This Selected Issues paper examines the risks and structural weaknesses in Bosnia and Herzegovina. The paper provides an estimate of the current account adjustment required to stabilize net foreign liabilities. It uses the external sustainability approach of the Consultative Group on Exchange Rate Issues (CGER) methodology for exchange rate assessment. The paper analyzes the impact of the newly introduced borrowing rules on the longer-term debt dynamics. An overview of salient facts about unemployment in Bosnia and Herzegovina is also presented.

Abstract

This Selected Issues paper examines the risks and structural weaknesses in Bosnia and Herzegovina. The paper provides an estimate of the current account adjustment required to stabilize net foreign liabilities. It uses the external sustainability approach of the Consultative Group on Exchange Rate Issues (CGER) methodology for exchange rate assessment. The paper analyzes the impact of the newly introduced borrowing rules on the longer-term debt dynamics. An overview of salient facts about unemployment in Bosnia and Herzegovina is also presented.

IV. Unemployment and Labor Market7

A flexible, well-functioning labor market is essential for a successful economy. From this perspective, the high and persistent unemployment in Bosnia & Herzegovina—estimated between 20 and 30 percent of labor force—along with low labor participation is a source of concern for two reasons: first, because it represents a waste of economic resources; and second, because it suggests the existence of underlying rigidities that may complicate the economy’s adjustment to the changing global economic environment.

What are the causes of high unemployment in Bosnia & Herzegovina? Limited and poor quality statistics make it difficult to answer this question in a definite way. But the data still allow us to draw some inferences that are important for policymakers.

After several years of robust growth, healthy wage increases, and a widening trade deficit, it is unlikely that deficient demand is at the root of Bosnia and Herzegovina’s unemployment. Consequently, more expansionary macroeconomic policies would not only be ineffective but could also undermine the country’s external competitiveness, eventually creating more unemployment.

Instead, there are several signs pointing to problems on the supply side. High unemployment among the young, and particularly those with low skills, suggests that the skills available in the labor force are not what the market demands. Also, prospects of employment abroad, income from remittances, or generous public employment and wage policies may also discourage unemployed workers from taking up jobs in the private sector. These problems are more difficult to fix: they require a reduction of the dominant presence of the government in the labor market and improvements in education and training.

There is also evidence of structural rigidities that hinder labor mobility and may discourage employment creation. The multiplicity and lack of harmonization among pension and health insurance systems and the limited portability of their benefits constrain labor movement within the country and undermine the creation of a single economic space. And the relatively heavy taxation of labor creates a strong disincentive to job creation in the formal (tax-paying) sector of the economy. Addressing these rigidities requires bold reforms in social security across Entity lines and reduction of the burden of labor taxes. Both have significant implications for the public finances and should be undertaken in conjunction with measures that ensure that their impact on the budget can be absorbed without compromising the financial position of the government.

A. Introduction

57. High and persistent unemployment has been a conspicuous feature of Bosnia & Herzegovina’s economic performance. Its coexistence with a recent growth in real wages raises broader questions about the workings of the labor market. This Chapter provides an overview of salient facts about unemployment in Bosnia & Herzegovina; places Bosnia & Herzegovina’s unemployment in a perspective by comparing it with other transition economies; explores alternative explanations of unemployment; and considers policies that could help reduce it.

58. The scope of the discussion is limited by lack of comprehensive data, in part a consequence of the large informal sector. Some of the conclusions should therefore be seen as tentative. Nevertheless, there is still merit in examining the available data in detail, putting them in international perspective, and drawing as many implications as possible.

B. Basic Facts

Unemployment, employment, and labor participation

59. Bosnia & Herzegovina’s unemployment has remained stubbornly high despite a cumulative increase in GDP of almost 30 percent between 2000–05. The estimates of the unemployment rate vary substantially (Table 1), ranging from 22.3 percent to 33.5 percent in 2004.8 The most recent estimate, from the April 2006 Labor Force Survey, puts the unemployment rate at 31.1 percent.

Table 1.

Bosnia and Herzegovina: Estimates of Unemployment Rate

article image

Living Standards Measurement Studies.

60. These divergences arise as a result of treatment of the large informal economy and associated unreported employment. This is most striking when comparing the official statistics produced by the Entities’ statistical offices with estimates from household surveys and the recent labor force survey. But the same data source, such as the household survey, can produce different results because of different definitions of unemployment: for example, the International Labor Organization (ILO) definition—where to be counted as unemployed, a person must actively search for a job—typically gives a lower estimate compared with self-reported unemployment.

61. The Entities’ high estimates based on registered unemployment data in all likelihood exaggerate the true unemployment. This is because of the large role of the informal economy—with estimates of between 20 and 40 percent9—and the practice of informal sector workers to register as unemployed in order to obtain health coverage. For the purposes of the discussion that follows, we assume that the unemployment rate is in the 20–30 percent range.

62. Over time, unemployment changes in response to net changes in employment and in the size of the labor force (Tables 1 through 3). In Bosnia & Herzegovina, the increase in the unemployment rate between 2001 and 2004—from 16 percent to the 22–24 percent indicated by sources using a standardized methodology10—occurred against the background of robust GDP growth and rising labor participation and employment rates. In other words, the ongoing economic recovery was supporting employment growth, but employment growth was outstripped by increases in labor force. This suggests that the improving employment prospects drew more working-age population into the ranks of the labor force.

Table 2.

Bosnia and Herzegovina: Estimates of Participation Rate 1/

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Labor force as percent of working-age population.

Living Standards Measurement Studies

Table 3.

Bosnia and Herzegovina: Estimates of Employment Rate 1/

article image

Percent of working-age population.

Living Standards Measurement Studies.

International comparisons

63. Bosnia & Herzegovina’s experience mirrors the experience of other transition economies. The contraction in output and employment losses in the initial stages of transition gave way to a renewed growth, but employment initially stagnated or continued to fall. The nascent private sector began to generate new employment opportunities, but initially not on a sufficiently large scale that would absorb the excess labor. Moreover, the new jobs typically required a different set of skills, complicating the transition of many unemployed from traditional industries, whose skills were not longer in demand. Gradually, however, the creation of new jobs started to reduce unemployment.

uA04fig01

GDP, 1989=100

Citation: IMF Staff Country Reports 2007, 269; 10.5089/9781451804942.002.A004

64. Unemployment rate has responded to output gains in transition countries since their low point (on average, 1993–95). Figure on the right relates the change in unemployment rate between 1995 and 2005 (vertical axis) to cumulative GDP change over the same period (horizontal axis). Not surprisingly, the fitted line is downward sloping: countries that recovered most of the lost ground also achieved better unemployment outcomes.

65. Given this international pattern, Bosnia & Herzegovina’s experience is not an exception. Its relatively high level of unemployment is consistent with the relatively slow degree of recovery during the transition: in 2005, its GDP was still below its 1989 level.11 More broadly, its labor market outcomes are close those in other Balkan countries, where both transition and accession to EU lagged behind Central and Eastern European (CEE) countries (Figure 1):

Figure 1.
Figure 1.

Labor Market Outcomes, Regional Comparison, 2001–05

Citation: IMF Staff Country Reports 2007, 269; 10.5089/9781451804942.002.A004

Sources: Eurostat; World Bank; national authorities; and Fund staff calculations.

The characteristics of unemployment

66. Unemployment in Bosnia & Herzegovina is characterized by: high youth unemployment, high long-term unemployment and persistent differences in regional unemployment. In that respect, the country broadly resembles other transition economies, although the severity of these problems makes it stand out even among them.

67. Unemployment affects disproportionately the young. Estimated at 62 percent, the unemployment rate for the 15–24 age group is at least twice as high as an average for other transition economies. Only FYR Macedonia, with a rate of 65 percent, has higher youth unemployment.

Labor Market Characteristics by Age Group

article image

Source: Labor Force Survey, 2006.

Percent of labor force.

Percent of working age population (15+).

68. In 2006, the highest unemployment rates were recorded for those with lower education: 12.5 percent for those with university education, and 31 percent for those with elementary education. In this respect, it is worrisome that only 73 percent of 15–18 year olds are enrolled in secondary education. This compares with an 85–95 percent rate for most European countries.

69. Most of Bosnia & Herzegovina’s unemployment is long term: 75 percent of the unemployed have been without a job for two years or more. Long-term employment is particularly high compared to other transition economies: in Bosnia & Herzegovina, the share of the unemployed out of work for more than a year is 86 percent, compared with a range of 40–60 percent reported for transition economies.12 Only Macedonia has a similar level of long-term unemployment.

Unemployment by Job Search Duration

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Note: 0 months means that the currently unemployed have found a job.Source: Labor Force Survey, 2006.

70. The process of transition does not affect all regions equally. While differences in regional unemployment would be expected to widen initially, they should diminish over time, as workers move and find employment elsewhere. This seems to have happened in Bosnia & Herzegovina only to a limited extent. The figures show, on the vertical axis, the unemployment rate in 2005 and, on the horizontal axis, the unemployment rate at the starting point (2003 in the upper figure; 2001 in the lower figure). The positive correlation suggests little or no unemployment shifts between cantons. In 2005, cantonal unemployment rates within the Federation mirror closely unemployment rates registered in 2003. Even viewed over a longer period, the differences between regions seem to persist: cantons with relatively lower unemployment in 2001, tend to be the same ones with lower unemployment in 2005.

uA04fig03

Persistence of unemployment in cantons, 2003–05

Citation: IMF Staff Country Reports 2007, 269; 10.5089/9781451804942.002.A004

uA04fig04

Persistent of unemployment in cantons, 2001–05

Citation: IMF Staff Country Reports 2007, 269; 10.5089/9781451804942.002.A004

C. Explaining Unemployment

71. At the risk of some oversimplification, we explore how the salient facts about Bosnia & Herzegovina’s unemployment are consistent with three possible alternative explanations of its causes: deficient demand, supply-side problems and structural unemployment.

Deficient demand

72. Is the high unemployment indicative of the aggregate demand falling short of the potential output? If that were the case, one could argue for more expansionary macroeconomic policies to help close the output gap. However, Bosnia & Herzegovina’s performance does not support this proposition, for several reasons:

  • Bosnia & Herzegovina has exhibited strong sustained growth, which—after an initial post-war spurt—has converged toward that of other CEE countries: 5.0 percent in 2000–05 (4.9 percent for CEE).13 The estimates of potential output using the Hodrick-Prescott (HP) filter suggest that an output gap unlikely to exist (Figure 2).14

  • The widening trade deficit—it almost doubled from $2.8 to $5.0 billion between 2000 and 2005—and the healthy pace of wage growth (close to 8 percent in nominal terms and 6 percent in real terms annually between 2000 and 2006) militates against concluding that deficient demand has been a problem in Bosnia & Herzegovina.

Figure 2.
Figure 2.

Bosnia and Herzegovina: GDP and GDP Gap, 2000–06

Citation: IMF Staff Country Reports 2007, 269; 10.5089/9781451804942.002.A004

Sources: BiH authorities; and IMF staff calculations and projections

Supply-side factors

73. If deficient demand is unlikely to be the cause of the observed unemployment, it may be appropriate to consider supply-side factors. First, it is possible that, despite the employment opportunities generated through economic growth, workers are not willing to be employed at the prevailing wage in the private sector, either because they have other incomes or because they prefer to wait for more attractive jobs; in other words, workers have a reservation wage that is higher than the prevailing market wage and at least part of the observed unemployment is “voluntary”. Second, it is possible that workers do not have the right skills to be employed in the private sector. Although in this case their unemployed status is “involuntary”, the cause is again on the supply side. These two factors are not mutually exclusive but may be at work simultaneously.

High reservation wage

74. A reservation wage is the wage at which unemployed workers are prepared to accept employment. Its level will generally depend on the amount of alternative sources of income of the unemployed (unemployment benefits, for example), workers’ valuation of their leisure, and other factors. If the reservation wage exceeds the wages offered by employers seeking to hire additional labor, the unemployed workers will forgo the offers of employment, because they will prefer waiting until better opportunities come along.

75. Because data on job vacancies is lacking in Bosnia & Herzegovina, it is not possible to gauge directly the extent to which the unemployed may be refraining from taking up available employment. Yet, it is also clear that there are several factors that may act to strengthen unemployed workers’ reluctance to accept employment at the going wages. One of them is the existence of a large contingent of Bosnian migrant labor force working abroad (about one quarter of Bosnia & Herzegovina’s population is estimated to live abroad). This suggests that there may be prospects, however uncertain, for Bosnians of finding employment abroad at a higher wage. The other side of the coin is the large amount of private transfers to Bosnian households sent from abroad (estimated at 30 percent of GDP) by emigrant workers. Some research (Chami and others (2003) for example) suggests that these remittance inflows can discourage work effort in the recipient country.

Public wages and employment

76. Public wage and employment policy can strongly influence labor market performance and outcomes. Demekas and Kontolemis (1999), for example, show on the example of Greece in the 1980s, how an expansion in public sector employment coupled with increases in government wages and benefits can lead to higher private sector wages and higher overall unemployment. This occurs as improved employment prospects (and higher wages) in the public sector push up workers’ reservation wage and reduce the attractiveness of private sector employment.

77. In Bosnia & Herzegovina, the public sector is large and average public wages particularly high. Comparing its general government wage bill (in percent of GDP) with a group of 25 emerging market economies, Bosnia & Herzegovina is an apparent outlier. The average public administration wage exceeds significantly the economy-wide average in both entities, and appears particularly high in an international comparison.

uA04fig05

Government wage bill, percent of GDP

Citation: IMF Staff Country Reports 2007, 269; 10.5089/9781451804942.002.A004

Sources: FAD database; Bosnian authorities; and Fund staff

Public Sector Wages—Comparison, 2006

(Percent of Average National Wage)

article image
Sources: National authorities; Haver Analytics; and IMF staff calculations.
Skill deficiencies

78. High youth unemployment is partly linked to the generally low quality of education in Bosnia & Herzegovina. According to the World Bank, 40 percent of students lack basic skills and knowledge, while many students in vocational schools receive inadequate general education and remain unprepared for the demands of the market place.15 The low school enrollment rates in secondary and tertiary education are also a serious problem.

79. More generally, the very young (15–19 years of age) lack work experience, as they are only entering the labor market for the first time. This limits their job possibilities even in developed countries—for example, in some countries of Western Europe youth unemployment rates exceeds 20 percent.

Demographics

80. Demographics also shape employment prospects for some age groups. With its relatively young population, youth employment opportunities Bosnia & Herzegovina may be constrained by “cohort crowding”—a situation where larger youth cohorts face reduced job opportunities in the presence of wage rigidities and imperfect substitutability between workers of different ages.16

Structural unemployment

81. In addition to demand or supply deficiencies, unemployment may also be caused by structural rigidities in the labor market. The process of transition entails profound structural changes and sectoral shifts in production, requiring commensurate shifts in employment across sectors and regions. Because the reallocation of labor between declining and expanding sectors and regions is likely to take some time, unemployment arising from a structural transformation may persist. The length of this period will depend, among other things, on the structural characteristics of the labor market.

82. There are indications of serious shortcomings in the functioning of the labor market in Bosnia & Herzegovina that interfere with optimal allocation of labor resources. The strongest indication is the existence of a widespread informal sector. Reliance on informal employment—revealed by the divergence between reported unemployment rates that are twice the level of its level estimated from household surveys—typically emerges as a coping mechanism for employers seeking to hire labor and for job seekers that cannot find jobs in the formal sector.

83. In a sense, the development of the informal economy could be viewed as a testimony to the resilience of the private sector in the face of structural impediments, but clearly it is a not an ideal solution.17 It points to the existence of institutional barriers which prevent normal functioning of product and labor markets, and underscores the urgency of reforms needed to correct these distortions. Possible factors that may help explain the presence of structural unemployment include: low wage flexibility; and limited labor mobility within the country.

Low wage flexibility

84. With inflexible wages, unemployment will be slow to adjust. Instead of falling in the face of increasing unemployment, wages will tend to remain relatively high. That will frustrate adjustment, which would otherwise see declines in wages help stem—and possibly reverse—employment losses over time. Some of the factors contributing to wage rigidity are: high minimum wages; centralized wage-setting process; and large labor tax wedge.

High minimum wage

85. In Bosnia & Herzegovina, several factors point to low wage flexibility and responsiveness to regional economic conditions. In the Federation, minimum wages in are set at relatively high levels and are binding for all regions within the entity.18 Thus, even if regions face different economic conditions, wage response in a region affected by an adverse shock is constrained by the minimum wage legislation. The higher the minimum wage, the greater the number of workers that are likely to be affected. High minimum wages also help explain why youth unemployment is disproportionately high in Bosnia & Herzegovina—one would expect to find young, inexperienced workers at the lower end of the pay scale. In contrast, in the RS, the minimum wage—estimated at 40 percent of average wage in 2006, does not appear to be a binding factor, and is in line with the 30–40 percent range observed in other CEE countries.19

Centralized wage-setting process

86. Another element limiting wage flexibility is the centralized wage-setting process. General collective agreements specify a system of wages in fairly detailed and rigid manner, with the relative levels reflecting the complexity of the performed work and the worker’s education level. Evidence suggests that these stipulations are only binding for the state-owned and mass-privatized sectors. In contrast, they are generally not respected in the new private sector.

Labor tax wedge

87. One source of labor market distortion, which can lead to a lower-than-optimal level of employment, is the labor tax wedge—the difference between the cost to the firm of employing a worker and the worker’s take-home-pay. This wedge, which corresponds to labor income and payroll taxes, discourages employers from hiring new workers and employees from seeking employment. The distorting effect of the labor tax wedge may be particularly strong in an open economy like Bosnia & Herzegovina’s where a large number in the labor force consider leaving abroad in search of employment.20

88. Viewed against OECD countries as a group (Figure 3), Bosnia & Herzegovina is not an outlier, but the same data also suggests that countries with the higher labor tax wedge tend to have higher rates of unemployment. The measure of the labor tax wedge includes all payments made to government on labor income, irrespective of whether these payments are made by the employee or the employer. It is expressed as a ratio of these payments divided by total labor cost.21 Calculated at the average wage, it is 34–41 percent in the Federation, and 34 percent in RS. Bosnia & Herzegovina’s high unemployment argues for exploring ways that would minimize any negative influence of the tax system on employment.

Figure 3.
Figure 3.

Labor Tax Wedge Comparison, 2004

Citation: IMF Staff Country Reports 2007, 269; 10.5089/9781451804942.002.A004

Sources: OECD; World Bank; and Fund staff calculations.

89. In the RS, the labor tax wedge becomes quite large at lower wage levels. That is because of the provision in the current law, which stipulates that the basis for calculating the social contributions cannot be less than 50 percent of average net salary in the RS in the preceding month. This means, for example, that at a wage which is one third of the average, the labor tax wedge reaches 42 percent of total wage cost (up from 34 percent for the average wage). This discourages formal employment of workers at the lower end of the salary scale.

uA04fig06

Labor tax wedge, percent of total wage cost

Citation: IMF Staff Country Reports 2007, 269; 10.5089/9781451804942.002.A004

Limited regional mobility

90. Limited spatial factor mobility weakens the mechanism by which regional differences in unemployment tend to even out. In Bosnia & Herzegovina, factors that seem to contribute to a relatively low mobility include a general shortage of adequate housing, regional differences in physical infrastructure endowments, and apparent reluctance of households to leave their own communities. In the 2004 household survey, only about 2 percent of respondents indicated that employment was the reason for their move to their current residence; and only 3.6 percent indicated that it was very likely or quite likely that they would move in the upcoming 12 months. In addition, the multitude of pension and social insurance systems (at entity and cantonal levels) and limited portability of these plans discourage labor mobility within the country.

D. Policy Implications

91. The preceding analysis does not allow to draw firm conclusions about the nature of unemployment in Bosnia & Herzegovina and the policy prescriptions that would work best; nevertheless, it does suggest caution in considering remedies and looking for quick fixes. In particular, it indicates that efforts to reduce unemployment by stimulating aggregate demand would be ineffective at the current juncture and, by leading to higher wages, would run the risk of undermining Bosnia & Herzegovina’s external competitiveness and exacerbating the macroeconomic imbalances. In contrast, strengthening the supply capacity of the economy by improving business environment and attracting private investment would not only raise sustainable growth, but also help absorb excess labor.

92. To the extent that some of the labor market structural and supply-side factors are at play, some of the unemployment will decline only over time. Yet, it is important that steps toward correcting some of the rigidities and shortcomings be taken early. Education and training policies will be key to reduce skill mismatches. An early education reform is essential not only to improve the quality of education but also to reduce the waste in education spending by streamlining and refocusing the expenditure on priority areas.

93. Public wage and employment policies require close attention. The government is a sizable employer—particularly when compared with other countries—and its actions have spillover effects on the private sector. The indications that public sector wages may be excessive relative to the wages that could be supported by productivity levels in the economy is worrisome. This imbalance may even be higher if the nonmonetary dimensions of public sector employment—job security and nonwage benefits, unavailable to workers in the private sector—are taken into account. The public sector needs to promote wage moderation through its public wage and benefits policy.

94. Accelerating privatization could be an important way of reducing the potentially distorting influence of the public wage and employment policies. It would help harden the budget constraint for privatized companies, cut the transfers to cover their losses and limit their capacity to grant excessive wage settlements. At the same time, it would reduce the size of the public sector more generally.

95. The large labor tax wedge argues for exploring ways that would minimize a negative influence of the tax system on employment. One possible approach for consideration would be to cut social insurance contribution rates as a way to encourage growth in formal sector employment, including by removing incentives for tax evasion. To avoid the risk of emergence of financing shortfalls in the social funds, their revenues could be supplemented with transfers from the budget (using part of the VAT proceeds, for example).

96. Steps toward harmonizing the provisions of the pension and social insurance systems and increasing their portability should be a priority area in a strategy aimed at promoting greater labor market flexibility. While the limited portability of these systems may not be the only factor in explaining the persistent regional unemployment differences, its greater nationwide harmonization would likely remove part of the disincentives that currently discourage greater regional mobility.

References

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7

Prepared by Milan Cuc.

8

Up to 44.9 percent, according to the Federation Statistics Office.

9

See, for example, Petrova (2005).

10

Living Standards and Measurement Study (LSMS); World Bank; EBRD

11

The deep initial decline was also a result of the civil war.

12

Schiff and others (2006).

13

In this respect, the difference in growth performance compared with Macedonia—another country with similar labor market characteristics—is striking. Macedonia’s growth averaged 2.2 percent between 1998 and 2005; and only 1.4 percent between 2000 and 2005.

14

Estimates of potential output always need to be interpreted with caution. Their usefulness may be limited in the case of Bosnia & Herzegovina, particularly because the country has experienced limited cyclical variations over the estimation period. Still, the HP estimates of potential output are consistent with other evidence on lack of deficient demand unemployment in Bosnia and Herzegovina

15

For example, according to a 2003/04 survey, at least 40 percent of eight-grade students failed to obtain a satisfactory score on the mathematics assessment (World Bank (2006)).

16

Jimeno and Rodriguez-Palenzuela (2002).

17

Krstic and Sanfey (2007) points to the superiority of the formal over informal activities for reducing poverty and inequality and enhancing life satisfaction. It estimates that monthly earnings in the formal sector are on average about 30 percent higher than those in the informal sector.

18

Each entity legislates their own minimum wage. The 2005 General Collective Agreement in the Federation stipulated a minimum wage of 55 percent of the average wage (about 51 percent of the 2006 average wage, which one of the highest among CEE countries). Yet, in some Branch Collective Agreements, minimum wages are even higher (for the telecommunication and postal service sector, for example, 100–110 percent of the average wage in the Federation).

19

However, the labor tax wedge for low wages is exceptionally large in the RS (see below), which discourages hiring of low-wage workers

20

See the 2004 Household Survey.

21

Total labor cost includes gross wages paid to the employee plus the related payments to government made by the employer

Bosnia and Herzegovina: Selected Issues
Author: International Monetary Fund