Bosnia and Herzegovina: Selected Issues

Abstract

Bosnia and Herzegovina: Selected Issues

Dire State of Labor Markets Calls for Broad-Based Reforms1

Labor market outcomes in the Bosnia and Herzegovina are among the worst in emerging Europe. The long-standing persistency of high unemployment and low employment rates in the region points at predominately structural reasons. Thus, poor labor market outcomes are likely to persist even as economic growth picks up. Only a simultaneous and comprehensive reform effort—aimed at retooling the economic growth model, improving the business and investment climate, strengthening labor market institutions, and reducing rigidities of the labor markets—is likely to produce the desired outcome.

A. Worrisome Labor Market Trends

1. The labor market in Bosnia and Herzegovina is characterized by notably worse outcomes than those in most other countries in emerging Europe, including many countries in the Western Balkans. In 2013, the unemployment rate—as measured by the labor force survey—in Bosnia and Herzegovina (BiH) reached 27½ percent, higher than 23 percent average among the Western Balkan countries and in sharp contrast with about 11 percent and 5 percent averages among Central European and CIS countries, respectively. This is a key social concern but also implies significant economic challenges in terms of lost potential output and additional fiscal costs.

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CESEE: Unemployment rate

(percent)

Citation: IMF Staff Country Reports 2015, 299; 10.5089/9781513578835.002.A003

Sources: WEO; National LFS data.1/ Data for 2012.Note: CEE5 (purple) includes Czech Republic, Hungary, Poland, Slovak Republic, and Slovenia; Baltics (green) includes Estonia, Latvia, and Lithuania; SEE (orange) includes Bulgaria and Romania; Western Balkans (red) includes Albania, Bosnia and Herzegovina, Croatia, FYR Macedonia, Montenegro, and Serbia.

2. Bosnia and Herzegovina’s inferior labor market trends predate the global financial crisis. While Central and Southern European countries—and even more so the Baltics—also experienced large cyclical swings of both employment and unemployment during the 2000s, these swings took place within a qualitatively different space of markedly lower unemployment and higher employment. In contrast, labor markets in BIH failed to significantly benefit from employment gains during the boom years while still registering significant job losses in the aftermath of the crisis.

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Labor market trends, 2000-2013

Citation: IMF Staff Country Reports 2015, 299; 10.5089/9781513578835.002.A003

Note: CEE5 (purple) includes Czech Republic, Hungary, Poland, Slovak Republic, and Slovenia; Baltics (green) includes Estonia, Latvia, and Lithuania; SEE (orange) includes Bulgaria and Romania; Western Balkans (red) includes Albania, Croatia, FYR Macedonia, Montenegro, and Serbia.

3. High youth unemployment and long-term unemployment are particularly worrisome. The unemployment rate for the youth (aged 15–24 years) exceeded 59 percent in 2013, while over 34 percent of the next potentially productive group (aged 24–34 years) is also unemployed. This situation is further complicated by high rate of long-term unemployment where over 80 percent of unemployed have not been able to find a job for more than 12 months.

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Sources: Country authorities; OECD; Haver; Eurostat; CEA: and IMF staff calculations.1/ 2012 data used in place of 2013 data.2/ Balkan average used for long-term unemployment rate. due to missing data.3/ Unemployed (15-24) as a percent of active population (15-24).

4. The public sector continues to be the main source of jobs in Bosnia and Herzegovina. Employment trends by sector highlight that much of private sector job gains of the boom years have been lost in the aftermath of the global financial crisis. These job losses were somewhat masked by a continued expansion of the employment in the broader public sector. Indeed, during the past decade, the number of public administration and defense jobs has increased by nearly 13 percent, while employment in education and health sectors has increased by over 22 percent. These trends are hardly surprising in the face of weak private activity and considering that, in addition to higher job security, public sector jobs enjoy high wage premium relative to the private sector employment. With high wages and large public sector employment, BiH is spending a greater share of GDP on compensation of public sector employees than its peers.

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Source: BiH Agency for statistics, and IMF staff calculations.1/ Private sector employment includes workers employed by a number of state-owned enterprises.

5. Unemployment is likely to persist even as economic growth picks up in the aftermath of the crisis. Indeed, smaller and statistically insignificant responses of labor market outcomes to swings in economic cycles—gauged by the size of Okun’s coefficient measuring the contemporaneous response of unemployment rate to changes in economic growth—suggest that unemployment in BiH—as well as in all other Western Balkan countries—is unlikely to drop radically once economic growth recovers in the future. This is in sharp contrast with larger and statistically significant response coefficients found in most Central European and Baltic economies.2

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Labor Market Cyclicality

Citation: IMF Staff Country Reports 2015, 299; 10.5089/9781513578835.002.A003

Source: IMF staff estimates.1/ Values of the response coefficient of unemployment to one percent increase in economic growth estimated over country-level data from the period of 1993-2013.

B. Diagnostics of Structural Impediments

6. Persistent labor market problems signal the presence of deep structural problems, likely going far beyond labor markets. One reason is BiH is a latecomer to the transition process, even by Western Balkan standards. Core structural reforms such as enterprise restructuring, competition policy improvements, and privatization are drastically less advanced in BIH than in other more dynamic peer countries. Furthermore, the country’s business environment indicators lag far behind the region and indeed most of the countries in the world, particularly in areas of ease of starting businesses, obtaining construction permits, connecting to electricity, paying taxes, and investor protection. This has held back FDI inflows, diversification from traditional sectors, and private sector job creation. At the same time, the country has experienced very large emigration and a brain drain—particularly among the better educated layers of population—likely contributing to labor shortages at the better-educated segment of the labor market. While high remittances inflows provide a welcome safety net for the poor and elderly (filling in significant gaps in the government-provided social assistance programs), they also could raise reservation wages, hamper external competitiveness, and contribute to the long unemployment duration.

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Doing Business Indicators 1/

Citation: IMF Staff Country Reports 2015, 299; 10.5089/9781513578835.002.A003

Source: World Bank.1/ The number corresponds to a global rank of a country. Lower rank means better business environment.
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Average EBRD Transition Indicator by Country Group

Citation: IMF Staff Country Reports 2015, 299; 10.5089/9781513578835.002.A003

Source: European Bank for Reconstruction and Development.
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BIH: EBRD Transition Indicator by Category

Citation: IMF Staff Country Reports 2015, 299; 10.5089/9781513578835.002.A003

7. Institutional rigidity of the labor markets compounds the impact of structural problems. Business surveys show that—even before the global financial crisis—up to 40 percent of younger and more vibrant firms in BIH considered existing labor market regulations as a major or very severe impediment for their economic activity and growth, the bottleneck that is likely to significantly constrain development of new industries with more sophisticated and better paid jobs. This is in sharp contrast with most CEE5 and Baltic countries were labor regulations were not considered to be an important constraint.

8. Private (non-financial) sector companies view the BiH labor market legislation as inadequate. According to a recent study conducted by the FBIH employers association, more than ¾ of companies are dissatisfied with the current labor legislation as it fails to promote entrepreneurship and positive attitude towards labor.3 Under the current economic conditions, about ⅓ of companies are unable to comply with provisions from the general collective agreements.

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Distribution of New Firms that Consider Labor Regulations a “Major” or “Very Severe” Constraint 1/

Citation: IMF Staff Country Reports 2015, 299; 10.5089/9781513578835.002.A003

Source: BEEPS 2008; IMF staff calculations.1/ New firms are those which operated for five yearsor less.

9. Indefinite duration of collective bargaining agreements poses a number of challenges for BIH labor markets and the broader economy’s ability to adjust to economic shocks:

  • It fosters job loss and results in higher occurrences of bankruptcies as stiff constraints on employers to renegotiate wages and benefits limit the space for firms’ responses to cyclical swings and economic shocks.

  • It fosters informal economy as employers would favor easily adjustable and cheaper illegal workers over inflexible and costly formal employment.

  • It leads to a higher wage premium in the public sector over the private sector as it benefits the negotiating position of heavily unionized public sector employees compared with a weaker bargaining position of less organized private sector workers (less than 10 percent of private sector workers belonging to a trade union).

  • It encourages lengthy and costly litigations and piles up fiscal costs. Unenforceable labor contracts, overly rigid redundancy procedures, economically unjustified wages and allowances encourage labor-related lawsuits, largely arising from the public sector employees.4

Ultimately, these challenges resulted in a creation of a dual labor market of “insiders”—mainly public sector workers, including SOE; and “outsiders”—mainly private sector workers and informal workers.

10. In line with ILO findings and positions, longer durations of collective agreements entail larger risks to the workers.5 In most countries in the region, collective agreements are limited in duration, with limits ranging from 1 to 5 years. BIH is the only country in the region with indefinite duration of collective agreements.

Duration of Collective Agreements

article image
Source: https://www.worker-participation.eu
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Global Competitiveness Indicators, 2013-14 1/

Citation: IMF Staff Country Reports 2015, 299; 10.5089/9781513578835.002.A003

Source: World Economic Forum Global Competitiveness Indicator database, 2013-14 edition.1/ The number corresponds to a global rank of a country. Lower rank means better competitiveness.

11. The BIH labor market was shaped by the particular legacy of the “self-management” system for enterprises, and the existence of the so-called social ownership.6 As in other Western Balkan countries, this led to a high level of job protection for the “insiders” and to overall rigidity. As witnessed by the country’s poor standing in the Global Competitiveness Indicators, Bosnia and Herzegovina is characterized by extremely rigid wage determination—rigidly regulated by collective agreements for job complexity groupings and by education and tenure of an employee—and coupled with a feeble link between work compensation and labor productivity. Similarly, the country stands out in terms of the dragging effect of taxation on incentives to work and extremely low women participation in the labor force. While BIH ranks surprisingly favorably in terms of overall hiring-firing practices and redundancy costs, these results need to be interpreted carefully as indices do not always agree with the public consensus within the country that identifies these areas as problematic. Moreover, a large share of the BIH labor market—capturing jobs in the civil service, public sector, and state-owned enterprises—is subject to strict rules for terminating the employment and generous severance payments guided by civil service regulations.

12. Average gross wages in BIH—while low in absolute level—are somewhat higher than labor productivity. However, these averages need to be interpreted with caution when making an overall assessment of BIH external cost competitiveness, as they are likely to be significantly inflated by high wages in the broader public sector, a dominant employer in the economy. At the same time, labor productivity is quite low by regional standards, amounting to just over 25 percent of average productivity in EU countries.

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Wages and Labor Productivity, 2014 1/

Citation: IMF Staff Country Reports 2015, 299; 10.5089/9781513578835.002.A003

1/ EU average = 100 (excl. Luxemburg), productivity calculated using 2014 IMF WEO projections for GDP. Wages for Montenegro, Poland, Russia, Serbia and Ukraine as of 2014q4. Source: Haver Analytics, IMF World Economic Outlook and IMF staff calculations.

13. Minimum wages are significantly higher in BIH than elsewhere in the region. This holds irrespective whether minimum wages are expressed in US dollars or as a share of the average value added per worker (a proxy for average earnings in a cross-country comparison). Faced by higher minimum wages, businesses are less likely to hire less experienced workers and workers who have been out of the workforce for some time. High minimum wages may also induce disincentive to higher the youth and depress formal employment, especially in low-paid sectors and poorer regions. The relatively high level of minimum wages in BIH also suggests that economic factors—such economic growth, productivity improvements, and the current state of the labor market—are insufficiently taken into account. Notwithstanding these findings, discussions with employer associations in both entities did not indicate that an elevated minimum wage level poses significant impediment to job creation.

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Minimum wages, 2012

Citation: IMF Staff Country Reports 2015, 299; 10.5089/9781513578835.002.A003

14. The BIH labor market is also characterized by a large share of informal employment. While inevitably the precise size of the shadow employment is subject to significant uncertainty, available estimates seem to suggest that nearly 15 percent of the country’s employment (or about 10 percent of the labor force) in 2014 is engaged in activities in the informal economy. And these figures were even higher during the boom years preceding the global financial crisis—likely because employers found it easier to shed illegal workers whose rights were not adequately protected—and the shadow employment is likely to increase again as economic growth picks up. Aside from obvious problems of tax evasion and unpaid social contributions, workers engaged in informal employment do not enjoy adequate level of employment protection available to officially employed peers and are subject to higher risk of employment violations.

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BIH: Shadow employment

Citation: IMF Staff Country Reports 2015, 299; 10.5089/9781513578835.002.A003

Source: BHAS, Labor and Employment Agency, and IMF staff calculations.Note: Shadow employment is estimated as a difference between the LFS-based employment and registered employment.

15. The decentralized political structure of Bosnia and Herzegovina imposes additional challenges to businesses operating in the country. Indeed, differences in labor regulations across the entities and inconsistent court interpretations of legal provisions add administrative hurdles and costs to companies that work in the whole country. 7 Most common problems are related to calculating the past service, sick leave payment, compensation and refunds by health insurance funds, and maternity leave payments. Furthermore, a special problem is related to different interpretation of legal solutions—collision of collective agreements with the Law on Personal Income Tax and the Law on Social Security Contributions—resulting in different court rulings related to the same legal mater, adding to a high degree of uncertainty for both employers and employees. More generally, businesses perceive the judiciary system as slow and inefficient, with a negative impact on the labor market and employer-workers relations.8

C. Making BIH a more Conducive Place for Job Creation

16. To sustainably bring down unemployment from its current high levels and to improve labor market participation, Bosnia and Herzegovina needs to become a more attractive place to invest and create jobs. This task is far from simple and favorable results cannot be achieved overnight. Nevertheless, several priorities emerge. First, there is a need to address remaining structural impediments to growth and job creation. Maintaining macro-financial and political stability is a key pre-condition, but robust economic growth will ultimately hinge on cultivating more competitive product and factor markets and deeper trade integration, both within the region and more globally. These, in turn, are not possible without decisive efforts aimed at improving business and investment climate to attract foreign investors, stimulate entrepreneurship, improve productivity, and create more and—importantly—better jobs, including for younger workers and women. This is the overarching challenge facing the country. That said, specific reforms to labor markets can also make a contribution to stronger growth, especially in the formal sector.

17. Second, strong labor market institutions are key to generating productive employment and addressing duality between “insiders” and “outsiders” in the labor market. This balance is difficult to achieve, but updating the labor market legal framework to make it more conducive to job creation should play an important role (Boxes 1 and 2). Most critically, the indefinite collective agreements have become a drag on private, formal-sector employment creation and the new labor laws should introduce a limit on their duration so that these could be adjusted regularly to reflect rapidly changing economic realities. Collective agreements that are limited in duration and apply only to those enterprises and workers that want to be part of the agreement will help ensure that the process of collective bargaining—currently stalled due to unwillingness of some social partners to revisit outdated agreements—can function effectively. Equally important, the new laws should enhance flexibility of wage determination frameworks and facilitate better linkage between work compensation and labor productivity by promoting differentiated wage setting based on skills, qualifications, experience, and performance. Finally, the legal framework governing employment in the civil service need to be updated to facilitate public administration reform, including by increasing the scope for reallocating staff within the administration and adjusting staffing and wage levels, and channel labor market resources to the private sector.

The Region Is Moving On

A number of countries in the region have recently reformed their labor market frameworks.

In 2014, Serbia adopted amendments to the labor law which are aimed at removing disincentives for hiring and making wage bargaining and employment procedures more flexible. Specifically, the reform limited severance payments by linking them to service with current employer rather than life-time employment, extended the maximum length of temporary contracts from one year to two years, clarified and simplified separation rules, and tightened the rules for extensions of collective agreements to all firms in the sector. The authorities also envisage wider use of job supporting programs such as job matching services, career counseling and training for both pre-redundancy workers and the unemployed, employer subsidies targeting disadvantaged job seekers, and self-employment support.

Also in 2014, Croatia adopted the new labor code with the aim to increase employment, decrease informal employment, introduce more flexible business operations, and adequately safeguard workers’ rights. Specifically, the reform envisaged support to different labor contracts including work though employment agencies, relaxation of working hours and part-time employment, and simplifying redundancy and lay-off procedures.

Over 2007–12, Macedonia implemented a number of legislative reforms focused on clarifying provisions governing part-and fixed-term contracts, allowing greater flexibility for overtime work, simplifying redundancy procedures to make compliance easier and less costly, and revamping the collective bargaining framework (including by limiting duration of collective agreements).

Modernizing Labor Laws in Bosnia and Herzegovina

Labor laws in Bosnia and Herzegovina are outdated and do not create an environment conducive to job creation in the formal sector.1 Labor markets could benefit from aligning labor legislations to ILO labor standards and EC labor directives, particularly in areas of labor market flexibility, protection of workers, and the role of the governments.

Labor market flexibility

Duration of collective agreements. The general collective agreement is mandatory for all employers and regulates the minimum rights of workers. It regulates the minimum wage, calculation of the basic wage, as well as the right and the amount of severance payment, meal, transportation, and vacation allowances. Although legislation allows for collective agreements with definitive and indefinite duration, in practice the general collective agreements date many years back, no longer reflect economic realities, and resulted in numerous failed negotiations. These agreements are seen as an obstacle to formal sector employment creation in a rapidly changing economic environment and give a rise to a large number of court proceedings—mainly involving workers in the public sector—due to the failure to implement collective agreements. Labor laws should set a limit on the duration of the collective agreements to ensure that the process of collective bargaining can function.

Fixed-term contracts. Although fixed-term contracts are allowed, the current framework sets an overly restrictive time limit (up to two years) on their duration. This may be insufficient for longer infrastructure projects, resulting in higher employee turnover and inadequate worker right protection. Also, a less rigid regime would benefit employment of vulnerable groups of workers as fixed-term contracts typically are held by younger people and other market entrants. Thus, they can provide a step forward to regular employment and an opportunity to gain skills and experience. New laws should allow duration of fixed-term contracts, with or without renewals, for up to five years. With these considerations in mind, however, careful attention needs to be given to avoid a situation where short term contracts are offered as a substitute to permanent contracts as this could damage job prospects for new labor market entrants, and particularly the youth.

Temporary employment agencies. A legal framework for operations of temporary employment agencies does not exist and needs to be established. Clear defining legal and operational status of employment agencies would help bringing temporary jobs into official economy and protect rights of workers.

Workers’ rights

Overtime activities. The current framework is overly restrictive in regulating overtime activities as it sets strict time limits on daily, weekly, and annual overtime hours. This not only constrains employer’s capacity to react quickly to temporary fluctuations in the economic activity, but also undermines workers’ ability to earn extra income. Legislation should permit greater flexibility in overtime activities, allowing employers and employees a possibility to negotiate specific overtime terms in collective agreements or individual contracts.

Probationary period. The current legal framework sets a fixed limit (six months) on the duration of probation period. However, some degree of differentiation might be warranted with longer trial periods for employees in managerial positions and shorter periods for unskilled workers.

Leave. Family-related and sick-leave arrangements are fairly generous, based on international standards. While maternity leave is an important public policy measure to protect the health of mothers and children, long maternity leave can reduce women’s attachment to the labor market, erode skills, and result in employer’s discrimination against women of child-bearing age due to the associated indirect costs. Family-related and sick-leave arrangements are particularly costly for small and medium enterprises and some flexibility may be warranted to allow these to be covered by employee’s annual leave or unpaid leave entitlements. Furthermore, maternity leave arrangements differ between the entities—and even between the cantons in the FBIH—and greater degree of harmonization may be warranted.

Role of the Government

Minimum wages. The level of minimum wage is relatively high in Bosnia and Herzegovina compared with the average productivity per worker and relative to the minimum wages in neighboring countries. The lack of a separate minimum wage for young workers may have also contributed to extremely high youth unemployment. The governments should consider taking a more active role in regulating the levels and differentiation of the minimum wage.

Severance entitlements. Current legal solutions overprotect the insiders, at the expense of lack of opportunities for those currently without the work. While the unemployment benefits are low, burden of income support is placed on employer through severance payments. This hinders job creation, creates disincentives for hiring new workers, and leads to informality and stagnant unemployment pool. The focus should be shifted from protection of jobs to helping the job transition via strengthening active labor market policies and an unemployment benefit system.

Penalties. It is important to ensure that penalties for the labor laws are sufficiently high to help protect worker’s rights and reduce the size of informal economy.

1 The current labor law in the FBIH was approved in 1999 and amended in 2000 and 2003. The current labor law in the RS was approved in 2000 and amended in 2000, 2002, 2003, and 2007.

18. Third, sustained employment growth requires improving cost competitiveness. Legislations governing minimum wages and redundancy costs would need to be reviewed, while strengthening the general system for unemployment insurance, to avoid creating disincentives for hiring new workers in the first place and placing a sizable burden exclusively on enterprises when they are forced to downsize at a time they can ill afford this. Introducing a separate minimum wage for young workers may be useful to facilitate youth unemployment. Also, containing current expenditure of the governments and broadening the tax base by addressing tax evasion are also needed to create fiscal space to lower the tax burden on labor and reduce the informal economy.

19. Fourth, welfare reforms aimed at better targeting of social assistance and incentivizing labor market participation for all groups are needed, as is boosting skills and adaptability of workers through improved training and education. In this context, active labor market programs such as job matching services, career counseling and training for both pre-redundancy workers and the unemployed, employer subsidies targeting disadvantaged job seekers, and self-employment support are of critical importance. These efforts need to be supported by stepped up labor inspections and increased penalties for labor law violations to help protect workers’ rights—consistent with ILO labor standards and EC labor directives—and reduce the informal economy.

20. Finally, completing the labor market transition in an environment of slow post-crisis recovery will inevitably have wide-ranging social consequences. Social cohesion should be achieved through extensive consultation between all social parties, including those that are currently out of work. The adjustment must be seen as fair, and as involving labor not just in the production sector, but also in the services and financial sectors. It is also important to have a well-targeted social safety net in place to protect the most vulnerable and make fiscal space for critical social and infrastructure spending.

References

  • Calvo, G., Goricelli, F. Ottonello, P., 2012, The Labor Market Consequences of Financial Crises with or without Inflation: Jobeless and Wageless Recoveries, Working Paper No 18480, Cambridge, MA: National Bureau of Economic Research.

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  • FBIH Employers Association, 2015, FBIH Labor Law: The Necessity of Introducing Flexecurity, Sarajevo, 2015.

  • ILO, 2006, Freedom of Association: Digest of decisions and principles of the Freedom of Association Committee of the Governing Body of the ILO, 2006.

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  • ILO, 2013, Global Employment Trends, Recovering from a Second Jobs Dip, January, 2013, Geneva.

  • ILO, 2014, Global Employment Trends, Weak Economic Recovery Does Not Extend to Jobs, January, 2014, Geneva.

  • Kuddo, Arvo, 2013, “South East Europe Six: A Comparative Analysis of Labor Regulations”, World Bank Technical Note, August 2013.

1

Prepared by Ruben Atoyan and Irena Jankulov.

2

In post crisis environment, sluggish responsiveness of job creation to growth is likely aggravated by weakened balance sheets affecting financing conditions (ILO, 2013). Also, job creation is impaired by a need for firms to build up new collateral to finance their activities (Calvo et. al., 2012), while concurrently fiscal consolidation could have depressed aggregate demand (ILO, 2014).

4

In 2013 and only in FBIH, the total value of all lodged legal challenges was over KM 500 million (about 2 percent of GDP), pointing to unsustainability of the current legal framework and requiring urgent changes.

7

White Book 2012/13, Foreign Investors Council BiH.

Bosnia and Herzegovina: Selected Issues
Author: International Monetary Fund. European Dept.