Threats to external stability in the pre-crisis period have now been reduced substantially and foreign non-debt creating flows have declined, sufficient to support external stability. The global economic downturn has raised challenges for evaluating the countries’ fiscal stance and fiscal policy focus should be lowering support to debt sustainability, private sector development, and the currency board stability. The two entity pension funds have been under increasing financial pressures. Putting the public pension systems on a sound footing will encompass a number of complementary steps.

Abstract

Threats to external stability in the pre-crisis period have now been reduced substantially and foreign non-debt creating flows have declined, sufficient to support external stability. The global economic downturn has raised challenges for evaluating the countries’ fiscal stance and fiscal policy focus should be lowering support to debt sustainability, private sector development, and the currency board stability. The two entity pension funds have been under increasing financial pressures. Putting the public pension systems on a sound footing will encompass a number of complementary steps.

I. Post-Crisis Growth Prospects And Supporting Policies1

A. Introduction

1. In this study, we examine the sources of post-crisis economic growth, identify the main impediments to domestic supply expansion, and highlight the need for growth-promoting government policies. We start by evaluating the BiH’s growth performance relative to potential. We then analyze the BiH economy’s production process to quantify the contributions of physical and human capital and technological change to real GDP growth. We use the developed growth accounting framework to structure the discussion of the potential drivers of future economic growth, the main stumbling blocks faced by domestic producers, and identify growth-promoting government policies.

B. Growth Performance and Medium-Term Prospects

2. Like elsewhere in the region, Bosnia and Herzegovina’s pre-crisis growth model relied on booming domestic demand financed from abroad. While in all Balkan countries residents spent more than they earned from domestic sources in 2000–2008, Bosnia and Herzegovina (BiH) boasted some of the highest ratios of domestic absorption over GDP.2 This was made possible mainly by large remittances from family members working abroad (15–18 percent of GDP each year), foreign direct investment, unrequited transfers to government, and a credit boom funded by foreign banks.

uA01fig01

Domestic Absorption as a ratio to GDP

(constant prices)

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

Source: IMF’s WEO database and Fund staff estimates.

3. The BiH economy fell into recession in 2009. The global financial crisis and recession triggered a collapse in the demand for Bosnian exports and severely curtailed cross border financial inflows. Private investment and spending on consumer durables collapsed, while private current consumption softened to a lesser extent, on the back of moderate growth of wages and social benefits. The slump in domestic demand led to a large improvement in the external trade balance.

uA01fig02

Contribution of Demand Aggregates to Real GDP Growth

(percent)

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

Source: IMF’s W EO database and Fund staff estimates.

4. Following a stagnation in 2010, growth is expected to rebound. Whereas the world economy appears solidly on the path of recovery, BiH main trading partners (EU and Western Balkan countries) are expected to lag behind booming emerging Asian economies, tempering external demand for BiH noncommodity exports. Domestic demand in 2010 will also remain soft, as banks are likely to hoard capital and keep interest rates high to shore-up flagging profitability, as they work through the losses in their loan portfolios. Over the medium term, domestic demand is expected to remain below pre-crisis levels relative to domestic income, reflecting fiscal consolidation and the end of the credit boom funded from abroad. As a result, real GDP is expected to remain permanently below the prevailing pre-crisis trend, despite a rebound in real GDP growth.

uA01fig03

BiH: Real GDP, 1999-2015

(natural logarithm)

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

Source: BiH Statistical Agency and Fund forecasts.

C. Potential Output and the Output Gap

5. The post-crisis potential growth rate of the BiH economy is projected to be slightly below its pre-crisis value, resulting in domestic output remaining permanently below the prevailing pre-crisis trend. We decompose domestic output into a long-run potential and a business-cycle component, by applying the Hodrick-Prescott filter with a smoothing parameter of 100 to the real GDP series (in natural logarithm). Under current Fund staff projections, the BiH’s real GDP series exhibit a structural break (in domestic demand) in 2009–10. Applying the H-P filter on a series containing a structural break produces spurious estimates of the long-run trend, as a shift in the latter across two sub-periods would be amalgamated in an overall slope that is different from those in each sub-period. Therefore, to obtain the potential output series over 1999–2015, we run the H-P filter separately on the sub-periods (1999–2008 and 2011–2015), and assume that its growth rate during and in the immediate aftermath of the global crisis was zero.3 Results show that the post-crisis potential growth rate of the BiH economy is likely to be, on average, slightly below its pre-crisis value (4.7 percent vs. 4.9 percent), leaving the real GDP permanently below its prevailing pre-crisis trend (Figure 1).

Figure 1.
Figure 1.

BiH: Actual and Potential Output and Real Growth, 1999-2015

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

Source: BiH Statistical Agency and Fund staff estimates and projections.Notes: The Ho drick-Prescott Filter with a smo othing parameter of 100 is applied on the pre-and post-crisis series of real GDP (in natural lo garithm). The growth rates of the H-Ptrend series are derived from the logarithmic differences of the un derlying series.

D. Growth Accounting

Setup and calibration

6. We analyze the BiH economy’s production process to quantify the contributions of physical and human capital and technological change to real GDP growth. We calibrate a Cobb-Douglas aggregate production function for Bosnia and Herzegovina and use it to decompose the growth of real GDP into contributions of factors of production and the Solow residual, which captures changes in output per unit input. The Solow residual—commonly referred to as total factor productivity (TFP)—represents “…the effect of ‘costless’ advances in applied technology managerial efficiency, and industrial organization…” (Abramovitz, 1962, as cited in Jorgenson and Griliches, 1967). The implementation of the growth accounting framework (Box 1) requires the mapping of theoretical concepts to existing data and in the process overcoming deficiencies in BiH statistics (Appendix Table 1):

  • Real GDP. We use the real GDP estimates under the production approach published by the Agency for Statistics of Bosnia and Herzegovina (ASBiH).4

  • Investment flows and depreciation rate. We measure investment flows using national accounts data on real gross fixed capital formation (GFCF). The share of investment in real GDP in BiH is similar to that in other Balkan countries and higher than in the Euro area, reflecting the need to retool the economy in its transition from market socialism to a market economy. We apply a constant annual depreciation rate of 4 percent, which is commonly used in cross-country studies (Nehru, Swanson, and Dubey, 1993; Chow and Lin, 2002).

uA01fig04

Real Gross Fixed Capital Formation in Percent of Real GDP

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

Source: Eurostat; BiH statistical agency; and staff estimates.
  • Physical capital stock. We construct the real capital stock series using the perpetual inventory method, which starts with an estimated value of the capital stock in a base year and recovers the remainder of the series by adding to the base stock the investments net of depreciation made in subsequent years (Kt = (1-δ)Kt-1 +It) (Nehru, Swanson, and Dubey, 1993).

Overview of Growth Accounting

The starting point of growth accounting is an aggregate production function—typically parameterized in the Cobb-Douglas form with constant returns to scale—that relates economy’s total real output [Y] to real factor inputs (physical [K] and human [H] capital) and output per unit input [A]:

Yt=AtKtaHt1a(1)

The parameter [A] represents shifts of the production function and is commonly referred to as total factor productivity (TFP). Using the fact that in continuous time, the instantaneous rate of growth of output equals the ratio of its derivative with respect to time and the value at which the derivative is evaluated, we can differentiate both sides of (1) with respect of time, divide by Y, and rearrange:

Y˙Yt=A˙At+(YKKtYt)K˙Kt+(YHHtYt)H˙Ht,where(2)
Y˙Yt=Yt;YK=AtaKta1Ht1a=aYtKt;andYH=At(1a)KtaHta=(1a)YtHt(3)
Y˙Yt=A˙At+aK˙Kt+(1a)H˙Ht(4)

The elasticities of real output with respect to physical (α) and human capital (1 - α) can be estimated by invoking the result that under the assumption of perfect competition in product and factor markets, the factors of production are paid their marginal products (e.g., Barro and Sala-i-Martin, 1999):

YK=randYH=w,where(5)rrealreturnoncapitalwrealwage

Substituting (3) in (5), we can show that the elasticity of real output with respect to human capital is equal to the observed share of labor (i.e., compensation of employees) in real income, which is equal to real output as per the circular income-expenditure flow diagram of economic activity and the system of social accounts associated with it (Jorgenson and Griliches, 1967; Hulten, 2000):

1a=wtHtYtanda=rtKtYt(6)

In our analysis, we use the discrete time approximation of (4), in which 1α¯ is the average share of labor in real income:

ΔYtYt1=ΔAtAt1+a¯ΔKtKt1+(1a¯)ΔHtHt1(7)

Equation (7) allows us to estimate the growth rate of TFP as the difference between the growth rate of output and the weighted growth rates of factor inputs, the weights being their respective aggregate income shares.

Source: Hulten (2000).
  • Base-year estimate of capital stock. We estimate the stock of real capital in 2003 using a widely used approach first suggested by Harberger (1978). It evokes the result that in the Solow model the capital stock and output grow at the same rate in steady state (e.g., Jones and Manuelli, 1997). Therefore, KtKt1Kt1=δ+ItKt1orKt1=Itδ+g,, where (g) is the steady-state growth of output. However, the BiH economy circa 2003 cannot be treated as being in a steady state, given the socialist heritage of outdated capital stock and the significant loss of productive capacity during the 1992–1995 war. Convergence of the BiH economy to EU standards requires a higher growth rate of the capital stock than that of potential output for a number of years. At the same time, the post-2002 pace of capital accumulation—fueled by a credit boom funded from abroad-was, in hindsight, exuberant. In this paper, we use a value for the potential growth rate of the capital stock circa 2003 of 6.8 percent (see notes to Appendix Table 1). The obtained ratio of real capital stock to real GDP in BiH in 1999 of 2.15 falls between the official estimates of the ratio of capital stock to GDP in Poland and the Czech Republic in 1998 (1.95 and 3, respectively, see Doyle, Kuijs, and Jiang, 2001), positioning BiH in the cluster of countries with similar per capita income; and, as expected, below the reported values in developed countries in 1990 (text figure).5

  • Human capital stock. We use as proxy the number of employees. We do not attempt to augment our measure of human capital to reflect its quality—typically accomplished by taking into account the average years of schooling and the return on education (Chow and Lin, 2002)—due to lack of data on BiH in existing cross-country datasets (Barro and Lee, 1996). The total number of employees can be viewed as an outcome of the interaction of a number of characteristics of the labor market in BiH, in particular the dynamics of total population, its age distribution, economic activity rate, and rate of unemployment (Appendix Table 1). Bosnia and Herzegovina has one of the lowest labor force participation rates and one of the highest unemployment rates in Europe (Figure 2).

  • Share of labor in real income. The parameter (1 - α) in the Cobb-Douglas aggregate production function is set to 0.468, which is the average share of compensation of employees in the income-approach estimates of real GDP in 2007–2008. This gives an estimate of α of 0.532.

uA01fig05
Source: Nehru and Dhareshwar (1993), IMF’s WEO database, and authors’ estimates.
Figure 2.
Figure 2.

BiH: Labor Market Characteristics Relative to Peers, 1997-2008

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

Source: Eurostat; BiH statistical agency; and staff estimates.

Results for 2000–2009

7. On the supply-side, the pre-crisis growth of output was mostly driven by rapid accumulation of factors of production. The massive build-up of productive capacity alone—financed by foreign direct investment and a credit boom funded by foreign savings—on average accounted for three-forth of the observed output growth in 1999–2008. The decline in the unemployment rate in 2007–08 has helped boost the contribution of the labor force to observed output growth. On the other hand, the 2009 output loss was accompanied by a decline in the effectiveness of capital utilization and employment losses.

uA01fig06

BiH: Contributions of Factors of Production to Real GDP Growth, 2000-09

(percent)

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

Source: BiH statistical agency; and staff estimates

Implications for future growth

8. Post-crisis, the growth of the BiH economy will likely become more dependent on gains in human capital and total factor productivity. The projected return to normalcy of credit growth—reflecting the switch of banks’ funding from foreign borrowing to domestic deposits—suggests that, unless private and public savings increase significantly relative to the baseline projection and/or structural reforms create fiscal space for stepped up public infrastructure investment, the pace of capital accumulation and its contribution to real GDP growth will be lower in the post-crisis period (Figure 3). This is consistent with the results of a large cross-country study of the effects of past financial crises on factors accumulation, which finds a permanently lower post-crisis growth of capital (IMF, 2009). Future growth will hence need to rely to a bigger extent on gains in human capital and total factor productivity.

Figure 3.
Figure 3.

BiH: Capital Accumulation Relative to Peers, 2003-13

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

Source: IMF’s WEO database and Fund staff estimates
uA01fig07

BiH: Contributions of Factors of Production to Real GDP Growth, 2000-15

(percent)

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

Source: BiH statistical agency; and staff estimates

E. Growth-Promoting Policies

9. Enhancing BiH’s human capital and speeding-up the pace of technological change would require a renewed emphasis on structural reforms to unleash BiH’s human capital and entrepreneurship potential. In this section, we analyze the main characteristics of the BiH labor market and business environment and identify specific government policies that can help unleash BiH’s human capital and entrepreneurship potential.

Labor market

Main characteristics

10. The profound change in the structure of the BiH economy in the 1990-s created large imbalances in the labor market, which have persisted ever since. Prior to the dissolution of Yugoslavia and the subsequent armed conflict in Bosnia and Herzegovina, the economy of Bosnia and Herzegovina was heavily industrialized and dominated by large-scale, export-oriented enterprises in the energy, raw materials, and the military complex (World Bank, 1997). The end of the cold war, the severance of the industrial links between Yugoslavia’s constituent republics, and the destruction of physical capital during the 1992–1995 war led to a massive deindustrialization. The resultant slack in economic activity was partially absorbed by a burgeoning public sector and small-scale, often “grey economy,” private firms operating in agriculture, services, and light manufacturing. The share of heavy and light industries in total value added declined from 43 percent of GDP in 1990 to around 20 percent in 2008, while the shares of both merchant and public services increased by 10 percentage points in 1994–2008. At present, the economy appears to be following a path of low-skill specialization, with 43 percent of exports classified as low-skill goods (ETF, 2007). The destruction of jobs in the old large-scale industrial enterprises and the war damages to the production infrastructure swelled the ranks of the unemployed, while the shift from heavy industry and military production to services and light manufacturing created major skill gaps and mismatches that impeded the quick re-entry of unemployed in the formal labor market.

11. The BiH labor market is characterized by high unemployment and robust nominal wage growth indicating the presence of structural bottlenecks. The BiH average wage is the second highest in Southeast Europe and exceeds those of second-wave new EU members (Bulgaria and Romania). Though declining in recent years, at 24–25 percent, the BiH’s unemployment rate remains one of the highest in Europe (Figure 2). Young people below the age of 25 are most affected, with close to 50 percent out of work. The structural nature of the unemployment problem in BiH is demonstrated by the fact that 75 percent of unemployed have been out of work for more than two years, and 50 percent for more than five years (BHAS, 2008). Among the main constraints holding back the development of the BiH’s labor market are the low labor force participation rate, sizable skill gaps, the large informal sector which distorts the labor market, and the ineffectiveness of the labor mediation public services.

uA01fig08

Average Gross Monthly Wages, 2009

(Euros)

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

Sources: Haver Analytics; and IMF staff estimates.

12. Though on the rise in recent years, BiH’s labor force participation rate remains one of the lowest in Europe (Figure 2) on account of the extremely low activity rate of women. The share of economically active men in the 15–64 years’ age cohort (around 67 percent) is comparable to those in other Balkan countries (Bulgaria, Croatia, Romania), but is 10 percentage points below the EU-wide average. At the same time, the labor force participation rate among working-age women is only around 40 percent, trailing the average in BiH’s Balkan peers and the EU by 15 and 22 percentage points, respectively (BHAS, 2008; ILO 2009). Women activity rates are below regional and EU comparators in both entities, though the outcome in the RS is around 10 percentage points better than in the Federation. While this is a complex socio-economic phenomenon, one contributing factor is the very low enrollment of children in pre-school programs in BiH (due to their scarcity in rural areas and cost), which complicates the simultaneous carrying-out of family and work responsibilities (ILO 2009).

uA01fig09

Pre-primary school enrollment

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

Source: UNESCO Institute for Statistics.

13. The sub-par general level of educational attainment and acute skill mismatches hinder the employment of many job seekers. Whereas near universal primary education has been achieved (ILO, 2009), the shares of the population with completed secondary and higher education fall short of the old and new EU members’ averages (ETF, 2007, WB, 2009b). Approximately two-thirds of secondary school students are enrolled in four year technical schools or three year vocational schools with narrowly-specialized and sometimes outdated programs and leave the system ill-equipped with core work skills (e.g., communication skills, problem-solving and team-work, etc.) that are in high demand in the labor market (WB, 2009a). As a result, unemployment rates are particularly high among young job seekers (Tiongson and Yemtsov, 2008). In 2003, the primary and secondary education in BiH were overhauled with the introduction of a nine-year basic education and the establishment of a common core curriculum. The legislative reform of the pre-school, vocational, and higher education has, however, stalled in parliament (ILO, 2009). The problem is exacerbated by the loss of skilled workers through emigration, and the paucity of life-long learning and on-the-job training programs. In the 2009 Enterprise Survey carried out by the World Bank, one third of managers of exporting firms cited inadequate skill pool as an obstacle to their operations (WB, 2009b).

uA01fig10

Human Capital Development Index

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

Source: OECD, 2010.Higher score represents superior policy or institutional conditions. A score of 5 is equivalent to best practice in the OECD area or globally.

14. The large informal sector creates disincentives and distortions in the labor market. The size of the grey economy is estimated at around 37 percent of GDP in the Federation and 21 percent in Republika Srpska (ETF, 2007). The informal employment is heavily concentrated in agriculture and light manufacturing (ILO, 2009) and accounts for a large share of the net employment generation (WB, 2005). Informal jobs are much lower paid than in the formal economy, do not pay social security and health care contributions, and lack job security. Workers in the grey economy, therefore, lack incentives for lifelong learning and opportunities for career development. The non-payment of social security and health care contributions, on the other hand, places a disproportionate burden for the running of the social security net on the formal sector.

15. The entrenchment of informal work arrangements is in part explained by population’s access to non-labor income and social benefits not conditioned on recipients’ income and ability to work (WB, 2009b, WB, 2010a). Private remittances from family members working abroad amount to between 15 and 18 percent of GDP each year. In addition, there are a number of government-run, noninsurance, cash benefits programs, which are not conditioned on recipients’ income and ability to work. Outlays on these programs—war invalids benefits, medal holders benefits, demobilized soldiers unemployment benefits (the latter terminated on May 1, 2010), civilian victims of war benefits, and non-war invalids’ benefits—collectively amount to 4.5 percent of GDP and cover 183,500 individuals.6 There are also close to 21,000 recipients of pensions granted under favorable conditions to former military personnel (many involving early retirement), for whom the informal sector is the only option for employment. Furthermore, “fictitious” workers in state-owned and voucher-privatized enterprises (SOEs and VPEs)7 prefer work in the grey economy rather than quitting the SOEs and VPEs and finding jobs in the formal sector, in the hope of large payouts of back wages and social security contributions. In the Federation, the system of unemployment benefits, though covering only 1.5 percent of registered unemployed (compared to 2.2 percent in the RS), does not provide sufficient incentives for quick re-entry in the workforce. The unemployment benefits of all recipients equal 40 percent of the average net wage (irrespective of the income and length of employment in the last job held), and are extended for periods of 3 to 24 months based on total years of work experience (ILO, 2009). At present, the unemployment benefit is slightly higher than the net minimum wage, which combined with the generous maximum length of the payout period discourages active job search. Finally, workers in the informal sector have access to free health care, as long as they remain registered as “formally” unemployed (see below).

16. The labor market legislation in BiH is fairly modern, but the flexibility of the regulatory framework is undermined by some outdated features of collective bargaining agreements. The Labor Laws in both the RS and the Federation—which establish the broad regulatory framework of employment—are fairly flexible (ETF, 2007). They are, however, supplemented by an extensive and generally rigid set of rules in collective bargaining agreements, many aspects of which are carried over from the old market socialism mode of labor relations. For example, the WB (2005) lists 40 different allowances that exist between the two Entities, including a tenure premium that puts younger workers with cutting-edge skills at a disadvantage to older workers, whose skills acquired under the old regime are often obsolete. In addition, the wage setting relies on a system of coefficients—reflecting the complexity of the performed work and the worker’s education—that is not compatible with the principles of a market economy. Furthermore, the minimum net wages in BiH (KM 308 in Federation, and KM 370 in RS (since July 1, 2010)) are among the highest in Eastern Europe, when expressed as a share of the average wage (WB, 2005). The potentially stifling effect of such provisions on labor relations is largely offset by widespread non-compliance, particularly in the private sector. However, the current status quo is sub-optimal, because “[n]on-enforcement of rigid regulations leads to informality, which creates rents for officials and uncertainty among employers and new investors, and leaves workers without protection (such as social insurance coverage)” (WB, 2005).

17. The work of the public employment mediation agencies in both Entities is bogged down by administrative mandates, with insufficient resources being allocated for active job placement policies. The provision of employment services—both passive and active—is carried out by Employment Funds in the RS and the Federation (1 central and 10 cantonal funds), which are primarily funded by payroll contributions.8 The Employment Funds in both Entities administer payments of “unemployment benefit for registered unemployed with paid contributions, health insurance coverage for all persons registered as unemployed, and, in the RS, pension insurance coverage for recipients of unemployment benefit” (ILO, 2009). In addition, until May 1, 2010 the Federation Employment Funds had the mandate to pay special unemployment benefits to demobilized soldiers. They continue to be responsible for the payment of “unemployment and pension benefits to all workers of state owned enterprises who become unemployed or receive early retirement as part of privatizations, liquidations or restructurings of those enterprises” (WB, 2009b). Furthermore, “applicants for all non-insurance cash transfers, except war veterans’ benefits, are required to register as unemployed to qualify for benefits” (WB, 2010a). As a result, most workers in the grey economy are formally registered as unemployed to have access to various benefits.9 The administration of these passive services consumes a large part of Funds’ time and treasure, leaving insufficient resources for job brokering, personalized counseling and guidance, and analytical work (ILO, 2009). The lack of emphasis on active job placement policies has opened sizable skill gaps in the area, particularly among staff with long tenure. The performance of Employment Funds is further impeded by stifling bureaucracy and the demoralizing effect on front-line staff of the extremely high ratio of unemployed to staff (1,100 to 1 in BiH).

18. The large labor tax wedge—the difference between the cost to the firm of employing a worker and the worker’s take-home-pay—discourages new jobs creation in the formal sector. The overall social security contribution rates in the RS and the Federation are similar (34 percent), when calculated at the average wage including allowances. While higher than the OECD average of 29.5 percent, they are not excessive in regional context (WB, 2005). However, when combined with the high level of wages in BiH relative to its Balkan peers, the magnitude of the labor tax wedge undermines the competitiveness of the country and makes informal employment more attractive to businesses (ILO, 2009).

19. The public sector is a major employer and often prices out the private sector in attracting workers. The BiH Constitution enacted as part of the Dayton Peace Accords created a decentralized governmental structure with numerous and often duplicating levels of government. As a result, the share of public sector in total employment in BiH is among the highest in Europe, and competition between the various levels of government has pushed the average public sector wage significantly above the level in the private sector. In addition to higher wages, public sector employment offers added job security and nonwage benefits, making private sector jobs less attractive.

uA01fig11

Share of Public Administration in Total Employment, 2008

(percent)

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

Source: Euro stat and Fund staff estimates
uA01fig12

Federation: gross wage, KM

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

Sources: BiH authorities; and IMF staff calculations.
uA01fig13

RS: gross wage, KM

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

Growth-promoting policies

20. Unlocking BiH’s full human capital potential requires renewed emphasis on labor market reforms. Cognizant of the need for further alignment of the domestic regulatory framework with international best practice, the Federation government is working on draft amendments of three laws in the area of employment protection (Labor Law, Work Safety Law, and Law on Employment Mediation and Social Security of Unemployed). There are plans for a new Labor Law in RS as well. Furthermore, the employment strategies adopted at the level of the country as a whole and by the governments of the Federation and the RS in 2010 define the broad outlines of the problems facing the labor market and the objectives of public policies in the area. The next step is to prepare periodic action plans with concrete measures and costing linked to the annual budgets of the public agencies responsible for implementing the employment policies. Some of the pressing priorities identified in existing labor market studies (WB, 2005; ILO, 2009) that need to be addressed in the actions plans under preparation and amendments of the employment protection legislation are:

  • Better alignment of the systems of collective bargaining and wage determination with the principles of a market economy through separation of the public sector wage determination from that in other sectors, formulation of criteria for representation of social partners involved in tripartite bargaining, limiting the coverage of collective agreements to those enterprises represented in the process, and rationalization and simplification of the system of “coefficients” and other aspects of wages, employment and benefit determination (WB, 2005);

  • Carrying out of the comprehensive reform of the education system via completion of the legislative overhaul of the pre-school, vocational, and higher education, following through the reforms of the primary and secondary education (ILO, 2009), and designing framework for continued education and life-long learning.

  • Public sector hiring and benefits restraint to contain the crowding out of formal private sector employment by generous public sector benefits and better job security.

  • Refocusing the work of Employment Funds to active job placement policies by relieving them from the burden of administering benefit programs unrelated to their core mandate, elimination of incentives for registration as unemployed solely to gain access to benefits while working in the informal economy (ILO, 2009), and the development of job activation programs. The reorientation of work priorities needs to be accompanied by a fundamental reform of human resource management of Employment Funds aimed at increasing the active job placement competencies of staff and linking employee compensation and career progression to their contribution to the agencies’ revamped mandate. Work in this area is supported by financing and technical assistance from the World Bank, under the recently approved “Social Safety Nets and Employment Support Project” (WB, 2010a), and the European Union project “Improving Active Labour Markets.”

  • Increasing the incentives for quick re-entry in the workforce, through (1) Conditioning of all non-insurance cash benefits on recipients’ income and ability to work and rigorous carrying-out of eligibility audits to weed out fraud. The reforms in this area are supported by the “First Programmatic Public Expenditure Development Policy Loan” approved by the World Bank in 2010 (WB, 2010b); (2) Revising the system of unemployment benefits in the Federation to decrease the maximum length of the payout period, setting the minimum amount of the unemployment benefits below the minimum net wage, and explicitly conditioning the right of unemployment benefits on the payment of unemployment contributions over a minimum period of time prior to the termination of employment.

Business Environment

Main Characteristics

21. The quality of the business environment in Bosnia and Herzegovina lags behind other countries in South-Eastern Europe. According to the World Bank’s Doing Business Report 2010, BiH ranks 116 out of 183 countries on overall quality of the business environment. An enabling business environment encompasses an efficient regulatory and enforcement system, enhanced corporate governance, and quality infrastructure.

Ease of Doing Business Rankings1

article image
Sources: World Bank, Doing Business Database, 2010.

Lower ranking means better environment.

22. The government has taken steps to improve the business environment in recent years, but more needs to be accomplished. Following the signature of the Stabilization and Association Agreement, significant steps have been made to reduce or abolish customs duties on a wide range of imports from the EU. The adoption of the Value-Added Tax (VAT) in Bosnia and Herzegovina in January 2006 has been an important step in promoting tax efficiency and giving firms an incentive to register (EBRD, 2008). BiH has also taken some effective measures to reduce the cost of starting a business and the time needed to register property (OECD 2010). Procedures were cut by 7 percent, time by 15 percent, and cost by 26.5 percent on average (WB, 2010c). Bosnia and Herzegovina has seen a 33 percent growth in transferred titles since the computerization of all municipal cadastres (WB, 2010c). The FBiH House of Peoples also has recently adopted amendments to 34 laws and amendments that aim to improve the business environment and restrict the informal economic activities. The amendments are part of the so-called “regulatory guillotine” project, co-financed by the IFC that aims to reduce bureaucracy and simplify business procedures in the entity. The Republika Srpska, which is further ahead in the implementation of this project, has so far removed 58 percent of unnecessary regulations, with an estimate that this reform would bring KM 23 million of savings annually for businesses. The introduction of a new Companies Law in the RS, effective from July 2009, aims to simplify the registration of new companies and bring companies law closer to EU standards (EBRD, 2009). The European Commission’s formal recommendation in May 2010 to lift the visa-regime for BiH citizens opens the prospect for further integration of the local economy in the larger European marketplace. Nonetheless, more reform efforts are needed in Bosnia and Herzegovina in order to unlock the country’s long-run growth potential.

23. Despite recent progress, the inefficiency and uncertainty of the regulatory regime continue to hamper the starting-up and running of businesses by imposing unnecessary costs and risks. Progress towards creating a single economic space within the country—a key European Partnership priority—has been limited (OECD 2010). This leads to slow decision making, duplication of policies, and an unclear division of powers. According to the World Economic Forum’s Competitiveness Report 2009, key factors impeding private sector growth in BiH include complicated and “expensive” bureaucracy, corruption, and weak legislative framework. Delays for business licensing are significant and the number of different tax payments is high. For instance, ten procedures and 127 days are needed for a business to get connected to the electricity network in Bosnia and Herzegovina, compared to a South Eastern Europe (SEE) average of 5.7 procedures and 109.2 days (OECD, 2010). In the 2008/09 Business Environment and Enterprise Performance Survey (BEEPS IV), more than one-quarter of the enterprises surveyed identified political instability as the main problem affecting their operations. The Foreign Investor Council White Book highlights business registration as a particular problem for foreign investors (FIC, 2009).

24. Bosnian and Herzegovina still lags other SEE economies on access to finance. More than half of enterprises report access to financing as an obstacle to their development (OECD, 2010). The financial sector is dominated by banks, the vast majority of which are foreign-owned. The global financial crisis put an abrupt end to the rapid growth of credit in recent years. Faced with worsening financial health of enterprises and households, banks cut back their loan portfolios, and raised interest rates to shore-up flagging profitability (World Bank, 2010a). The nonbank financial sector is relatively underdeveloped. Stock exchanges are dormant and their potential for raising new funds for companies is limited. While the legal framework for leasing is currently developed and the market is expanding rapidly, no specific regulation covers factoring, which remains underdeveloped. Efforts at entity level to extend credit guarantees to private sector enterprises are in their infancy. In the RS, the RS Investment Development Bank extends credits to commercial banks for lending at below-market interest rates to individuals (mortgage financing) and companies in agriculture and export sectors. A national export guarantee scheme, run by the Export Credit Agency, is inadequately funded and has had a limited impact thus far.

uA01fig14

BiH: Private Sector Credit Growth

(percent, 12-month growth rates)

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

25. The 1992–1995 war in BiH and the slow pace of the subsequent reconciliation resulted in substantial delays in privatization and enterprise restructuring relative to other Eastern European countries. The slow progress in restructuring of underperforming state-owned companies is noted in both the Investment Climate Assessment performed by the World Bank in 2008 and the 2009 European Commission Progress Report. About 1000 enterprises in the Federation and 600 enterprises in the RS, holding around a quarter of total assets of state-owned enterprises, were privatized under a voucher privatization scheme in 2000–2001 (IMF, 2005). The follow-up privatization of strategic enterprises has been slow. Republika Srpska privatized its largest and most attractive industrial assets in 2004–2006. However, there are still a number of loss-making medium enterprises that will be hard to sell (World Bank, 2008). In the Federation of Bosnia and Herzegovina, a dozen or more large strategic companies operating in aluminum production, construction and telecommunications remain to be privatized, as well as many loss-making medium-size enterprises.

uA01fig15

Large Scale Privitazation

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

uA01fig16

Small Scale Privatization

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

Source: EBRD Transition Report, 2009; and IMF staff estimates of unweighted regional averages.The EBRD maximum score is 4.33, with maximum being best.CEE-6 includes Bulgaria, Hungary, Romania, Poland, Slovalk Republic, and Slovenia.

26. Many state-owned and voucher-privatized enterprises suffer from poor corporate governance and are heavily indebted. The process of voucher-to-share conversion resulted in poor incentives for the new owners (investment funds or individuals) to put their own capital at risk, as the ownership transfer was provided on a grant basis from the government to citizens. As a result, many voucher-privatized enterprises (VPEs) remain undercapitalized and operate below potential. Furthermore, many low performing VPEs have accumulated arrears to the government for worker pension obligations, taxes, and unpaid salaries to workers. According to the World Bank (2008), broad calculation of pension and tax arrears owed to the government by VPEs, plus the additional capital estimated to be needed to ensure successful operating performance, yields an estimated gap equivalent to 15 percent of GDP. Many state-owned enterprises are also heavily burdened with arrears to suppliers, unpaid health and pension fund contributions, and delayed salary payments to workers.

uA01fig17

Enterprise Restructuring

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

Source: EBRD Transition Report, 2009; and IMF staff estimates of unweighted regional averages.The EBRD maximum score is 4.33, with maximum being best.CEE-6 includes Bulgaria, Hungary, Romania, Poland, Slovalk Republic, and Slovenia.

27. The rationalization of number of workers is still pending in many state-owned and mass-privatized enterprises (WB, 2005). In the past, SOEs were treated as a social safety net and were pressured into hiring of large numbers of veterans at the time of the demobilization of military personnel (IMF, 2005). Rather than going through the process of formal termination, many SOEs and VPEs dealt with surplus labor by stopping payments of wages and contributions while keeping workers nominally on their payroll (so called fictitious workers; World Bank, 2005). This problem is perpetuated by the legal requirement for clearance of all unpaid wage and social security contributions arrears prior to dismissal of workers (IMF, 2005) and fictitious workers’ expectation for government takeover of SOEs and VPEs unpaid obligations and eventual payout (World Bank, 2005). The existence of fictitious workers deters potential buyers and delays corporate governance restructuring.

28. The state of BiH’s infrastructure is inadequate. The telephony services in Bosnia and Herzegovina are available at high quality and lower cost compared with the region. Also, 96 percent of the roads are paved, which is high in comparison with the region. However, foreign investors have expressed concerns about the capacity of local transportation network to move their inputs and ship their final goods to market destinations in other countries (World Bank, 2008). Total road density and air traffic in Bosnia and Herzegovina is below the SEE average (OECD, 2010).

uA01fig18

Overall Infrastructure Reform

Citation: IMF Staff Country Reports 2010, 347; 10.5089/9781455212705.002.A001

Source: EBRD Transition Report, 2009.The EBRD maximum score is 4.33, with maximum being best. CEE-6 includes Bulgaria, Hungary, Romania, Poland, Slovalk Republic, and Slovenia.
Growth-Promoting Policies

29. Despite recent progress in reducing obstacles to business, significant further efforts are needed to attract foreign investors and empower domestic entrepreneurs. Some of the pressing priorities identified in existing business environment studies by the World Bank (Doing Business Report 2010; Investment Climate Assessment 2008), OECD (Investment Reform Index 2010), EBRD (Transition Reports 2008 and 2009), and the World Economic Forum (Global Competitiveness Index 2009) are:

  • Increasing the efficiency of the regulatory system by streamlining regulations to allow quicker business startups, fewer authorizations for business operations (in particular, simplification of licenses and permits), reduction in the number of different tax payments and mechanisms for business closure to facilitate restructuring (WB, 2008). To this end, speeding up the regulatory reform under the “regulatory guillotine” project and the IFC Subnational Competitiveness Programs, especially in the Federation, is crucial to improving the business environment.

  • Ameliorating access to finance through greater emphasis on credit and export guarantees and the development of alternative financing sources, such as leasing and factoring (OECD, 2010).

30. Corporate sector performance can be boosted by policies to enhance corporate governance via change in ownership and enterprise restructuring. Government policies in this area should focus on:

  • Speeding up the privatization of large strategic enterprises in the Federation and medium-size public companies in both entities.

  • Restructuring the underperforming voucher-privatized enterprises (VPEs). As noted above, many VPEs suffer from hidden losses, pension and tax debt arrears, and salary payment delays. The government should use its status of de facto main creditor of such VPEs to effectuate their restructuring, which may entail the government temporary becoming a large shareholder. To avoid the government getting reengaged in the enterprise sector on a permanent basis, the conversion of debt to equity in viable VPEs should only take place when interested investor willing to participate are identified and should be accompanied by operational restructuring. The latter would likely entail debt forgiveness, which could be well offset by higher tax collections in the future (WB, 2008).

  • Resolving the issue of disguised unemployment in state-owned and voucher-privatized enterprises by offering a cash-out option to such workers, based on a minimum severance and pension payment, which could be fully repaid from reduced future company losses, generation of more income, and thus increased taxes paid over the long term (WB, 2008).

31. Full implementation of planned large infrastructure projects can support growth through a boost in investment spending. Modern infrastructure enhances the competitiveness of an economy by efficiently linking firms to their customers and suppliers, and enabling the use of modern production technologies. In the roads sector, several projects have been signed in the past year with international financial institutions for building parts of the 330 km Corridor 5c (a branch of the fifth pan- European corridor), as well as strengthening the institutional development of the Motorway Directorate in both entities. In the railways sector, various projects to upgrade and modernize services are ongoing, with the support of bilateral donors and international institutions (EBRD, 2008).

F. Conclusions

32. Following a recession in 2009 and stagnation in 2010, the potential growth rate of the BiH economy would likely stay slightly below its pre-crisis value, resulting in domestic output remaining permanently below the prevailing pre-crisis trend. On the supply-side, the pre-crisis growth of output was mostly driven by rapid accumulation of factors of production. Post-crisis, the growth of the BiH economy will likely become more dependent on gains in human capital and total factor productivity.

33. Enhancing BiH’s human capital and speeding-up the pace of technological change requires a renewed emphasis on structural reforms to unleash BiH’s human capital and entrepreneurship potential:

  • Unlocking BiH’s full human capital potential requires renewed emphasis on labor market reforms. Reform priorities include better alignment of the systems of collective bargaining and wage determination with the principles of market economy; follow through the comprehensive reform of the education system; public sector hiring and benefits restraint; refocusing the work of Employment Funds to active job placement policies; and conditioning of all non-insurance cash benefits on recipients’ income and ability to work and rigorous carrying-out of eligibility audits to weed out fraud.

  • Speeding-up the pace of technological change calls for a drastic improvement in business environment consistently ranked among the worst outside Africa. The efficiency of the regulatory system can be improved by streamlining regulations to allow quicker business startups, fewer authorizations for business operations, and reduction in the number of different tax payments. Corporate sector performance can be boosted by policies to enhance corporate governance via change in ownership and enterprise restructuring. Full implementation of planned large infrastructure projects can also support growth by boosting investment spending.

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Appendix Table 1.

BiH: Data Used in Growth Accounting Exercise

article image
Sources: Agency for Statistics of Bosnia and Herzegovina, International Labour Organization’s Labour Statistics Database, Fund staff estimates.

Production-approach real GDP: 2003–008-chained series constructed from Agency for Statistics of Bosnia and Herzegovina (ASBiH) data on real GDP at previous year’s prices; 1999–2003-chained series constructed from unpublished data provided by the ASBiH.

The real capital stock series is constructed using the perpetual inventory method (Kt = (1-δ)Kt-1 + It) applied on an assumed base value of real capital stock in 2003 and using a constant annual depreciation rate (δ) of 4 percent. Following an approach first used by Harberger (1978), the base value of real capital stock in 2003 is obtained by dividing the real gross fixed capital formation (GFCF) in 2003 by the sum of the rate of depreciation and the potential growth rate of the capital stock estimated at 6.8 percent.

2005–2008-nominal gross fixed capital formation is estimated by applying the share of gross fixed capital formation in expenditure-approach GDP published by ASBiH to the production-approach nominal GDP. The real GFCF is then estimated by dividing the nominal GFCF by its deflator, constructed as a chained series from ASBiH data on year-on-year changes in GFCF price index; 1999–2004-chained series constructed from unpublished data provided by the ASBiH.

Population data for the period 1999–2015 from the International Labour Organization’s Labour Statistics Database, which extrapolates annual values from the bi-decennial median estimates published by the Population Division of the Department of Economic and Social Affairs of the United Nations Secretariat (http://esa.un.org/unpp).

2006–2009-data from the BiH Labor Survey published by the Agency for Statistics of Bosnia and Herzegovina; 2010–2015-chained series constructed using the growth rates of the variable taken from the International Labour Organization’s Labour Statistics Database; 1999–2005-assumed that values are the same as in 2006 (first available data point).

2006–2009-data from the BiH Labor Survey published by the Agency for Statistics of Bosnia and Herzegovina; 1999–2005-assumed that values are the same as in 2006 (first available data point).

1

Prepared by Plamen Iossifov and Khaled Abdelkader (both EUR).

2

Domestic absorption equals the sum of residents’ private and public consumption and investment of domestic and foreign goods and services.

3

The short time span of the second sub-period makes the derived long-run trend from the H-P filter indistinguishable from a simple fitted time trend.

4

The discrepancy between the production and expenditure measures of GDP is high (between 10 and 13 percent in 2006–2008). The production-approach GDP is the primary approach used by ASBiH.

5

Overestimation of the base-year capital stock will underestimate the contribution of capital to real GDP growth (and hence overstate the importance of total factor productivity gains), as it would result in lower real growth of capital for a given path of investment flows (Nehru and Dhareshwar, 1993).

6

Existing beneficiaries of non insurance social transfers include: civilian disabled − 42,000; civilian victims of war (disabled) −6,341; war veterans − 47,142; families of fallen soldiers − 46,000; and remaining case load of demobilized soldiers who are yet to receive benefits − 42,000 (WB, 2010A).

7

In the past, SOEs were treated as a social safety net and were pressured into hiring of large numbers of veterans at the time of the demobilization of military personnel. Rather than going through the process of formal termination, many SOEs and VPEs dealt with surplus labor by stopping payments of wages and contributions while keeping workers nominally on their payroll (so called fictitious workers; see following section for further details).

8

In the Federation, individual cantonal employment funds are funded by the payroll contributions collected in their respective cantons, resulting in inadequate funding of employment programs in cantons with high rates of unemployment.

9

The number of unemployed registered at the Employment Funds exceeds 40 percent of the BiH labor force, whereas labor force surveys suggest that the actual unemployment rate is around 24 percent.

Bosnia and Herzegovina: Selected Issues
Author: International Monetary Fund