SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE ROMANIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE ROMANIA © 2023 International Bank for Reconstruction and Development /The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with exter- nal contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other infor- mation shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any ter- ritory or the endorsement or acceptance of such boundaries. Rights and Permissions The material in this work is subject to copyright. 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Cover design: Wojciech Wolocznik, Cambridge, United Kingdom Interior design and typesetting: Piotr Ruczynski, London, United Kingdom CONTENTS Key Messages of the Romania Systematic Country Diagnostic Update   7 Acknowledgements    9 Acronyms and Abbreviations    11 EXECUTIVE SUMMARY    12 1 UPDATED COUNTRY CONTEXT     17 1.1 Recent developments in growth, poverty reduction, and shared prosperity    18 1.2 A tale of two Romanias    23 1.3 Emerging risks and opportunities for sustainable and equitable growth    26 2 CONSTRAINTS TO GROWTH AND PROSPERITY IN ROMANIA     32 2.1 Weak institutions and low administrative capacity remain key constraints     33 2.2 Ineffective policy implementation and insufficient public expenditure contribute to poor and unequal development outcomes     36 2.3 Shortage of skilled workforce and labor market frictions constrain the labor supply    41 2.4 Low connectivity, a shallow financial sector, and an unfavorable business environment hold the private sector back    44 2.5 The challenges of climate change mitigation and the green transition become prominent    50 2.6 Resilience to natural hazards and climate change is low    54 3 PRIORITIES FOR INCLUSIVE, STRONG, AND SUSTAINABLE GROWTH     56 HLO-I Predictable political and economic environment for people and businesses    58 HLO-II Equal access to high-quality public services at central and local levels    60 HLO-III Better health and education outcomes for all     63 HLO-IV Favorable conditions for more and better private-sector jobs     65 HLO-V Climate change mitigation for environmental sustainability of economic activity     68 HLO-VI Resilience to shocks and adaptation to climate change, especially for vulnerable households    69 Knowledge gaps    71 ANNEX 1  Boxes    73 ANNEX 2  Priorities and selection criteria    77 References    79 Notes    82 BOXES BOX 2.1  Unequal access to shared BOX A.3  Development of secondary cities     74 opportunities in Roma communities     38 BOX A.4  Green growth and opportunities BOX A.1  An update on firm productivity     73 ahead     75 BOX A.2  SCD 2022 is an Update to SCD 2018    74 BOX A.5  The NRRP and its expected impact     76 FIGURES FIGURE 1.1  Economic growth has been among FIGURE 1.17  …its natural capital has declined the highest in the EU…    18 over time, calling for a more sustainable growth FIGURE 1.2  …leading to a strong convergence in model    28 living standards with the rest of the bloc    18 FIGURE 1.18  Romania is lagging the rest of the EU on digitalization    29 FIGURE 1.3  Romania’s growth has been largely driven by private consumption    19 FIGURE 1.19  Over the next 5+ years, available EU funding will effectively double and cover FIGURE 1.4  Productivity and capital new thematic areas, further straining capacity    31 accumulation have driven growth, with negative contribution from labor    19 FIGURE 1.20  Romania had access to substantial EU funding in the past but did not fully use it, FIGURE 1.5  Labor productivity has been partly due to capacity constraints    31 catching up with the EU average, but a 33 percent gap remains    20 FIGURE 2.1  Romania’s ranking on the Corruption Perception Index is among the FIGURE 1.6  Significant progress has been made worst in the EU    34 in reducing poverty and inequality…    20 FIGURE 2.2  Romania lags the EU average on FIGURE 1.7  …but Romania’s poverty rate is by far quality of electoral processes, rule of law, the highest in the EU    21 access to information, and civil rights    34 FIGURE 1.8  Progress in poverty reduction FIGURE 2.3  Romania ranked last in the EU on between 2014 and 2019 was due to rising labor digital public services in the last four years    35 and pension incomes    21 FIGURE 2.4  Romania falls well below the EU FIGURE 1.9  Most Romanians in the bottom average on efficiency and effectiveness of income quintiles either do not work, or rely on policy implementation     36 low-productivity agriculture    22 FIGURE 2.5  Government expenditure on health FIGURE 1.10  Income per capita in the and education is among the lowest in the EU    37 Bucharest-Ilfov region is by far the highest in the country    23 FIGURE 2.6  The impact of social transfers on poverty reduction in Romania is the lowest in FIGURE 1.11  Despite Romania being a high- the EU    39 income country, vast rural areas have low- income status    24 FIGURE 2.7  Inequality of opportunity in Romania is higher than in most of the EU    40 FIGURE 1.12  The at-risk-of-poverty rate is highest among people living in rural areas, FIGURE 2.8  Romania’s population is shrinking unemployed, self-employed, elderly, or with and aging    41 low education    24 FIGURE 2.9  A shortage of skilled workforce has FIGURE 1.14  Self-reported unmet needs for become the top constraint for businesses    42 medical examination in rural, suburban, and FIGURE 2.10  Share of population involved in urban areas, Romania and EU-27, 2020    25 lifelong learning is low    43 FIGURE 1.13  The urban-rural divide in access to FIGURE 2.11  Romania's spending on labor- basic water and sewerage services is stark    25 market programs is the lowest in the EU    44 FIGURE 1.15  Human Capital Index scores FIGURE 2.12  Motorway density in Romania is are positively correlated with the level of among the lowest in the EU    45 urbanization    25 FIGURE 2.13  Railway density is on par with EU FIGURE 1.16  While Romania’s overall wealth has average, but the network needs urgent repairs seen a robust upward trend…    28 and modernizations    45 FIGURE 2.14  The level of fixed-broadband FIGURE 2.20  CO2 emissions per capita household penetration is relatively high in (1962 – 2018)    50 Romania    46 FIGURE 2.21  Romania's GHG emissions are FIGURE 2.15  Regional differences in internet concentrated in the energy sector    51 access (fixed and mobile) are wide    46 FIGURE 2.22  Electricity generation in Romania FIGURE 2.16  Investment in Romania (as percent relies heavily on fossil fuel, hydropower, and of GDP) is comparable to the EU-27 average nuclear    51 (2019 – 2020), but the needs are much greater    47 FIGURE 3.1  Priorities, to HLOs, to Twin Goals    57 FIGURE 2.17  Total assets of the banking sector FIGURE BA.1.1  Decomposition of Growth in as a share of GDP remain low (Q2 2021)    48 Manufacturing Productivity (TFP)    73 FIGURE 2.18  Romania ranks the lowest on the FIGURE BA.1.2  Decomposition of Growth in EU Innovation Scoreboard    49 Services Productivity (TFP)    73 FIGURE 2.19  The number of firms varies FIGURE BA.4.2  The European Green Deal    75 substantially across county    50 FIGURE BA.4.1  Diagram of green growth    75 TABLES TABLE KM.1  High-Level Outcomes TABLE ES.1  High-Level Outcomes and Priorities    16 and Priorities   8 TABLE 3.1  High-Level Outcomes and Priorities    58 KEY MESSAGES OF THE ROMANIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE This report is an update to the first comprehensive Despite visible progress, several key constraints hold Romania Systematic Country Diagnostic (SCD), pub- Romania back from ensuring growth that is more in- lished in 2018, which identified a set of development clusive, and more sustainable economically and en- priorities for Romania to achieve the twin goals of pov- vironmentally. This SCD Update groups them into six erty reduction and shared prosperity. While the ear- broad and interrelated topics: lier diagnostic remains largely valid, several emerging themes have become prominent in recent years, bring- • Weak institutions and low administrative capacity. ing both challenges and opportunities for the country • Ineffective policy implementation and insufficient to reach the development goals in the medium and long public expenditure, which contribute to poor and term. These include impacts from the COVID-19 pandemic unequal development outcomes. and Russia’s invasion of Ukraine on Romania’s economy • A shortage of skilled workforce and labor market and people, a drive toward the digital and green trans- frictions, which constrain the labor supply. formations, and access to sizable EU funds. Alongside • Poor connectivity, a shallow financial sector, and an these trends, challenges around demography, institu- unfavorable business environment that hold the pri- tions, and governance continue to play a crucial role on vate sector back. Romania’s development agenda. This report validates the • The challenges of climate change mitigation and the relevance of priorities identified in the SCD 2018, revis- green transition. es the priorities and high-level outcomes based on new • Low resilience to natural hazards and the effects of evidence, and provides the analytical underpinnings for climate change. the next Country Partnership Framework. This SCD Update identifies six High-Level Outcomes Romania continues its economic progress of growth (HLOs) to expedite Romania’s achievement of the twin and income convergence, yet the ‘tale of two Romanias’ goals. The HLOs, if achieved over the next five to ten persists. The SCD 2018 summarized the overarching nar- years, would mark an improvement in the wellbeing of rative of the country’s socio-economic development as the population, and especially of the poorest and most A Tale of Two Romanias: one urban, dynamic, and inte- vulnerable. These are: grated with the EU; the other rural, poor, and isolated. Five years on, the country has made some progress in (i) a predictable institutional and economic environ- addressing constraints to growth as well as in reduc- ment for people and businesses; ing poverty and inequality, despite several unprece- (ii) equal access to high-quality public services at the dented shocks — such as the COVID-19 pandemic, and central and local levels; Russia’s invasion of Ukraine. Romania’s growth rate re- (iii) better health and education outcomes for all; mains among the highest in the EU, boosting conver- (iv) favorable conditions for more and better private gence in living standards with the average Europeans. sector jobs; However, Romania’s poverty rate is still the highest in (v) climate change mitigation for environmental sus- the EU. Inequality also remains relatively high com- tainability of economic activity; and pared with other EU countries, with sizeable dispari- (vi) resilience to shocks and adaptation to climate ties across Romania’s regions. change, especially for vulnerable households. 7 The SCD Update identifies 17 priorities that are con- in the SCD Update are aligned with those identified in ducive to meeting the HLOs and tackling Romania’s the SCD 2018 but are grouped differently, to highlight binding constraints. Multiple priorities can be rele- their roles in improving the population’s living stan- vant to different HLOs as the HLOs are complex and dards and to allow environmental adaptation and mit- interrelated. Table KM.1 summarizes the priorities and igation a more visible role given the importance of the their relevance to different HLOs. The reforms proposed green transition and EU funds in national priorities. TABLE KM.1  High-Level Outcomes and Priorities High-Level Outcomes Priorities I. Predictable institutional and 1. Mitigate the impact of political instability through establishment of me- economic environment for dium-to-long-term strategic and spending priorities [HLO2, HLO3, HLO4, people and businesses HLO5, HLO6] 2. Improve citizens’ trust in the state [HLO2, HLO3, HLO4, HLO5, HLO6] 3. Ensure fiscal sustainability [HLO2, HLO3, HLO4, HLO5, HLO6] II. Equal access to high-quality 4. Enhance public sector human-resource management to improve pub- public services at central and lic-service delivery [HLO1, HLO3, HLO4, HLO5, HLO6] local levels 5. Increase effectiveness and efficiency of public-service delivery at central and local levels [HLO3, HLO4, HLO5, HLO6] 6. Improve access to quality public infrastructure and services (e.g., transport, digital network, water and sanitation, district heating, solid waste manage- ment, social benefits and social services) for the poor, the vulnerable, and those in rural areas [HLO3, HLO4, HLO5, HLO6] III. Better health and education 7. Improve health outcomes and provide equitable access to healthcare ser- outcomes for all vices [HLO4] 8. Provide access to quality education for all [HLO4] 9. Strengthen lifelong skills formation, especially for vulnerable groups [HLO4] IV. Favorable conditions for more 10. Close the gaps in transport and other infrastructure for international and and better private-sector jobs domestic connectivity [HLO2] 11. Increase financial intermediation and inclusion [HLO 5, HLO6] 12. Enhance market competition and innovation [HLO5, HLO6] V. Climate change mitigation for 13. Accelerate decarbonization, improve regional interconnections, and ensure environmental sustainability energy security [HLO2] of economic activity 14. Reduce environmental degradation (water, land, atmospheric) [HLO2] VI. Resilience to shocks and 15. Scale-up risk prevention/reduction, and improve preparedness for, re- adaptation to climate change, sponse to, and recovery from natural disasters [HLO2] especially for vulnerable 16. Enhance financial resilience of the public and private sectors to natural di- households sasters [HLO2, HLO4] 17. Safeguard water security, and ensure better prevention of and protection from water-related disasters [HLO2] Note: Secondary HLOs in brackets. Key Messages of the Romania Systematic Country Diagnostic Update 8 ACKNOWLEDGEMENTS This report was prepared by a World Bank Group International Finance Corporation (IFC), and the Mul- team led by Nga Thi Viet Nguyen and Emilija Timmis tilateral Investment Guarantee Agency (MIGA). The (both Senior Economists), together with team mem- main contributors to specific chapters and background bers from across the World Bank Global Practices, the notes are listed below. Global Practice or Cross-Cutting Solutions Area Team members Task Team Leaders Nga Thi Viet Nguyen and Emilija Timmis Country Management Unit Anna Akhalkatsi (Country Manager) Operations Corina Mirabela Grigore, Alexandra Calin, Thomas Paulovici, Camelia Gusescu, Cristian Popa, Eliza Mara Barnea External Corporate Relations Ioana-Alexandra Irimia, Flavius Marusca Equitable Growth, Finance, Reena Badiani-Magnusson (Program Leader) and Institutions Finance, Competitiveness, Lukasz Marek Marc, Bujana Perolli, Pietro Calice, Damian and Innovation Iwanowski, Magda Malec Governance Carolina Rendon, Holly Burduja Macroeconomics, Trade, Emilija Timmis, Catalin Pauna, Andrei Dospinescu, Mona Prasad, and Investment Jorge Pena Poverty and Equity Nga Thi Viet Nguyen, Reena Badiani-Magnusson, Irene Hu, George Stefan, Vlad Nerau Procurement Elzbieta Sieminska, Tanvir Hossain, Elena Corman, Carmen Calin Human Development Rafael E. De Hoyos Navarro (Program Leader) Education Alina Sava Health, Nutrition, and Population Dorothee Chen, Ana Mercado, Adina Maria-Iorganda, Marcelo Bortman, Radu Comsa Social Protection and Labor Victor Sulla, Zohar Ianovici, Adina-Maria Iorganda Sustainable Development Marc Sadler (Program Leader) Agriculture Anatol Gobjila, Jan Nijhoff Environment and Natural Resources Alexandru Cosmin Buteica, Klas Sender Social Sustainability and Inclusion Valerie Morrica, Chifundo Patience Chilera, Irina Costache Urban, Disaster Risk Management, Alanna Simpson, Marcel Ionescu-Heroiu, Carli Bunding-Venter, and Land Zuzana Stanton-Geddes, Paul Scott Prettitore, Alexandra Calin, Anda Anica, Andrea Sitarova Water Chris-Philip Fischer, Amelia Midgley, Ivaylo Hristov Kolev 9 Global Practice or Cross-Cutting Solutions Area Team members Infrastructure Marc Sadler (Program Leader) Digital Development Charles Hurpy, Andras Tamas Torkos Energy and Extractives Mariano Gonzalez Serrano, Odile Johnson Naveo Infrastructure Finance & Guarantees Zhengjia Meng Transport Nadia Badea, Gregoire Gauthier, Alexandru Damian International Finance Corporation Ary Naim (Country Manager), Cristian Nacu, Aimilios Chatzinikolaou, Mariya Stankeva Hake Multilateral Investment Guarantee Olga Sclovscaia, Olanrewaju Malik Kassim, Gianfilippo Carboni, Agency Susan Josefina Vasquez Plasencia The team thanks Alexandra Calin, Camelia Gusescu, The SCD Update reflects the views of a diverse range Corina Mirabela Grigore, and Ioana-Alexandra Irimia of members of the society across Romania that have for their tireless support. shared inputs through an extensive consultation pro- cess, which relied on both qualitative and quantitative The work was performed under the overall guidance methods. Throughout 2022, the World Bank held over of Gallina Andronova Vincelette (Country Director); 50 in-person consultation sessions in Bucharest, other Anna Akhalkatsi (Country Manager); Ary Naim (IFC large cities, and smaller localities in Romania, includ- Regional manager); Salman Zaidi (Practice Manager); ing semi-structured interviews, roundtable discussions, and Jasmin Chakeri (Practice Manager). The team town-hall meetings, and site visits. Over 500 represen- received advice and support from Reena Badiani- tatives of the public sector — including central and lo- Magnusson (Program Leader, World Bank); Rafael E. cal Government, Parliament, the Presidency, and the De Hoyos Navarro (Program Leader, World Bank), Andrea National Bank of Romania — as well as of the private Liverani (Program Leader, World Bank); and Marc Sadler sector, academia, donors, civil society organizations, (Program Leader, World Bank). The team also benefit- International Financial Institutions, and UN agencies ted from guidance and feedback from the SCD Central participated in consultations. A subsequent session of Team — Alexandru Cojocaru (Senior Economist) and in-person consultations was held in Brussels, Belgium, Samuel Freije-Rodriguez (Lead Economist); and the in November 2022, in which the World Bank team met Operations Policy and Country Services Team — Michael with NGOs, think tanks, foundations, and representa- Geiger (Economic Adviser), Kamer Karakurum Ozdemir tives of the European Commission and the Permanent (Senior Economist), and Karima Saleh (Senior Operations Representation of Romania to the EU. Additionally, over Officer). The team thanks Donato De Rosa, Lars M. 1,200 Romanian citizens shared their views through an Sondergaard, and Emilia Skrok (all Lead Economists), online questionnaire composed of multiple-choice and Yeon Soo Kim (Senior Economist), and other colleagues open-ended questions. The questionnaire was published for their insightful comments. Marcello Arrigo edit- on a dedicated webpage entitled “Consultations: Romania ed the report. Systematic Country Diagnostic Update 2023” and open to the public between September 9 – October 9, 2022. The The team is grateful to public authorities across Romania questionnaire was promoted extensively through the for their excellent collaboration during the prepara- World Bank’s social media channels and during in-per- tion of this report. Moreover, the team would like to son meetings between World Bank teams and stakehold- express its gratitude for the great efforts of the Ministry ers. The majority of the inputs collected through this ex- of Finance in providing in-depth review of this report tensive consultation process validated the findings of and consolidating feedback from other institutions and the SCD, and helped calibrate the report to better reflect agencies on behalf of the Romanian Government. the stakeholders’ first-hand experience on the ground. Acknowledgements 10 ACRONYMS AND ABBREVIATIONS ANAF Tax Administration Agency IT Information Technology ANAR National Administration “Romanian IVET Initial Vocational Education and Training Waters” LBEI Local Business Environment Index ANOFM National Public Employment Agency LPI Logistics Performance Index ANRSC National Authority for the Regulation of LULUCF Land Use, Land-Use Change and Forestry Public Utility Community Services MFF Multiannual Financial Framework ATM Automated Teller Machine MIGA Multilateral Investment Guarantee Agency CAP Common Agricultural Policy MSMEs Micro, Small and Medium-sized Enterprises CCDR Country Climate and Development Report NBFIs Nonbank Financial Institutions CGA Country Gender Assessment NBR National Bank of Romania CMU Country Management Unit NEET Not in Education, Employment and Training CNAIR National Company for Administration NGEU Next Generation EU of Road Infrastructure NHIF National Health Insurance Fund CoG Center of Government NIS National Institute of Statistics CPSD Country Private Sector Diagnostic NRRP National Recovery and Resilience Plan CVET Continuing Vocational Education and NUTS Nomenclature of Territorial Units for Training Statistics DRM Disaster Risk Management OECD Organization for Economic Cooperation and EAPI Energy Architecture Performance Index Development ECA Europe and Central Asia PHC Primary Healthcare ECEC Early Childhood Education and Care PIM Public Investment Management EGD European Green Deal PIT Personal Income Tax EIB European Investment Bank PMR Product Market Regulation ESIF European Structural and Investment Funds POS Point of Sale EU European Union PPP Purchasing Power Parity EV Electric Vehicle PPPs Public-Private Partnership FDI Foreign Direct Investments R&D Research and Development FDP Forcibly Displaced People R&I Research and Innovation FSPs Financial Service Providers RCOA Romania Court of Accounts FUA Functional Urban Area RER Regular Economic Report GDP Gross Domestic Product SCD Systematic Country Diagnostic GHG Greenhouse Gas SILC Statistics on Income and Living Conditions GNI Gross National Income SMEs Small and Medium-sized Enterprises GOR Government of Romania SOE State-Owned Enterprises HLO High-Level Outcome TEN-T Trans-European Transport Network HR Human Resources TFP Total Factor Productivity HRM Human Resources Management TVET Technical and Vocational Education and ICT Information and Communications Training Technology UNHCR United Nations High Commission for IFC International Finance Corporation Refugees IFMIS Integrated Financial Management VAT Value-added Tax Information System VET Vocational Education and Training IMF International Monetary Fund WDI World Development Indicators ISP Institutional Strategic Plans WHO World Health Organization 11 EXECUTIVE SUMMARY Context and emerging trends Inequality in Romania also remains relatively high com- pared with other EU countries, with sizeable spatial dis- Romania’s growth rate remains among the highest in parities. With a Gini coefficient of equivalized disposable the EU, boosting convergence in living standards with income of 34.3 in 2021, the level of income inequality in the EU average. With annual economic growth averaging Romania is the fourth highest in the EU. About 70 percent 3.8 percent over the past two decades, Romanians’ living of the country’s poor live in rural areas. Large rural-ur- standards1 more than doubled from US$12,179 in 2000 to ban disparities are visible across the board — from the US$30,777 in 2021. Correspondingly, Romania’s income quality and availability of transport infrastructure and per capita (in Purchasing Power Parity) increased from public services to resilience to natural disasters and cli- 26.4 percent of the EU average in 2000 to 74.2 percent mate change. Notably, due to shortcomings in rural infra- in 2021. Since the SCD 2018 — which this document up- structure and service delivery, as of 2020 Romania was the dates — Romania’s economic growth has showcased sub- only EU country without universal access to piped water. stantial resilience in the face of the COVID-19 pandemic, Russia’s invasion of Ukraine, and other economic shocks. And so, the “tale of two Romanias” persists. The SCD 2018 summarized the overarching narrative of the Economic growth translated to impressive pover- country’s socio-economic development as A Tale of Two ty reduction, but Romania’s poverty rate is still the Romanias: one urban, dynamic, and integrated with the highest in the EU. Between 2014 and 2019, the share of EU; the other rural, poor, and isolated. Five years on, Romanians living below the upper-middle-income pov- the country has made some progress in addressing con- erty line (i.e., on less than US$6.85-a-day in 2017 PPP) straints to growth as well as in reducing poverty and in- declined rapidly from 30.0 percent to 11.3 percent, on the equality, despite several unprecedented shocks — such back of strong labor markets domestically and across the as the COVID-19 pandemic, and Russia’s invasion of EU. Much of the poverty reduction stemmed from ris- Ukraine. However, sizable development gaps remain be- ing labor and pension incomes linked to tax, minimum tween urban and rural areas. A substantial improvement wage, and pension reforms, although these measures in outcomes for citizens and businesses across income also put increasing pressure on the public budget. The groups and regions, aiming to catch up with European recent economic impacts standards, will require significant effort. of the pandemic, the asso- ciated human capital scar- To stay on the path of income convergence and pov- ring, and the cost-of-living erty reduction, future growth needs to be sustain- crisis have disproportion- able economically and environmentally, especially ately impacted the more as favorable base effects fade. Although rapid on av- vulnerable segments erage, Romania’s economic growth has been highly vol- of the population and atile, mainly consumption-driven, and associated with are slowing down prog- major environmental externalities — such as high lev- ress in poverty reduc- els of air pollution in urban areas. Moreover, the sup- tion. Today, Romania’s ply-side constraints identified in the SCD 2018 continue poverty rate is still to hamper Romania’s potential. The productivity divi- the highest in the dends from the reforms spurred by EU accession have EU by far, ex- dwindled and would benefit from a reinvigorated boost. ceeding that Governance and quality of institutions remain the key of member cross-cutting constraints to productivity growth and states with better public-service delivery. In the face of limited similar or prospects for sustainable growth and improved living lower aver- standards, many Romanians — especially those with age income per capita — such as Bulgaria, Croatia, the skills to advance the country’s prospects — left to Hungary, and Poland. pursue economic opportunities abroad. Consequently, Executive summary 13 emigration, labor market fundamentals, and an increas- administration has suffered from limited planning and ingly acute skills shortage affect the quantity and qual- shifting political priorities. Relatively low trust in the ity of labor, as well as productivity. Wage increases are state and in the ability of public institutions to deliv- decoupled from labor productivity growth, and thus er services can lower political civic engagement among unsustainable as a driver of poverty reduction. Despite the population and further hinder progress. more than 15 years of EU membership, infrastructure gaps remain wide relative to Romania’s income level, Ineffective policy implementation and insufficient constraining private investment and productivity in public expenditure contribute to poor and unequal key sectors. All these factors can hamper the country’s development outcomes. Poor cross-government coor- future growth, which faces the combined challenges dination and lack of alignment between strategic pri- of becoming more sustainable economically and envi- orities and investments undermine Romania’s capacity ronmentally, more inclusive, and more resilient to di- to absorb EU funds and deliver better public services. sasters and climate change. Insufficient budget allocation and inefficient spending in health and education also lead to low human capital Romania’s socio-economic development over the next outcomes relative to other EU countries. Moreover, poor five to ten years will hinge on seizing opportunities and vulnerable groups, such as those within Roma com- for sustainable growth and job creation, while man- munities and in rural areas, suffer from major short- aging risks that could aggravate existing inequali- comings in the provision of social services and infra- ties and constraints. Two ongoing negative external structure services — e.g., water, sanitation, transport, shocks — scarring from the COVID-19 pandemic, and and energy. In addition, the social benefits system faces the repercussions of Russia’s invasion of Ukraine — will fundamental challenges in supporting poor and vul- require continued policy interventions to mitigate their nerable population segments. Spending on social ben- impact on the most vulnerable. In particular, Russia’s efits in Romania is below the EU average, the coverage invasion of Ukraine — in addition to causing security of means-tested social assistance programs is limited, concerns and a humanitarian crisis — has prompted and the impact of social transfers on poverty reduction energy security considerations and recessionary pres- is the lowest in the EU. sures, while accelerating the cost-of-living crisis. On the opportunity side, the EU-wide green and digital transi- A shortage of skilled workers and other labor market tions have the potential to boost productivity and envi- frictions limit the supply of labor. Romania’s active ronmental sustainability, but require substantial and population is shrinking — largely due to emigration efficient investments, as well as careful policy action to and low labor force participation — reducing the labor mitigate the impact of the transitions on those at risk supply and, in turn, potential growth. Inefficiencies in of being left behind. Unprecedented levels of EU fund- the education system, unfavorable attitudes to lifelong ing are available to help the country address both risks learning, and ineffective vocational training and active and opportunities but using it effectively will require labor market policies combined with brain drain cause greater institutional capacity. skills shortages and mismatches, reducing innovation capacity as well as growth and earnings potential. The inequality arising from skills and broader labor mar- Major constraints to sustainable growth ket gaps is at risk of widening as a result of the digital and prosperity and green transitions, which will boost demand for a higher-skilled workforce. Weak institutions and insufficient administrative capacity remain the key constraints. Ineffective pub- Low connectivity, a shallow financial sector, limit- lic institutions, comparatively low civil-service capac- ed competition and innovation, and an insufficient- ity, and political volatility — including frequent, polit- ly favorable business environment hold the private ically driven government re-organizations — hinder sector back. Infrastructure gaps — largely due to inef- public-service delivery and slow down the pace of re- ficient public investment stemming from institution- forms. The implementation of key reforms of the public al weaknesses — impede private-sector development Executive summary 14 both nationally and, in particular, in lagging regions. also widen certain existing regional and income inequal- Underdeveloped financial markets and lack of capac- ities, requiring targeted policy action to ensure its fair- ity in the public sector limit the absorption of vast EU ness and mitigate its impact on those adversely affected. funds and hold back private sector growth and solu- Considering the long-term approach and multisectoral tions. In addition, Romanian firms underperform their challenges of the green transition, and the effort of im- EU peers in product and process innovation, market- plementing an inclusive economic development agenda, ing and organizational innovation, R&D expenditure, broad institutional strengthening will be paramount. patent applications, and ICT training. Finally, the busi- ness environment is often unpredictable, overregulat- ed, and not conducive to innovation and competition. A way forward for Romania Romania remains highly vulnerable to natural hazards This SCD identifies six High-Level Outcomes (HLOs) to and climate change. Although the country has made sig- expedite Romania’s achievement of the twin goals — re- nificant efforts in the last decade to strengthen its insti- duced poverty and shared prosperity. The HLOs, if tutional framework for disaster response, more needs achieved over the next five to ten years, would mark to be done to mitigate disaster risk and adapt to climate an improvement in the wellbeing of the population, change, as the country remains vulnerable to a wide and especially the poorest and most vulnerable. These range of geophysical and climate change-induced disas- are (i) predictable institutional and economic envi- ters — e.g., earthquakes, floods, and droughts — as well as ronment for people and businesses; (ii) equal access to to epidemics/pandemics, and technological accidents. In high-quality public services at central and local govern- particular, climate change exacerbates the risk of hydro- ment; (iii) better health and education outcomes for all; climatic hazards, but the country’s readiness to adapt is (iv) favorable conditions for more and better private low. The potential resulting damage to natural, physical, sector jobs; (v) climate change mitigation for environ- and human assets can curtail economic growth while mental sustainability of economic activity; and (vi) re- deepening inequality, as poorer counties in Romania are silience to shocks and adaptation to climate change, es- disproportionately impacted by disaster risk. pecially for vulnerable households. While many HLOs are connected, HLO-1 — Predictable political and eco- As an EU member, Romania has committed to rising nomic environment for people and businesses — is the to the challenge of climate change mitigation and the most cross-cutting. This reiterates the key lesson from green transition, while delivering on its development the SCD 2018: despite impressive economic growth, objectives. Romania is a signatory to the European Green achieving shared prosperity and sustainable welfare Deal and has committed to its two key goals: (i) reducing improvements will remain a distant reality if Romania net greenhouse gas emissions (GHG) by at least 55 per- does not address its governance challenges. cent by 2030, relative to 1990 levels (‘Fit for 55’); and (ii) achieving net zero GHG emissions by 2050 (‘Net zero’). The SCD Update identifies 17 priorities that are condu- Meeting these ambitious supranational targets within cive to meeting the HLOs and tackling Romania’s bind- constrained timelines will require significant national ing constraints. Table ES.1 summarizes the priorities policy action, particularly in key polluting sectors such and their relevance to different HLOs. The reforms pro- as energy, transport, industry, and agriculture. The green posed in the SCD Update are aligned with those iden- transition provides an opportunity to place Romania’s tified in the SCD 2018 but are grouped differently, to growth on a more environmentally sustainable path and highlight their roles in improving the population’s liv- enhance the country’s competitiveness in Europe and ing standards and to grant emerging priorities — par- beyond. Urban areas, with their concentration of peo- ticularly climate change adaptation and mitigation — a ple and economic activity, are expected to be at the fore- more visible role, given the prominence of the green front of a green, resilient, and inclusive model of de- transition (and the associated EU funds) in national and velopment. While the transition would bring long-term EU-wide policy goals. Each priority maps into and helps benefits in the aggregate — such as improved air quality progress towards one or multiple HLOs, with mapping and fewer premature deaths from air pollution — it may presented in Table ES.1. Executive summary 15 TABLE ES.1  High-Level Outcomes and Priorities High-Level Outcomes Priorities I. Predictable institutional and 1. Mitigate the impact of political instability through establishment of me- economic environment for dium-to-long-term strategic and spending priorities [HLO2, HLO3, HLO4, people and businesses HLO5, HLO6] 2. Improve citizens’ trust in the state [HLO2, HLO3, HLO4, HLO5, HLO6] 3. Ensure fiscal sustainability [HLO2, HLO3, HLO4, HLO5, HLO6] II. Equal access to high-quality 4. Enhance public sector human-resource management to improve pub- public services at central and lic-service delivery [HLO1, HLO3, HLO4, HLO5, HLO6] local levels 5. Increase effectiveness and efficiency of public-service delivery at central and local levels [HLO3, HLO4, HLO5, HLO6] 6. Improve access to quality public infrastructure and services (e.g., transport, digital network, water and sanitation, district heating, solid waste manage- ment, social benefits and social services) for the poor, the vulnerable, and those in rural areas [HLO3, HLO4, HLO5, HLO6] III. Better health and education 7. Improve health outcomes and provide equitable access to healthcare ser- outcomes for all vices [HLO4] 8. Provide access to quality education for all [HLO4] 9. Strengthen lifelong skills formation, especially for vulnerable groups [HLO4] IV. Favorable conditions for more 10. Close the gaps in transport and other infrastructure for international and and better private-sector jobs domestic connectivity [HLO2] 11. Increase financial intermediation and inclusion [HLO 5, HLO6] 12. Enhance market competition and innovation [HLO5, HLO6] V. Climate change mitigation for 13. Accelerate decarbonization, improve regional interconnections, and ensure environmental sustainability energy security [HLO2] of economic activity 14. Reduce environmental degradation (water, land, atmospheric) [HLO2] VI. Resilience to shocks and 15. Scale-up risk prevention/reduction, and improve preparedness for, re- adaptation to climate change, sponse to, and recovery from natural disasters [HLO2] especially for vulnerable 16. Enhance financial resilience of the public and private sectors to natural di- households sasters [HLO2, HLO4] 17. Safeguard water security, and ensure better prevention of and protection from water-related disasters [HLO2] Note: Secondary HLOs in brackets. Executive summary 16 1 UPDATED COUNTRY CONTEXT 1.1 RECENT DEVELOPMENTS IN GROWTH, POVERTY REDUCTION, AND SHARED PROSPERITY Romania’s growth rate remains among the highest in the EU, boosting convergence in living standards. With annual economic growth averaging 3.8 percent over the last two decades — nearly triple the EU average (Figure 1.1) — living standards (i.e., real GDP per capita in PPP 2017 international US$) more than doubled from US$12,179 in 2000 to US$30,777 in 2021. Romania’s income per capita (in PPP) increased from 26.4 percent of the EU average in 2000 to 74.2 percent in 2021 (Figure 1.2). Growth has also proved resil- ient in the face of unprecedented external shocks: Romania had one of the shallowest COVID-19-induced recessions in the EU, and the recovery in 2021 – 2022 was rapid and sustained — even in the onset of the Russia’s invasion of Ukraine. FIGURE 1.1  Economic growth has been among the highest in the EU… 6 Real GDP growth (2000–2021) 5 3.8 4 3 2 1.4 1 0 Fi ds Be nd Ro and nd Fr y ec un s Lu epu y ly en ce he in Re aria ic Po ce Au rk EU a Cr m Sw tia Sl en Cy ia m lic ov Bu rg Po a ia th a m l Es ta Ire ia 7 G uga H ru an ri i Li oni R ar -2 bl Ita en tv an n et Spa al a u iu n an xe b e st oa ed a la p ua g m bo rla La re ak lg pu nl l M lg m rt ov t er G D h N Cz Sl Source: World Bank calculations using EUROSTAT data. However, the country’s growth FIGURE 1.2  …leading to a strong convergence in has been among the most living standards with the rest of the bloc volatile in the EU, and its path and sustain- 100 Real GDP per capita, EU-27=100 (PPS) EU-27=100 ability are in ques- 90 tion. Growth remains 80 73 largely consumption 70 driven, with contri- 60 butions from both 50 investment (Figure 1.3) and productivity (Figure 1.4) subsiding sub- 40 stantially since the years leading to EU accession. 30 Structural transformation has been shifting the sec- 26 20 toral contribution to growth, characterized by a declin- 20 0 20 01 2002 20 03 2004 20 05 2006 20 07 2008 20 9 200 20 11 2012 20 13 2014 20 15 2016 20 17 2018 20 19 20 0 21 0 0 1 2 20 ing role of agriculture and increased contributions Bulgaria Croatia Czech Republic from services. The ICT sector is one of the main con- Poland Romania Slovenia tributors to growth and was the eighth largest in the EU as a share of GDP (6.3 percent) as of 2021. As noted Source: Eurostat. Updated country context 18 in the SCD 2018, Romania is on a growth path that entails widening macroeconomic imbalances. A procyclical fiscal policy and the narrow base of economic growth, which has been mainly driven by consumption and rising public-sector wages, have resulted in persistent twin deficits (i.e., fiscal and external). Fiscal policy, underpinned by rel- atively low taxation and limited redistribution, has played a limited role in addressing Romania’s inclusion challenges. FIGURE 1.3  Romania’s growth has been largely FIGURE 1.4  Productivity and capital driven by private consumption accumulation have driven growth, with negative contribution from labor 12 10 6 6 Percent, percentage points 8 5 5 6 4 4 Percentage points 4 3 3 Percemt 2 2 2 0 1 1 −2 0 0 −4 −1 −1 −6 2000-2008 2009-2019 2020 2021 EU −2 −2 2000-2021 2002-07 2008-09 2010-19 2020-21 2022-30 Private consumption Public consumption Labor Gov Capital Private Capital Gross fixed capital formation Net export TFP Potential Output (RHS) Changes in inventories GDP Source: World Bank calculations and projections, World Bank EU Source: World Bank calculations using EUROSTAT data. Regular Economic Report 8 (2022). The supply-side constraints identified in the SCD 2018 continue to limit Romania’s growth potential. Governance and quality of institutions remain the key cross-cut- ting constraints to productivity growth and public-service delivery (see sections 2.1 and 2.2). Migration, labor market fundamentals, and skills shortages affect labor quan- tity, quality, and productivity (section 2.3). Wage growth is decoupled from productiv- ity growth, while the country grapples with demographic challenges due to an aging, shrinking population and significant outward migration. Despite more than 15 years of EU membership and rising income levels, infrastructure gaps remain wide, constrain- ing private investment and productivity in key sectors (section 2.4). Taken together, these factors have been limiting Romania’s growth potential (Figure 1.4). Finally, the country’s growth path needs to become more sustainable not only economically, but also environmentally (section 2.5), as well as more resilient to disasters and climate change (section 2.6). Although total investment levels — driven mostly by the private sector — are com- parable to the EU average, they do not fully cover the country’s significant invest- ment needs. Romania invested 24.9 percent of its GDP on average every year between 2000 and 2021, with private-sector investment accounting for more than 80 percent of the total. Nevertheless, an unpredictable policy and business environment, alongside a shortage of appropriately skilled workers, has constrained long-term investment.2 Updated country context 19 While more investment is needed to accelerate the convergence with the EU and over- come the middle-income trap,3 financial markets remain underdeveloped, limiting the private sector’s investment potential. Notably, in the run-up to the COVID-19 crisis, the net investment rate FIGURE 1.5  Labor productivity has been catching of Romanian companies4 was already four times lower up with the EU average, but a 33 percent gap than before the Global Financial Crisis (GFC) of 2008 – 09. remains Compounding that, the share of Romanian firms plan- ning to revise their investments downward as a con- 100 EU-27 2020 = 100 sequence of the pandemic is the largest in the EU (38.3 90 percent), according to a recent EIB survey. 80 Romania’s labor productivity has been growing on 70 67 average, but the output gap between micro/small and Percent GFC 60 medium/large firms is the second largest in the EU. Labor productivity grew strongly before the GFC, help- 50 48 ing the country reduce the gap with the EU (Figure 1.5), 40 but it has slowed down since. A persistent challenge (despite significant progress) is the performance of 30 33 micro and small firms, where value added per employee 20 in 2019 amounted to 65 percent of the level recorded 20 5 06 20 7 08 20 9 10 20 1 12 20 3 14 20 5 16 20 7 18 20 9 20 21 1 0 1 1 0 1 0 1 20 20 20 20 20 20 in large firms.5 Companies with fewer than 50 employ- 20 20 20 ees account for 98.2 percent of Romanian firms and Romania EU-27 almost half of total employment, with most large firms Source: Eurostat. Labor productivity per person employed and clustered in the Bucharest-Ilfov region.6 Thus, reduc- hour worked (EU27_2020=100). ing the productivity gap between firms of different size would contribute to both strengthening economic FIGURE 1.6  Significant progress has been made in growth, and addressing regional disparities. Annex 1, reducing poverty and inequality… Box A.1 provides a brief analysis of firm-level produc- tivity in the country. 40 35 Robust economic growth has translated into impres- Poverty headcount (percent) sive progress in poverty reduction, although Romania’s 30 poverty rate is still the highest in the EU. Between 2014 25 and 2019, the share of Romanians living on less than US$6.85 a day (2017 PPP) declined rapidly from 30.0 per- 20 cent to 11.3 percent, on the back of strong labor markets domestically and in the wider EU (Figure 1.6). Yet, the 15 country’s poverty rate remains by far the highest in the 10 EU, exceeding that of countries with similar or lower per capita incomes — e.g., Bulgaria, Croatia, Hungary, 5 and Poland (Figure 1.7). As highlighted in the SCD 2018, 07 08 09 10 11 12 13 14 15 16 17 18 19 20 20 20 20 20 20 20 20 20 20 20 20 20 the role of the government is crucial in achieving the Poverty per international upper-middle class line twin goals — reduced poverty and shared prosperity. Poverty per national at-risk-of-poverty line Romania’s weak governance remains the key binding — holding line at 2011 level (15.7 leu in 2011 prices) constraint to government effectiveness and efficien- Poverty per national at-risk-of-poverty line cy, and to further progress in growth and poverty re- (changes yearly) duction (see section 2.1 for a discussion of governance Source: World Bank calculation using EU Statistics on Income and institutions). and Living Conditions (SILC) 2008 – 2020. Updated country context 20 FIGURE 1.7  …but Romania’s poverty rate is by far the highest in the EU 12 Poverty headcount ratio at $6.85 a day (2017 PPP) ROU 10 8 BGR (percent of population) 6 GRC 4 ITA ESP HUN LTV HRV LTU 2 EST SVK AUT SWE POL PRT CYP MLT FRA DEU NLD DEN IRL LUX 0 CZE SVN BEL FIN −2 0 10 20 30 40 50 60 70 80 90 GNI per capita, Atlas method (current US$, thousand) Source: World Bank calculation based on WDI and PIP data. Latest poverty rates for EU countries are from SILC 2020, except for Germany, France, Ireland, Italy, and Poland (from 2019). GNI per capita data is from 2021. Moreover, the strategies that enabled past progress in poverty reduction are struc- turally unsustainable. Much of the poverty reduction recorded between 2014 and 2019 stemmed from rising labor and pension incomes (Figure 1.8), as a result of tax, mini- mum wage, and pension reforms. Namely, the flat personal income tax (PIT) rate, social security contributions, and value-added taxes (VAT) were reduced; the coverage of the PIT exemption was expanded; the minimum wage rose; and the pension system was restructured, with the com- FIGURE 1.8  Progress in poverty reduction bined effect of lifting many households out of poverty. between 2014 and 2019 was due to rising labor However, these measures put increasing pressure on the and pension incomes public budget, aggravating its imbalances. In addition, the reductions in PIT and VAT contributed to increasing Tax Ratio inequality, as most of the tax relief accrued to house- Ad. Eq. Ratio holds at the top of the income distribution.7 Share of Adults Romania’s growth has not been inclusive, as a large Share Employed share of those in the bottom 40 percent of the income Labor income distribution still depend on low-productivity subsis- tence agriculture. Many poor Romanians have not ben- Soc. Assist. Income efitted from the strong labor market driven by thriving Other Income sectors such as manufacturing, trade, and ICT. Nearly Pension Income half of the adults in the poorest quintile of the income distribution did not work in 2020, while another 38 −7 −6 −5 −4 −3 −2 −1 0 1 2 Change in poverty between 2014 and 2019 percent relied on subsistence agriculture (Figure 1.9). Agriculture and agribusiness remain the key sources of Source: World Bank calculation based on EU SILC 2020 and 2015 data (referring to 2019 and 2014 income years). income for many poor and rural Romanians, but agri- Note: Poverty rates are based on at-risk-of-poverty line cultural labor productivity is the lowest in the EU, and anchored in 2011 to allow for comparison over time. Marginal land productivity (measured in output per hectare) contribution to change in poverty rate is in percentage points. Updated country context 21 is the second lowest.8 The minimum-wage increases enacted in recent years have also widened the income FIGURE 1.9  Most Romanians in the bottom gaps between informal and formal workers. income quintiles either do not work, or rely on low-productivity agriculture The economy has bounced back from the pandemic-in- 100 duced shock, but fiscal and financial risks remain sig- Proportion of households (percent) nificant. Romania experienced a sharp contraction in 80 economic output in 2020 (3.7 percent), although the re- cession was less severe than the EU and ECA averages. The 60 recovery was also swift, with real GDP climbing back to pre-pandemic levels in 2021. However, the crisis caused 40 sizable increases in both the fiscal deficit9 (9.2 percent of GDP in 2020) and the public debt (46.9 percent of GDP at 20 the end of 2020). The deficit remains high (at 7.1 percent of GDP in 2021), and could push public debt to 50.2 per- 0 cent of GDP in the medium term,10 amid rising borrow- Q1 Q2 Q3 Q4 Q5 ing costs in a context of high inflation.11 The banking sys- Income quintile tem’s non-performing loans ratio remained low in 2021, Not working Agriculture Services at 3.4 percent, although the sector is not immune from Industry and manufacturing Construction risk.12 Capital flows dropped in 2020, but soared back well above pre-crisis levels at the end of 2021. Source: World Bank calculation based on EU SILC 2020. The COVID-19 crisis has disproportionately affected the poor and most vulnerable, and scarred Romania’s human capital (see section 1.3 on scarring, and 2.3 on skills). Lower- earning workers, those on non-standard contracts, and women were more affected by employment stoppages during the pandemic. The crisis might also widen gender gaps in labor market outcomes, as Romanian women are over-represented in sectors negatively affected by the pandemic.13 If not managed well, the pandemic’s impact could increase poverty and vulnerability in the long run. In addition, while the pandemic and associated containment measures led to an 18 percent decline in annual sales across Romanian firms on average, the shock affected smaller firms disproportionately, as they had less access to public support and were slower to adopt digital technologies. The COVID-19 crisis could also induce severe losses in learning outcomes: estimates suggest the already high share of functionally illiterate students (41 percent pre-pandemic) may have increased by up to 10 percentage points,14 thus affecting the future availability of skills in the labor market. Moreover, the crisis highlighted a pre-existing urban-rural divide in access to health- care. Hospitals struggled to meet the additional need for healthcare services generated by the pandemic and have seen falling levels of admissions, especially among patients suffering from chronic diseases. Romania faces significant challenges in the short and medium term. Russia’s invasion of Ukraine and the ensuing international sanctions have prompted higher inflation, uncertainty, and supply-chain disruption, eroding Romania’s short-term growth pros- pects. The country’s capacity to absorb EU funds will be critical to a sustainable, green, and inclusive recovery. The sizable investment and reforms envisioned under the EU’s Resilience and Recovery Facility, the multiannual financial framework for 2021 – 2027, and other EU-funded programs should partially mitigate the impact of higher interest rates and uncertainty on private investment. If implemented, these reforms can meaningfully Updated country context 22 boost growth and accelerate convergence with the EU (see section 1.3 for more details on EU funds).15 Rising food and energy prices and declining remittances could entail a longer recovery process for vulnerable population segments. A protracted Russia’s inva- sion of Ukraine may significantly weaken growth and heighten poverty in the short run. Once the recovery is firmly established, cutting down the fiscal deficit — a critical step to prevent a sharp increase in debt levels — will require reforms aimed at reducing inef- ficient expenditures and strengthening revenue mobilization. 1.2 A TALE OF TWO ROMANIAS Romania’s recent socio-economic development reflects a persistent “tale of two Romanias”: one urban, dynamic, and integrated with the EU; the other rural, poor, and isolated as illustrated in the SCD 2018 (see Annex 1, Box A.2 for a summary of findings from the SCD 2018). While Romania is, overall, a high-income economy,16 income levels vary widely across the country. On the one hand, Bucharest and the surrounding Ilfov county have experienced booming growth, with income per capita exceeding the EU av- erage since 2007 (Figure 1.10). Other large and dynamic cities — including Brasov, Cluj, Constanta, and Timisoara — have also become prosperous centers for business, inno- vation, and culture. On the other hand, GNI per capita in vast rural areas, particular- ly those that are far away from a dynamic urban center, is on the level of a low-income country (Figure 1.11).17 (See Annex 1, Box A.3 for the importance of urban areas and sec- ondary cities). FIGURE 1.10  Income per capita in the Bucharest-Ilfov region is by far the highest in the country 50 40 PPS per capita (LCU, thousand) 30 20 10 0 0 1 02 3 04 5 06 07 08 09 0 11 12 13 14 15 16 17 18 19 20 0 0 0 0 1 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Romania Nord-Vest Centru Nord-Est Sud-Est Sud-Muntenia Bucuresti-Ilfov Sud-Vest Oltenia Vest Source: Eurostat 2022. Updated country context 23 FIGURE 1.11  Despite Romania being a high-income country, vast rural areas have low-income status GNI/capita 2009 (atlas method) Low income (US$12,195) Source: NIS. While the combined effects of taxes and social spending help to substantially reduce inequality in Romania, inequality remains relatively high compared with other EU countries. With a Gini coefficient of equivalized disposable income of 34.3 in 2021, Romania has the fourth-highest level of income inequality in the EU, after Bulgaria, Lithuania, and Latvia. Redistributive efforts through taxes and social spending are relatively large in Romania compared with developing countries, but lower than in other countries in Europe (with most of the reduction in inequality in Romania being achieved by pen- sions).18 Inequality in income across population groups is also large: the unemployed, self-employed workers, FIGURE 1.12  The at-risk-of-poverty rate is highest and elderly people who live alone are significantly more among people living in rural areas, unemployed, exposed to poverty (Figure 1.12).19 A growing sense of self-employed, elderly, or with low education widespread poverty and inequality has been straining Romania’s social contract: 76 percent of Romanians iden- Roma* tify a lack of social rights as a serious problem, while Primary education 59 percent deem improving the standards of living the Unemployed most important element for achieving social and eco- Self-employed nomic development in the EU.20 Elderly living alone Rural National Poverty is highly concentrated in rural areas, which Town/Suburban host approximately 70 percent of Romania’s poor. The Cities national at-risk-of-poverty rates in rural areas are nearly six times higher than in cities (Figure 1.12). Disparities in 0 10 20 30 40 50 60 70 80 90 100 Percent of population living standards are large: in 2019, average income per capita in urban areas was more than 60 percent high- Source: World Bank calculation based on EU Statistic of Income and Living Conditions 2020; *Roma poverty is based on EU Agen- er than in rural areas — a large gap that has remained cy for Fundamental Rights 2022, which might not be fully com- stubbornly stable over the past decade.21 parable to the national poverty rate based on EU SILC 2020. Updated country context 24 The urban-rural divide is also visible in public services. As of 2020, Romania was the only EU country without FIGURE 1.13  The urban-rural divide in access to universal access to piped water. While water services basic water and sewerage services is stark reach nearly 100 percent of the urban population, only Connected to 39 percent and 15 percent of the rural population is con- public water nected to the water supply and the wastewater system, system respectively (Figure 1.13).22 In terms of transport infra- Connected to structure, the 2019 Global Competitiveness Report indi- sewage system cates that despite large public investments boosted by Connected to EU funds, Romanian regions are poorly interconnected, water treatment plants with a transport infrastructure competitiveness index 0 10 20 30 40 50 60 70 80 90 100 far below the EU average. Socio-economic resilience to Percent of population disasters and climate change is also unequal, with the Urban Rural level of disaster resilience among the poor amounting to less than one-quarter the national average.23 Source: INS Databases, 2021 and 2020. Stark inequalities in service delivery have caused disparity in human development out- comes. 15.2 percent of the population in rural areas reports having unmet medical needs, a significantly greater share than in cities (10.9 percent) (Figure 1.14). Health levels vary across income groups, with a higher prevalence of chronic diseases at the bottom of the income distribution: for example, the likelihood of high blood pressure is nearly twice as high among the poorest (19 percent) than among their better-off peers (10 percent).24 According to the National Health Insurance House 2020, 15 percent of the country’s popu- lation has no health insurance, and the share is larger in the lowest quintiles of the income distribution. The disparity in educational outcomes is also wide: to close the learning gap with their peers in Bucharest-Ilfov (as measured by harmonized test scores), students in the rest of the country would need, on average, more than two years of additional school- ing.25 In addition, the county-level Human Capital Index (HCI) score in Bucharest-Ilfov is 0.68, but drops to 0.51 in neighboring Giurgiu — indicating a nearly 20 percent gap in potential productivity between children born in the two counties (Figure 1.15). FIGURE 1.14  Self-reported unmet needs for FIGURE 1.15  Human Capital Index scores are medical examination in rural, suburban, and positively correlated with the level urban areas, Romania and EU-27, 2020 of urbanization 0.7 Total Bucharest-Ilfov Cities 0.6 HCI Dambovita Towns and suburbs Rural areas 0.5 0 10 20 30 40 50 60 70 80 0 2 4 6 8 10 12 14 16 Percent of rural population (0 – 18 years old) Percent of 16 years+ EU-27 Romania Source: World Bank (2020). Note: The size of the bubbles represents the total population Source: Eurostat, 2021. (0 – 17 years old) in each county. R² = 0.3022. Updated country context 25 Romania lags its regional peers on financial inclusion, particularly in rural areas. More than 30 percent of adult Romanians are unbanked (one of the highest percentages in the EU), and the share of underserved population is even higher in rural areas.26 The payments infrastructure (e.g., ATMs and POS terminals) is underdeveloped, and digital financial services, while growing, are still nascent. Moreover, internal differences in busi- ness development opportunities are glaring: on the Local Business Environment Index,27 Bucharest’s score is nearly seven times as high as that of the lowest-scoring location, Vaslui. 1.3 EMERGING RISKS AND OPPORTUNITIES FOR SUSTAINABLE AND EQUITABLE GROWTH Romania’s socio-economic development over the next five to ten years will hinge on seizing opportunities for economically and environmentally sustainable growth and job creation, while managing risks that could aggravate existing inequalities and constraints. First, two ongoing negative external shocks — scarring from the COVID-19 pandemic, and the repercussions of Russia’s invasion of Ukraine — will require contin- ued policy interventions to mitigate their impact on the most vulnerable. Second, the EU-wide green and digital transitions have the potential to boost productivity and envi- ronmental sustainability, but require substantial and efficient investments, as well as careful policy action to mitigate the impact of the transitions on those at risk of being left behind. Unprecedented levels of EU funding are available to help the country adjust to such developments but using it effectively will require greater institutional capacity. Scarring from the COVID-19 pandemic The COVID-19 pandemic has left lingering economic and social scars. Although the pandemic-induced recession in Romania was one of the mildest in Europe, it has none- theless left sizeable scars, especially on public finances and educational outcomes. Fiscal support to households and firms, while limited compared with EU peers, increased the fiscal deficits; in turn, the public debt rose significantly, from a relatively low 35.1 per- cent of GDP in 2019 to 48.9 percent of GDP in 2021. Pre-pandemic, the estimated func- tional illiteracy rate among 15-year-olds was 41 percent; post-pandemic, the new esti- mated rate is 50 percent, with a disproportionate impact on those already vulnerable. Moreover, nearly half of all households report increased financial difficulties, even with containment measures long lifted and an economic recovery underway.28 If not addressed and mitigated, these scars can jeopardize growth and inclusion. In a context of rising global borrowing costs, higher debt will limit fiscal space. At the same time, learning losses hinder skills formation among young people that will enter the labor force over the next decade, and risk holding back Romania’s growth potential, its ability to benefit from the green transition, as well as hopes for reducing inequality. Concerns about future COVID-19 breakouts and potential containment measures remain, espe- cially as the vaccination rate is among the lowest in the EU — 42.4 percent of the popu- lation has received the primary course (with virtually no uptake in many poorer coun- ties), versus the EU average of 72.6 percent (see section 2.2 for further discussion of the economic impact of such scarring).29 The inclusion challenges coming at the time of the Updated country context 26 fast-rising debt level highlight that fiscal consolidation is inevitable, but will need to strike a balance with preserving growth and mitigating negative impacts on the poor. Impact of Russia’s invasion of Ukraine Flows of forcibly displaced people (FDPs) from Ukraine into Romania were largely tran- sitory in 2022, but still require action from the government considering their unprec- edented pace and size. Over a quarter of Ukraine’s population is estimated to have fled their homes since February 24, 2022, making this the fastest-growing refugee crisis since World War II. About 8 million Ukrainian FDPs have been recorded across Europe, while the UNHCR estimates that Romania30 has received the second-largest number of them (after Poland), with over 3.0 million arrivals — about 100,000 of which were still in the country as of February 2023.31 32 Most FDPs are women and children, and many suffer from seri- ous health conditions or disabilities. A potential escalation of hostilities in Ukraine could swell the inflow of FDPs, testing Romania’s capacity to accommodate them and adding to fiscal pressures. Over the medium term, the economic impact of the influx of FDPs will depend on their demographic characteristics. If they remain in the country, and appro- priate action is taken to help them integrate and support host communities, Ukrainian migrants could boost the labor supply and bolster labor’s contribution to growth. Romania is among the more resilient EU member states on the energy front, due to lim- ited reliance on Russian energy imports and the availability of domestic gas supplies. However, Romania has been a net energy importer since 2019 (see section 2.5). The coun- try did set ambitious objectives for energy security, aiming to decrease its energy depen- dency (i.e., dependency on non-EU imports related to energy) to 68 percent by 2030, in- stead of the 77 percent previously aimed for under the Energy and Climate plan. Energy security objectives are aligned with green transition objectives in the medium term, al- though bridge measures that increase emissions might be necessary in the short term. The spillovers of Russia’s invasion of Ukraine have accelerated inflation, created addi- tional fiscal pressures, and slowed down economic growth and poverty reduction. The poorest 40 percent of households already spent more than half of their income on energy, food, and housing prior to the recent rise in inflation, which is likely to weigh on consumption, increase poverty, and raise concerns about food security. The govern- ment has stepped in to limit the rise in energy tariffs for households and firms, but the measures (primarily price caps) have not been targeted, add to already elevated fiscal pressure, and might deter behavioral responses focused on energy efficiency and sav- ings. Greater uncertainty which discourages investment, coupled with a slowdown in the European economy and domestic demand, tempers near-term growth prospects and increases the urgency of structural reforms to boost medium-term growth. Green transition As an EU member, Romania is a signatory to the European Green Deal (EGD), with firm decarbonization targets and timelines. The EGD has advanced regional ambi- tions for climate mitigation and adaptation measures, while highlighting the need for Updated country context 27 an equitable transition. At the heart of the EGD are the firm targets of (i) reducing net GHG emissions by at least 55 percent by 2030, compared with 1990 levels (‘Fit for 55’); and (ii) achieving net zero GHG emission by 2050 (‘Net zero’). Please see Annex 1, Box A.4 for an overview of the green transition. The green transition provides an opportunity to put Romania’s growth on a more envi- ronmentally sustainable path. While the country’s economic wealth has grown signifi- cantly over the past decade (Figure 1.16), its natural capital has been in steady decline (Figure 1.17).33 Using resources efficiently has a direct impact on productivity and com- petitiveness. Over the last two decades, OECD countries have increasingly disentangled economic growth from energy intensity by investing in energy-efficient technologies. Although Romania is responsible for a modest and declining share of the EU’s GHG emis- sions, reaching net zero requires substantial investments and broader policy action, at both the national and subnational levels (see section 2.5). Delivering on the decarbon- ization targets along with Romania’s development objectives will also require substan- tial institutional strengthening and yet more focus on long-term planning. FIGURE 1.16  While Romania’s overall wealth has FIGURE 1.17  …its natural capital has declined over seen a robust upward trend… time, calling for a more sustainable growth model 140 300 120 Constant 2018 US$ per capita (thousand) 250 Constant 2018 US$ (billion) 100 200 80 150 60 100 40 50 20 0 0 1995 2000 2005 2010 2015 2018 −20 Forests, timber Forests, ecosytem services 1995 2000 2005 2010 2015 2018 Mangroves Fisheries Cropland Human capital Produced capital Protected areas Pastureland Minerals Net foreign assets Natural capital Fossil fuel energy Natural capital Source: Calculations based on World Bank Changing Wealth of Source: Calculations based on World Bank Changing Wealth of Nations (2021). Nations (2021). The green transition carries risks that may deepen regional and income inequalities, requiring policy action to protect those adversely affected and ensure that changes are managed in a just and equitable fashion. Climate mitigation action may dispropor- tionately affect regions where polluting activities (e.g., the coal industry) are concen- trated, as well as specific occupations, skills, or income groups, as the economy under- goes structural change. New, greener industries may require labor mobility and skills upgrading. The increase in carbon prices can have a broadly positive but uneven impact Updated country context 28 on employment, and an adverse impact on the poor,34 requiring compensatory measures and Active Labor Market Policies (ALMP) to reskill the affected labor force. At the same time, the increasing risk of natural hazards due to climate change makes it necessary to take adaptation action and build resilience. As articulated in the SCD 2018, Romania is at risk from a range of hazards, including natural disasters (e.g., earth- quakes, floods, and droughts), epidemics/pandemics, and technological accidents. Higher temperatures and increasing rainfall variability cause more intense and frequent flood and drought events, affecting water supply, agriculture, energy, and transport. The po- tential damage to natural, physical, and human assets from natural disasters can curtail economic growth, jeopardize fiscal sustainability, and affect the well-being of Romania’s population — especially in poorer counties. The financial sector is also significantly ex- posed to climate-related risks: about 50 percent of the loan portfolio of the country’s banks is with companies affected by transition and physical risks, especially in the ag- ricultural sector. See section 2.6 and the forthcoming Romania Country Climate and Development Report (CCDR) for a more detailed discussion. Digitalization Digitalizing the economy and public services — a priority highlighted by the COVID- 19 pandemic — offers opportunities to raise productivity, create new jobs, and tap into novel global value chains. Digital platforms are reshaping relationships between citi- zens and governments, customers and businesses, workers and employers. At the same time, digitization has the potential to cause job displacements and losses, while leaving those ill-equipped to benefit from it further behind. FIGURE 1.18  Romania is lagging the rest of the EU on digitalization 70 Digital Economy and Society Index (DESI), 60 50 2021 ranking 40 30 20 10 0 N nm d Sw ds nd G d ro th y Cr us Sl ar y m in Po ion Cz ly he ark Ire n Es rg Au ia Sl ria Fr ia er ce m ia Cy ia H atia Po ia m a Bu e ia ta Un a lg l B e ga Li an Ro ari an ni ec an n e Ita n en tv h ak an xe Spa al u iu n pr an st ed la la u to ec pe ua g bo rla m La re lg o nl M ov ov rt un Fi e G D et Lu Eu Human capital Connectivity Integration of digital technology Digital public services Source: DESI Eurostat Updated country context 29 Romania is lagging the rest of the EU on digitization.35 Digital connectivity is rela- tively good and above the EU average, due to the wide availability of fixed high-capac- ity broadband networks (see section 2.4). However, the national average hides large regional disparities: although urban areas enjoy 82 percent coverage by fast-broad- band services (above 30 Mbps), and 49 percent of Romanian homes (mostly in cities) subscribe to ultrafast (at least 100 Mbps) broadband — the fifth-highest share in the EU — rural areas are trailing behind. Despite a relatively extensive network coverage, consumer uptake of broadband and use of internet services remain among the low- est in the EU, with 18 percent of individuals aged 16 – 74 having never used the internet (versus the EU average of 9 percent). Furthermore, those who use the internet mainly do so for communication and entertainment purposes, rather than for activities such as online banking or education. Overall, Romania ranks last in the EU on the Digital Economy and Society Index, which accounts for a range of indicators on digital skills, connectivity, integration of digital technologies in economic activity, and digital pub- lic services.36 Romania’s digital deficit risks deepening existing inequality between regions and population groups, while limiting the country’s ability to reap the benefits of digi- talization. Less than a third of Romanians have at least basic digital skills (versus the EU average of 58 percent), with a considerable urban-rural wedge (see section 2.3). The adoption of digital technologies by Romanian firms is considerably lower than in most EU member states, especially among smaller companies: in 2021, Romania had the low- est share of SMEs with at least a basic level of digital intensity in the EU. 37 There are signs of positive change: the share of Romanian firms engaging in e-commerce is on par with the EU average (17.3 percent) and has more than doubled since the beginning of the pandemic.38 However, a shortage of appropriate skills is a challenge. Among Romanian firms, adopters of Industry 4.0 (I4.0) technologies generate on average 8 percent more value added per hour worked than non-adopters, a gain equivalent to less than half the EU average. The limited size of productivity gains among I4.0 adopters in Romania sug- gests that a scarcity of skilled workers constrains the intensity in the use of such tech- nologies, relative to regional peers. EU funds — growing in scale and advancing in new thematic areas To boost its growth, inclusion, and sustainability agenda, Romania has access to EU funds on an unprecedented scale, equivalent to about 37 percent of its GDP over the next five years. The regular allocation of structural EU funds from the Multiannual Financial Framework (MFF) for 2021 – 2027, under the bloc’s cohesion and common agricultural policies, amounts to 24 percent of Romania’s GDP (Figure 1.19) — a size- able increase from 16 percent in 2014 – 2020 (Figure 1.20). In addition, Romania is eligi- ble to receive the equivalent of 13 percent of its GDP — one of the highest shares in the EU — from the Next Generation EU funds (primarily distributed through the National Recovery and Resilience Plan), to support post-pandemic recovery as well as the digital and green transitions.39 The latter allocation amounts to €29 billion, comprising €14.2 bil- lion in grants and €14.9 billion in loans. Further funding is available through REPowerEU to boost energy security, as well as through additional instruments. See Annex 1, Box A.5 for more details. Updated country context 30 FIGURE 1.19  Over the next 5+ years, available EU FIGURE 1.20  Romania had access to substantial funding will effectively double and cover new EU funding in the past but did not fully use it, thematic areas, further straining capacity partly due to capacity constraints 50 50 Current Current 45 Allocation of Allocation of 45 NGEU- RRF NGEU-other 40 funds funds 40 Percent of GDP (2020) 35 €1 Percent of GDP (2020) Current 35 Allocation of €29 billion 30 EU MFF funds billion 30 2021-2027 25 25 20 Past Allocation 20 of EU MFF funds 2014–2020 15 Actual spending €52 15 of EU MFF funds 10 billion 2014–2020 10 5 €35 billion €20 5 0 billion MFF 2021–2027 NGEU-RRF* NGEU other 0 allocation* MFF 2014-2020 MFF 2014-2020 allocation* absorption** Source: World Bank, based on National and European Commis- sion documents. Source: World Bank, based on National and European Commis- Notes: MFF refers to the EU Multiannual Financial Framework, sion documents. and includes allocations under Cohesion Policy, Common Notes: MFF refers to the EU Multiannual Financial Framework, Agricultural Policy. ‘NGEU-RRF’ refers to Next Generation EU and includes allocations under Cohesion Policy, Common Recovery and Resilience Facility (grants and loans); ‘NGEU-other’ Agricultural Policy. includes Just Transition Fund and React-EU Facilities. Legend: *computed as percentage of 2020 GDP, ** as of Decem- Legend: *computed as percentage of 2020 GDP. ber 2021. Provided it can bolster national and municipal institutional capacity to use such funds efficiently, Romania has an opportunity to boost all channels of growth. In particular, Romania is in a favourable position to: (i) equip citizens across the country with skills relevant for the labor market (through better active labor market policies), and update its education system accordingly; (ii) shape core infrastructure to connect people to markets in an environmentally sustainable fashion; and (iii) focus on reforms that can improve not only the quality of services (e.g., funding innovation and digitiz- ing public services), but also their inclusivity (e.g., digitizing access to finance to help reach the unbanked in rural areas). However, Romania’s past track record in absorbing and using EU funds effectively high- lights persistent challenges. Between 2014 and 2020, Romania was eligible for an overall funding envelope of €34.8 billion (16 percent of 2020 GDP). However, by the end of the pro- gramming period, it had only absorbed 56.7 percent of its allocation,40 due to institutional bottlenecks (e.g., low capacity, especially at the municipal level), complex processes, and the extended time usually required for completing investment projects. With both new mechanisms (the results-based NRRP disbursements) and thematic areas (digital, green, just transitions) being introduced, the government will need to build additional institu- tional capacity to deliver both the structural programs for the 2021 – 2027 programming period, and the ambitious reforms and investments articulated under the NRRP. Fiscal consolidation will eventually limit the available fiscal space, underscoring the importance of a maximal absorption of EU funds to deploy public investments over the medium term. Updated country context 31 2 CONSTRAINTS TO GROWTH AND PROSPERITY IN ROMANIA 2.1 WEAK INSTITUTIONS AND LOW ADMINISTRATIVE CAPACITY REMAIN KEY CONSTRAINTS Albeit a high-income country with access to sizeable EU funds, Romania often struggles to meet its citizens’ needs because of weak governance and poor administrative capac- ity. Almost five years after the SCD 2018, the tale of two Romanias persists, as the rural-ur- ban divide and regional divergence have become even starker. Weak public institutions, low civil-service capacity, and political volatility — including frequent, politically driven gov- ernment re-organizations — hinder public service delivery and slow down reform imple- mentation, resulting in inefficient spending, inadequate public infrastructure and services, and social inequality. Romania has seen some progress at the subnational level: seven of the largest cities in the country ranked among the ten fastest growing in the EU between 2000 and 2019,41 and with some local administrations managing to successfully respond to citi- zen’s needs and deliver quality public services and investments. Some urban administra- tions, predominantly in larger cities, managed to deliver services such as public transport, solid waste management, maintenance of public spaces, public safety, or housing to citizen’s satisfaction.42 For example, over 90 percent of respondents from Cluj-Napoca, Oradea, Alba Iulia, Brașov, Drobeta Turnu Severin, Timișoara, and Sighișoara, indicated they were happy to live in the respective cities. There are also smaller towns and rural localities that have managed to deliver quality public services, but discrepancies to larger cities are significant, with generally a lower quality of public service delivery and poorer development outcomes. In recent years Romania has introduced key reforms in the public administration, but limited planning and shifting priorities have slowed their implementation. Since the SCD 2018, the government has enacted several important initiatives, including the introduction of a strategic function for cross-government coordination and for linking institutional strategies to the budget; human resource management (HRM) reforms to professionalize the civil service; digitalization measures; and reforms to strengthen institutional accountability. However, frequent changes in political leadership have disrupted — and sometimes reversed — early phases of progress. Internal strug- gles and change within ruling coalitions reduce appetite for cross-government collaboration, create vacuums, demoralize public servants, and diminish the institutional capacity for medium- and long-term reforms. Furthermore, the need to redirect government resources to respond to urgent and unanticipat- ed crises, such as the COVID-19 pandemic and Russia’s invasion of Ukraine, has also affected progress on necessary reforms. Low trust in the state, and in the ability of public institutions to deliver services, further hinders progress. Romanians have a deep-seated distrust of the state, stemming from both its com- munist past and its more-recent inability to commit to a re- form agenda and provide quality public services. In 2022, 67 percent of Romanians stated that they did not trust the government, a percentage that has remained broad- ly stable over time.43 60 percent of respondents rated the quality of public services as poor or very poor — a dissat- isfaction rate among the highest in the EU. Instability in government and constant political gridlock fuel a perception Constraints to growth and prosperity in Romania 33 that politicians prioritize their interests over those of the citizens they represent, while less than 15 percent of Romanians believe the government will deliver on its promises. The NRRP will provide the government with a medium-term horizon for major reforms on judicial independence, the FIGURE 2.1  Romania’s ranking on the Corruption rule of law, and anti-corruption which, together with on- Perception Index is among the worst in the EU going initiatives to bolster the Court of Accounts, could improve transparency and trust among citizens. Denmark: 88/100 Distrust of the state is at the root of low civic engage- Sweden: 85/100 ment and poor response to public awareness efforts, Finland: 88/100 including health campaigns during the pandemic. In 2020, only 32 percent of eligible voters participat- ed in the national elections. A persistently strong per- ception of widespread corruption has hollowed out Romania’s social contract, becoming more acute as a result of the pandemic: according to Transparency Romania: 45/100 International’s Corruption Perceptions Index 2021, Bulgaria: 42/100 48 percent of Romanians believe that corruption in- Hungary: 43/100 creased between 2020 and 2021 (Figure 2.1). Only half of Romanians perceive courts and judges as independent from economic interests, the government, and politi- cians.44 Lack of trust derails urgent public campaigns, as evidenced by Romania’s poor uptake of COVID-19 vacci- nations. Despite aggressive government efforts to make vaccines easily accessible, and ongoing campaigns to re- EU Average: 66/100 assure the public about their efficacy and safety, uptake in Romania is among the lowest in the EU (42.4 percent Source: Transparency International, 2021. of the population received the primary course), with less than 5 percent of vaccinated adults in certain parts FIGURE 2.2  Romania lags the EU average on of the country. Non-state communication through so- quality of electoral processes, rule of law, access cial networks has drowned out state-sponsored health to information, and civil rights campaigns, often spreading misinformation. Electoral Access to Processes Information The public sector’s lack of credible commitment to 7.4 long-term reforms is partly responsible for low civ- 6.7 4.0 ic trust. Frequent government reshuffles hamper long- 5.6 term plans to strengthen public institutions, while incentivizing an overuse of emergency ordinances. Recommended reforms tend to receive mixed political 4.3 5.7 support, despite the need for strong political backing 7.2 6.8 through completion and beyond. Notably, the govern- Civil Rights and Rule of Law ment struggles to commit to counter-cyclical fiscal pol- Political Liberties icies, which reduces the fiscal space available to react to economic shocks. Moreover, according to the Sustainable Overall Score: 4.9 Romania 7.0 EU Governance Indicator 2022, the quality of the electoral Source: The Sustainable Governance Indicator 2022, Bertels- process and the rule of law in Romania is worse than in mann Stiftung relies on a combination of expert qualitative assessments and quantitative data drawn from official sources its EU peers (Figure 2.2), although strengthening it has such as the World Bank, the IMF, the OECD, and the World been a long-standing government priority. Economic Forum. Constraints to growth and prosperity in Romania 34 Weak institutional capabilities and HRM within public institutions further ham- per reform implementation. The public administration faces challenges in attracting, retaining, and deploying talented public servants at all levels of government. HRM prac- tices in the Romanian civil service remain highly fragmented and inconsistent across institutions. Moreover, clientelism and patronage undermine public sector capacity. Recent HRM reforms — such as a new Administrative Code that entered into force in 2019, the adoption of a new civil service recruitment model in 2020, and the inclusion of the National Contest for recruitment in the NRRP — signal the government’s commit- ment to professionalizing the public service. However, the roll-out of such reforms is in its early stages, and their impact remains to be seen. The digital transformation could offer an opportunity to transform service delivery and increase citizens’ trust. Romania’s bureaucracy, “paper-based culture”, and out- dated regulatory framework have resulted in inefficient government services that place a heavy burden on citizens and businesses. The digital transformation can enhance the accessibility, quality, and efficiency of public services, lowering transactional costs (in both time and money) for internal users as well as beneficiaries of public services. An effective digital transformation also fosters transparency by offering greater access to information, and builds trust in public institutions. The government has highlighted the digital transformation as a top priority in the NRRP and the 2021 – 2024 Government Programme, notably with the deployment of, and the migration of prioritized public ser- vices to, the Government Cloud infrastructure. The COVID-19 pandemic evidenced many longstanding governance challenges and the urgency of the digital transformation. During the lockdown, public institutions urgently adjusted working modalities and adopted technological solutions to ensure the provision of critical services, but faced continuity challenges in working remotely and accessing data. Citizens could not access certain critical public services without breaching health-related guidelines, due to a lack of online services and the need to produce physical docu- FIGURE 2.3  Romania ranked last in the EU on ments. Although Romania is well placed on connectiv- digital public services in the last four years ity, the availability and uptake of digital services are low (Figure 2.3).45 The country ranked 46th out of 193 on the Country with highest score UN’s 2020 e-Participation index, and the digital divide between urban and rural areas leaves much of the pop- ulation underserved. The Romanian public sector’s digi- EU tal transformation faces major barriers, including a lack of strategic vision and institutional enablers (such as governance structures and mandates), weak inter-in- Country with lowest score stitutional coordination, limited digital awareness and es y I l ity skills, missing or outdated data governance policies and se lic ES ta ol f og hn o ic tiv ub pi D ec n rv ca l t tio ec lp regulations (e.g., on interoperability frameworks, e-au- nn an ta ra ita gi g um Co ig thentication, and e-signature standards), and short- di Inte D H comings in key digital platforms (e.g., the national elec- tronic identification system). Source: International Digital Economy and Society Index, 2022. Constraints to growth and prosperity in Romania 35 2.2 INEFFECTIVE POLICY IMPLEMENTATION AND INSUFFICIENT PUBLIC EXPENDITURE CONTRIBUTE TO POOR AND UNEQUAL DEVELOPMENT OUTCOMES Romania’s weak governance hinders the country’s overall development. According to the Bertelsmann Stiftung Sustainable Governance Indicators 2022, the Romanian government’s effectiveness remains sub-optimal and well below the EU average (Figure 2.4). Moreover, inter-ministerial coordination and implementation capacity have deteriorated slightly in recent years, highlighting two challenges for the public administration: being able to implement policies, and oper- FIGURE 2.4  Romania falls well below the EU ating as a unit.46 While many countries used the COVID-19 average on efficiency and effectiveness of policy pandemic as a catalyst to strengthen coordination mech- implementation anisms and align priorities, Romania made few changes Government Ministerial Compliance in its approach. Arrangements for monitoring progress Effectiveness 6.3 and evaluating results in the public administration are 7.2 incomplete. At a higher level, the role of Parliament in 4 5 Regulatory Monitoring the oversight of public spending is limited, as financial Enforcement 6.6 Ministries 5.7 6 and performance audits are within the remit of the Court 3 of Accounts (CoA). 4 4 5.7 6.4 National 3 3 Monitoring The pre-eminence of State-Owned Enterprises (SOE) Standards Agencies in key sectors results in vast inefficiencies in service 5.7 5.6 /Bureaucra- cies delivery, with large budgetary losses. Romania counts Consitutional Task Funding 1,400 operational SOEs, the largest number in the EU, Discretion including: Romgaz, one of the country’s two main gas production companies; Transgas, the only gas transmis- Overall Score: 3.8 Romania 6.1 EU sion company; and Electrica, which controls three major Source: The Sustainable Governance Indicator 2022, Bertels- electricity distribution companies. The presence of large mann Stiftung relying on a combination of expert qualitative assessments and quantitative data drawn from official sources state-controlled conglomerates and an inadequate regu- such as the World Bank, the IMF, the OECD, and the World latory framework deter private investment, inhibit com- Economic Forum. petition, and compromise market efficiency (see also sec- tion 2.4). SOEs in energy, gas, postal services, and transport are the least efficient, with the latter generating the largest losses and requiring subsidies which accounted for nearly 7 percent of the Ministry of Transport’s spending. District heating SOEs, which are mostly owned by municipalities, also suffer from financial distress and suboptimal management. Limited cross-government coordination, and lack of alignment between strategic prior- ities and investments, undermine Romania’s capacity to absorb EU funds and to deliver public services at EU standards. In the health sector, a lack of coordination among key stakeholders hinders the achievement of national goals on transparency, cost effectiveness, and quality of care. For example, the procurement of medical supplies and drugs occurs at the facility level, leading to fragmentation, a lack of economies of scale, and non-stan- dardized quality; similarly, provider payment mechanisms do not incentivize quality of care. Moreover, although education policies promote high-quality school systems and learning outcomes, their implementation is largely uncoordinated, with poor transpar- ency, accountability, and no integrated management framework for public investments.47 In the water sector, the National Administration of Romanian Waters (ANAR) — the oper- ational arm for water resource management — is underfunded and understaffed, and thus Constraints to growth and prosperity in Romania 36 unable to properly maintain an aging infrastructure and implement investment projects. In addition, the implementation of land administration policies and strategies has been slow, particularly regarding the systematic registration of land (notably, more than 60 percent of the country’s land is likely to be unregistered). Such delays have perpetuated land disputes, caused a loss of revenue to the state, complicated urban and spatial plan- ning, and constrained investments in related sectors, such as agriculture and housing. The provision of high-quality public infrastructure services — potable water, sani- tation, energy  —  remains low, especially for the poor and rural residents. As of 2020, more than 20 percent of Romanians lacked a bath, shower, and indoor flushing toilet in their household — a rate far higher than in any other EU country. Among poor Romanians, this figure reaches a startling 56 percent. Moreover, 23 percent of poor Romanians can- not keep their home sufficiently warm, versus 6 percent of their non-poor peers.48 As noted previously, Romania is the only country in the EU without universal access to piped water; achieving it would require investments for €6 billion. The rehabilitation of viable irrigation perimeters would require more than €1 billion, while important flood protection measures would cost an estimated €3.6 billion.49 Romania’s human capital outcomes consistently lag the other EU countries, due to in- sufficient spending and inadequate health and education services. As of 2021, Romania’s public investment in healthcare and education as a share of GDP was among the low- est in the EU (Figure 2.5). As a result, health outcomes have been lagging EU standards; FIGURE 2.5  Government expenditure on health and education is among the lowest in the EU a. Health expenditure b. Education expenditure Germany Sweden France Belgium Austria Estonia Sweden Denmark Netherlands Cyprus Belgium Finland Spain Latvia Portugal Malta Denmark Slovenia EU-27 9.9 France Italy Croatia Greece Netherlands Czech Republic Lithuania Finland Poland Malta Austria Bulgaria Czech Republic Slovenia EU-27 5.0 Cyprus Luxembourg Croatia Portugal Estonia Germany Lithuania Hungary Latvia Slovak Republic Hungary Spain Ireland Greece Slovak Republic Italy Poland Bulgaria Romania 6.3 Romania 3.7 Luxembourg Ireland 0 2 4 6 8 10 12 14 0 2 4 6 8 Percent of GDP Percent of GDP Source: Eurostat 2022. Constraints to growth and prosperity in Romania 37 notably, Romania has the second-highest rate of preventable mortality50 in the EU, be- hind Latvia.51 In addition, the rate of participation in early-childhood development ac- tivities — the cornerstone of learning ability, and an enabler of female participation in the labor force  — among Romanian children aged three and over is 78 percent, one of the lowest in the EU, and has been steadily declining since 2015.52 Among disadvantaged chil- dren, such as those in the Roma community, the participation rate is merely 27 percent.53 Furthermore, educational attainment differs vastly across geographical areas and income levels. Student achievement scores are lower in rural schools: in 2018, 40 percent of eighth- grade students in rural schools scored below the 5-mark level on the national evaluation. The share of early school leavers has only decreased slightly and stayed above govern- ment targets, with wide discrepancies between the share of early leavers in cities (4 per- cent) and rural areas (23 percent) in 2020.54 The forthcoming Romania Country Gender Assessment (CGA) will also discuss the drivers of gender gaps in human capital outcomes. An unsustainable financing model exacerbates issues in access to healthcare. A tax reform implemented in 2019 reduced the tax base of the National Health Insurance Fund (NHIF); as a result, only 6 million people — mostly wage earners — contributed to the NHIF in 2019 – 21. The estimated loss of contributions from pensioners and con- struction workers during this period — in total, around 6.5 million people — amounted to leu12.5 bn (€2.5 billion, or 40 percent of all health contributions in 2020). Therefore, every year, the state budget compensates for the NHIF’s deficit through ad-hoc subsidies. Moreover, inefficiency in health spending is evident in the underfunding of cost-effec- tive primary healthcare services, the decentralized procurement of medicines and med- ical supplies, the lack of innovative pharmaceutical policies, and the limited use of data to track spending. Access to services is obstructed by the uneven distribution of physi- cians and nurses between urban and rural areas, and between counties that host med- ical schools and those that do not. BOX 2.1  Unequal access to shared opportunities in Roma communities The Roma are the second-largest ethnic minority in parents, guardians, and students have been increasing- Romania, and suffer from a high prevalence of pover- ly experiencing discrimination from school authorities: ty and material deprivation. According to estimates by 14 percent of Roma people reported being discrimi- the Council of Europe, the Roma make up between 6 nated in 2021, up from 4 percent in 2016.c and 12 percent of the Romanian population. The share Roma communities have limited access to health ser- of Roma at risk of poverty was 78 percent in 2021.a Poor vices and formal job opportunities. 58 percent of Roma housing quality, inadequate infrastructure, and lack of adults are covered by basic health insurance.d While access to basic communal services remain major vul- Romania’s maternal mortality rate is already among nerabilities for many Roma communities. About half the highest in the EU, it is more than 15 times higher for of the Roma population lives in low-quality housing, Roma women than for the non-Roma.e With low levels versus 10 percent of the non-Roma.b 68 percent of of human capital accumulation, Roma adults (wom- Roma households lack tap water, and 80 percent lack en in particular) have scarce access to formal employ- a shower or bathroom. ment. In 2021, about 41 percent of the Roma indicat- Children from Roma communities are severely mar- ed being in paid work, versus a national employment ginalized, and face disadvantages early on in life. Being rate of 66 percent.f a Roma attracts a strong social stigma in Romania, Informality and a lack of legal documents hinder access and spatial segregation and discrimination are severe. to social services for the Roma, with civil society orga- Notably, school segregation affects more than half of nizations trying to fill the gaps. During the pandemic, Roma children aged 6 – 14 in Romania. Moreover, Roma the lack of property and residence documentation and Constraints to growth and prosperity in Romania 38 IDs resulted in the most marginalized Roma not being to comply with hygiene and social distancing mea- eligible for emergency services. Although local NGOs sures. As Roma workers are often employed in informal have played an important role in delivering services jobs, they were less likely to benefit from the govern- and support, especially in well-connected communi- ment’s labor support programs during the pandemic. ties, the civil society is not well organized within Roma Marginalized communities were severely affected by communities, exacerbating gaps in access to services.g disruption to community health services and schools. The COVID-19 pandemic has deepened inequalities In addition, the Roma have experienced increased iso- affecting the Roma. Overcrowded living conditions lation, stigmatization, and discrimination in connec- and lack of access to running water made it difficult tion with the pandemic.h a. EU Fundamental Rights Agency, 2022 b. Carrera et al. 2019. Scaling up Roma Inclusion Strategies Truth, reconciliation and justice for addressing antigypsyism. European Parliament. c. EU Fundamental Rights Agency, 2022. d. EU Fundamental Rights Agency, 2022. e. World Bank, 2014. f. EU Fundamental Rights Agency, 2022. g. World Bank 2020. Romania Rapid Community Assessments. h. World Bank 2020. Romania Rapid Community Assessments. The coverage of the social safety net in rural areas, where the need is greatest, is lim- ited. According to the European Commission’s 2021 report on the adequacy of pensions, nearly two-thirds of the elderly in Romania cannot af- ford adequate care. In addition, one-third of rural com- FIGURE 2.6  The impact of social transfers on pov- munities and nearly half of all small municipalities erty reduction in Romania is the lowest in the EU (counting fewer than 2,000 inhabitants) have no pub- lic social assistance services.55 The government has Romania Bulgaria started several projects to introduce an integrated ap- Malta proach to community-level public services, including Croatia Spain social assistance, healthcare, education, and employ- Latvia ment, but they have suffered from delays and report- Greece ed no substantial results.56 Portugal Lithuania Germany The social benefits system in Romania, and means-test- Estonia EU-27 ed programs in particular, face fundamental challeng- Cyprus es. In 2020, spending on social benefits — including uni- Poland Netherlands versal, targeted, and means-tested benefits — stood at Luxembourg 1.16 percent of GDP, below the EU average of 1.36 percent Slovak Republic Czech Republic of GDP. Only 0.15 percent of GDP (or 14 percent of to- Austria tal social assistance spending) goes toward means-test- Sweden Hungary ed social assistance programs — less than half the EU- Slovenia 27 average. The means-tested programs (Guaranteed Belgium Minimum Income, Family Support Benefit, and Heat France Finland Benefit) do not offer generous benefits, and their cov- Denmark erage is limited. In addition, the value of social bene- Ireland fits has not been systematically adjusted to inflation, 0 10 20 30 40 50 60 70 Percent despite the launch of the Social Reference Indicator in 2020 2021 2008. Overall, the impact of social transfers on poverty reduction in Romania is the lowest in the EU (Figure 2.6). Source: Eurostat 2022 (TESPM050). Constraints to growth and prosperity in Romania 39 Starkly unequal access to public services, and shortcomings in the social benefits sys- tem, entail that inequality of opportunity in Romania is high. Relative inequality of opportunity57 in the country — i.e., the share of inequality that is due to circumstances beyond an individual’s control, such as where they were born and their family’s sta- tus — amounts to 40.5 percent. Such a level is the fifth highest in the EU and nearly dou- ble that of Sweden, the EU country where inequality of opportunity is lowest (Figure 2.7). FIGURE 2.7  Inequality of opportunity in Romania is higher than in most of the EU 55 50 45 40 IOE 35 30 25 20 15 Cr s en d Po nd Ro nd us Be r y Cy n Au y Re lic Cz Re rg Bu lic ia en Fi ia un k m ia e ce Ire a Li atia Sl xem nia ta he al Po a nd l ri ni ar ec n ai Ita ar tv n et tug ga al ou iu pr an b b st ed a la la Sp a to ua m rla La re lg o ec pu pu nl M lg Lu m b Fr r Sw Es th G H D ak h N ov Source: World Bank calculation based on EU-SILC 2020 data. The COVID-19 pandemic could exacerbate gaps in access to services and have long- term effects on poor and marginalized groups. Disruption in the already limited deliv- ery of public services may place EU-level living standards further out of reach for rural Romanians. Temporary school closures disproportionately affected poor and marginal- ized students, especially Roma girls, partly due to their inability to access IT equipment and a stable internet connection.58 Income losses due to COVID-19 will also test house- holds’ ability to keep children in school, boost the numbers of out-of-school youth and early leavers, and hinder the transition to tertiary education for many. Learning losses and reduced years of schooling for student cohorts affected by COVID-19 will lower their expected earnings by an estimated 3.6 percent — assuming that one year of schooling increases earnings by 8 percent on average — for a potential total economic loss of up to US$2 billion (2011 PPP) per year.59 Moreover, the effects of the pandemic may put con- tinued pressure on the already strained healthcare system, especially in rural areas. New technology and digital tools can improve the quality of healthcare and educa- tion, but without universal and affordable access to digital services, inequality may widen. Remote consultations for mild conditions could enable healthcare services to reach rural areas in a cost-effective way. In education, innovative, flexible, and interac- tive delivery of digital content can foster greater participation from students, parents, local communities, and technology providers. However, unequal access to digital chan- nels will place vulnerable students at a higher risk of missing out on education oppor- tunities. The experience of online schooling during the pandemic shed light on the acute effects of the digital divide: due to a lack of access to the internet and digital devices, the Constraints to growth and prosperity in Romania 40 reading achievement gap between children in the poorest and richest quintiles — already equivalent to over three years of schooling — is expected to increase by a further 10 per- cent, although schools were closed for only three months.60 This widening gap will have further adverse effects on job opportunities for poorer students later in life. 2.3 SHORTAGE OF SKILLED WORKFORCE AND LABOR MARKET FRICTIONS CONSTRAIN THE LABOR SUPPLY Romania’s active working-age population is shrinking — largely due to emigration and low labor force participation — reducing the labor supply and, in turn, poten- tial growth. Inefficiencies in the education system, unfavorable attitudes to lifelong learning, and ineffective vocational training and active labor market policies combine with brain drain to cause skills shortages and mismatches, as well as reduced innova- tion capacity, growth, and earnings potential. Largely due to emigration, both Romania’s population and its labor force have been shrinking and aging. Romania’s population fell from 22.8 million to 19.1 million between 2000 and 2021 (Figure 2.8), and is expected to further drop to 17.8 million by 2030.61 Over the last 10 to 15 years, more than 2 million Romanians — near- ly 20 percent of the labor force — emigrated, many on a FIGURE 2.8  Romania’s population is shrinking permanent basis, resulting in skills gaps, labor shortag- and aging es in key roles (e.g., medical doctors), distorted wage de- mands, and falling real labor productivity. As Romanian 24 45 migrants tend to be younger and more educated than the 43 remaining population, Romanian society has been aging 23 and suffering one the most severe brain drains globally.62 40.1 Population (million) Median age (years) 22 40 The fertility rate is below replacement level, at an esti- mated 1.8 in 2020,63 while the median age in the country 21 rose from 34.4 years in 2000 to 43.0 in 2021.64 Regional 20.2 variations are sizable, with Bucharest-Ilfov recording 20 35 the country’s lowest median age (41) and share of popu- 19.2 lation over 65 (16.5 percent) — more than four years and 19 4.4 percentage points, respectively, below the levels of Sud-Vest Oltenia. Thus, demographic pressure points (for 18 30 instance, greater demand for more complex healthcare 11 12 13 14 15 16 17 18 19 20 21 20 20 20 20 20 20 20 20 20 20 20 for the elderly) are more acute in lagging regions, where Population (LHS) Median age (RHS) service delivery is already challenging (see section 2.2). Source: Eurostat (demo). Although the country’s labor market benefited from solid economic growth pre-pandemic, many Romanians still do not work, constrain- ing the labor force. The Romanian labor market performed strongly before the COVID-19 crisis, with the unemployment rate in the 15 – 64 age cohort dropping to 4 percent in 2019, its lowest level in 20 years65 and well below the EU average of 6.8 percent. However, the employment rate remains low (65.6 percent in 2020) relative to the EU average (67.5 per- cent). Romania’s inactivity66 rate (30.8 percent) is among the highest in the EU,67 while labor force participation (69.2 percent in 2020)68 is among the lowest,69 constraining labor supply amid increasing demand from a growing economy. Constraints to growth and prosperity in Romania 41 The participation rate is particularly low among women, the young, and those with lower levels of education. As of 2020, the female labor force participation rate in Romania stood at 59.3 percent, 19.4 percentage points below the male rate, and 8 percentage points below the EU average for women — in line with low rates of enrollment in early-child- hood education, and rigid societal attitudes towards female labor.70 The youth labor force participation was even lower: 38.3 percent, far below the EU average of 58 percent. The share of young people between the ages of 15 and 24 not in education, employment, or training (NEET) stood at 14.7 percent — second only to Italy in the EU — with the stark- est gender disparity in the EU (17.9 percent among women, versus 11.5 percent among men).71 The labor force participation rate was highest among those who completed ter- tiary education (90.9 percent in 2020, and 89.1 percent for women), versus 71.8 percent and 47.7 percent among those who completed secondary and primary education, respec- tively. The gender gaps in the labor markets will be explored further in the forthcom- ing Romania CGA. Labor force participation is especially low among the poor. Close to half of those liv- ing in households in the bottom 40 percent of the income distribution have no for- mal work, and a further 28 percent remain engaged in agriculture.72 With rural areas suffering from higher poverty rates, a concentration of lower-skilled segments of the labor force, and a weaker labor market, this data highlights the linkages between lack of employment opportunities and poverty. While the labor supply is shrinking, the demand for skills is growing, and shortages and mismatches are expected to intensify as the green and digital transitions prog- ress. Skills shortages and mismatches, already considerable, are on the rise: the lack of adequate skills among the workforce was already the top constraint for business- es in Romania before the pandemic, according to the World Bank Enterprise surveys (Figure 2.9), and vacancy rates doubled between 2013 and 2019. A high proportion of people with tertiary ed- FIGURE 2.9  A shortage of skilled workforce has ucation are either overeducated for their occupation become the top constraint for businesses (vertically mismatched), or working in a sector that does not match their field of education (horizontally labor regulation mismatched).73 74 Automated production processes and practices of the an increasingly services-dominated economy require informal sector business licensing more non-routine cognitive skills, such as critical think- and permits ing and socio-behavioral skills, as well as more digital transportation skills (both basic, for the majority of workers; and ad- tax administration vanced, for IT-related jobs). However, labor shortages access to finance have been recorded in both high and low-skilled occu- corruption pations.75 The forthcoming Romania Country Private Sector Diagnostic (CPSD) offers more detailed analy- political instability sis on this topic. tax rates inadequately edu- cated workforce Skills deficits could hamper the green and digital tran- 0 5 10 15 20 25 30 35 40 45 sitions, while the concurrent adjustment in demand Percent of firms for skills may deepen inequalities across Romania’s 2013 2019 regions and population groups. Romania fares poorly on digital skills, ranking last in the EU on digital human Source: World Bank Enterprise Surveys 2013, 2019. Constraints to growth and prosperity in Romania 42 capital. Less than one-third of those aged between 16 and 74 have at least basic digi- tal skills (versus the EU average of 58 percent), and 35 percent have at least basic soft- ware skills (versus the EU average of 61 percent). Among urban areas in the EU, those in Romania rank last on digital skills; while among rural areas, those in Romania rank second-to-last. Emigration continues to take a toll: while Romania has a relatively high proportion of ICT graduates (5.6 percent of all graduates in 2020, versus the EU average of 3.6 percent), its share of ICT specialists in the labor force (2.2 percent) lags the rest of the EU (3.9 percent). Pockets of digital skills exist, but they often appear to service for- eign markets: Romania is the only EU country among the top-20 suppliers of software development workers on English-language online labor platforms.76 The overall lack of digital skills within the population is a clear impediment to the wider adoption of digi- tal services by citizens and businesses, and may also slow down the transition to green jobs, which tend to require comparatively high skill levels. Skills development and activation are low, with a deficient skills-supply system pre- venting Romania from responding to changing global circumstances. The education and training system is struggling to provide the skills the country needs, with a discon- nect between employers, workers, and education and training providers causing the various stakeholders to act in isolation.77 As a result, only about 20 percent of the labor market’s current needs are covered. Before the outbreak of the COVID-19 pandemic, the education system was struggling to provide high-quality education to all students, and the country faced several challenges in human development (see section 2.2). The num- ber of early school leavers, functional illiteracy rates, and the quality of tertiary educa- tion are all areas of concern. Romania performs particularly poorly relative to EU aver- ages, with high numbers of early school leavers and NEETs.78 Romania has the lowest participation rate in lifelong learning in the EU, due to both cultural and systemic barriers. Around 1 percent of those aged 25 – 64 participate in adult learning activities, well below both national targets and the EU average of 9.1 per- cent (Figure 2.10). Lifelong learning does not usually unlock salary or career progres- sion in Romania, nor is it valued on a personal level, especially among those aged over 40.79 Vocational education and training (VET) has gained public attention over the last decade due to the coun- FIGURE 2.10  Share of population involved in try’s labor shortages, but its quality is suboptimal. Soft lifelong learning is low skills are also in short supply, as neither the traditional education system nor the VET system focus on them.80 10 Finally, Romanian firms invest comparatively little in Participation rate (percent) in education and training 7.8 among 25 – 64 year olds 9.1 8 skills formation, with only 21 percent of firms offer- ing formal training to their employees, versus 31 per- 6 cent in ECA and 36 percent in high-income countries. 81 4 Low and relatively inefficient public spending on 2 1 ALMPs contributes to the poor accessibility of infor- 1.4 mation about labor market opportunities.82 Despite ad- 0 2010 2020 equate EU funds to support the expansion of labor-mar- ket programs, Romania is the EU country that spends Romania EU-27 the least in this area relative to its GDP83 — just 0.09 per- Source: Eurostat (TRNG_LFS_02), participation rate in educa- cent of GDP in 2018, less than 10 percent of the average tion and training (previous 4 weeks). Constraints to growth and prosperity in Romania 43 spending in the EU-27 (Figure 2.11).84 Moreover, 40 percent of the expenditure goes to- ward passive measures, rather than active measures aiming to boost prospects for gain- ful employment or earning capacity. Romania’s public spending on social protection and social assistance is relatively low, compared with other EU members and other coun- tries in ECA. Thus, in addition to experiencing inequality in access to services, the poor lack resources to invest in their human capital.85 FIGURE 2.11  Romania's spending on labor-market programs is the lowest in the EU 3.2 2.8 2.4 Percent of GDP 2.0 1.6 EU-27 average = 1.2 1.2 0.8 0.4 0.0 d Sw ds nd Es d Fr k Fi ce Be ain m he ria en Po ic Lu ort y Ire rg un ia G ia th ce ia Bu via ec Cy ia ov Rep us Re blic Ro ta ia ly Cr r y m al Sl nia an ar an n bl Ita n t en ar an xe ug l ga u iu n r an e e t st ed oa la la a t Sp to ua p m bo rla m La re lg ak u pu nl M lg m ov u en er A H P G Li D h N Cz Sl Employment Services ALMPs Passive measures Source: Eurostat. 2.4 LOW CONNECTIVITY, A SHALLOW FINANCIAL SECTOR, AND AN UNFAVORABLE BUSINESS ENVIRONMENT HOLD THE PRIVATE SECTOR BACK Several factors, in addition to skills shortages and mismatches (discussed in section 2.3), hold back private sector development in Romania. First, infrastructure gaps — largely due to inefficient public investment stemming from institutional weakness — are signifi- cant both nationally and, in particular, in lagging regions (section 2.1). Second, underde- veloped financial markets and lack of capacity in the public sector limit the absorption of vast EU funds and hold back Public-Private Partnerships (PPPs). Third, the business environment is unpredictable, overregulated, and unconducive to innovation and com- petition. The forthcoming Romania CPSD offers more detailed analysis on these topics. Despite significant public investment, quality and coverage of infrastructure remain below EU standards. The quality of overall infrastructure in Romania throughout 2008 – 2018 was the lowest in the EU.86 According to the 2019 World Economic Forum’s Global Competitiveness report, Romania ranked 55th globally on quality of overall infrastructure, behind countries such as Morocco and Mexico, and even lower on quality of roads (119th out of 141 coun- tries). Key infrastructure sub-sectors need larger and more-efficient investments, includ- ing: transport (roads, railways, air, waterways and ports), energy (transmission network, Constraints to growth and prosperity in Romania 44 renewables, and energy efficiency), digital (telecom networks and data centers), and mu- nicipal services (water, waste management, urban and peri-urban transport, and district heating). The major presence of SOEs in the infrastructure sector (especially in transport and energy) leads to underinvestment and/or crowds out the private sector (see section 2.2). Romania’s transport network is among the shortest and least dense in the EU. Romania is among the EU countries that have made the least progress on building out the Trans- European Transport Network (TEN-T), having completed only 35 percent of the length of the central TEN-T road network (886 km out of 2,544 km) and 23 percent of the TEN-T conventional central railway network (572 km out of 2,514 km). The densest motorway net- work is located around Bucharest and key economic hubs in the Centre and West of the country, with entire regions in the East and South lacking any motorways (Figure 2.12). Rail density is around the EU average (Figure 2.13), although the network needs urgent repairs and modernizations: less than 40 percent is electrified, with average speed in 2022 below 45km/h for passenger trains and 15km/h for freight trains. The inland water- way network has low density and is largely unused. FIGURE 2.12  Motorway density in Romania is FIGURE 2.13  Railway density is on par with EU among the lowest in the EU average, but the network needs urgent repairs km of motorways per 1,000 km² and modernizations > 80 km of railway per 1,000 km² 30 – < 80 ≥ 300 15 – < 30 100 – < 300 1 – < 15 60 – < 100 0 30 – < 60 Data not available 1 – < 30 0 Data not available Source: Eurostat 2020. Source: Eurostat 2020. Better governance is key to achieving higher-quality and greener transport infrastruc- ture.87 Governance arrangements marked by instability and ineffectiveness in project delivery are, in large part, at the root of Romania’s infrastructure deficit. Despite major investment needs and the availability of significant financial resources, the Ministry of Constraints to growth and prosperity in Romania 45 Transport routinely underspends relative to both original and rectified budget appro- priations (by an average of 29 percent in 2015 – 2019). Romania is also missing on the opportunity to adopt the Public Private Partnership model, where suitable, to involve the private sector in financing, developing, upgrading, and operating key infrastruc- ture assets — due, in part, to the lack of a sound legislative and regulatory framework.88 The insufficient coverage of transport infrastructure networks hampers competitive- ness and job creation. Shortcomings in core transport infrastructure are oft-mentioned binding constraints to investment and private sector development,89 and a major cause of persistent regional divides in economic performance. In a 2019 EIB survey, 73 percent of respondent SMEs mentioned inadequate transport infrastructure as a key barrier to expanding investments.90 In addition, in 2017 the World Bank found a statistically sig- nificant correlation between road conditions and access to education (i.e., lower qual- ity of roads goes hand in hand with less access to education).91 Finally, a lack of metro- politan railways hinders labor mobility. Romania performs relatively well on digital infrastructure, but regional differences are wide and skill levels insufficient. While 92 percent of households in Bucharest-Ilfov were connected to the internet (fixed and/or mobile) in 2020, the rate was only 77 per- cent in the North-East region (Figure 2.15). In addition, as discussed in section 2.3, met- rics of digital skills and productive use of the internet remain poor. FIGURE 2.14  The level of fixed-broadband FIGURE 2.15  Regional differences in internet household penetration is relatively high in access (fixed and mobile) are wide Romania PRT 100 BLR GRE Fixed broadband household penetration SVK GEO MKD HUN 80 SRB BGR ALB ROU HRV CZE (percent of household) LTU BIH TUR RUS AZE EST 60 ARM POL MDA 40 UKR KAZ UZB TKM 20 KGZ TJK ≥ 80 – 82 ≥ 82 – 84 ≥ 85 – 88 ≥ 88 – 91 ≥ 91 – 96 0 0 5 10 15 20 25 Source: Cartographic visualization using EUROSTAT Data. GNI per capita (US$, thousand) Note: Access of households to the internet is measured as the percentage of households in which any member can access the Source: TeleGeography data 2021; ITU data 2020. internet from home. Romania’s energy sector has made strides since the country joined the EU, but much remains to be done on energy security and decarbonization. On the World Economic Forum’s 2017 Energy Architecture Performance Index (EAPI),92 which ranks 127 coun- tries on their ability to deliver secure, affordable, and sustainable energy, Romania came Constraints to growth and prosperity in Romania 46 24th — a jump of 15 places from the 2009 EAPI — and 16th among EU members. According to the index, Romania outperforms the EU average with respect to the energy sector’s ability to support economic growth and development, but underperforms it on environ- mental sustainability and energy access/security. Key challenges for Romania’s energy security include: (i) making use of natural endowments that favor renewables (espe- cially wind); and (ii) developing interconnectors, which would also boost the country’s energy export potential. In 2020, the level of electricity interconnection in Romania was 9 percent,93 below the target of 10 percent set by the EU. Heating infrastructure is old and inefficient: 80 percent of heat generation capacity is more than 30 years old, and the age of some installations exceeds 45 years. Greening the energy sector will be central to achieving Romania’s decarbonization targets and ensuring energy security (see section 2.5 and the forthcoming Romania CCDR and CPSD for more details).94 Municipal infrastructure — including water, urban transport, street lighting, and sol- id-waste management — remains underdeveloped and requires significant investment. Urban transport faces challenges in many cities, with Bucharest ranked among the most congested in the world, and the transport sector has been responsible for the greatest share of the increase in GHG emissions in the country in recent years, primarily from daily com- muting within metropolitan areas. E-mobility remains low. Romania is also lagging on waste disposal, relying on landfills — a polluting and inefficient solution — at the highest rate in the EU, while recycling rates, conversely, are among the lowest in the EU (0.392 tonnes per capita, versus the EU average of 2.304 tonnes per capita, per Eurostat). FIGURE 2.16  Investment in Romania (as percent of GDP) is comparable to the EU-27 average Low, volatile, and inefficient public investment per- (2019 – 2020), but the needs are much greater petuates infrastructure gaps. Public investment aver- Ireland aged 4.2 percent of GDP in 2000 – 2020, above the EU-27 Estonia average of 3.2 percent of GDP, but it was highly vola- Hungary Czech Republic tile.95 The government’s use of cuts to investment as an Austria instrument to meet fiscal deficit targets has been a major Sweden Latvia contributor to volatility. Moreover, the impact of pub- Finland lic investment has been weak, due to factors including Belgium Romania insufficient institutional coordination, ineffective pol- France icy implementation and monitoring, politicized deci- Denmark Croatia sion-making, and poor human-resources policies in the EU-27 public administration. As a result, transport infrastruc- Germany Malta ture remains poor in quality and insufficient in quan- Netherlands tity, despite the availability of substantial EU funds. Lithuania Spain Cyprus Private investment has been relatively high in recent Slovak Republic years, but an unpredictable business environment, a high Bulgaria Portugal degree of state control over the economy, and shallow fi- Slovenia nancial markets constrain its growth. In 2020, business Italy Luxembourg investment in Romania equaled 14.8 percent GDP, slight- Poland ly above the EU average and higher than in most regional Greece peers.96 Foreign Direct Investment (FDI) inflows recovered 0 10 20 30 40 Percent of GDP after the pandemic, reaching €8.9 billion in 2021 and rising to €10.7 billion in 2022.97 Frequent government reshuffles Source: Eurostat. Constraints to growth and prosperity in Romania 47 have left much of the reform potential identified in the SCD 2018 untapped. Progress on im- proving SOE governance and adjusting the scope of their activity has stagnated, while in certain sectors the state remains both the regulator and the owner of key corporate play- ers.98 Thus, Romanian firms across all sizes and sectors indicated in 2016 – 2021 that the po- litical and regulatory climate was the main barrier to carrying out planned investment.99 Romania’s financial sector remains underdeveloped compared with regional and in- come peers. Financial sector assets as a percentage of GDP stood at 77.1 percent as of end- 2021. While banks dominate the sector,100 their assets were equivalent to 53.5 percent of GDP in 2021 — less than half as in peer countries (Poland, Bulgaria, Hungary, and Croatia), and approximately one- FIGURE 2.17  Total assets of the banking sector as fifth of the EU average.101 Bank credit intermediation is a share of GDP remain low (Q2 2021) shallow, limiting the supply of investment financing for firms. According to Finstats 2020, total credit amounted 300 Euro area to 26 percent of GDP in 2020, significantly below the ex- Percentage of GDP 250 pected 25th percentile, and lower than the ECA average of 200 41 percent.102 The supply of loans to enterprises stood at 150 12.9 percent of GDP in 2021, versus an average of 22.5 per- 100 cent for Bulgaria, Croatia, Hungary and Poland.103 Overall, 50 bank lending is highly concentrated in the Bucharest-Ilfov 0 region.104 Moreover, the private sector receives limited fi- nd ia ia ry tia bl ch an ar ga ic pu ze oa la lg nancing from non-bank financial institutions (NBFIs) and m un Po Re C Cr Bu Ro H capital markets, particularly for the long term. NBFIs are small — although they can play an important role for mi- Source: ECB data warehouse. cro-entrepreneurs, as many are located in rural areas and small towns. Romania’s capital markets remain the shallowest in Europe, and the institution- al-investor base is narrow. Government bonds dominate the domestic debt market, while the corporate debt landscape remains underdeveloped. The Bucharest Stock Exchange has scarce liquidity and is significantly smaller than its regional peers: its main market counted only 83 listed companies as of September 2022, for a total market capitalization of €28.5 billion (or 11.9 percent of GDP).105 Financing for venture capital and private equity is also limited. Romania has low levels of financial inclusion, including in account ownership and usage, access to finance, and use of digital payments. 69.8 percent of adults own a trans- action account106 — below regional and income group averages. Access to financial ser- vices is concentrated in the Bucharest region, with major gaps among rural, lower-in- come, and less educated consumers.107 Account usage and savings are also lower than in regional peers. While card ownership and usage have been low historically, digital pay- ments have increased significantly in recent years:108 according to Global Findex 2021, over 63 percent of adults reported making or receiving a digital payment in the previ- ous year.109 The low level of financial inclusion is due to both demand- and supply-side constraints: poor financial literacy, mistrust of the financial sector, comfort with using cash, as well as a limited rural payments infrastructure, as physical access points in rural areas (such as ATMs and bank branches) have experienced steady declines. MSMEs are poorly served by the financial sector. In 2019, MSMEs accounted for 53 per- cent of GDP and employed 66 percent of the labor force in Romania. However, outstanding SME loans from commercial banks amounted to 7.5 percent of GDP in 2020, the lowest share Constraints to growth and prosperity in Romania 48 among regional peers except Poland.110 The World Bank’s Enterprise Surveys 2019 found that 36 percent of small enterprises and 46.6 percent of medium-sized enterprises had a loan/ line of credit.111 Less than one-third of firms rely on banks to finance investment (a lower share than in regional peers), while many firms count primarily on internal sources of fi- nancing.112 Nevertheless, MSME themselves do not perceive access to finance as a signif- icant obstacle to operations, according to both WB Enterprise Surveys and NBR surveys. Overall, MSME finance in Romania is constrained by both demand-side (undercapitaliza- tion of firms, informality, limited collateral, low financial literacy) and supply-side factors (deficiencies in the financial infrastructure). The forthcoming Romania CPSD offers a more detailed discussion of the enabling role of the financial sector for private-sector investment. The economy in Romania is more heavily regulated and less competitive than almost anywhere else in the EU. State control is pervasive, with state ownership of companies and preferential treatment of SOEs greater than in any OECD or EU country.113 The regu- latory burden in Romania is also among the highest in the EU.114 For example, rigid con- straints to the provision of legal services hinder the ability of firms to access necessary inputs, while administrative requirements for start-ups were the second-most onerous in the EU (after Bulgaria) as of 2018.115 Banks also consider the unpredictable legisla- tive framework as a major risk factor, with a resulting negative effect on the degree of financial intermediation in the economy.116 The innovative capacity of Romania’s economy is limited, mainly due to chronic un- der-investment and skills shortages. The EU Innovation Scoreboard considers Romania an “emerging innovator” and ranks it last in the EU, signaling a poor ability of Romanian firms to move up the value chain. The country has, by far, the lowest share of innova- tive enterprises in the EU — as 2019, only 10 percent of Romanian firms had introduced a new or significantly improved product or service in the previous 12 months. Romanian firms underperform their EU peers in product and process innovation, marketing and organizational innovation, R&D expenditure, patent applications, and ICT training.117 FIGURE 2.18  Romania ranks the lowest on the EU Innovation Scoreboard 160 140 120 100 Score 80 60 40 20 0 Re and B nd en s Sw d G ry er us Lu Au y ia Cr ic n Re taly P ia Sl lic Bu nia H tia th e Es ia Fr ia Cy e m ria Ire rg he um Fi rk en a Po t a al D nd an ni Li ec c an ai bl ar tv en n ug ga al a u pr an b t oa ed la Sp a to ua m bo i s m rla La re lg pu I pu ak ol M nl N elg m un rt ov Ro G xe et h ec ov Cz Sl Emerging innovators Moderate innovators Strong innovators Innovation leader 2015 2021 Source: European innovation scoreboard 2022. The quality of the business environment is highly uneven across the country. The re- gional human capital index highlights stark disparities of opportunity for citizens across Constraints to growth and prosperity in Romania 49 Romania’s municipalities.118 The concentration of firms also varies substantially around the country. (Figure 2.19). FIGURE 2.19  The number of firms varies The Local Business Environment Index by the Romania substantially across county Aspen Institute rates and ranks Romanian municipali- ties based on four factors: local entrepreneurship, inno- vation, investment financing, and local public support. The score for Bucharest, the best-performing municipal- ity, was nearly seven times as high as that of Vaslui, the worst-performing one. Past regional assessments, finan- cial indicators, and other regional statistics paint a simi- lar picture. The digital and green transitions may further deepen regional inequalities by exacerbating the digital divide, reducing business opportunities in regions with high-emission industries, or exhausting municipal ca- pacity to absorb additional EU funds. An unpredictable business environment, shallow fi- 3,841 – 6,939 6,940 – 12,492 12,493 – 20,854 nancial markets, weak institutions, lack of connectivi- 20,855 – 36,580 36,581 – 119,798 ty, and skill shortages hold back private sector develop- ment, with the contribution of MSMEs to the nation- Source: World Bank using National Institute of Statistics data (2019). al economy smaller than in regional peers.119 The gap in firm performance between the Bucharest region and the rest of the country is widening. As consequence of these challenges, 14 percent of Romanian firms had more liabilities than as- sets in 2018, one of the highest ratios of negative-equity firms in Europe.120 2.5 THE CHALLENGES OF CLIMATE CHANGE MITIGATION AND THE GREEN TRANSITION BECOME PROMINENT Climate change presents both enormous opportunities and significant risks for Romania. The SCD 2018 outlined Romania’s need to develop climate adaptation and resilience to natural hazards (see section 2.6). Since then, the EGD has emphasized equitable climate mit- FIGURE 2.20 CO2 emissions per capita igation action through the green transition. The EGD (1962 – 2018) also provides an action plan for EU member states to boost the efficient use of resources via a clean, cir- 12 CO emissions (MTper capita) cular economy, restore biodiversity, and cut pollu- 10 tion. The forthcoming Romania Country Climate and 8 Development Report (CCDR) will discuss these is- sues in detail. 6 4 The EGD and Romania’s national strategies set out 2 ambitious goals, requiring considerable policy ac- tion. Romania’s CO₂ emissions per capita are below 0 the EU average (Figure 2.20). However, in the absence 19 0 19 3 66 19 9 19 2 19 5 19 8 19 1 84 19 7 19 0 19 3 96 20 99 20 2 2005 20 8 20 11 20 4 17 8 9 8 7 6 7 0 7 0 6 1 6 9 19 19 19 19 of policy action,121 they are projected to increase, and Romania European Union risk compromising the achievement of targets set out in the Paris Agreement and the EGD. Source: World Development Indicators. Constraints to growth and prosperity in Romania 50 The energy sector is the main contributor to GHG emissions in Romania, highlighting the importance of the energy transition. The energy sector accounts for 66 percent122 of GHG emissions in Romania (and within the sector’s emissions, 32 percent come di- rectly from the energy industry, 24 percent from transport, and 15 percent from man- ufacturing activities), agriculture for 17 percent, industrial processes and use of prod- ucts for 12 percent, and waste for 5 percent (Figure 2.21). FIGURE 2.21  Romania's GHG emissions are concentrated in the energy sector 32% Energy industries Industrial processes 12% and use of products 15% Manufacturing industry Waste 5% Energy 66% 24% Transport Agriculture 17% 13% Fugitive emissions 16% Other sectors Source: Ministry of the Environment, Waters and Forests, National Inventory of Greenhouse Gas Emissions, 2018. Note: Land use, land-use change, and forestry. Excludes LULUCF activities. Transitioning to a greener energy supply and a more efficient energy consumption is key to meeting ambitious climate goals and enhancing energy security. Electricity gen- eration in 2020 was heavily based on fossil fuels (36 percent), followed by hydropower (28 percent), and nuclear (20 percent) (Figure 2.22). Wind and solar made up approximately 16 percent of the energy mix. The last decade has brought significant structural changes in the energy sector: as the share of coal halved, renew- ables filled most of the gap thanks to their accelerated FIGURE 2.22  Electricity generation in Romania development in 2010 – 2015, and natural gas grew from relies heavily on fossil fuel, hydropower, and 11 percent to 18 percent of the mix. However, with the nuclear gradual closure of coal-fired plants and no new invest- ments in generation since 2015, Romania became a net Biofuels Nuclear importer of electricity in 2019, and its share of renew- 1% 21% able generation remains well below the EU-27 average. Energy intensity in Romania, albeit above the European Hydro average, has been declining, while opportunities for 28% 12% Wind energy efficiency remain largely untapped. 3% Energy decarbonization efforts need public investment Solar PV (e.g., in transmission networks) as well as private in- 17% vestment (e.g., in renewable electricity and heating 18% Coal generation). In the NRRP, Romania has committed to a Natural gas complete coal phase-out by 2032. Private-sector invest- ment in renewable generation capacity has been scant Source: International Energy Agency. Constraints to growth and prosperity in Romania 51 since 2015, at a time when all coal-fired plants are set to be decommissioned. In addition, new transmission and balancing infrastructure, including smart grids, is needed to man- age the substitution of coal units with variable electricity generation technologies, as well as to enable the decentralization of generation capacity and a more active participation of energy consumers in the system’s management. In district heating, most existing gener- ation facilities have been operating for more than 30 years, and upgrades will require in- vestment for more than €300 million. In addition, district heating — along with the indus- trial and freight sectors — will need to shift from fossil fuels to cleaner alternatives such as green or blue hydrogen, biogas, or biofuels, which entails investment in their genera- tion, transport, and in the refurbishment of equipment and facilities for end use. Finally, a renovation of the building stock is urgent, to reduce energy consumption and exposure to the volatility of international energy prices, and to improve the security and comfort of households. In this challenging context, the energy sector is struggling to attract pri- vate investment at scale, due to unstable regulatory and legal frameworks, limited capac- ity and resources in the public sector to manage the transition, and the excessive influ- ence of SOEs on the sector. The forthcoming Romania CPSD and the CCDR assess these issues in more detail. Decarbonizing transport will also be important to reaching net-zero emission tar- gets, against a backdrop of overreliance on road transport and poor readiness for e-mobility. Transport is responsible for about 16 percent of the country’s GHG emis- sions, and more than 90 percent of that share arises from road transport123; thus, the road sector has a major role to play in the transition. Romania’s e-mobility sector is still in its early stages.124 Electric vehicles (EVs) numbers are growing (in 2022, one in five cars sold in the country was either electric or hybrid) but still low as a share of the total car park (in 2022, the shares of EVs and hybrid vehicles stood at 0.25 percent and 1.2 per- cent, respectively), while more than one in four cars registered in the country is over 20 years old. Charging infrastructure is modest, and most charging stations are concen- trated in Bucharest and other large cities. The ratio of plug-in EVs to charging points was 15 at the end of 2020, versus the EU average of 12.125 The intensity of Romania’s GHG emissions from agriculture is among the lowest in the EU. This is due to the relatively low productivity of the sector, but emissions could increase in the absence of mitigation measures if agricultural productivity and efficiency improve. Romania’s agricultural agenda is connected to the EU’s Common Agricultural Policy (EU CAP), which provides a framework for mainstreaming climate change mitigation and adap- tation activities. The next CAP programming period will be inextricably linked to the EGD, at the heart of which is the EU’s Farm to Fork strategy. Direct payment schemes for greening activities will be further embedded to achieve environmental and climate objectives, with hard spending targets for climate change mitigation and adaptation measures in agriculture. Romania is the EU member state least ready to achieve a circular economy. Multiple efforts are ongoing to accelerate the circular transition, including the development of a national circular economy (CE) strategy. A rich body of legislation is in place, but it mainly has a narrow focus on waste management. Furthermore, scarce enforcement and monitoring undermine the effectiveness of the National Waste Prevention and Management Plan. Key barriers to igniting a more profound transition include the absence of a long-term vision, scarce administrative and technical capacity in the central and Constraints to growth and prosperity in Romania 52 local governments, insufficient monitoring and enforcement, poor and unreliable data, and scant cooperation between stakeholders. Environmental externalities increase in lockstep with economic activity and pros- perity in Romania’s urban areas. Air pollution in urban areas frequently exceeds EU limits, driven by unsustainable residential heating practices, growing urban transport, a prevalence of polluting vehicles, and a broader increase in economic activity. Pollution levels are higher in the winter, due to the impact of residential heating. Rural areas struggle with forest management, including illegal logging and localized deforestation. Furthermore, nutrient and chemical pollution in water bodies, especially the Black Sea, are of increasing concern, not least due to their transboundary effects. Cities, through their concentration of people and economic activities, are expected to lead a green, resilient, and inclusive development. To achieve the Paris Agreement and EGD objective of climate neutrality by 2050, and the intermediate Fit-for-55 target, the European Commission guides the cities to lead the change. The 100 Climate-Neutral Cities by 2030 Mission will allocate significant resources to 100 EU cities and to other “follower” cities, to achieve climate neutrality by 2030, serve as examples for other local- ities, and generate innovation that will speed up the transition to climate neutrality. In Romania, the cities involved are Sector 2 of Bucharest, one of the capital’s administra- tive units; Cluj-Napoca; and Suceava. Romania’s shift to a sustainable growth model will require substantial action from the public and private sectors, as well as a shift in public perception. Three green fis- cal measures will be critical to achieving the economic, social, and environmental objec- tives of the EGD: raising carbon taxes, eliminating fossil fuel subsidies, and — with sup- port from EU funds — ramping up green public investment, especially to decarbonize the energy and transport sectors. Policy action will also need public support. Climate change is less of a burning issue for Romanian citizens than for the average European: only 7 percent of Romanians deem climate change the most serious global problem, ver- sus an EU average of about 20 percent.126 Financial markets have a critical role to play in the green and digital transitions. Romania’s green transition will require substantial investments.127 EU and domestic public funds will contribute, but the financial sector will have to fill the gaps. Green assets make up about 3 percent of the portfolio of Romanian banks, less than half the euro area average, while the green borrowing potential of local companies is estimated at about €3 billion. At the same time, about 50 percent of the loan portfolio of Romanian banks sits with companies exposed to climate-related risks. On the supply side, limited institutional capacity is holding back lenders from engaging more in green finance, although banks are making progress towards developing tailored approaches. On the demand side, borrowers lack understanding of the risks and opportunities associated with climate change as well as the ability to develop transition plans, resulting in scarce demand for green investment, and poor bankability for the green projects that are sub- mitted to lenders. While banks will be expected to finance the bulk of green private-sec- tor investment in Romania, capital markets will also have a role to play. The government plans to set up its Green/Sustainable Bond Sovereign Framework in 2023 to issue ESG- themed bonds that will further help Romania’s green transition. Constraints to growth and prosperity in Romania 53 The ability of the government to build a supportive environment for the green transi- tion will determine the future competitiveness of the national economy. Governments may facilitate the green industrial transition by ensuring access to green inputs, such as energy, at competitive prices; supporting the efficient use of resources by industries and consumers; optimizing and targeting subsidies for green outcomes; designing carbon pric- ing frameworks conducive to a structural shift in the economy; ensuring the availability of human capital adapted to the demands of green markets; deepening financial markets and instruments to support the transition; and ensuring the public sector has clear long-term strategies, technical capacity, and an adequate institutional architecture. Failing to do so may erode economic competitiveness, reduce the market share of local companies in Europe, and shift exports to lower value-added markets. This topic will be explored in the forthcoming Romania CCDR, while the forthcoming Romania CPSD offers a brief analysis of Romania’s strengths and opportunities in the solar, wind, and EV value chains. The design and imple- mentation of the overall government program for the transition, and the relevant sectoral policies, will determine whether Romania can: (i) protect its natural resources without sac- rificing growth and development; (ii) decarbonize the economy, while ensuring energy se- curity; and (iii) protect the vulnerable from both the impact of climate change, and potential economic dislocation induced by the green transition. Addressing governance and institu- tional constraints to program implementation and crowding in the private sector will be key. 2.6 RESILIENCE TO NATURAL HAZARDS AND CLIMATE CHANGE IS LOW Romania is prone to a range of geophysical and climate change-induced disasters, epi- demics/pandemics, and technological accidents. 101 catastrophic events were recorded in the country between 1900 and 2021 — including 53 floods, 11 earthquakes, 20 extreme temperature events, 11 storms, and two major droughts — affecting over 2 million peo- ple, and causing nearly 5,000 deaths and more than US$17.2 billion in losses and dam- ages.128 Notably, Romania is among the EU countries at highest risk of earthquakes and floods from fluvial and surface water.129 More than 75 percent of the country’s popu- lation lives in areas susceptible to earthquakes, with Bucharest widely regarded as the most seismically risky city in Europe. Potential risks and damages from flooding and seismic events are on the rise, due to climate change and aging infrastructure. The government liability from losses in the event of a major disaster could exceed 0.4 percent of GDP, considering the vulnerabil- ity of the residential building stock (estimated to account for more than 50 percent of potential losses) and of public assets.130 Romania needs to substantially reduce exposure to disaster and climate risk in both the private and public sectors, incentivize the uptake of household and public-asset insurance, and consider making use of sovereign-level financial instruments (e.g., contingent financing and catastrophe bonds). As of 2020, Romania’s building stock comprised more than 5.5 million buildings — with residential buildings accounting for more than 90 percent of the total, followed by educational and commercial buildings.131 Most public assets are owned or managed by local authorities, which thus have a major role to play in strengthening disaster and climate resilience. Disasters also affect people’s livelihoods and well-being, risking to push families into pov- erty.132 The Social Vulnerability Index133 shows that high levels of vulnerability correlate Constraints to growth and prosperity in Romania 54 with low disaster resilience in peripheral rural areas, which are especially exposed to risk from earthquakes and floods.134 Urban areas also show signs of social vulnerability. Disaster impacts are also increasing due to the concentration of people and eco- nomic assets and climate change. Forest fires, droughts, landslides, strong winds, and extreme heat also pose significant threats, with climate change likely to increase the fre- quency and severity of weather-related disasters. At the same time, adaptation readi- ness in Romania is relatively low, as highlighted in the SCD 2018 and the ECA CCAP. The MunichRe NatCat database135 estimates €12 billion of losses (99 percent of which were not insured) and almost 1,322 fatalities in the country since 1980 due to climatological and hydrometeorological events. Notably, natural disasters and climate risk dispropor- tionately affect Romania’s poorer counties.136 Climate change is causing greater variability in precipitation, leading to increasingly severe flood and drought events and attendant water security challenges. This will significantly increase the challenges of Romania’s water sector to safely provide water for consumption, agriculture, and energy production, and to protect society, the econ- omy, and the environment from flooding. Water security is already at stake under cur- rent climate condition. Existing water infrastructure assets, including many reservoirs and flood defences, have significant shortcomings, and may collapse under the strain of a changing climate. Both infrastructure and institutions for managing water resources, and especially water-related risk, need urgent modernization and reinforcement. Challenges in the water sector augment vulnerability in energy and agriculture. More se- vere and frequent droughts will impact hydro and nuclear power generation, which account for around 30 and 20 percent of electricity generation in Romania, respectively. Enhancing energy-sector resilience calls for improving the management of water resources and the ef- ficiency of hydropower generation infrastructure, diversifying energy sources, reducing de- mand pressure through energy efficiency measures, and investing in additional capacity to offset potential hydropower reduction during dry periods. Moreover, the agriculture sector is particularly vulnerable to the effects of climate change because of fragmented land holdings, inadequate agricultural extensions services, lack of modern and efficient irrigation/drain- age systems that could reduce dependency on rain-fed production, and poorly developed ICT systems to share information and provide advisory and support services to farmers, particu- larly smallholders who struggle to access such services through traditional market channels. While Romania’s vulnerability to climate change and natural disasters is relatively high, its readiness to adapt remains low. Romania has been strengthening its legisla- tive and organizational framework for disaster mitigation, preparedness, and response. However, the investment required to support effective climate policies and disaster risk reduction remains limited, with missed opportunities to maximize adaptation and the inclusion co-benefits achievable when improving public and private assets. Preparing for catastrophic events requires better cross-institutional coordination, and increased hor- izontal and vertical capacity. In addition, the social protection system is not well placed to adapt to climate-induced shocks, lacking capacity to integrate data on poverty and natural disasters to identify vulnerabilities.137 Coordination between the Disaster Risk Management (DRM) sector and the social protection system is limited, as shown by the lack of early-action trigger disbursement mechanisms to support communities in case of need. Constraints to growth and prosperity in Romania 55 3 PRIORITIES FOR INCLUSIVE, STRONG, AND SUSTAINABLE GROWTH This SCD Update reassesses Romania’s priorities for achieving inclusive, strong, and sustainable growth, building on: the analysis presented in the previous chapters; exten- sive consultations with central and local governments, NGOs/CSOs, academia, and other stakeholders; and guidance from the Country Management Unit (CMU). The reforms proposed in the SCD Update are aligned with those identified in the SCD 2018, but they are grouped differently. This revision aims to highlight the role of relevant reforms in improving the population’s living standards, and to grant emerging priorities — partic- ularly climate change adaptation and mitigation — a more visible role, given the prom- inence of the green transition (and the associated EU funds) in national and EU-wide policy goals. The selection of priorities relied on extensive consultations with the Romania CMU and sectoral teams from the World Bank, IFC, and MIGA. From these discussions, the team collected a longlist of nearly 100 policy actions to address the constraints described in Chapter 2. The team then used four criteria to prioritize these actions: (i) expected impact towards the WBG’s twin goals; (ii) complementarity with other policies and goals; (iii) feasibility of policies under current economic, governance, and capac- ity conditions; and (iv) time horizon for the policies to produce results. As a result of the prioritization pro- FIGURE 3.1  Priorities, to HLOs, to Twin Goals cess, the SCD Update sets forth 17 priorities, with spe- cific measures underpinning them. Annex 2 provides a detailed table mapping each of the priorities into the Priorities, with specific measures four selection criteria. ...address constraints (Chapter 2) The resulting 17 priorities were mapped to six High- ...and help achieve Level Outcomes (HLOs), formulated to capture desired (multiple) HLOs improvements in the population’s wellbeing (Table 3.1). The identified priorities aim to address key con- straints discussed in Chapter 2. Each priority High-Level Objectives (HLOs) maps into and helps progress towards one or multiple HLOs, with ...denote outcomes resulting mapping presented in in improved people wellbeing Table 1. The HLOs, if achieved over the next five to ten years, would Twin Goals mark an improvement Reduced Shared in the wellbeing of the poverty prosperity population, and espe- cially of the poorest and most vulnerable (Figure 3.1). The HLOs are complex, interrelated, and — as the name suggests — high-level; therefore, multiple pri- orities can be relevant to multiple HLOs. This chapter outlines the relevant priorities for each HLO. The priorities are numbered, but the numbering is not a ranking. The chapter also recommends specific measures that would help meet priorities and HLOs, but the list of suggested measures is not exhaustive. Priorities for inclusive, strong, and sustainable growth 57 TABLE 3.1  High-Level Outcomes and Priorities High-Level Outcomes Priorities I. Predictable institutional and 1. Mitigate the impact of political instability through establishment of me- economic environment for dium-to-long-term strategic and spending priorities [HLO2, HLO3, HLO4, people and businesses HLO5, HLO6] 2. Improve citizens’ trust in the state [HLO2, HLO3, HLO4, HLO5, HLO6] 3. Ensure fiscal sustainability [HLO2, HLO3, HLO4, HLO5, HLO6] II. Equal access to high-quality 4. Enhance public sector human-resource management to improve pub- public services at central and lic-service delivery [HLO1, HLO3, HLO4, HLO5, HLO6] local levels 5. Increase effectiveness and efficiency of public-service delivery at central and local levels [HLO3, HLO4, HLO5, HLO6] 6. Improve access to quality public infrastructure and services (e.g., transport, digital network, water and sanitation, district heating, solid waste manage- ment, social benefits and social services) for the poor, the vulnerable, and those in rural areas [HLO3, HLO4, HLO5, HLO6] III. Better health and education 7. Improve health outcomes and provide equitable access to healthcare ser- outcomes for all vices [HLO4] 8. Provide access to quality education for all [HLO4] 9. Strengthen lifelong skills formation, especially for vulnerable groups [HLO4] IV. Favorable conditions for more 10. Close the gaps in transport and other infrastructure for international and and better private-sector jobs domestic connectivity [HLO2] 11. Increase financial intermediation and inclusion [HLO 5, HLO6] 12. Enhance market competition and innovation [HLO5, HLO6] V. Climate change mitigation for 13. Accelerate decarbonization, improve regional interconnections, and ensure environmental sustainability energy security [HLO2] of economic activity 14. Reduce environmental degradation (water, land, atmospheric) [HLO2] VI. Resilience to shocks and 15. Scale-up risk prevention/reduction, and improve preparedness for, re- adaptation to climate change, sponse to, and recovery from natural disasters [HLO2] especially for vulnerable 16. Enhance financial resilience of the public and private sectors to natural di- households sasters [HLO2, HLO4] 17. Safeguard water security, and ensure better prevention of and protection from water-related disasters [HLO2] Note: Secondary HLOs in brackets. political and economic environment HLO-I Predictable for people and businesses While many priorities and HLOs are connected, HLO-I — Predictable political and eco- nomic environment for people and businesses — is the most cross-cutting, with each of its priorities mapping into all HLOs. This reiterates the key lesson from the SCD 2018: despite impressive economic growth, achieving shared prosperity and sustainable wel- fare improvements will remain a distant reality if Romania does not address its gover- nance challenges. Institutional strengthening is required across all tiers of the govern- ment (national and local) and policy areas, for both existing and emerging challenges Priorities for inclusive, strong, and sustainable growth 58 and opportunities. The priorities identified under this HLO aim to strengthen the pub- lic planning and implementation framework, anchoring it with medium-term objec- tives; reduce disruption from political instability; gradually enhance fiscal sustainabil- ity; and foster accountability to increase citizens’ trust. PRIORITY #1: Mitigate the impact of political instability through the establishment of medium-to-long-term strategic and spending priorities, supported by the following specific measures: Link strategic planning to budget priorities at center-of-government (CoG) level. This can be achieved by strengthening the link between planning and public spending (effi- ciency/efficacy); aligning strategic policy priorities to public investment, in order to reduce duplication, inefficiency, and the infrastructure gap; and by increasing trans- parency and improving monitoring of the implementation of strategic plans. Strengthen the strategic management and planning framework at central level. This entails a focus on implementing recent legislative changes under the NRRP, aiming to strengthen strategic management and planning and gradually introduce results-based budgeting. Such effort will require political leadership, as well as bolstering the plan- ning and budgeting capacity of ministries and agencies through skills upgrades and systems enhancement. Institutional strategic plans prepared by ministries will benefit from being integrated into the budget preparation process. PRIORITY #2: Improve citizens’ trust in the state Strengthen the accountability of institutions by reinforcing the Court of Accounts. Enhancing the auditing capacity of Romania’s Court of Accounts (RCOA) would have a positive impact on public services and the efficient use of government resources. To this end, it is critical to develop the RCOA’s annual and multi-year audit programs linked to the goals and objectives of its strategic plan, and to implement a staff recruitment and training model that matches staff competencies to institutional strategic priorities, and while improving the quality of audits. Develop and implement a new strategy for the justice sector. Such a strategy would be best focused on improving intra- and inter-institutional capacity, strengthening HRM practices, and building out more responsive and resilient infrastructure to deliver high-quality, efficient, and effective services to citizens. PRIORITY #3: Ensure fiscal sustainability Reduce the fiscal deficit and stabilize public debt through policy and institutional reforms. To close the fiscal deficit stemming from structural issues (public wages and Priorities for inclusive, strong, and sustainable growth 59 pensions), the pandemic-induced crisis, and Russia’s invasion of Ukraine in a sustain- able fashion, the government has committed in the NRRP to promoting reform on both sides of the budget: revenues and expenditures. To improve revenue collection, a mod- ernization of the Tax Administration Agency (ANAF) has been launched, although results will only become apparent in the medium term. Removing or reducing tax exemptions (e.g., for the self-employed, or for certain categories of employees) would significantly boost budget revenues. On the expenditure side, the recently launched reforms of public wages and public pensions, if brought to conclusion, have the potential to lead towards a more fiscally sustainable and equitable path. Adopt medium-term fiscal consolidation measures, such as improving the tax ad- ministration as well as payments processes and systems. Relevant measures include streamlining budget processes; developing a digitized Integrated Financial Management Information System (IFMIS); enhancing the efficiency and effectiveness of revenue col- lection and the tax administration through business process reengineering, integrated risk management, and systems modernization; and mandating the use of electronic in- voices to increase VAT collection and combat tax evasion. access to high-quality public services at central HLO-II Equal and local levels HLO-II focuses on achieving public services that are both high-quality, and equally accessible across geographical, income, ethnic, and any other formal or informal divides. As is the case for HLO-I, the priorities under HLO-II are highly cross-cutting. For instance, priority #4 recognizes the urgency to equip the government with skills and incentive structures that can both boost service delivery for people across Romania and strengthen core government functions at central and local levels. In addition to capac- ity improvements, stronger coordination across government departments and tiers of government can bring efficiency gains, while selective decentralization can bring more accountable, locally informed decision-making tailored to citizens’ needs. At the same time, enhancing the quality of social services and coverage of outcome-oriented social protection systems, while targeting vulnerable groups and those with less access to opportunities, would contribute to a more equitable society. PRIORITY #4: Enhance public sector human-resource management to improve public-service delivery Speed up the implementation of human-resource management (HRM) reforms in the civil service and digitize the HRM system. Operationalizing HRM reforms developed for the civil service would help ensure a competency-based approach to recruitment, perfor- mance management, and career progression. This includes rolling out the competency framework model, along with an improved classification of public administration jobs and the development of clear job descriptions. The new merit-based recruitment system (the National Contest) should be piloted and updated based on the pilot’s results. Digitizing the HRM system and developing more-effective competency-based training would be also Priorities for inclusive, strong, and sustainable growth 60 valuable. Finally, the government can introduce employee engagement tools to monitor progress on key reforms, including the future implementation of performance-based pay mechanisms. Implementing HRM reforms will also require a stronger institutional set-up and greater capacity within the National Agency for Civil Servants.  PRIORITY #5: Increase effectiveness and efficiency of public-service delivery at central and local levels Support the digital transformation of the public sector, including digital skills devel- opment. The government can accelerate the digital transformation of the public admin- istration through a holistic approach, starting from bolstering foundational elements such as ICT architecture, the policy and regulatory frameworks, and digital skills. The mandate of the Ministry of Research, Innovation and Digitalization can encompass the role of digital transformation office in the center of government, with a clear re- mit for cross-government coordination. The government can also consider developing Government Cloud Infrastructure, establishing a citizen-centric e-government portal, and preparing and implementing an HR strategy for ICT staff in the public administra- tion. These measures will require upgrades to the data infrastructure, new digital plat- forms and services, and new or updated laws and regulations. At the same, guarantee- ing sufficient physical access to services will be necessary for inclusiveness. A successful transformation will also depend on upskilling public servants and boosting basic dig- ital skills among the wider population, with a focus on low-education, low-income, el- derly and fragile groups. Implement results-based and programmatic budgeting. The efficiency and effective- ness of public investment programs would benefit from a shift from a retail approach that addresses individual investments, to a more systematic and results-oriented frame- work. Thus, investment allocations should be tied to a set of minimum-access and/or performance-based conditions. Collecting and analyzing information from the execu- tion of the budget, and feeding it back into the decision-making process, would con- tribute to incrementally stronger links between performance and budget allocations. Strengthen CoG to promote cross-government coordination and the alignment of Public Investment Management (PIM) with strategic priorities. Relevant steps include: strengthening national and subnational government capacity to increase efficiency and value for money in public capital spending; developing integrated IT planning and monitoring systems, to support informed decision-making on public investments; es- tablishing a consolidated government investment strategy; rolling out a consolidat- ed data platform and a project bank to better prioritize projects and more effectively monitor individual investments and broader portfolios. Moreover, public procure- ment can be a strategic tool to secure social, environmental, and innovation benefits. Reducing administrative costs through centralized procurement, enhancing transpar- ency, strengthening procurement monitoring, supervision, and control functions, and further developing the capacity, capability, and integrity of procurement profession- als at both national and subnational levels would also improve the quality of public in- vestment management. Priorities for inclusive, strong, and sustainable growth 61 Decentralize, transfer certain public assets, and create own-source revenue opportu- nities for local governments. Transferring some of the assets owned by the central gov- ernment to local authorities, or enabling partnerships between central and local admin- istrations — while ensuring the latter are adequately resourced — could enable local regeneration projects with transformative potential. Reviewing the subnational fiscal transfer framework, developing a market-based property valuation system, and equipping local governments to enhance their property tax collection system are other critical areas. PRIORITY #6: Improve access to quality public services for the poor, the vulnerable, and those in rural areas Improve accessibility and quality of municipal infrastructure and services — transport, digital networks, clean water and sanitation, district heating, and solid-waste manage- ment, including through public-private partnerships, where appropriate. Bridging the urban-rural divide and closing the infrastructure gap in peri-urban localities requires major investments in public infrastructure (potentially in the form of public-private partnership), integrated approaches (e.g., at the metropolitan or functional urban area level), well-coordinated spatial planning, better targeting, and a stronger focus on results, impact, and sustainability. Public investments in digital connectivity will be necessary in regions that are not economically viable for private telecoms operators. Moreover, the government’s preparation, implementation, and monitoring of programs in water and sanitation infrastructure — such as the national program First Connection to Water and Sanitation under the NRRP — can make a meaningful impact, while developing a national Water Supply and Sanitation Strategy can help address infrastructure implementation bottlenecks and incentivize performance improvement. Further capacity building and institutional strengthening of important sectoral players, such as the National Authority for the Regulation of Public Utility Community Services (ANRSC), is also important. Legislation on waste-management responsibilities and ownership would be beneficial to the ailing and largely inefficient solid-waste management system, especially if it encour- ages private-sector participation. In transport infrastructure, addressing the maintenance and rehabilitation backlog on the road and railways network, on and beyond TEN-T cor- ridors, is paramount. The maintenance of the rail network would need additional fund- ing, with 75 percent of all lines needing urgent repairs. Moreover, almost 60 percent of national roads and highways have exceeded their service life and require capital repairs, an issue that CNAIR (the state-owned road administrator) has little capacity to address. The solution may reside in the new entity CNAIR managing new motorway investments, and CNAIR partnering with local authorities to ensure maintenance services. Overall, the most effective way of bringing benefits to transport users is to ensure competition in the supply of transport services, thus incentivizing efficiency and quality among operators. Enhance the effectiveness and administrative efficiency of the social benefits sys- tem. Relevant steps include: (i) ensuring that means-tested benefits are more effective in reaching the poorest, and of sufficient value to help beneficiaries rise out of poverty and social exclusion; (ii) consolidating means-tested benefits, to enhance administra- tive efficiency and facilitate access for eligible families; and (iii) linking social benefits to human development outcomes, e.g., by using early childhood development interventions Priorities for inclusive, strong, and sustainable growth 62 and other social services to raise school attendance among vulnerable population groups; as well as incentivizing employment by linking vulnerable groups to employment ser- vices and skills development. Strengthen community-level social services for vulnerable groups, including people with disabilities and the elderly population. Progress in social services hinges on an ade- quate regulatory framework, a clear strategy for developing services at the county level tailored to the needs of vulnerable groups, and budgetary arrangements ensuring suffi- cient financing. Given the country’s demographic trends, demand for social services for vulnerable groups — including children, people with disabilities, and the elderly, among others — is expected to grow. Meeting this demand will require enhanced case manage- ment; accurate needs assessments; integrated service provision at the community level; greater room for co-decision and participation of beneficiaries in the provision of social ser- vices; faster deinstitutionalization; and better information management and monitoring. HLO-III Better health and education outcomes for all With lack of skills an increasingly binding constraint to growth and inclusion, HLO-III defines human capital improvement as a standalone objective, while acknowledging its close connections with HLOs II and IV. Although human capital outcomes depend on a multitude of factors, health and education have a substantive impact on a person’s eco- nomic and physical wellbeing. Human capital — and particularly skills — was also flagged as an ever more urgent bottleneck during extensive consultations with stakeholders in the private sector, government, academia, and civil society. Similarly to HLO-II, HLO-III is underpinned by priorities focused on improving health and education outcomes for all — while paying special attention to those currently with poorer access or lower qual- ity services, and those whose learning outcomes deteriorated during the pandemic. In addition, priority #9 advocates for a lifelong approach to skills formation, with a view to not only improving economic outcomes for workers — especially those falling behind or employed in declining sectors — but also to building a stronger, more adaptable labor force that can help boost growth in the coming decades. PRIORITY #7: Improve health outcomes and provide equitable access to healthcare services Boost efficiency in health spending and improve the quality of healthcare and patient safety. Introducing discipline in public expenditure and supporting preventive care and primary healthcare (PHC) is recommended to ensure that Romania gets the best value for money. Relevant steps include: rebalancing the currently hospital-centric system towards effective PHC; implementing centralized procurement and other pharmaceu- tical policies; and improving data governance and health IT systems. Expand the scope of PHC and the supply of outpatient healthcare in vulnerable commu- nities, and harmonize benefits packages for the insured and the uninsured. Enhancing access to PHC for underserved populations — the poor, the uninsured, and vulnerable Priorities for inclusive, strong, and sustainable growth 63 communities — requires expanding legal entitlements and public financing. Harmonizing the benefits packages for the insured and the uninsured would yield direct economic ben- efit through greater efficiency in health spending. Moreover, the role of family physicians should be strengthened by (i) expanding their mandate toward preventive care and ini- tiation of care for several ambulatory care-sensitive conditions, and (ii) adjusting capi- tation rates by disease risk, so that providers are incentivized to treat high-risk groups. Strengthen community healthcare services, such as community nurses and Roma health mediators. Community-based models of care can facilitate health education, and help address cultural norms hindering the use of care that is legally, physically, and finan- cially accessible. Relevant steps include: (i) expanding community healthcare, includ- ing through increased budget allocations, and strengthening its collaboration with PHC; (ii) standardizing the daily work of community health workers, including community health nurses and Roma health mediators, and (iii) providing health education and sup- port in navigating the health system, particularly PHC. Modernize public healthcare infrastructure and service delivery. Targeted invest- ments — building on synergies between World Bank support, NRRP financing, and struc- tural funds — could focus on: (i) improving access to and quality of selected life-sav- ing services and screenings, (ii) strengthening government capacity for improving the quality of medical care; (iii) reinforcing public health emergency response, espe- cially in relation to COVID-19; (iv) increasing resources for hospitals, PHC, and inpa- tient care; and (v) reforming lagging areas of healthcare, such as mental health, palli- ative care, and geriatrics. PRIORITY #8: Provide access to quality education for all Increase access to integrated, affordable, and quality Early Childhood Education and Care (ECEC), especially in rural, poor, and marginalized areas, and in areas where employment and learning opportunities for women are greater. The supply of qual- ity ECEC services can be coupled with vocational education and training or dual educa- tion programs, prioritizing low-literate mothers — including those in Roma communi- ties, where the risk of child marriage is greater — and NEETs. Improve the quality of education in primary and secondary schools where more stu- dents are at risk of dropping out and exhibit poor academic performance. An integrated framework of education and psychosocial support in such schools hinges on greater and more effective investment in developing the cognitive and socio-emotional skillsets of children, teacher training, and a modern and inclusive learning environment. In addition, a School Early Warning Mechanism would help schools identify, support, and track the progress of students at risk of dropping out, with a focus on creating a positive climate in schools, bringing out-of-school children back to school, implementing learning recovery plans, and monitoring progress toward better learning outcomes and school completion. Accelerate learning recovery, particularly for children from households with low socioeconomic status. An appropriate learning recovery framework encompasses an Priorities for inclusive, strong, and sustainable growth 64 initial assessment, a consolidated curriculum, improved classroom practices, expanded instructional time, digital equipment, small group tutoring, and self-guided learning, especially for disadvantaged students. PRIORITY #9: Strengthen lifelong skills formation, especially for vulnerable groups Develop activation and employment support measures for vulnerable job seekers and the inactive population. The government can enhance the capacity and efficiency of the public employment agency (ANOFM) to help the young, the vulnerable, and other dif- ficult-to-employ groups enter the labor market. Reform can enable ANOFM to provide programs and training courses addressing specific labor market demand for skills, sup- port the transition from education to the labor market (particularly for at-risk youth), and improve labor market mediation. In addition, the government can incentivize the implementation and effective integration of existing programs on outreach, counseling, training, and mediation, and enhance case management to improve services for disad- vantaged or at-risk job seekers and the economically inactive population. It is equally important to align migration policy to labor market needs, to help fill emerging labor shortages. Stronger monitoring and evaluation capacity would help ensure that public resources are directed to programs with a strong track record of positive results. Design a flexible vocational training system focused on skills relevant to the labor market. It is important to harmonize the quality of Initial Vocational Education and Training (IVET) and Continuous Vocational Education and Training (CVET), clarify the links between occupational standards, qualifications, and curricula, and ensure that cur- ricula and skills have relevance on the job market. Technical and Vocational Education and Training (TVET), including short courses, needs to be more flexible, permeable, and accessible, to offer lifelong learning opportunities to the Romanian workforce. Investments in digital infrastructure and training programs for teachers and students can enhance online learning and teaching, especially in IVET. Moreover, the govern- ment can consider more inclusive approaches to program delivery and collect more data on vulnerable students. Improve on-the-job training, including traineeships and apprenticeships. The govern- ment can use the existing social partnership structure to increase the role and respon- sibility of employers in providing on-the-job training to workers, as well as incentivize private investment in more effective on-the-job training. HLO-IV Favorable conditions for more and better private-sector jobs HLO-IV recognizes that the private sector will remain the engine of growth, but needs a better enabling environment to operate effectively and be competitive within the EU and beyond. With Romania’s public resource envelope among the smallest in the EU, it is paramount to focus on key priorities: better infrastructure; a more predictable regula- tory environment to boost market competition, innovative capacity, and financial sector Priorities for inclusive, strong, and sustainable growth 65 development; and functioning labor markets where employers can find, and build on, relevant skills. While the forthcoming Romania CPSD will delve into these issues, this section outlines some of the necessary measures. PRIORITY #10: Close gaps in transport and other infrastructure for international and domestic connectivity Invest more and more efficiently in national and subnational transport infrastructure, mobilizing private financing where appropriate. The on-going partnerships with the local administrations and the challenge to fund numerous transport projects in the next decade stretches well beyond the available EU funding. This raises two challenges: (a) building the capacity to evaluate, deliver, and monitor dozens of transport infrastruc- ture projects; and (b) mobilizing the necessary funds. Legally insulated project delivery units, clear mechanisms for project-related political debate, and stability of the tech- nical process can help mitigate political economy challenges at different stages of the project cycle. Such arrangements could apply to nationally important projects, such as the modernization of motorways and national railways. PRIORITY #11: Increase financial intermediation and inclusion Develop a strategic and coordinated approach to foster financial inclusion, financial literacy, capital market development, and greening of the financial sector. Coordinated efforts among policymakers are essential to tackle significant financial inclusion gaps. Critical measures include: designating a lead institution on financial inclusion, with a clear mandate; developing a comprehensive approach to financial literacy for individ- uals and MSMEs, targeting key segments; and rolling out a coordinated strategy in sup- port of capital market development, integrated with the sustainable finance agenda. Development finance institutions, including the soon to be established national devel- opment bank, can play a catalyzing role in green finance markets. The data infrastruc- ture supporting financial inclusion, especially in relation to data about the rural gap, needs to become more robust. Enhance access to finance for individuals, by increasing account ownership and usage and leveraging digital financial services. Key initiatives should focus on: (i) digitiz- ing person-to-government and government-to-person payments, to incentivize a shift away from cash among consumers; (ii) enhancing the rural payments infrastructure, particularly to boost acceptance of electronic payments among merchants; (iii) lever- aging existing rural networks, such as Posta Romana and third-party retail agents, as low-cost delivery channels; and (iv) further fostering fintechs and broader innovation. Other valuable steps include performing a broad analysis of constraints to digital pay- ments, and developing a retail/digital payment strategy.  Enhance access to finance for MSMEs by diversifying available financial instruments and market players, and strengthening financial infrastructure. Relevant measures Priorities for inclusive, strong, and sustainable growth 66 include: supporting cooperative banks and microfinance institutions to modernize sys- tems and expand operations; enabling financial institutions to access relevant govern- ment data on SMEs; encouraging the use of instruments that are especially valuable to SMEs, such as factoring; conducting a comprehensive assessment of legal, regulatory, tax, and market-infrastructure issues affecting the development of the capital markets; and fostering capacity building across capital markets stakeholders. Public support instru- ments, such as credit guarantee programs for SMEs, can be reassessed to identify areas for improvement and maximize the efficiency of public resources, including through the upcoming development bank. Steps to improve credit infrastructure include enabling the Credit Bureau to capture alternative data sources and company information, low- ering the coverage threshold for the Central Credit Registry to capture small borrow- ers, and addressing challenges in the insolvency and secured transaction frameworks. Setting up the Romanian national development bank will aim to address gaps in access to finance and help catalyze private investments. PRIORITY #12: Enhance market competition and innovation Remove regulatory constraints to growth of productive firms and streamline admin- istrative procedures. The deterioration in allocative efficiency in selected sectors points to the importance of removing barriers to the undisturbed flow of production factors, as well as of greater competition. The services sector requires particular attention from policy makers, as it faces specific challenges from anticompetitive barriers and oner- ous administrative procedures that significantly hold back the growth of more-pro- ductive firms. Reduce/streamline the role of SOEs to ensure competitive neutrality. SOE activ- ity should have a clear economic rationale and avoid crowding out the private sector. Therefore, state-controlled firms should only operate in sectors where the presence of the state is needed as a last resort, to correct for a market failure. When SOEs compete with the private sector they should follow commercial rules, showing a positive net pres- ent value and achieving a commercial rate of return. Improve the design and implementation of policies that promote technology adoption, technology transfer, digitization, and the upgrade of firm capabilities. It is important to design policies that incentivize firms to digitize, build innovation capacity, and enhance managerial skills to successfully transition towards Industry 4.0. Linkages between for- eign firms and local suppliers would also promote corporate expansion, innovation, and skills upgrades, especially in the ICT and automotive sectors, which feature a significant concentration of highly productive companies. Increase the scale and effectiveness of R&I spending and enhance the innovation ecosystem. Greater financing for research and innovation (R&I) can help improve the quality of innovation outputs. Moreover, increasing the predictability and competitive- ness of the resources made available to the R&I sector is a pressing priority, along with reinforcing governance, coordination, and capacity across institutions that design and implement R&I policy. Priorities for inclusive, strong, and sustainable growth 67 change mitigation for environmental sustainability HLO-V Climate of economic activity HLO-V and attendant priorities set out the first key steps for delivering on Romania’s climate ambition, anchored in the EU-wide legally binding commitments and dead- lines. As climate action presents an additional challenge to Romania’s development pri- orities, it is intrinsically linked to, and relies on progress toward, other HLOs — espe- cially the institutional strengthening and long-term planning articulated under HLO-I. While the forthcoming Romania CCDR will outline mitigation and adaptation opportu- nities in more detail, the priorities below emphasize decarbonization in key polluting sectors (particularly energy and transport), the expansion of carbon sinks through for- est management, and measures to avert broader environmental degradation. Careful policy consideration will be needed to not only ensure the equitability of the transi- tion — not just in the coal regions, but in the shrinking sectors of the economy as miti- gation policy action induces structural transformation; but also to limit the trade-offs between development and climate objectives, instead aligning them for inclusive and sustainable growth. PRIORITY #13: Accelerate decarbonization, improve regional interconnections, and ensure energy security Accelerate the deployment of low-carbon electricity and heat generation technolo- gies and the electrification of the economy, ensuring an equitable energy transition. Boosting adoption of new technologies and achieving efficiency and financial sustain- ability in the energy sector hinge on mobilizing private-sector investment at scale and increasing the absorption of EU funds. This requires more efficient institutions, well-gov- erned SOEs, and stable, predictable, and transparent legal and regulatory frameworks. An upgraded electricity transmission network is necessary for the growth of green energy generation. The progressive phasing out of obsolete, polluting technologies will require adding new renewable energy capacity at the appropriate pace, as well as poli- cies to ensure an equitable transition for negatively impacted population groups. Reduce the energy intensity of the economy through more-efficient energy consump- tion. The building stock, including public buildings, will need progressive renovation to reduce energy losses, and the installation of energy-efficient equipment and appli- ances. Renovating distribution networks can also reduce energy consumption by util- ities (e.g., district heating and water networks). Industrial and agricultural processes should incorporate low-carbon technologies and integrate energy-efficient systems. The general public can contribute by embracing energy efficiency and conservation. Support transport decarbonization by shifting to cleaner transport modes. The trans- port sector, in particular road transport, is the third-largest source of CO₂ emissions in Romania, after electricity and heat generation. To meet binding EU emissions targets, Romania will need to implement effective road pricing, end fossil fuel subsidies, and improve railway management. Priorities for inclusive, strong, and sustainable growth 68 Facilitate the transition of cities to climate neutrality. Coordinated and integrated efforts at the local level are critical to the transition to climate neutrality, especially as urban and peri-urban areas generate nearly half of domestic GHG emissions. If supported with sustained and coordinated efforts, more cities in Romania can follow the lead of Bucharest, Cluj-Napoca, and Suceava, which have pledged to complete the transition by 2030 under the EU’s flagship “100 Climate Neutral Cities by 2030” Mission. PRIORITY #14: Reduce environmental degradation Bolster the management of protected natural areas and forests. Under the NRRP, Romania has committed to reforming the protection of natural areas and implementing the EU Biodiversity Strategy. The NRRP also envisions a reform of forest management and governance systems, through the development of a new national forest strategy and a robust strategic and regulatory framework for the implementation of sustainable for- est policies in support of climate change mitigation and adaptation. Implementing such reforms would help reduce biodiversity loss and forest degradation. Implement the National Circular Economy Strategy. As part of the NRRP, Romania adopted a National Circular Economy Strategy in September 2022. Further measures under the NRRP include the adoption of a circular economy action plan covering the whole life cycle of products, as well as legislation on unitary waste management, waste treatment, municipal sanitation services, and the responsibilities of packaging produc- ers. A swift implementation of the National Circular Economy Strategy and the related action plan will be critical.  Adopt a National Air Pollution Control Program. Romania needs to reach full compli- ance with EU air quality standards, and maintain a downward trend in the emission of air pollutants to reduce adverse impacts on health and the economy. To this end, priority measures include upgrading the air quality monitoring network, and ensuring timely reporting of air quality data. to shocks and adaptation to climate change, HLO-VI Resilience especially for vulnerable households Considering Romania’s high vulnerability to natural disasters and climate change impacts, HLO-VI reiterates the importance of continued upgrades to the country’s response, recovery, and adaptation capabilities. Resilience to natural disasters and ability to adapt to climate systems rests on development of response systems with ade- quate capacity and funding. Enhancing financial and social protection systems would not only directly support the population, but also help build the foundation for the mit- igation efforts outlined under HLO-V. With lagging water service access and its role in key economic sectors’ ability to adapt to climate change, water action is paramount. Priorities for inclusive, strong, and sustainable growth 69 PRIORITY #15: Scale up risk prevention/reduction, and improve preparedness for, response to, and recovery from natural disasters Integrate disaster and climate resilience into development policies and investments. Action areas for the government include: streamlining approval processes, conducting regular revisions based on legislative or technical priorities, and evaluating their effec- tiveness after regular consultations. Investments can be targeted to maximize cost-ef- fectiveness, address multiple hazards, and ensure co-benefits in sustainability inclusiv- ity, and population’s well-being. Invest in disaster- and climate-resilient public and private buildings. Increasing the share of disaster- and climate-resilient buildings in the total stock, and investing in crit- ical emergency-response infrastructure, are urgent priorities. Land use and urbaniza- tion planning also need to integrate disaster and climate resilience. Bolster the civil protection system (vertical and horizontal). There are opportunities to upgrade infrastructure, equipment, and tools, mobilize additional human and financial resources, and improve evacuation, sheltering, and volunteer-engagement frameworks, in line with a whole-of-society approach. A coherent recovery framework will need to take into account ‘Building Back Better’ principles for post-disaster reconstruction. Build surge capacity in the public and private sectors for catastrophic, complex, and cascading events. In a context of more frequent and intense disasters, adequate surge capacity is critical to saving lives and livelihoods and protecting assets. Achieving it entails supporting key institutions and the private sector to improve emergency con- tingency and business continuity planning, as well as readiness for multiple risks. Critically, this includes ensuring surge capacity in emergency response, healthcare, and social services. PRIORITY #16: Enhance financial resilience of the public and private sectors to natural disasters Develop an adaptive social protection system. Romania’s social protection programs need to become adaptive, so they can better respond to shocks and support the poorest and most vulnerable in recovering from disasters. This entails: (i) optimized data collec- tion, (ii) integration of DRM and social protection strategic frameworks and strategies, (ii) coordination and collaboration across government and with CSOs; and (iv) interop- erability of social protection and disaster event data. Expand the availability of disaster insurance for private and public assets. Disaster response, recovery, and reconstruction place a major financial burden on the govern- ment, partly due to a low uptake of catastrophe insurance among homeowners (even though it is legally mandatory), and the limited application of public-asset insurance. A broad review of natural-disaster insurance would help assess existing instruments and/or develop new ones. Priorities for inclusive, strong, and sustainable growth 70 Enhance the financial sector’s readiness to support climate change adaptation and mitigation and increase public awareness. A clear funding gap exists in many disaster scenarios. A disaster finance strategy aimed at devising predictable, rapid, and flexible financing instruments (e.g., contingent lines of credit, insurance) for disaster response, recovery, and reconstruction is a critical step. PRIORITY #17: Safeguard water security, and ensure better prevention of and protection from water-related disasters Accelerate investments in water infrastructure and create a new financing model for the water sector. The operation, maintenance, and modernization of water resources and flood-risk management infrastructure hinges on updated, more robust financing mechanisms. This entails a revision of current legislation (the Water Act and related secondary legislation), as well as expanding ANAR’s capacity and resource allocation through both training and a new approach to the three Ts: tariffs, taxes, and transfers. Expand water storage, both natural and man-made. With increasing variability in pre- cipitation due to climate change, the role of water storage at times of drought, as well as in retaining excess water and preventing flooding, is ever more important. Investment is needed to rehabilitate, retrofit, and better operate existing reservoirs. Natural storage is to be protected more effectively and, where possible, re-established, e.g., by recon- necting flood plains to rivers, or through reforestation. Assess water security and develop drought-risk management strategies at river-ba- sin scale. A better understanding of water security risks and the preparation of long- term water management strategies require an updated assessment of water availabili- ty and demand, as well as of flood, drought, and water quality risks at river-basin scale. Plans drawing from these assessments should set out water allocation policies, mea- sures for more efficient use and re-use of water, and drought forecasting and contin- gency programs. Enhance agriculture’s adaptability to climate change. Many risks to agriculture are water-related (e.g., from intensifying flooding and droughts), spelling out a need to improve the sector’s readiness for climate change adaptation. Efforts in this area could start with developing a national strategy and action plan for the adaptation of agricul- ture to climate change, underpinned by a diagnostic study at the level of agro-eco zones and exploitations. KNOWLEDGE GAPS The priorities for Romania will continue to evolve as the political and economic land- scape changes domestically and internationally, and new evidence emerges. During the diagnostic, the team identified certain knowledge gaps that would merit further research. Filling these gaps would help policy makers design more effective interventions and better assess their impacts. Some gaps will be addressed in forthcoming diagnostics, Priorities for inclusive, strong, and sustainable growth 71 such as the CCDR, CGA, and CPSD; others depend on shortcomings in the available data. Notable knowledge gaps include: • Up-to-date analysis of the pattern of migration and its linkage with the spatial pat- tern of labor market demand and supply, detailed characteristics of Romanian mi- grants, and the role of remittances in the local economy. A fresh round of EU-wide census data from 2021 – 2022 can be an important source to fill this knowledge gap. • In-depth analysis and interlinkage of spatial disparities in poverty, climate vulner- ability, and related development outcomes at granular level (e.g., town/commune). Data from Romania’s 2022 census, together with household and administrative data and climate risk maps, can potentially address this gap. • The effects of demographic trends (e.g., aging and emigration) on fiscal space (both for tax revenue and social spending), growth, and development outcomes. • The determinants of gender gaps in labor market opportunities. Addressing the root causes of the gender gaps in economic opportunities can help ease the pressure of skills shortage identified in this SCD Update. The forthcoming CGA can build a foun- dation for in-depth understanding of gender disparity and help design appropriate policies to tackle the constraints Romanian women in the labor market. • In-depth analysis of the whole-of-economy impacts of reaching the EGD targets, and the trade-offs and policy options for Romania in relation to climate change mit- igation and adaptation. The forthcoming CCDR will be a starting point for analytical work on the interplay of development and climate objectives. Priorities for inclusive, strong, and sustainable growth 72 ANNEX 1 BOXES BOX A.1  An update on firm productivity Despite three decades of dynamic economic growth, followed by improvements in allocative efficiency labor productivity in Romania remains below the EU (Figure BA.1.1) — effectively, the increased capabilities average. To produce the same output as its average of high-productivity firms translated into greater mar- German peer, the average Romanian manufacturer ket share, underlining an efficient market dynamic. The needs almost four times as many employees, while slow-down in within-firm productivity after that peak the average firm in construction or services needs indicates a need for policies that incentivize continued three times as many. capability improvements among firms — e.g., through digitization, building innovation capacity, and enhanc- Aggregate productivity performance is mainly driven ing managerial skills — in order to successfully transi- by two components: i) within-firm productivity growth, tion towards Industry 4.0. i.e., firm-level improvements in productivity due to, for example, innovation, technology adoption, or better In services, an inefficient allocation of resources to managerial practices; and ii) between-firm productiv- less-productive firms (i.e., a negative between-firm ity growth, i.e., greater allocative efficiency that helps component) has countered a positive performance in more-productive firms increase their market share. within-firm productivity. Services firms in Romania also experienced a positive within-firm productivity shock, Starting in around 2013, rising firm-level efficiency which gradually faded after its peak in 2015 – 2016 improvements and markups (within-firm productiv- (Figure BA.1.2). Unlike in manufacturing, productive ity growth) boosted total factor productivity (TFP) services firms were not able to capitalize on improved in Romania’s manufacturing sector; in recent years, efficiency, which points to an inefficient market dy- more-productive firms have increased their market namic. The lack of progress in allocative efficiency in share (between-firm productivity growth), sustaining services warrants urgent investigation from econom- productivity performance in the sector. Manufacturers ic policymakers, and emphasizes the need for instru- in Romania experienced a positive within-firm pro- ments that facilitate the mobility of production fac- ductivity shock that peaked around 2015  – 2016, tors across firms in the sector.  FIGURE BA.1.1  Decomposition of Growth FIGURE BA.1.2  Decomposition of Growth in Manufacturing Productivity (TFP) in Services Productivity (TFP) 5 7 Percentage change Percentage change 6 4 5 3 4 3 2 2 1 1 0 0 −1 −1 −2 2012 2013 2014 2015 2016 2017 2018 2019 2020 2012 2013 2014 2015 2016 2017 2018 2019 2020 Within Between Entry Exit Within Between Entry Exit Source: World Bank analysis based on data from Romanian Ministry of Finance.  Note: Decomposition of three-year productivity growth rates per the Melitz-Polanec method (Melitz and Polanec, 2015), smoothed out to show annual change. Annex 1 73 BOX A.2  SCD 2022 is an Update to SCD 2018 This study aims to update the first Romania Systematic Against this backdrop, the SCD 2018 focused on four Country Diagnostic (SCD), completed in 2018, which main areas… identified four priority areas to boost growth and in- 1. Easing supply-side constraints to growth clusion in the country (see below). Romania has made some progress since the publication of the SCD 2018 2. Expanding opportunities for shared prosperity in addressing constraints to growth, as well as in re- 3. Improving resilience to natural hazard and cli- ducing poverty and inequality, but more needs to be mate change done to substantially improve outcomes for citizens 4. Strengthening institutions for inclusive growth and businesses across income groups and regions. … and identified four priority areas of intervention: A Summary of the 2018 Romania SCD • increasing the effectiveness and efficiency of the The country’s transformation in the 30 years prior to state in public-service delivery 2018 was “a tale of two Romanias”: one urban, dynamic, and integrated with the EU; the other rural, poor, and • ensuring equal opportunities for all isolated. A consolidation of democratic institutions ac- • catalyzing private-sector growth and companied an unprecedented rise in income per cap- competitiveness ita. The most dynamic firms and individuals fully ben- • building resilience for sustainable growth efited from the country’s EU membership since 2007, with Bucharest and a handful of other cities becoming Key lesson from SCD 2018: Despite impressive eco- vibrant centers with growing population and income. nomic growth, shared prosperity and sustainable Yet, vast segments of the population were left behind, welfare improvements will remain a distant reality if unable to take advantage of the same opportunities. Romania does not address its governance challenges. BOX A.3  Development of secondary cities Most well-performing regions in the EU have a dynam- areas (FUAs) that extend beyond their administrative ic urban area or agglomeration within their boundar- boundaries. The population of these FUAs has grown ies, or are close to such an area. A significant body of significantly in recent years. research shows that urban areas are a country’s eco- The FUAs of Bucharest and of Romania’s 40 county nomic growth engines, and the areas most likely to capitals account for 90 percent of national firm reve- generate the productivity surplus necessary to sus- nues. They also concentrate 80 percent of the popu- tain regional and national growth. lation that has completed higher education, attract- Secondary cities are particularly important, as their ed 67 percent of commuters in 2011 and 66 percent performance can boost or tank a regional economy. of migrants between 2001 and 2011, and account for Lagging regions tend to have poorly performing urban 61 percent of national employment and 58 percent areas. Conversely, dynamic urban areas have a posi- of the population. tive development impact well beyond their adminis- More importantly, the rural areas within these FUAs trative boundaries. have registered the fastest growth in recent years. This Among Romania’s less-developed regions, those near indicates that the most efficient path to development a dynamic city display much higher rates of socio-eco- in lagging regions involves strengthening their main ur- nomic development than those further away, accord- ban areas, and expanding the access of the rural hin- ing to a range of indicators (e.g., firm revenues and terland to the opportunities that cities offer (e.g., jobs, the Local Human Development Index). While not all education, specialized healthcare, art, culture, enter- Romanian cities are vibrant economic hubs, most have tainment, shopping, and transportation). witnessed a trend of development in functional urban Annex 1 74 BOX A.4  Green growth and opportunities ahead The expression “green growth” describes economic Climate action is at the heart of the European Green growth which ensures that natural assets continue to Deal (EGD) launched in December 2019, and access provide resources and environmental services for peo- to EU funds will provide opportunities to implement ple’s wellbeing. The sustainable use of renewable re- targeted measures. The EGD is an ambitious package sources such as forests, fisheries, water, and clean air, of measures aiming to turn the EU into the first cli- and the efficient exhaustion of non-renewable re- mate-neutral continental bloc by 2050, resulting in a sources such as minerals, have been considered part cleaner environment, more affordable energy, smarter of a sustainable growth agenda for decades. Romania transport, new jobs, and a better quality of life overall. is well-endowed with various natural resources, which, In addition, at the end of 2020, the EU and its mem- if used productively, can support strong and sustained ber states jointly committed to the binding target of a economic growth. net domestic reduction of at least 55 percent in GHG emissions by 2030, compared with 1990 levels. The mitigation of GHG emissions is another critical, and especially challenging component of environmental The green transition provides an opportunity to place sustainability. As a member of the EU, Romania has Romania’s growth on a more sustainable path. To sup- an obligation to reduce its GHG emissions, with cur- port this transition, over 41 percent of funds from the rent and prospective targets that will result in pro- Recovery and Resilience Plan for Romania are allocat- gressively tighter requirements for carbon reduction. ed to green measures. Additionally, the EU Cohesion Funds for 2021 – 2027 will provide ample opportunity Adaptation to a changing climate is also part of a coun- to support EGD objectives. try’s sustainable growth path. Regardless of future GHG emissions, the climate is already changing, with increas- ingly frequent and severe extreme weather events. As a country that faces significant risks from climate FIGURE BA.4.1  Diagram of green growth change, Romania needs to factor their potential im- pacts into planning for sustainable development paths. The most recent element of the green growth agenda Sustainable use of Mitigation of greenhouse is a strong emphasis on innovation and green jobs. A natural resources gas emissions shift towards greener growth is expected to spur tech- nological innovation, especially in the energy sec- Green tor, and promote the emergence of new industries. Growth Innovation can help decouple growth from natural resource depletion and GHG emissions, by allowing Adaptation to a Innovation and changing climate green jobs for more output with fewer and more environmen- tally friendly inputs. FIGURE BA.4.2  The European Green Deal Mobilising research and fostering innovation Increasing the EU's Climate A zero pollution ambition for ambition for 2030 and 2050 a toxic-free environment t e ing th EU's ec Th e E U e a n C li m a t e P a c Supplying clean, affordable rm o Preserving and restoring and secure energy fo ecosystems and biodiversity no ns my Tra The a s a gl o b a l l ea d e Mobilising industry for European From 'Farm to Fork': a fair, healthy and a clean and circular economy Green environmentally friendly food system Deal A E uro p Building and renovating in an Accelerating the shift to ra ur fo e energy and resource efficient way sus ut sustainable and smart mobility tain a ble f r Financing Leave no one behind the transition (Just Transition) Annex 1 75 BOX A.5  The NRRP and its expected impact The Romanian government’s National Resilience and percent of Romania’s NRRP funds have been allocat- Recovery Program (NRRP) outlines the country’s re- ed to the green (41 percent) and digital (20.5 percent) form and investment priorities, with a view to support- transitions. Romania has prioritized investment in sus- ing resilience and crisis preparedness, and promot- tainable transport and EV charging stations (€8.9 bil- ing adaptability, sustainability, and inclusive growth. lion), education and training to support digital skills A thorough NRRP is a prerequisite for accessing funds (€4.9 billion), and clean technologies and renewables from the EU’s Recovery and Resilience Facility. (€4.5 billion). These efforts aim to address critical is- The Romanian NRRP focuses on six pillars: (i) green sues that affect growth and development, such as the transition; (ii) digital transformation; (iii) smart, sus- poor state of infrastructure, skills mismatches, and tainable, and inclusive growth; (iv) social and terri- shortcomings in labor quality. torial cohesion; (v) health, and economic, social, and The government estimates that NRRP funds and ini- institutional resilience; and (vi) policies for the next tiatives will add up to 5.4 percentage points to the generation, children, and the youth. Key proposed real GDP over the 2021 – 2026 period, in a scenario of reforms in these six areas touch on the pension sys- 100 percent absorption for both grants and loans. On tem; the judiciary; the public administration; the tax the other hand, in a scenario of 100 percent absorp- system; social inclusion programs and the minimum tion for grants and 33 percent for loans, the cumulative wage; education and healthcare; and decarbonization, impact would reduce to 4.3 percentage points. Given particularly in energy and transport. Romania’s low historical absorption of EU funds, a less- Substantial funding will support the green and digital er impact than under even the more pessimistic gov- transitions, aiming to heal social scarring from the pan- ernment scenario is conceivable, and may slow down demic and address infrastructure bottlenecks. Over 60 the country’s economic recovery. Annex 1 76 ANNEX 2 PRIORITIES AND SELECTION CRITERIA Feasibility of Time horizon policies under for policies to Expected Comple- current econom- yield results impacts mentarity ic, governance, (short term, High-Level on the to other and capacity medium term, Outcomes Priorities twin goals policies conditions long-term) * I. Predictable in- 1. Mitigate the impact of politi- High High Medium Long term stitutional and cal instability through estab- economic en- lishment of medium-to-long- vironment for term strategic and spending people and priorities businesses 2. Improve citizens’ trust in the High High Medium Long term state 3. Ensure fiscal sustainability High High Medium Medium – long term II. Equal access 4. Enhance public sector hu- High High High Medium – long to high-quality man-resource management term public services to improve public-service at central and delivery local levels 5. Increase effectiveness and ef- High High High Medium – long ficiency of public-service de- term livery at central and local levels 6. Improve access to quali- High High High Medium – long ty public infrastructure and term services (e.g., transport, dig- ital network, water and san- itation, district heating, sol- id waste management, social benefits and social services) for the poor, the vulnerable, and those in rural areas III. Better health 7. Improve health outcomes High High High Medium – long and educa- and provide equitable access term tion outcomes to healthcare services for all 8. Provide access to quality ed- High High High Medium – long ucation for all term 9. Strengthen lifelong skills for- High High High Medium – long mation, especially for vulner- term able groups 77 Feasibility of Time horizon policies under for policies to Expected Comple- current econom- yield results impacts mentarity ic, governance, (short term, High-Level on the to other and capacity medium term, Outcomes Priorities twin goals policies conditions long-term) * IV. Favorable con- 10. Close the gaps in transport High High Medium Medium – long ditions for and other infrastructure for term more and bet- international and domestic ter private-sec- connectivity tor jobs 11. Increase financial intermedi- High High High Medium – long ation and inclusion term 12. Enhance market competition High High High Medium – long and innovation term V. Climate change 13. Accelerate decarbonization, High High Medium Medium –  mitigation for improve regional intercon- long term environmen- nections, and ensure energy tal sustainabil- security ity of economic activity 14. Reduce environmental High High Medium Long term degradation (water, land, atmospheric) VI. Resilience to 15. Scale-up risk prevention/re- High High Medium Medium – long shocks and ad- duction, and improve pre- term aptation to cli- paredness for, response to, mate change, and recovery from natural especially for disasters vulnerable households 16. Enhance financial resilience High High Medium Long term of the public and private sec- tors to natural disasters 17. Safeguard water security, and High High Medium Medium – long ensure better prevention term of and protection from wa- ter-related disasters (*) Short term is defined as within 2 years, medium term is between 2 and 5 years, and long term is above 5 years. Annex 2 78 REFERENCES Aiyar, Shekhar and Christian Ebeke. 2020. “Inequality of op- De Rosa,Donato; Kim,Yeon Soo; Chatzinikolaou,Aimilios; portunity, inequality of income and economic growth”. Bulman,David Janoff; Hopkins, Johns; Dospinescu,An- World Development. 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Constructed by Romania Aspen Institute, the Local Busi- 2. European Investment Bank, 2021 ness Environment Index (LBEI) rates and ranks Ro- 3. Pal et al. 2019 manian municipalities based on four factors: local en- 4. The net change in the fixed assets of companies. trepreneurship (30 percent weight); innovation (20 5. Eurostat. 2022. Labor productivity per person employed percent); investment financing (35 percent); and local and hour worked. Online data code: TESEM160. https:// public support (15 percent). ec.europa.eu/eurostat/databrowser/view/tesem160/ 28. World Bank, 2021a default/table?lang=en 29. European Centre for Disease Prevention and Control, 6. Cruz, Marcio et al, World Bank report — Starting Up: data as of October 2022. Entrepreneurship Ecosystems in Romania, World 30. Romania borders Ukraine to the north and to the east Bank, 2022: https://openknowledge.worldbank.org/ and is a potential route for FDPs. Romania has an eth- handle/10986/37564 nic Ukrainian minority of around 8,000 permanent res- 7. Inchauste and Militaru 2018. idents—the sixth-largest in the country—concentrated 8. World Bank 2018. ROU SCD 2018 — Agriculture back- in the north. ground note 31. UNHCR data, accessed February 2023 9. Romania has been under the EU’s excessive deficit proce- 32. Romania Prime Minister’s Office, 2023. dure since 2020, with a deadline to eliminate the excess 33. World Bank, 2021a deficit by 2024. 34. World Bank, 2021c 10. World Bank staff Debt Sustainability Analysis, 35. Romania lost two positions on the Digital Economy and February 2023 Society Index (DESI) between 2020 and 2021, most re- 11. In 2021, public sector assets, mainly denominated in do- cently ranking last out of 27 countries. mestic currency, represented 24.2 percent of the bank- 36. DESI, 2021 ing sector’s aggregate asset portfolio, making bank port- 37. Eurostat, 2022 folios especially sensitive to changes in interest rate. 38. Eurostat COVID-19 Impact on ICT usage among enterpris- Between January and late April 2020, 10-year sovereign es, 2021 bond yields increased from 4.38 percent to 4.74 percent, 39. In addition to the Recovery and Resilience Facility, the while the spread in 10-year credit-default swaps for Ro- Next Generation EU plan includes funding for other mania increased from 115.6 bps to 169.8 bps. programs, including Just Transition, React-EU, Invest 12. The share of stage 2 loans (those with increased credit EU, Horizon, and RescEU. risk) was the highest in the EU in 2021. 40. Per Ministry of Investments and European Projects re- 13. ILO, 2020; Kulic et al., 2020 ports as of December 2021 14. WB working estimate 41. Eurostat 2022 15. World Bank 2022d 42. Ministry of Public Works, Development and Administra- 16. Per WB classification, based on 2021 data. The pandem- tion and the World Bank 2022 ic-triggered crisis briefly brought Romania down to up- 43. European Commission 2022. “Summer Eurobarometer per-middle-income status in 2020, but strong econom- 2022 — Romania Country Factsheets” ic growth boosted GNI per capita and pushed Romania 44. Flash Eurobarometer 489, Q1 (available at: https://europa. back into the high-income group in 2021. eu/eurobarometer/surveys/detail/2272) 17. Gross National Income 45. Only 17 percent of Romanian internet users engage active- 18. Inchauste and Militaru 2018. ly with e-government services. The country performs 19. This SCD refers to two types of poverty rates: (i) the na- significantly below the EU average in the availability of tional, official at-risk-of poverty rate, per Eurostat defi- digital public services to citizens (with a score of 44, ver- nition; and (ii) the international poverty rates used for sus the EU average of 75) and businesses (with a score comparison across countries and time. The national at- of 42, versus the EU average of 82). The use of pre-filled risk-of poverty line is defined as 60 percent of the me- forms has been increasing year over year, but Romania’s dian adult-equivalent income after social transfers. The score of 19 in this area is significantly below the EU aver- international poverty line is US$6.85 per capita per day age of 63. Furthermore, at 76 percent, the country ranks at 2017 Purchasing Power Parity. below the EU average (81 percent) on open data. 20. European Commission, 2021 46. European Commission, 2020 21. Eurostat, Romania SILC 2010 – 2020, referring to house- 47. See first evaluation of 2014 – 2020 POCU interven- hold income 2009 – 2019 tions in education, 2020, accessed Nov 2021: Prim- 22. National Institute of Statistics, 2022 ul-raport-de-evaluare-a-intervențiilor-PO- 23. GFDDR and World Bank, 2021 CU-2014-2020-în-domeniul-educației-1.pdf. 24. Eurostat 2022 48. Eurostat 2022 25. World Bank, 2020 49. World Bank 2018. Water Analysis 82 50. Avoidable mortality encompasses preventable deaths 80. Soft skills in high demand include interpersonal and (i.e., avoidable through better public health interven- communication abilities, professionalism, collaboration tions, such as systematic screening for cancer), and and teamwork abilities, attention to detail, and plan- treatable deaths (i.e., avoidable if the healthcare system ning and organizational abilities. provides timely and effective medical treatment). 81. World Bank Enterprise Survey 2019. 51. Eurostat 2022 82. World Bank 2020c 52. Eurostat 2022 83. In the 2014 – 2020 EU programming period, Romania’s Na- 53. EU Fundamental Rights Agency, 2022 tional Employment Agency (ANOFM) was scheduled to 54. Eurostat 2022 utilize European Social Funds to support multiple mod- 55. Tesliuc et al., 2015 ernization and capacity-building projects. However, due 56. European Commission (2020) Country Report Romania to ANOFM’s limited capacity in project formulation as 2020, Brussels, SWD(2020) well as other institutional constraints, less than 10 percent 57. We computed inequality of opportunity based on the of the allocated funds were deployed by the end of 2020. methodology introduced by the European Bank for Re- 84. Eurostat LMP data, 2022 construction and Development (2017). 85. The Draft National Strategy for Employment 2021 – 2027 58. World Bank 2021a reflects the importance of a new approach by ANOFM 59. World Bank calculation based on National Institute of in implementing ALMPs to improve access to the labor Statistics data, 2021 market for job seekers and inactive persons. EU funds, 60. World Bank, 2020b namely the NRRP and the Education and Employment 61. Eurostat. The 2021 EU Aging Report Operational Program 2021 – 2027, will be key to rolling 62. World Bank, 2018. Romania SCD out relevant measures. 63. Eurostat, 2022 86. Global Competitiveness Scores 2008 – 2018. World Eco- 64. Eurostat, 2022 nomic Forum, The Global Competitiveness Report 65. Eurostat, 2022 2017/18 66. Rate of working-age individuals not in the labor force 87. Romania InfraSAP, 2019 (neither working, nor actively looking for a job). 88. Please see InfraSAP (2019) and CPSD (forthcoming) for a 67. Eurostat indicator lfsa_ipga, accessed April 2021. The in- more detailed discussion. activity rates for those between the ages of 15 and 64 de- 89. World Bank, 2019 clined from 34.4 percent in 2016 to 31.4 percent in 2019 90. European Investment Bank Investment, 2019 68. Eurostat, 2022 91. Elements for the Design of Romania’s Strategy for Infra- 69. World Bank, 2020c structure Investments in Education Institutions, Trans- 70. A 2020 survey by Romania’s Department for Sustainable De- port Component, June 2017, World Bank. velopment found that the majority of respondents believed 92. The EAPI includes a set of indices considering three key in equality between women and men, but were more con- energy sector objectives: i) economic growth and devel- servative in relation to gender roles within the family. 76 opment; ii) environmental sustainability; and iii) ener- percent of respondents believed that a man’s role is to earn gy access and security. Its ranking is based on the aver- money, while 83 percent believed that women’s most im- age of these three dimensions. portant role is to care for the home and family . 93. Romania’s 2021 – 2030 Integrated National Energy and Cli- 71. ILO 2019 mate Plan 72. EU SILC 2020 94. Decarbonization of the energy sector is explored in the 73. World Bank, 2020c forthcoming Romania CCDR. The role of the private sec- 74. Eurostat experimental statistics on skills mis- tor in renewable energy is at the core of the forthcom- matches: https://ec.europa.eu/eurostat/web/ ing Romania CPSD. experimental-statistics/skills 95. Measured based on standard deviation over the period 75. E.g., software and applications developers and analysts, considered. Volatility of public investment in Romania generalist and specialist medical practitioners, electri- was around five times higher than the EU-27 average. cal engineers, physical and engineering science tech- 96. Eurostat, 2022 nicians, machinery mechanics and repairers, cooks, 97. National Bank of Romania van and motorcycle drivers, garment and related trades 98. OECD PMR, 2020 workers (Romania Systematic Country Diagnosis, 2018). 99. European Investment Bank, 2021 76. Otto Kässi, Vili Lehdonvirta, Online labour in- 100. Other financial sector institutions include non-bank fi- dex: Measuring the online gig economy for poli- nancial institutions (5.1 percent of financial sector as- cy and research, Technological Forecasting and Social sets), investment funds (5.7 percent), private pension Change, Volume 137, 2018, Pages 241 – 248 funds (10.2 percent), and insurance companies (3.5 per- 77. World Bank 2020c cent). Source: NBR 78. European Commission Education and Training Monitor, 101. ECB Data Warehouse. 2019 Romania Report 102. Similarly, the penetration of deposits (37.8 percent 79. Per the “Survey regarding the participation to continuous of GDP) is lower than both the expected 25th percen- education and training of employees at risk on the labor tile (83.8 percent) and the ECA average (43.8 percent). market,” Magdalena Balica, Cezar Bîrzea, Ciprian Far- Source: Finstats 2020. tusnic, Irina Horga, Mihaela Jigau, Laura Tufă, Bogdan 103. Loans to households stood at 14.2 percent of GDP at end- Voicu, Vlad Achimescu. 2010. 2021. Source: NBR. Notes 83 1 04. World Bank analysis of NBR data. 2 percent target for 2020 and the EU average of 2.12 per- 105. Bucharest Stock Exchange Monthly Report for Septem- cent. In 2021, Romania was last in the EU for number of ber 2022. World Bank calculations based on domestic patent applications to the European Patent Office per market capitalization of the BSE (per BSE monthly re- million inhabitants (2.79 versus the EU average of 147). ports for December 2020 and December 2021). GDP esti- 118. World Bank, 2022b mates from the IMF WEO October 2022 database. 119. Eurostat Structural Business Database 106. World Bank Global Findex Database, 2021. 120. OECD, 2021 107. The poorest 40 percent of the population was 20 percent- 121. World Bank staff estimates, EU RER 7, 2021 age points less likely to have an account than the rich- 122. Figures concerning sectoral GHG emissions vary by est 60 percent, a gap that has narrowed since 2017 but source due to differences in methodology, but this does remains substantial. The gap in account ownership be- not affect the conclusions of a qualitative assessment. tween more educated and less educated adults amounted 123. European Commission, Romania Country Report, 2020 to 38.6 percentage points. Source: Findex 2021. 124. World Bank Romania, 2021d 108. According to the IMF’s Financial Access Survey (FAS), 125. European Commission 2022. the number of debit and credit cards per 1,000 adults 126. Eurobarometer — Special issue on Climate Change, 2021 in Romania was 1,149 in 2020, the lowest among region- 127. National Committee for Macroprudential Oversight al peers. Similarly, Global Findex 2021 places debit card (NCMO) Working Group on Supporting Green Finance, ownership among Romanian adults at 52.6 percent, low- final report, June 2021. er than regional peers such as Serbia (61.5 percent), 128. EM-DAT. 1900 – 2019. “Global Occurrences from Natu- Hungary (79.0 percent), Bulgaria (71.3 percent), Poland ral Disasters.” EM-DAT: The Emergency Events Data- (83.9 percent), Czech Republic (89.0 percent), and Croa- base, Université Catholique de Louvain–CRED (EM-DAT, tia (67.5 percent). CRED / UCLouvain), D. Guha-Sapir. Brussels, Belgium. 109. The share was 87.5 percent in Serbia, 87.1 percent in Cro- Link. atia, 93.2 percent in Poland, 94.1 percent in Czech Re- 129. Romania has the third-highest annual seismic risk of all public, 86.4 percent in Hungary, and 75.2 percent in EU member states, with an annual average loss of €512 Bulgaria. In Romania, 61.9 percent of adults reported million mostly arising from damage to residential build- paying utility bills in cash only—a significantly higher ings. The estimated annual average risk to life is 275 fa- share than in regional peers. talities. The annual average loss from flood damage to 110. IMF Financial Access Survey 2020. private and public buildings is estimated at €585 million 111. 40 percent of firms had a loan/line of credit. Enterprise (0.28 percent of GDP). The annual expected windstorm Surveys 2019. damage is estimated at €83 million, and over 660,000 112. Financial Inclusion in Romania: Issues and Opportuni- people in Romania are exposed to windstorm hazard. ties. World Bank, March 2020. Similar findings are re- 130. Cook, Samantha et. al, 2021 ported in NBR 2021 “Survey on the access to finance of 131. World Bank, 2021c non-financial corporations in Romania”. 85 percent of 132. Kerblat, Yann et. al, 2021 respondents used only internal sources for financing, 133. Török, I. 2017. “Assessment of Social Vulnerability to while only 7 percent of enterprises used bank loans as a Natural Hazards in Romania.” Carpathian Journal of financing source. Earth and Environmental Sciences 12 (2): 549 – 562. Link. 113. OECD PMR, 2020 134. Kerblat, Yann et. al, 2021 114. OECD 2020 135. Munich Re, NatCatService — data on natural disasters 115. Global Competitiveness Index, 2020 since 1980, https://www.munichre.com/en/solutions/ 116. Romanian National Bank — Survey June 2021 for-industry-clients/natcatservice.html, accessed No- 117. In 2021, the percentage of Romanian MSMEs that intro- vember 2022 duced product or process innovations, marketing or or- 136. World Bank 2018. Romania SCD ganizational innovations, or provided ICT training to 137. According to a World Bank analysis of the adaptivity of their staff were all below EU averages. Spending on social protection systems to natural shocks (e.g., earth- R&D equaled 0.48 percent of GDP in 2019, well below a quakes and floods) in 2021. Notes 84