would need to focus on include the following: 2.5. Investment in R&D: 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 innovationis oftenconsideredto be investment inR&D, largelyby the privatesector. Available empirical evidence suggests that R&D investments have a positive impacton productivitygrowth." R&D enhances technology transfer by helpingfirms to learn about advances at the technology frontier. For example, a 9 For a review on current thinking on growth see for example, Rodrik, ed. (2005) In Search of Prosperity; and Aghion (2006) "A Primer on Innovationand Growth", BruegelPolicy Brief, Issue 2006/06, October. lo See for example Lederman and Maloney (2001) "R&D and Development." Policy Research Working Paper No 3024, the World Bank. study on OECD countries" shows that countriesthat are behindthe world technology frontier can grow 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 replacement by entirelynewtechnologies. 2.6. However, while R&D investments are important, they alone are by no means enough to foster productivity growth. Above all, it is necessary to create micro and macro-economic conditions that enable innovation and technological progress. These include promotion o f (i)competition in product markets; (ii)flexible labor markets; and (iii) an educated labor force. 2.7. For Bulgaria,these other areas are the more pressing priorities, and warrant most attentionin the short run. In Bulgaria, it is the adoption of existing technologies-that is, imitation-that primarily matters at the moment. In general, Bulgarianfirms are not yet at the frontier of technology, but should strive to move there over time. Their immediate task, therefore, is to acquire and put to use the best technologies available, while also building capacities for the creation of new ones-that is, moving beyondthe adoption stage. For this to happen, it is vital for Bulgariato have in placethe basic micro and macro-economic conditions. This includes above all promotion of competition, flexibility in labor markets and a topnotch system of general as well as vocational and lifelong education. Measures that would support these would also go a longway towardshelpingdevelopa stronginnovationenvironment. 2.8. Product Market Regulation: Unhindered entry, exit and turnover of firms are crucial for productivity rowth. Firms have little incentiveto adopt new technologies, if they are not challenged by competition.19 Regulations limiting entry may hinder the adoption of existing and new technologies, as well as technology spillovers by 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 rapid productivity growth, while also promoting employment growth. 2.9. Flexible Labor Markets: Recent research indicates that product and labor market policies are complementary. Therefore, improvingthe functioningof bothmarkets inparallelis likely to have a much greater impact on productivity growth, than improvements in each of the two markets alone. The evidence from OECD countries suggests that countrieswith restrictive product market policies also tend to have restrictive labor market policies, and vice versa.I3 Effectively functioning and flexible labor markets are essential to the quest to raise productivity as well as employment, since they are the critical link in ensuringthat 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 notjust labor mobility but innovationand productivity growth, since they make it hard for a firm to move to a new activity and adopt a new technology. Thus, further enhancement of labor market flexibility would need to be I'Griffith, Redding, and 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. l2Recent economic researchsuggests that there is an invertedU-relationshipbetweencompetition and innovation: while too little competitionleads to no innovation,too much competition can discourage innovation since firms are not able to reap the benefits of their efforts. See Aghion, Bloom, Blundell, Griffith, and Howitt (2002) "Competition and Innovation: An Inverted U Relationship." Working Paper 9269, National Bureau of Economic Research. l3Nicoletti and Scarpetta (2005) "Product Market Reforms and Employment in OECD Countries", Economics DepartmentWorkingPaperNo.472, OECDandthe WorldBank. 8 considered in Bulgaria to promote convergence. This is particularly important in Bulgaria where the reallocationof labor across sectors is still rather slow, andwould needto be increased. 2.10. Equipping the Labor Force with Relevant Skills: Finally, having a highly skilled and technically savvy labor force is also essential to effective adoption and adaptation of new technologies, and becomes increasingly important as a country moves closer to the technology frontier. Existing empirical evidence indicates that skill compositionof the labor force matters for innovation-an increase in the stock of skilled labor is positively correlated with innovation effortsI4, and a more educated labor force is quicker in adopting new techn01ogies.l~Research indicates that tertiary education investment increases a country's ability to make leading-edge innovations, while primary and secondary education impact the country's ability to implement existing technologies.'6 The fact that in the age of globalization, knowledgeis becomingan increasingly important driver of growth, further emphasizes the importance ofhigher education. 2.11. Thus, it is secondary and tertiary education that are critical for productivity growth in Bulgaria. In addition to tertiary education, this report covers both general secondary and vocational education and training. However, since none of these education institutions would be effective without strong primary feeder institutions,the reform of primary education also matters. For that reason it is also covered in this report even though reforms in that sector are well on the way and the report is mostly a summary of what is already happening. 2.12. Changes in these various areas are likely to affect productivity differently. Labor and product market reforms can be expectedto promote labor mobility, and aggregate productivitygrowth can increase, if workers move from lower to higher productivity sectors and thereby improve resource allocation. Reforms in these areas are also critical for employment generation, which can also increase aggregate productivity growth by improving resource utilization. However, in addition to raising aggregate productivity,R&D, education, and liberalizationof product marketshavethe potentialto increase the rate of growth of productivity. This shift allows any given level of productivityto be achievedmore rapidly. It is this that Bulgariashouldbe aimingfor, ifit is to achieve faster convergence. 2.13. Chapters that follow examine the situation and challenges in each of the sectors and offer some options for reform. Chapter 3 looks at rigidities in product market regulation which if reduced would raise efficiency and lower the costs of production. The chapter lays out the main channels throughwhich this mightbe accomplished. 2.14. The labor market connects the demand for a whole range of skills with the supply of these skills. Iflaborproductivity is to be raised, the labormarketmust be efficient inreallocatinglaborfrom lowerto higher productivity areas. It must achieve that in a constantly changing environment, so it must be flexible. Optionsto improve labor market functioning are covered in Chapter 4. 2.15. Chapters 5 through 7 deal with the accumulationof humancapital in a number ofways. Chapter 5 covers the ongoingfinance and governancereforms in primaryand general secondary education. Chapters 6 and 7 examine the quality of vocational education and training as well as the quality of and access to tertiary education, with a particular focus on how well and efficiently the relevant institutions are l4See for example Grossmanand Helpman(1991) Innovation and Growth in the Global Economy, Cambridge, MA, MIT Press. IsNelson and Phelps (1966) "Investment in Humans, Technological Diffusion and Economic Growth," American Economic Review, 56(1/2), 69-75. l6See Aghion (2006) "A Primer on Innovationand Growth", BruegelPolicy Brief, Issue2006/06, October. 9 preparingthe students for the demands of today's private businesses and public institutions. Reforms in these sectors could lead to major improvements in the use of public resources for creatingthe needed humancapital. 2.16. Chapter 8 covers the Bulgarian R&D and innovation sector, both in terms of its size and its effectiveness. Chapter 9 maps the sector program options into four core messages that relate to the achievement of the twin objectives of raising employment and labor productivity. Finally, Chapter 10 linksthe proposedreforms with the budget. 10 3. IMPROVINGPRODUCTMARKET REGULATIONI7 3.1. Competition in product markets provides incentives to firms to reallocate resources to more productiveactivities, increase innovationandtechnologicaldiffusion. Inthe process it raises productivity. In addition, less restrictive regulations may help increase employment by reducing the rents that some firms extract from overregulationand force firms to expandtheir activities.I8 Unhinderedentry, exit, and turnover of firms are crucial for productivity growth. Bulgaria's productivity growth has indeed been fastest in sectors most exposedto competition. 3.2. The analysis in Chapter 3 of the main report shows that over the last few years Bulgaria has improved the regulatory environment for doing business. In some areas of product market regulation Bulgariaperformseven betterthan the OECD average. Areas in which Bulgariaoutperformsthe OECD average (see Figure 3.1) 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. Figure 3.1: Convergence to Best Performers in Product Market Regulation: Areas of Bulgaria's Relative Strength I E! Distancefrom OECD average 3'61 HDistancefrom OECD best performer -1 J Antitrust Discrim. Commun.B Legal Regulatory Licenceand Price Scope of Tariffs exemptions procedures simpiif. barriers barriers permits controls public sector Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD countries, de Rosa, Fay, an 1 Ilieva, World Bank, (2006). Note: The values are for 2006 for Bulgariaand for 2003 for all other countries. Distancesare calculated as the difference between Bulgaria's scores and those of the comparator group. Negative values show better performanceof Bulgaria, while positivevalues show worse performancerelativeto the comparatorgroups. 3.3. Areas, in which Bulgaria is comparable to the OECD average, or at least not seriously lagging, include: price controls, the scope of the public enterprise sector, and tariffs. In all other areas Bulgaria l7 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 o f this benchmarking exercise for Bulgaria and a detailed description o f 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). I SConway, Janod, andNicoletti (2005). significantly lags the OECD average (see Figure 3.2). 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 licensingand permits and legalbarriers. Bulgariathus standsto gain from further easing of its product market regulations. In addition, comparison of 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 of the OECD countries (Figure 3.12 of the main report)that have succeeded in reducingby half the duration of registration procedures and the cost to register a company between 2003 and 2006. Progress in Bulgariahasbeenmore modest. Figure 3.2: Distance from Best Performers in Product Market Regulation: Areas of ODi8tanCe from EU8 best performer 1.6 1.0 0.6 0.0 --r -r 1 Size o f public Ownership barrier8 Direct control over U8e o f command 8 Sector 8pecific sector bU8lneS8 control regulation admin. burdens Source: 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 performance relative to the comparator groups. 3.4. The methodology for benchmarking product market policies used in this analysis does not allow comparison of another important complement of regulatory quality-the functioning of institutions, includingthejudiciary. Nevertheless, a number of internationalcomparative studies (see Chapters 3 and 9 of the main report) suggest that Bulgariawill needto further improve the functioningof its institutions to ensure that institutionshaveadequatecapacityto enforce better regulations. I. BENEFITSOFREFORM 3.5. The benefits to be gained by Bulgaria through actions to further deregulate its markets are potentially large. The rate of growth of labor productivity could increase by 1.4-1.6 percent per year, if the regulatory environment was further freed up to the standards of OECD's best performers (US, Canada, UK, Australia, and New Zealand)." With Bulgaria's product market regulationsin 2006 being slightlymorerestrictivethan Portugal and as restrictiveas Greece in 2003, the gains couldbe even greater (see Figure 3.3 of the main report). Restrictive market regulations have also been found to have a negative impact on investmentsin ICT. Conway et a1(2006) estimatethat 12 percentof the cross country l 9Conway, et a1(2006) 12 differences in ICT investment in OECD countries could be attributed to differences in product market regulations. 3.6. Investment, both foreign and domestic, could also be expected to rise as a result of the easing of product market regulations. A study by Alesina et a1(2005) found that reducingbarriersto entry and the extent of public ownership in transport, communicationsand utilities could permanently raise the ratio of investmentto GDP by 2 percentage points. Another study by Nicoletti et a1(2003) estimatesthat inward positionsof FDI could rise by 60-80 percent in countries such as Greece, whose regulatory environment i s of a similar level of restrictiveness to that of Bulgaria. Finally, Nicoletti and Scarpetta(2005) show that lessening barriers to entry and state control in non-manufacturing services could increase employment rates by 2.5-5 percentagepoints. 11. OPTIONSFORREFORM 3.7. 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 performersexist in all but 4 of the 15 benchmarked policy domains (see Figures 3.1 and 3.2). To address them, both short and medium-termmeasureswould be warranted. 3.8. Inthe short term,the programshould, inthe order of priority, try to: 0 Minimize administrative burdens 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, even 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 required in 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 introduced in Portugal would be worth considering also in Bulgaria (see Box 3.1 of the mainreport). 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. Suchreformswould 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. Simplify 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, accordingto a 2005 survey, 27 percent 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 13 automatic licensingto simplify the system further and thereby facilitate business. This area of action couldalso includefurther progress inthe simplificationand communication of rules andregulations. 3.9. Inthe medium-term,the following steps couldbe taken to improvethe investmentclimate: e 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. A range of possible instruments is described in Box 3.2 of the main report. Authorities could also consider implementing a "regulatory guillotine" to eliminate unnecessary and burdensomeregulations. Zmprove 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 thejudiciary system in the country. Even ifsome regulationshave already beenoptimizedde jure, their actual implementationdepends on the quality of enforcing institutions. This may further increase the costs of regulation, if processes and procedures are cumbersome, or if they result in corruptionand/or anti-competitivepressureson selected firms and individuals. Bulgaria does not fare well in international comparisons in the quality of its governance framework. It ranks low in terms of the quality of institutionsin the Global Competitiveness Index, Transparency Index, and BEEPS indicators. Therefore, improving regulation of product markets in Bulgaria and reaping the benefits from this would hinge upon reforms aimed at upgradingthe quality of institutions. Furtheringreforms in public administration andjudiciary would maximizethe gains from better regulationof productmarkets in terms of higher productivity, innovation and technological upgrade of the economy, which are of importancein achievingthe goals ofthe LisbonAgenda. 3.10. Finally, being behind on the productivity ladder and behind best performers in product market regulation,impliesthat Bulgariacould reap high returns from reforms aimed at liberalizingthe business environment bothin terms of quality of regulationsand quality of regulatoryauthorities. These returnsto the society couldbe even higher, ifcombinedwith reforms that increasethe flexibility ofthe labor market that allow firms and individualsto allocate resourcesto their most productiveuses. 14 4. IMPROVINGTHE FUNCTIONING OF LABOR MARKETS 4.1, Recent cross-countryempirical analysis for OECD countries finds that restrictiveproduct market policies tend to go hand in hand with restrictionsin labor market policies.20Correlationbetweenproduct 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 to promote employment and productivity growth. 4.2. On the surface, Bulgaria's labor markets are doingwell. Employmenthas increased significantly in Bulgaria since 2002. Some 300,000 jobs were added during the period 2002-2005, bringing the number of employedto 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-term unemployed. If GDP growth continues at its currentpace, the unemploymentrate is soon likely to drop to under 8 percent. 4.3. Nevertheless, major challenges lie ahead. Employmentand 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 registeredunemployedand those who, for a variety of reasons, choose not to participate in the labor force. Unemployment remains high among youth and people with few skills and a low levelof education. Regionaldisparities in employmentsituationare significant. 4.4. Strong growth in employment in the past four years was mostly concentrated in less productive and lower paying sectors. Even there, the relatively high minimum wage may have dampened the demand for labor of the small vulnerable enterprises. At the same time, some sectors are reporting shortages of relatively high skilled workers, which would suggest a supply side problem. Also, on the labor supply side there may exist an unemploymenttrap, wherein relatively high social benefits, when compared to the likely after-tax wage, do not give sufficient incentive to some of the workers to seek employment. 4.5. But increasingemployment is only one of the objectives, although perhaps the most important one in the short run. The other objective is to speed up the rate of growth of labor productivity. A key ingredientofthat is high mobility of labor across sectors. Research reportedearlier pointsto a problemin this area. If it is not addressed, productivity growth, and with it GDP growth, are boundto slow down considerably,once the labor markettightens. Lack of labor mobility suggeststhat sectors with high levels and/or high growthof labor productivity have not beengrowingsufficiently rapidly-whether throughthe expansion of existingfirms or the entry of new ones-to demand newworkers. 4.6. Enhancingflexibility of labor markets-in parallelwith reducing barriers in product markets-is also important from the macroeconomic point of view. Given the Currency Board Arrangement, the 2o See Nicolettiand Scarpetta(2005). A summary indicator of labor market policies has been estimatedfor OECD countries, which includestax wedges, gross replacementrates, andemploymentprotection legislation.The indicator of product market regulation includesbarriers to entry, public ownership, market structure, vertical integration, and price controls insevenindustries-gas, electricity, post, telecoms, air transport, andrailways. adverse consequences of a macroeconomic shock on growth and employment can only be minimized through labor and product market flexibility and adaptability. 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. Constraints thus exist in both product and labor market areas, andthey needto betackled in parallel. I. BENEFITSOFREFORMS 4.7. Most of the benefits are the same ones that would come from reducing constraints in product markets. Higher investment and greater labor productivitythat would result from the reforms in product markets, when taken in parallelwith the reforms proposedfor the labormarkets, would increasedemand for labor, including for increasinglyhigher skilled and hence higher paid workers. Rough calculations presented in Chapter 4 of the main report suggest that if these reforms were taken, the Lisbon and Stockholmemployment targets of an employment rate of 70 percent overall and 60 percent for women couldbe reachedby 2015. To reach high rates of employment for young workers, older workers (55-64), and those with low educational attainment levels and those living far from the urban centers, may, however, take more effort. Some of the recommendations for the active labor market policies and lifelong learning presented below may be of particular importance for these groups. In addition, the reformoptions put forwardwould promote labor mobility. 11. OPTIONSFORREFORM 4.8. The 2006 EU Joint Employment Report highlightsthat a good balance between flexibility and security in the labor market, also referredto as "flexicurity", can be achieved by the interactionof four key elements: (i)sufficientlyflexible contractual arrangements; (ii)effectiveactive labor market policies; (iii)a credible lifelong learningsystem; and (iv) a modern social security systems. Bulgaria faces challenges in all of these areas. EU guidelines for employment policies suggest that member states should: (i)encouragejob creation by supporting entrepreneurship 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-trainingby employees; (iv) reform overly restrictiveemployment 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 eliminateundeclaredemployment. 4.9. Actions (i)and (ii)suggestedabove by the EUguidelines for employment policy are arguably the most important in terms of creating a strong demand for labor. They belong more to the overall business climate, and some aspects of them were discussed in the chapter on product market regulation. Actions covered by (iii)will be presented in Chapters 6 and 7 on vocational and tertiary education, although lifelong learning is covered here. The main focus of this chapter is on actions (iv)-(vi). The proposed reforms that the government may wish to consider inthese areas are listedbelow roughly in the order of priority and groupedinto short andmediumterm measures. 4.10. 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 Bulgarianlabor 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 network of adulttrainingcenters, VET schools and privateproviders, and other 16 alternative training opportunities. Also, their curricula need to be adjusted so that the certificatesobtained by their graduates at the end of their training are recognizedand valued by the employers. Many countries have established tax incentives to 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 contributionequivalent to 1S 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 competitiveness of SMEs, and the development of entrepreneurial skills are supported by grant schemes.21Although it may have budgetary implications,Bulgariamay also consider introductionoftax incentivesto stimulate lifelonglearning. Meetingthe training needs of employed individualsmay requirethem 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 introduced statutory or contractualtraining leave schemes that guarantee employees the right to return to their jobs after completing the training course, as well as institutional arrangementsfacilitatingaccess to training andeducation 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 make do withoutthem on a temporary basis). Revise labor legislation and regulations, while complying with EU requirements: Drafting a new Labor Code and revisinglabor 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 representativesof the employees-need to be given a greater role indeterminingemployment 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 protectionbecause, 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 renegotiate regulations that are particularlycostlyto them, but of less value to workers. Shqt the emphasis of active labor market programs (ALMP) to support job search and strengthen their monitoring and evaluation: NEA shouldretunethe structure and content of ALMPs, and increasingly shift resources from the job creation program to other ALMPs deemed to be more cost effective. These include, first of all, activation policies, such asjob- search assistance, counseling,job brokerage, and career guidance. Job seekers should have stronger incentivesto look for newjobs, even in other occupations and in other regions of the country. This would requirea more intensivefollow-up of the individual cases by the front- line social workers than at present. A large-scaledirectjob creation program i s justified at times of economic downturns, when aggregate demand is depressed and there are few 21See: (httD://europa.eu.intkommiem~lovmentsociaVemployment strategv/O4 national en.htm). 17 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 shouldbepossible, over the next couple ofyears, to carryout 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 youngworkers so that they do not turn into long-rununemployed. However, there is a needto modernize and strengthenthe administrativecapacity ofNEA 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 Bulgaria. The net impact of most ALMPs has not been assessed since 1999.22A net impact assessment 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). Inthe meantime, NEA canbeginto shift emphasisto programs, which experience has shown in other countriesto be the most effectivein reducingunemployment. Revisit the mechanismfor establishment of the minimum wage and its level: Current levels of minimum wages are high in Bulgariacompared to other transitioneconomies. 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 reducedover time. Currently, the minimumwages are set by the Council of Ministers. It may makebetter 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.23 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 Economic and Social Developmentuntil 2009. Also, while evidence is mixedon the impact of minimumwages on employment, it is fairly clear in the case of young workers. Creating sub-minimumwages for young workers or in economicallydepressed regions, 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 minimumwages) in an attempt to alleviateyouth unemployment. Revisit the current eligibility and entitlement rules of the unemployment beneflt: 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 proportionof the prevailingmarket wage of low skilled labor, or for job seekers who had low wages before losingajob thus giving less incentiveto the beneficiaries 22The net impact of most ALMPs in Bulgaria has been evaluatedonly once. In 1999the 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 unemployedhave on the primary labormarket. 23Currently, the thresholds for minimumsocial security contributionsare negotiatedbetweensocial partnersand the government by most branchesand mainprofessionalgroups. 18 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 unemploymentbenefits with ALMPs. Inparticular,NEA couldmonitor more closelythejob search efforts of an unemployed personusing individual action plans preparedfor particular job seekers and, if their efforts are found wanting, impose sanctions ranging from partial to total withdrawal of the benefits. Although same performance criteria-such as "availability for work", or evidence of "active job search"-are usedto 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 brokerageservices may help speeduptransitionsout ofunemployment. 4.1 1 In the medium term, the key actions to consider for increasing labor productivity and employmentwould be as follows: Reduce labor taxes further in a fiscally sustainable manner: According to the 2005 BEEPS survey, about six percent of the formal enterprise workforce and 13 percent of the wage bill is not reported. This combined with the still sizeable informal sector, means that 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, followingthe 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, includingfurther 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 minimizingthe 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 curriculaof training institutions. This process is in train but should be evaluated and adjusted in linewith 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, couldfocus 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 24Recently NEA launchedan employer survey to determine labor demand by professionsand qualification levels. 19 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, and projections of labor demand and supply. 20 5. GOVERNANCE AND FINANCEREFORMINPRIMARYAND SECONDARY EDUCATION 5.1. An important step in promotinglabor 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. Rather than protectingexistingjobs, policiesshould aim at equipping workers through education, on the job training, and lifelong learning for inevitable changes in the demand for labor, and thereby promotetheir adaptabilityand mobility across industries and sectors. While Bulgariahas a highly educated populationfor its level of income, that education does not necessarily translate into marketable skills. To raise labor productivity and mobility, Bulgaria would need to further upgrade its human capital by modernizing its education system. The next three Chapters of this Overview present the most important benefitsof goodperformanceinprimaryand generalsecondaryeducation(Chapter 5); vocational education andtraining(Chapter 6); andtertiaryeducation(Chapter 7), and identifyoptions for further strengtheningof education delivery. This chapter presents reform options for finance and governance of primary and general secondary education based on a more detailed analysis and discussion of the sector in Chapter 5 of the mainreport.25 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.26The Government's National Program for the Development of School Education 2006-20015 describes the current primary and general secondary education system as excessively centralized, and the legalframework as complex and inconsistent. Also, the current system of financing municipalities for the costs of managing schools does not provide incentives for efficient school management. Detailed norms about teaching hours and class sizes determine the number of teachers, and hence teacher salary costs, for which municipalities are then compensated. There is, therefore, little incentive or possibility 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. Currently, the bulk of education-related resources a municipalityreceives from the state go to pay staff, andthese funds are only looselytied to the number of students in the municipality. Moreover,the closingof a school can be postponedfor years, as municipal councils can simply choose to overrule the minimum class size requirements, and provide the gap in fundingfrom their own sources or postpone repair work. Inthis way, the current 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 declining. As a consequence, the decline in student numbers has not been followed by the expected proportionatedecline in the number of teachers. This, along with risingteacher salaries, has helpedpush upreal costs per student. 25This 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, Rosalind LevaEiC, Nickolay Mladenov, Juan ManuelMoreno and ReemaNayar. The authors expresstheir gratitude to StoyanBaev fiom the National Statistical Institute for preparing extensive datasets with school-leveldata. 26The 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 (2005~)"Bulgaria-Education and Skills for the Knowledge Economy", Policy Note. 5.3. Shiftingto per student financing (unified standardper student), delegated school budgetswith the allocation between salaries and other expenses left for the school, and school-based management are considered as some ofthe key levers to address these problems. The underlyingpremise is that the current spending pattern is inefficient, and a lot more could be done within the existing budgetary framework, with efficiency savings to be allocatedto improvements in quality. The three-pronged approach would also be able to adjust bestto the problems createdby shrinking student cohorts. I. BENEFITSOFREFORM 5.4. The goal of the reforms is to increase the quality of education, raise participation rates by ensuring equitable access for to all, and increase the efficiency of resource use. The initiation of the school governance and finance reform in primary and general secondary education opens an opportunity to promote long-termreforms improving access to and quality of education. First, the reform agenda, if sustained, would lead to a more efficiently managed school system with greater quality orientationthan before, in particular if coupled with the introduction of internal and external assessments of learning outcomes to promote achievement of nationaleducation standards. Second, providedthe reforms lead to school consolidationand adjustment to the size of the staff, there could be substantial efficiency savings amounting to BGN100 million per year. These savings would open the possibility of financing in a sustainable manner measures aimed at achieving improvededucation outcomes, and needs in other parts ofthe education system. 11. OPTIONS FORREFORM 5.5. While the government has already shifted to per student financing for primary and general secondary schools on January 1 of 2007, further policy steps inthe financing and governance areas would still needto be taken. The remainingshort and medium-termreformoptions can be grouped as follows. 5.6. The four keyshort run policy steps and recommendationswould be: 0 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 of the school network. Therefore, ensuring that school consolidationhappens is critical. The government would need to announce a credible timeline for the roll-out of 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 those municipalities which proceed with the consolidation of their school systems. In addition, hands-on advice to municipalities on how to manage consolidation would be helpful. Several municipalities have gained experience in school consolidationover the past years, and MES could promote peer learning activities among municipal authoritiesjointly with the National Association of Municipalities. This support and advice would need to be availablethroughoutthe reform period. Monitor the impact of reforms, and introduce external evaluation of learning outcomes: It is essential that the roll out of the reforms andtheir impacts are closely monitoredand, 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 importantto monitor that municipalities treat all schools equally and fairly in their funding allocations, in particular prior to the roll-out of delegated budgets to schools. In parallel, the Ministry of Education and Science (MES) capacity to monitor education outcomes would need to be strengthened through the introduction of 22 nationwide external testing to determine learning outcomes, and through its management informationsystem. MES has already conducted pilot student assessments and will phase in systematic externaltestingover the comingyears. Relax central regulations on teaching hours and class sizes: The per student formula funding, and rigid top-down regulations regardingteacher 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 i s recommendedthat MES leaves the class sizes for municipalitiesto decide, andrelaxes regulationson teachinghours. Implement school-based management and delegated budgets: Per student financing enhances efficiency and quality only if it is accompanied by an expansion of school-based management and further delegation of 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 of the shift to school-based management, capacity building for school directorsand municipaleducation department staff will be needed, including on budgetary issues and determination of the delegated budget formula. MES has recently established an Institute of School Directors for this purpose, and a number of school principals have already been trained. In the meantime, however, MES should not hold off delegatingresponsibilitiesto directors, as the most importantlearningwill happen on the job. When shifting to school-based management, introducingperformance- related pay scheme for teachers might also be contemplated: school principals, who are accountable for quality, would need means to evaluate teachers and influence teaching quality. MES is also promoting the establishment of school councils comprised of 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, providedthey are empowered and given full information. 5.7. The key medium-termpolicy step would be; Reinvest savings in measures aimed at promoting quality of education and access: The introduction of per student formula financing, if it leads to the consolidation of the school network, can yield substantial savings. Since consolidated spending on education as a share of GDP is projectedto remainconstant inthe 2007-2009 medium-termfiscal framework, this implies that a growing share of the education budget can be reinvested in other education system needs, including policies to enhance education access and quality. In addition to the needs in the vocational and tertiary education side, this could include teacher training, external assessments of schools to promote school and teacher accountability, and pre- primary education to promoteschool readinessand reduce subsequentdrop outs. 23 24 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 of the vocational educationand training(VET) system and its institutions,especially the publicvocational secondaryschools. These schools were establishedto serve the needsof centrallyplanned economic sectors of production, such as mining, ore processing, chemical and oil products, and heavy machinery-that is, sectors that have suffered major downturns in their share of productionin the past ten years. The old VET system was also designed to serve the needs of 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 opportunitiesfor practical traininghavebecome limited. Vocational secondaryschools still focus on programsdesignedto servethe old economic sectors, such as forestry, wood processing, and chemical, metallurgical, and machine technology. However, the new emergingeconomy is dominated by private smalland mediumenterprises (SMEs) in light industries and service sectors, and the needs of these enterprises are quite different from those that prevailedinthe old one. 6.2 Duringthe transitionperiod, the labor market has experienced disequilibrium,and there is general consensus among officials and representatives of employers association^^^ that the knowledge and skills of the graduates of vocational secondary schools do not match the skill set required for the emergingjob vacancies, despitethe relatively low unemployment rates among its recentgraduates in 2005. The situation is further aggravatedby negativepopulationgrowthrate andemigration. 6.3 With this in mind, the Council of Ministers approved in 2001 the Employment PromotionAct (EPA, 2001), which introducedincentives for employers to traintheir employeesand maintainand improve their qualifications.28 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 educationand trainingprovidedfor the needs of the labor market, and in accord with the trends in the European Union".29 Since then a National Agency for Vocational EducationandTraining(NAVET) has beenestablished, which is in charge of licensingVET providersand the classificationof occupations. Amendments to the VET Act were introduced in 2003 and 2005 to approve a new list of professions and framework programs regulating the acquisition of vocational qualifications. The Bulgarian approach in defining qualificationlevels and professionalcompetences is consistent with the approach developed by the European Qualification Framework and is based on knowledge, skills and personal qualities required for the profession. In 2005, consistent with European directives,progresswas made inthe mutualrecognitionofvocationalqualifications. These developments notwithstanding,there is still significantroomfor improvement inthe system as a whole. 6.4 As detailed in Chapter 6 of the main report, the VET system in Bulgaria streams students into vocational schools and designated occupational areas before the end of the compulsory education. Students streamed narrowly early in their education are harder to reorient than their contemporaries in general secondary education when they become unemployed, because of their weak general educational 27Suchas the BulgarianChamber ofCommerceandIndustries,the BulgarianIndustrialAssociation, andthe Bulgarian Small andMediumEnterprisesAgency. 28EPA regulatesthe types of continuingVET organizedbythe NationalEmploymentAgency, andthe conditionsof its delivery. 29Republic ofBulgaria-Councilof Ministers, "National Strategyfor ContinuingVocational Training, 2005-2010". 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 of compulsory general education, roughly at age 16. Many OECD countries have also been exploring the development of flexible educational pathways in upper secondary education, which allow the integration of relevant generic vocational skills in all secondary schools, in order to respond to the needs of a diverse student population, and changes inthe nature of work. This is what the EUBologna process is also aiming for.30 To achieve that typically requires reducing the number of vocational education programs by broadening the definition of vocational areas; creating linkages between general and vocational secondary schools; developing a combination of school and work-based learning; and building bridges between vocational secondary education and tertiary education. 6.5 Early introduction of VET at the secondary school level is also costly. 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. However, the unemployment rates of graduates of secondary vocational schools have been consistently 1-2 percentage points lower than those of their general secondary school counterparts. 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 of either type. Those skills are increasingly in 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 of curricula inthe remaining vocational schools at the secondary level. 6.6 Further, Bulgaria has a fairly small alternative sector of tertiary education, which may partly explain the low overall tertiary enrolment in Bulgaria compared to other EU countries. The sector consists of two public and nine private colleges, which enrolled only about 3.1 percent of all tertiary students in 2005. In addition, Bulgaria has a large number of post-compulsory, and specialized vocational colleges. This is in stark contrast with other EUand OECD countries, most of which have significant and strong alternative sectors of tertiary education, with enrolments ranging from a minimum of 16.4 percent of total tertiary enrolment in Finland to about 40 percent in Australia, Canada, Ireland, and Spain. All EU8 countries and Romania have alternative tertiary institutions and colleges with larger relative enrolments than Bulgaria. Academic programs offered by these institutions are typically vocationally and occupationally oriented, which differentiates them from universities. For that reason it is covered in this chapter on VET. I. BENEFITSOFREFORM 6.7 The proposed reforms would create a VET system that would be more responsive to the emerging labor market demands by giving a wider general education to VET graduates as well as providing them with various avenues for rejoining the more academic streams should they so wish. The system is also expected to be more cost effective. 30In 1999 the EU launched 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. 26 11. OPTIONSFORREFORM 6.8 High quality vocational education is needed to promote adoption of existing technologies and promotionof labor productivity. To movethe BulgarianVET 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 adaptabilityand mobility across sectors and industries, the government may wish to consider five short and medium-runreformoptions. 6.9 In the short run, the government would be advised to pursue the following financing reform to promote the efficiencyofVET: Introduce per student jkancing to VET: To provide incentives for improvements in relevance and for cost control,the ongoinggovernance and finance reforms at the primary and general secondary levels could be extended to vocational secondary schools. This would includethe shift to per student financing and delegated budgetsto schools. The process of the reform extension, and revisions that might be required compared to primary and general secondary schoolswould needto beworkedout andrequirefurther analysis. 6.10 To promote labor adaptability and in Table 6.1: AlternativeSector in SelectCountries(2004) response to market needs, it is Gross Percentageof Enrolment in: critical that all students are Enrolment Rate University Sector Alternative Sector equipped with basic general Australia Canada 46.4 59.9 40.1 49.2 60.5 39.5 education, and the education Finland 64.6 82.6 16.4 System provides options for France 40.0 72.0 28.0 continued lifelong learning. To Ireland 42.2 62.7 37.3 shift the Bulgarian VET system Norway 40.7 78.1 21.9 into that direction calls for Spain 31.1 56.9 43.1 broader structuralreforms in the Bulgaria 25.7 96.9 3.1 medium term. The four key Source: OECD Statistics 2004. Tables C6.1 andA3.0 medium-term reformoptionsthe authoritiesmay want to consider are the following: Start vocational secondary education only after the completion of compulsory education: Following the example of other EU countries, Bulgaria would be well advised to delay the streaming of students into VET until the completion of compulsory education. Students streamed early in education are hard to reorient when they become unemployed, because of 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. In parallel, develop curriculafor the remaining vocational secondary schools that balance vocational and general studies. The curricula would need to emphasize occupationally- oriented skills and competencies as well as strengthening the core of natural and social science, mathematics, foreign language, and the applied dimensions of this knowledge.This would imply increased integration of the curricula of the vocational and general secondary schools. The aim would be to ensure strong general education of vocational students, which would enhance their adaptability and readinessfor continuedlearning. Establish Occupationally-Oriented Regional Colleges: In today's world, increasingly sophisticated skills are required even in many vocational occupations. As Bulgariaclimbs up the technology ladder, the demandfor peoplewith occupational skills andeducationbeyondthe 27 vocational secondary can be expected to rise. To strengthen the existing alternative 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 of the institution, quality of its human and physical resources, and relevance of its programs to the needs of 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 inother 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 of 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 of 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 of these institutions can, after a period o f employment, or immediately after completing their sub-degree studies, continue their studies towards a universitydegree. 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 of each. Figure 6.11 shows in turn an example of the relationship among the various occupations in the construction sector in terms of the type and duration of studies at the secondary andthe tertiary levels, and the corresponding occupational categories. Establish a National Qualification Framework and Authority to Strengthen Life Long Learning: If the proposed occupationally-oriented regional colleges were established, it would be important that aNational 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 of a National Qualifications Authority (NQA), based on other similar existing successful 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 of the standards for education and training awards in all institutions (secondary, alternative tertiary, universities); (iii)the promotion and facilitation of 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 of such a framework that adopts the guidingprinciples of the European Qualification Framework. 28 7. STRENGTHENINGTERTIARY (HIGHER) EDUCATION 7.1 A modern knowledge-economy needs an adequate supply of skilled educated workers, and the bulk of workers are expectedto havetertiary education. There is extensive evidence that effectivetertiary education investment increases a country's ability to make leading-edge innovations. Highly skilled people are also usually adaptable in the face of changing labor market needs. Further, tertiary education and researchare amongthe key elements to promote European integration:throughprovisionof skills and knowledgethat promote labor mobility, and through participationin the EuropeanHigher Education Area (the Bolognaprocess) and the European Research Area. Bulgaria should follow these trends and take measures to increase the quality, efficiency and effectiveness of its tertiary education to promote productivitygrowth. 7.2 Tertiary education institutions are facing the challenge of adapting themselves to the multiple demands from stakeholders: students for the high quality education, employers for the relevance of education to their needs, and the government for accountabilityof the public resources allocated to the tertiary institutions. Institutions of 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, andthe advancementofknowledge. 7.3 Tertiary education participation rates in Bulgaria are among the lowest in EU. With the EU accession it becameeasier for Bulgarianstudentsto study abroad, which can be expectedto have a further adverse impact onthe tertiary participationratesunlessaction is taken. This is in stark contrast to the rises in participationrates in most EU8 countries (especially Hungary and the Baltic states), and the continued gradual growth in tertiary enrolment in EU15. This would need attention. Tertiary education is an important determinant of individuals' earning capacity and employment prospects, and therefore plays an important role in determining the level and distribution of income in society. In most developed and transition economies, the wage premium earned by the graduates of tertiary education compared to the graduates of upper secondaryeducation are substantialand increasingwith work experience.The graduates oftertiaryeducationalso face a lowerrisk ofunemploymentthanthosewithout tertiary education. 7.4 The present disjointed admission process is an obstacle to improved access to higher education. Currently, each university sets its own standards, entrance examinations, and criteria for admission, and studentshaveto take differententrance examinationsfor each ofthem. 7.5 Bulgaria's tertiary education system is currently characterized by a large number of small single discipline universities and institutions, some of which are serving sectors of the economy that have become less relevant in the past decade. This is a concern not just from the fiscal point of view, but above all for quality and effectiveness ofR&D. The large number of smalluniversitiesmeansthat a large share of university funding goes to overhead costs to finance administration, which implies that less is available for equipment and materials, with adverse implicationsfor quality. It also preventsraisingthe student-facultyratios, which at 10:1are much lower than in other EU countries. Further, from the R&D point of view, a critical mass of researchers, usually across disciplines, would be required, which could not be assembledinsuch smallsingle disciplineinstitutions. 7.6 Bulgarian universities have significant autonomy without adequate accountability. Since universityrectors are chosen by the faculty, each of them is essentially aprimus-inter pares beholdento the academic colleagues who elected them. Most of them, when newly elected, do not have relevant management experience or training to manage the complex enterprises that modern universities and colleges have become. To exacerbate the problem, the evaluation and accreditation of universities and their programs are carriedout by academic peers. 7.7 Tertiary education in Bulgaria is largely financed by the state, with nominal tuition fees in practice, and relatively long study periods. Compared to other EU countries, public spending per full- time tertiary student is relatively high in Bulgaria. To provide incentives to improve quality, and efficiency of resource utilization would require increasingthe competition for finding amongthe tertiary education institutions. 7.8 Finally, the often heard complaint in Bulgaria about the lack of relevance of programs, knowledge, and skills universities and tertiary institutions impart to graduates, is partly the result of the current divide between universitiesandtheir externalenvironment. The faculty and rectors of universities have had little experience in seeking advice from the private sector on the structure and content of academic programs. Lack of relevance is also attributable to the limited institutional diversity, which constrains as well enrolment growth in priority areas such as science, technology, and engineering. I. BENEFITSOFREFORM 7.9 Research indicates that effective tertiary education investment increases a country's ability to make leading-edge innovations. Highly skilled people are also usually more adaptable in the face of changing labor market needs. Bulgaria should follow this trend and take measures to increase the efficiency andeffectiveness of itstertiary educationto promote productivity growth. 11. OPTIONS FORREFORM 7.10 To address these issues and to strengthenthe overall performance of the tertiary education sector and facilitate R&D, Bulgarianauthoritiesare in the process of preparinga new higher education strategy. The aim of the strategy is to improvethe 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 of university R&D. Initial steps have already been taken inestablishingthe Maturaas the universityentrance examination. Infinalization ofthe strategy, the government may want to consider a set of short and medium-termreform options. There is no single measurethat alone would fix the system. 7.11 In the short term, the following four reform options may be considered, in the order of priority. Of these recommendations, the first two options would be the most critical ones for improvement of the performance of universities: Base thefunding on actual student enrolments: To promotecompetitionamong universities and thereby provide them with incentivesto improve quality and efficiency, as thefirst step the current funding formula could be adjusted so that instead of enrolment targets, the subsidy is based on actual enrolments. This change in the formula is critical to promote competition and influence incentives. However, over time this kind of 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 mediumterm, as outlined below. Strengthen university governance through the establishment of Boards of Trustees and a Tertiary Education Council: To enhance accountability of universities in terms of quality, relevance of programs, and use of resources, the Bulgarian authorities may consider instituting a contemporary governance structure for tertiary education, embodying many of 30 the reforms adopted in other EU or OECD countries. The governance reform would have two parts: First, change the role of government in tertiary educationfrom directing and managing the system to that of "steeringfrom a distance". This change would requirethe establishment of a Council of 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 oftertiary institutionsand colleges. These two councilswould develop the appropriate policies relevant to their sectors. Figure 7 highlights the proposed revised governance framework. The Council of Tertiary Educationwould replace the existingCouncilof Rectors. It would be an independent body mandated to develop and implement a national strategy- and relatedpolicies-in tertiary education, and ensure that the practices of tertiary institutions comply with them and serve the public interest.31The 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 of tertiary education policies in Bulgaria. Lessons learned from the experience of OECD countries that have introducedsimilar reforms over the past decades show the importance of such a two-tier governance structure. The linkages between the councils and other tertiary education bodies would need to be determined duringthe preparationstage. Universities // \ \ New Tertiary Institutions * Council ofTertiary 1 University Boardof1 Institution Second, establish a Board of Trusteesfor each university/ertiary institution and have them appoint the heads of institutions. The Board of Trustees would govern the affairs of the universityhertiary institution by: (a) developing broad administrative and management policies for the institution; (b) providing broaddirection and coordinationto the development of academic programs; (c) overseeing the efficient management of funds, property, facilities, and investments; (d) appointing the rector, as a chief executive of the institution; and (d) 3 1In other countries, a typical Council consists of 15 members; 9 (5 senior public sector and 4 private sector representatives) appointed by the Government, and 6 members representing the university council and the tertiary education council. In most countries, the Chair of the Council is a private sector representative appointed by the Government. 31 determining the representation of the institution on the Council of UniversitiedTertiary ~nstitutions.~~ MES has recently proposed to establish Boards of Trustees, but only with an advisory function and with membership consistingprimarily of faculty members. The implied lack of authority and the composition of membership are concerns. While these Boards, once in place, might be upgraded and provided proper authority, the concern is that until then as proposed they would simply further entrench the existing interests. This could tarnish the whole Boardconcept andmake further adjustments unfeasible. Strengthenlinks with labor markets: The relevance of tertiary programs could be enhanced by strengthening the links to employers. In many countries such links include work placement of students with private and public sector employers during their studies, and setting up strong professional orientation programs and services. These measures give the employers an opportunity to assess the knowledge, skills, and competencies of 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 includeemployerrepresentativesin sectors such as engineering, engineering technology, business, or medicine. The mandate of the proposed PACs would include: (i)validatingmarket intelligenceabout the existing and future demand for graduates of various disciplines; and (ii)providing advice on the knowledge and skills needed by employers. PACs and similar committees are used successfully in many EU countries, UnitedStates, provincesin 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 of the Center for Control and Assessment ofthe Quality of Education(CKOKO) to managethe Matura. 7.12 In the medium term, 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 of priority. Increase tuitionfees, establish a student loan scheme, and review scholarshipprograms: As the second step of financingreform, to provide incentivesbothto universitiesand students to perform, it is recommended that the tuition fees are raised to the maximum level of 30 percent of the actual tuition cost per student, that is, to the maximum permittedby law. In parallel, to ensure that the access to universities will not be unduly affectedby the increased fees, a means-tested and/or income-contingentstudent loan system would need to be rolled out together with a revised policy of existing scholarship programs to target qualified low income students and to encourage enrolment in public or private tertiary institutions. Taken together, these reformswould: (i)augment sector financing and potentially expand access and make it more equal; (ii)provide incentivesfor students and their parents to demandvalue for their money, and press for quality improvements; and (iii)improve graduation rates and 32In other countries,the Boardof Trustees is typically composed of 15-20 members, dependingon 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 and represents the key internal stakeholdersof the institution: faculty, students, academic managers, staff, and alumni. The chairofthe boardis usuallyappointedbythe government fromthe rosterofappointedmembers. 32 throughput, since students who pay or borrow money are likely to be more vigilant about their studies. Introduce a performance-based component to tertiary institutionfunding: As the$final step of financing reform, the authorities may want to consider introducing a performance-based component to tertiary funding, initially equivalent to 10 percent of the total state fundingto an institution, but increasing it to 20-30 percent over five years. The performance-based component would be dependent on the performanceof the institutionin the previous year, or the movingaverage of the two most recent years. Performance could be assessedusingkey performance indicators (KPIs), which would measure the success of the institution in achieving the agreed outcomes, including cost-effectiveness of education delivery.33 This step would provide further incentives to universities to improve quality, and avoid delaying student completionor focus on low cost programs, ifKPIs are appropriatelyselected. Consolidate universities and tertiary institutions: As discussed in this chapter, the large number of small, single discipline universities is a concern notjust from the fiscal point of view, but above all for quality and R&D reasons. The large number of small universities means that a large share of university funding goes to overhead costs to finance administration,which impliesthat less is available for equipment and materials, with adverse implicationsfor quality. Further, from the R&D pointof view, a criticalmass of researchers, usually across disciplines, would be required, which could not be assembled in such small institutions. Australia and Hungary provide examples of 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 comprehensiveinstitutions. In Bulgaria, the government may consider merging some universities to create a smaller number of comprehensive universities with larger average enrolment than at present. The aim would be to reduce the number of small, specialized universities, and increase the student-facultyratioto about 16:1 inall universities.An exampleofthis kindof consolidation would be the establishment of a second comprehensive multi-campustechnicaluniversity in Sofia by clustering the specialized small institutions of architecture, civil engineering and geodesy; chemicaltechnology and metallurgy; forestry; mining and geology; transportation; and civil engineering. The consolidation or merger of universities is a classic example of changemanagement involvingstrongvestedinterest. Hence, it would needto bemanagedby capable change managersusingfair andtransparent criteria. The benefits ofthe consolidation or mergers would need to be articulatedto all affected parties, especially to the university faculty andrectors. Strengthen accreditation and quality assurance of universities and their programs: The government may want to consider separatingthe institutionalaccreditationfrom the program accreditation. NEAA should continue its work on institutional accreditation using the framework developed. However, program accreditation would require the involvement of international experts and professional organizations, which can add value in assessing the 33Examples o f KPIs include: (i) student satisfaction indicator (based on student surveys) measuring the quality o f a 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 o f the education received; (iii)employers' satisfaction indicator (based on surveys o f employers of graduates o f the institution) assessingthe occupational relevance o f the education received; (iv) the employment rate o f graduates six months after graduation, which would measure the relevance o f the program content for labor markets (taking into account graduates who are pursuing further education instead o f employment); and (v) a graduation rate indicator assessing academic programs' efficiency and throughput. 33 quality of 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 of ensuring that program accreditation is rigorous, and that university faculty members are not directly involved in the evaluation of their peers. In addition, it is recommended that internal quality assurance units and procedures are established in each tertiary institutionto promote a culture of quality and ownership of quality assurancereforms. Continued teacher andfacul?y 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 establishinga Leadership and Faculty Development Institute (LFDI). The institute could be established in one of the leadinguniversities, basedon a competitivebiddingprocess. 34 8. TOWARDSRESEARCHAND DEVELOPMENT (R&D) STRUCTURESAND POLICIESINSUPPORT OF INNOVATION 8.1 The final piece of the productivity puzzle covered in this report deals with the R&D policies. As mentioned earlier, 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 of product and labor markets, and strengthening the education delivery-are likely to have the largest impacts on productivity growth inthe short andmedium term, Bulgaria will need to start paying increasing attention as well to its R&D policies to sustain high productivity 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 determiningeconomic development and international competitiveness of countries. Globalization and rapid distribution and transfer of knowledge by information and telecommunication technologies have also made investments in knowledge increasingly pertinent. This includes the generation and adoption of new knowledgecreated by scientific research and technological development, investments in education and research, adoptionof best practices, andopennessto social, economic, and culturalinnovations. 8.3 BulgarianR&D system faces many challenges and opportunities. The country's recent entry into EU has brought along new competitive pressures, but also new windows of 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 of 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.`I In Lisbon, and two years later in Barcelona, a number of concrete objectivesinterms of researchquantity and quality were f~rmulated.~~ 8.4 Lisbon goals call for all EU member states to increase their R&D spending to three percent of GDP by 2010, of which two-thirds-two percent of 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-technologystart-ups. However, as can be expected, the quantity and quality of R&D investment varies significantly across EU countries. Achieving these goals-in particular, the private sector investmentgoal-will be a significant challenge for Bulgaria, and unrealistic to achieve by 2010. Bulgariamay wish to quickenthe paceof its progress inthat direction. 8.5 Analysis presented in Chapter 8 of the main report benchmarks Bulgaria's R&D and innovation system and finds it weak in many respects. Despite major changes in the BulgarianR&D and innovation system in the last decade, Bulgaria has started to fall farther behind the European and world leaders in innovation. It is an important area in which Bulgaria is not converging. While Bulgarian education establishment turns out fairly numerous and competent scientists, the research output is not particularly strong and tends toward basic rather than applied. The links of academia and research institutes to industry are not well developed and industry funds little of R&D. While the public sector funding of R&D, relativeto GDP, stands at about one half ofthe Lisbontarget, industry's share is only one twentieth of what it is in some of the most dynamic knowledge-based economies. Given Bulgaria's current 34 Lisbon goals apply primarilyat the national level, since the bulk of R&D investmentsare made at that level. EU researchprograms account only for about five percent ofthe total R&D investmentsbythe member states. industrial structure, a rapid increase in industry financed R&D is highly unlikely, but will take time. Much of the answer lies in the competitiveness of the product markets and the flexibility of the labor markets in these economies as well as in their education systems. Buildinga knowledge economy is thus a longer term issue, but it pays to start as soon as possible. Unlessdecisive action is takento rethinkthese systems in Bulgaria now, the gap between Bulgaria and European and world leaders in innovationmay well continue to widen. I. BENEFITSOFREFORM 8.6 Strong long term productivity growth is impossiblewithout a steady flow of innovations. The mother of innovationis competition. It is for this reasonthat so much emphasis in this report is put on promoting competitive product markets and complementary inputs that are needed for such markets to thrive-flexible labor markets and a high quality, equal access education system that delivers people with knowledge and skills neededby the economy. However, R&D also matters. Since in the long run it is only high productivity that delivers a high standard of living, the benefitsof reform in Bulgaria's R&D and innovationsystemare obvious. 11. OPTIONS FORREFORM 8.7 The benchmarking and analysis presented in Chapter 8 of the main report point to a number of reformoptions that the Government may wish to consider. The options are grouped intothose that should get priority attention("short-run") andthose that are ofa more medium-termnature. 8.8 Fiveareas would needattentioninthe short term: Increase the share of competitive R&D funding: Bulgarian R&D funding, above all by industry, remains small and is below the targets set by the Lisbonagenda. Over time it would need to be increased aiming at a better balance between public and private funding as well as between institutionaland competitive funding. Bulgaria has recently established instruments for competitive R&D funding (such as NIF and NSF), but their share of budget allocations is still small and dwarfed by funding that maintains existing institutions(e.g. BAS and NCAS). Competitive funding has a number of advantages. It allows funds to be allocated directly to new research areas, rather than having to achieve desired changes through existing research programs of researchinstitutions. It is likely to identify the best researchproposals. It rewards active teams, who are likely to use the additional resources effectively. Also, increasing the share of competitive fundingwould allow increased industryengagement in the R&D process. Except for the funding of big international science facilities, all international funding is competitive,so why not establishand follow that practiceat the nationallevel. Competitivefunding is better executed by independent agencies than by ministries. Strategic technology programs couldalso be planned and executed for key industries by pullingtogether the stakeholders from both industryand research. The strategic planningand directionof such programs should be inthe handsof industry,which best knowsthe challengesandopportunities it is facing and for whom success may be a matter of survival. These programs couldthen be partly funded through the competitive processes. They could also be linked with the EU technology platformprograms, which aim to provide industrieswith the best informationabout new enablingand generic technologies. Encourage public-private partnerships in R&D: Public-privatepartnerships in R&D would help ensure that R&D carriedout is relevant to business, and hence likely to have an economic impact through increased chances for commercialization. The government could promote public-privatepartnershipsby makingteaming up with industry increasinglya requirement for 36 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 importantfor SMEsthat can ill-affordresearchdepartments andfacilities oftheir own. Also, to ensure that R&D results yield economic benefits, applied research projects should routinely havecorporate partners. Re-evaluatethe role of the Bulgarian Academy of Science: All Bulgarianresearch institutes would benefit from a functionaland impact evaluation, but the BulgarianAcademy of Science, becauseof its size and potential, needs it most urgently. The size of BAS, with its 87 research centers, is massive-ne of the largest in Europe-and does not appear particularly well justified in the current economic and industrialcontext of Bulgaria. It also suggests that there is room for improving efficiency and effectiveness of government resources. Some of the equipment and facilities in these entities is obsolete and not conducive to contemporary researchmethods, and some units are doing research in areas and sectors, which are no longer viable. Thus, a significant, but careful, reorientation of BAS is recommended, along with a concerted effort to shift the researchconducted by BAS increasinglytowards appliedR&D, in order to respond to the needs of clients, including industrial corporations. By a carefully planned and executed reform process, BAS could become more competitive,the quality of its researchcouldbe raisedto an even higher level, and its impact on the Bulgarianeconomy and society could increase. Inadditionto the proposedre-evaluationofthe role of BAS, efficiency gains might be achieved also by reviewingthe roles and responsibilities of NCAS and other existing research entities under line ministries, which spend close to one-third of the government R&D budget. The role of NCAS could be very important given Bulgaria's agro- industrialpotential. Introduce systematic evaluation of R&D policies, institutions, and programs: There is an urgent need to establish systematic, regular and independent evaluations of R&D policies, institutions, and programs in order to assess their functioning and impact, and to identify the neededadjustments and reforms. So far no evaluations seem to have been carried out. Also, regular periodic evaluations would need to be carriedout of all funding mechanisms (such as NIF andNSF), to assess their instruments, operational methods, impact, and fundinglevels. Rethink the institutionalR&D set-up. To keep up with the world and to become world-class in some niches, Bulgariawould be well-advisedto rethink its institutionalR&D set-up. The current dual structuretwo parallel strategies, two responsible ministries, and two coordinatingcouncils-raises concerns, since researchand innovationare 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 elevatingthe coordinationto a higherlevelof Governmentto give the issuesgreater prominence. R&D and innovationissues and activitiesare 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 technologicalfrontier inan increasingnumber of sectors. 8.9 Inthe medium term,the following issueswouldneedto beconsidered: Enhance industry-financed R&D: Enhancing industry investments in R&D offers the best way to improvethe performanceand economic impact ofthe BulgarianR&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 37 development and to raise productivity, increasedprivate sector R&D would be called for over time. The challenge is how to get the Bulgarian industry to find it in its interest to raise its R&Dexpenditures 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 enabling environment. As discussed in previous chapters, this will include above all ensuringthat the regulatoryenvironment promotes competitionand does not prevent entry and exit of firms, including those from abroad, since contested markets force firms to innovate and raise their productivity in order to stay afloat. There must be effective enforcement of intellectual property rights. And access to input markets such as capital, materials, and informationneedsto be unhindered. Finally, labormarkets needto be flexible so that peoplecan easily move from lowerto higherproductivityactivities. Encourage university research: The reformoptions presentedin the previous Chapter for the tertiary education system would not only improveeducation 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 professional work after graduation. Also, thesis projects addressing development needs of companies should be actively encouraged. In addition to promotinga shift to more applied researchand practicalproblem-solving,this would provide a recruitment channel for students and companies. As was discussed in Chapters 4-7, strengtheningthe links betweenthe higher education system and labor markets is a priority. Introduce new competitivefunding instruments: A portfolio of further competitive funding instrumentsbest suitedfor particularneedscouldbe developedover time. Universities,research institutes, and perhaps SMEs would benefit primarily from grants (such as NIF and NSF), perhaps in the form of vouchers, larger corporations may benefit from risk loans, and high technology companies may needrisk and profit-sharingventure capital. However, ifand when this is done, caveats presentedunder the recommendationto "enhance industry-financedR&Dy shouldbe kept inmind. 38 9. SUMMING UPBY COREMESSAGES 9.1 To promote income convergence with other EUcountries, Bulgarianeeds to raise employment and productivity.This meanstakingactionon several fronts.The analysis inthis report pointsto four core areas for actions : Increaseemployment; Enhance labor mobility; Narrowthe skill gap; and Strengthen R&D. 9.2 Bulgaria is doing well on the employment front (the first core message), but this is not yet true of the other three core messages4nhancing labor mobility, narrowing the skill gap, and strengthening R&D-which are all ways to increase productivity growth. Having a mobile labor force that moves from lower to higher productivityjobs and sectorsas opportunities emerge is a core buildingblock inthe quest to raise productivity. Both product and labor market policiesandregulationsimpact the mobility, and are thus the key levers to effect a change. Havinga skilled andtechnically savvy labor force is in turn essential to effective adoption and adaptation of technologies, whereas R&D enhances technology transfer by helping firms to learn about technologicaladvances. 9.3 All the reformoptions presented inthe previous sectoral chapters can be mappedto the four core messages(see Table 9.1). Since some of the recommended reforms in product and labor markets would promote both employment and labor mobility, there is inevitable overlap among the recommendations in these two areas. By contrast, for the skill and R&D themes, the sector andtheme mappings are the same. Increase Labor market policies: employment 0 Revise labor legislationand regulationswhile complyingwith EU Reduce labortaxes further in a fiscally requirements sustainablemanner 0 Shift the emphasis of active labor market programs(ALMPs) to Strengthen labor market statistics supportjob search and strengthentheir monitoringand evaluation 0 Revisitthe mechanism for establishmentofthe minimumwage and its level 0 Revisitthe current eligibility andentitlement rules for the unemploymentbenefit Product market regulation: 0 Minimize administrativeburden on business, includingbarriersto entry of firms Enhance labor Labor market uolicies: mobility 0 Developand encourage lifelong learning Engage employers' associations 0 Revise labor legislationand regulations 0 Shift the emphasis of active labor market programs(ALMPs) tojob search and strengthentheir monitoringand evaluation Product market regulation: 0 Minimize administrativeburden on business, includingbarriers to Rely more on the use of incentive-based entry of firms regulation 0 Continue privatizationand abolish state's special voting rights in Improvethe enforcement of regulations in privatizedcompanies productmarkets 0 Simplify furtherthe licensingand permit system Narrow the Priman, and general secondan, education: skill gap 0 Establish a clear andcredibletimelinefor reformimplementationto Reinvestsavings in measurespromoting facilitate school consolidation quality of education and equitable access 0 Monitor the impact ofreformsand introduceexternalevaluation of learningoutcomes 0 Relax central regulations on teachinghours and class sizes -Implementschool-basedmanagementand 0 delegated budgets VET: 0 Introduceper student financing to VET 0Start vocational secondary education only after completionofcompulsory education 0Develop curriculafor vocational schools that balance vocational and general studies 0EstablishOccupationally-OrientedRegional Colleges 0EstablishaNationalQualifications Frameworkand Authorityto strengthen lifelong learning Tertian, education: Base tertiary institutionfundingon actual student enrolments 0Increaseuniversitytuition fees and establish a student loan scheme Strengthenuniversitygovernancethroughestablishmentof Boards 0Introducea performance-basedcomponent of Trustees and a Tertiary EducationCouncil to tertiary institution funding Strengthenlinks with labormarkets 0Consolidateuniversitiesandtertiary institutions Institutethe Maturaas access examination 0Strengthenevaluation and accreditation of universitiesandtheir programs 0Continuedteacher and faculty training Strengthen Increasethe share of competitiveR&D funding 0Enhance industry-financedR&D R&D Encouragepublic-privatepartnershipsin R&D 0Encourageuniversity research Re-evaluatethe role ofthe BulgarianAcademy of Science 0Introducenew competitivefunding instruments Introducesystematic evaluationof R&D RethinktheinstitutionalR&D setup 40 10. BUDGETAND CAPACITY IMPLICATIONS I. BUDGETIMPLICATIONS 10.1 All the reform options suggested in this report could be carried out within Bulgaria's currently projectedbudgetenvelopesfor 2007-09. Investmentcosts couldlargelybe coveredby grant funds available from EU. This would require some co-financingfrom Bulgaria's budget, but the total amount might be on the order of EUR15-20million, which is roughly0.06-0.08 percent of GDP. Eventhese 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 runningcosts ofthe options taken together are miniscule compared to the potential savings. This leaves room for a good portion of savings to be kept by the ministriesconcernedto give them incentiveto carry out the reforms rapidly and efficiently. The savings could be redeployed for other reform and quality enhancement measures. This implies the need for leadership to make the case for the proposed reforms and build consensus. Since Bulgarian leaders have already beenthinkingabout andplanninganumberofthese reforms, this shouldbe feasible. This reporthas tried to estimate some of the pay-offs to the reforms, which can be substantial, and thus help with the processof settingpriorities. The detailsare presentedinChapter 9 ofthe mainreport. 11. CAPACITYIMPLICATIONS 10.2 Much of the success of the reforms proposed in this report will depend on the capacity of Bulgaria's institutions. Many of 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 of the reforms and reduce resistance, and for determined follow-through on implementation. That will involve many institutionsand many individualsat all levels ofgovernment. 10.3 Available evidence suggests that in a number of ways the capacity of Bulgaria's institutions relativeto that of other countries is lagging. Evidenceto that effect was presented bothin Chapters 3 and 9 of the main report, along with the identification of the specific areas of weakness. It is thus implementationcapacity ratherthan the cost of reforms that is a cause for concern. However, eventhat is a relative matter. Various indexes of governance and implementation capacity are typically highly correlated with per capita GDP, so it is likely just a matter of time before the capacity of Bulgaria's institutionscatches up with its per capita GDP. The problem for Bulgariais that, becauseof the distance it has to travel to converge to EU15 and because of its demographic challenge, it has to overachieve on the productivitygrowth front, and thus also in terms of its institutionalframework that would make the rapidcatchingup possible. 41 22°E 23°E 24°E 25°E 26°E 27°E 28°E This map was produced by the Map Design Unit of The To 0 20 40 60 80 Kilometers World Bank. The boundaries, Negotin colors, denominations and To any other information shown To Danube Calarasi on this map do not imply, on 0 10 20 30 40 50 Miles Bucharest the part of The World Bank To SilistraSilistra Group, any judgment on the To Vindin ndin To Bucharest Tutrakan utrakan 44°N legal status of any territory, Zajecar Calafat To or any endorsement or KulaKula Alfatar Alfatar a c c e p t a n c e o f s u c h Danube ROMANIA SILISTRASILISTRA Constanta boundaries. 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