73011 LATVIA PUBLIC EXPENDITURES REVIEW EDUCATION SECTOR Nancy Vandycke ECSHD (CEUST) January 29,2001 LATVIA PUBLIC EXPENDITURES REVIEW EDUCATION SECTOR Table of Contents I. OVERVIEW .................................................................................................................................................1 II. EDUCATION SECTOR OUTCOMES ......................................................................................................2 III. PUBLIC EXPENDITURES AND BUDGET FORMULATION..............................................................5 PUBLIC SPENDING ON EDUCATION ....................................................................................................................... 5 ADMINISTRAnON AND FINANCING OF GENERAL EDUCATION ............................................................................. 6 ADMINISTRATION AND FINANCING OF HIGHER EDUCAnON ................................................................................ 8 ADMINISTRAnON AND FINANCING OF VOCAnONAL EDUCAnON ..................................................................... 10 INSTITUTIONAL CAPACITY FOR BUDGET MANAGEMENT ................................................................................... 10 IV. PROGRAM EXPENDITURES AND EFFICIENCY .............................................................................12 THE ROLE OF DECENTRALIZATION .................................................................................................................... 12 INEFFICIENCIES IN EDUCAnON EXPENDITURES ................................................................................................. 13 V. POLICY RECOMMENDATIONS...........................................................................................................15 A SET OF CHALLENGES ........ :............................................................................................................................. 15 WHAT IS THE BEST INCENTIVES STRUCTURE? .................................................................................................... 15 WHAT CAN BE DONE? ........................................................................................................................................ 15 MATRIX OF ISSUES AND RECOMMENDATIONS ................................................................................................... 19 Latvia Public Expenditures Review 1 Education EDUCATION SECTORl I. Overview The Latvian government has demonstrated a strong commitment to education. With 7.2 percent of GDP allocated to education in 1999, Latvian spending on education compares most favorably to OEeD standards. Although reforms in the education sector are being implemented, the sector faces critical challenges. The education sector has resisted adaptation, in spite of significant shifts in the enrollment pattern. The number of preschool teachers and schools only slightly decreased, while the number of children aged 0 to 6 has been falling. With fewer children arriving at the school door, it is becoming harder for the education sector to justify maintaining small schools, very low student to teacher ratios and standard teachers workload of less than 16 hours a week. In the immediate aftermath of its independence, Latvia returned to a highly decentralized form of local government. The administration and financing of general education were assigned to the smallest units of government, the pagast. In a country with 2.5 million inhabitants, there are 483 pagasts organized in 26 regions and 7 metropolitan cities. Out of these pagasts, 40 percent have less than 1,000 inhabitants, and 46 percent has between 1,000 and 2,000 inhabitants. Decentralization reforms have however not helped to address structural weaknesses in the education sector. For example, serious mismatches have emerged between the authority and the responsibility in education. Also, the structure does not provide the right incentives to optimize the schools network and respond to the shrinking school-age population through the consolidation of schools. In an attempt to remedy to problems raised by the excessive fragmentation of the administrative structure, the Parliament adopted in 1998 the Law on Administrative and Territorial Reform. This Law proposes a 6-year timeframe for a series of attempts to implement a new regional structure. In the first stage, pagasts would be granted financial incentives to merge. In the second stage, the national government would encourage mergers of pagasts. The implementation of the Law has however lagged behind and no concrete action has yet been adopted. This review has three objectives: (i) assess the education sector outcomes; (ii) evaluate the cost of the education program and the budget formulation process; (iii) identify areas to improve the efficiency of public expenditure on education and make medium-term savings. I The chapter is based on ajoint Bank-Fund PER mission in Latvia from May 23 to June 6,2000. Latvia Public Expenditure Review 2 Education II. Education Sector Outcomes Latvia has a strong education base. The adult literacy rate (in Latvian and/or Russian) is about 98 percent. Compulsory education starts at the age of six. The education system includes four levels: 1) pre-school education (for children aged 1 to 6 years); 2) general education (including basic education, grade 1 to 9-primary, grade 1 to 4, and lower secondary, grade 5 to 9-and general (upper) secondary education, grade 10 to 12); 3) vocational education; and 4) higher education. Over the last ten years, the Latvian society experienced deep demographic and economic transformations that affected the enrollment pattern: • Between 1995 and 1999, the number of Figure 1: Total Fertility Rate, 1991-98 children enrolled in preschool education fell by more than 10 percent. The 2.6 ] dramatic decline in the birth rate in the 2.4 early years of transition can partly account 2.2 for the decline in the number of children 2 in preschool age. The drop in the fertility 1.8 rate was remarkable, both in rural and 1.6 urban areas (Figure 1). 1.4 1.2 • The number of students enrolled in higher education more than doubled. The 1991 1992 1993 1994 1995 1996 1997 1998 sharpest increase was among the number of "correspondence students". Between • City and Towns D Rural Areas 1995 and 1999, their number increased from 1,300 to 33,600 (a third of higher education students). ill 1999, higher education students accounted for a fifth of the total number of students. Student enrollment in higher education has sharply increased over the last five years and represents a sixth of the total number of students enrolled in the education system (89,509 students in higher education and 21,300 students in specialized education). Although the number of students enrolled in vocational education decreased during the transition, it still accounts for a sizable fraction of the total number of students, which are enrolled in the education system (Table 1). ill 1998, out of those students who graduated from general education, a third pursued the vocational stream of education-12 percent in secondary professional education and 21 percent in vocational education. Table 1. Vocational and Secondary Professional Schools, 1998 Schools Enrollment Teaching Staff 53 26,652 2161 38 13,062 1663 6 1,630 378 14 1,786 911 4 784 85 5 2,323 76 Time series data on outcomes of the education system, such as students' performances, access to and market relevance of education, are not readily available. Scattered evidence however suggests that the Latvian education system does not adequately meet its goals. These goals can be broadly Latvia Public Expenditure Review 3 Education defined as: (a) ensuring a universal access to general education; (b) providing state-support for the poor; and (c) securing a market relevant education. Signs of differentiated access to compulsory education. The 1998 Household Survey suggests that households spent on average one percent of their budget on education (Table 2), with significant disparities between rural and urban areas. Households report paying (in cash or in-kind) for general education, despite the fact that general education is purportedly free. Parents with children attending general education often contribute to School Funds. The Law on Education permits "voluntary contributions" to these school funds, which are used both for school repairs and teachers' salaries. Although further study is required in the Latvian context, there is some regional evidence that differentiated ability to contribute to these school funds results in differentiated access to education (World Bank ECA Poverty, 2000). Table 2 . Household Consumption Expenditures (in cash and in-kind) (average per household member per year, LVL) All Urban Riga Rural households Consumption Expenditure 707.32 769.58 873.68 569.03 O/w Education 7.09 8.92 9.49 3.02 Preschool 2.15 2.65 1.94 1.05 Primary (1 to 4) 0,41 0.57 0.98 0.04 Lower Secondary (5 ~ 9) 0.32 0,42 0.72 0.10 Upper Secondary 0.21 0.30 0.33 0.01 Vocational 0.26 0.29 0.33 0.18 Higher 2.00 2.71 2.70 0.43 Others 1.65 1.98 2,49 0.92 Health 24.68 26.65 30.39 20.30 Source: Household Budget, Statistical Bulletin, 1999 Regressive incidence of some education spending. The incidence of public education expenditure­ that is, the relationship between expenditure per family and family income, can vary substantially from one level of education to another. Cross-country evidence in the region suggests that, at the primary level, public spending has a progressive incidence (Table 3). In contrast, higher education spending tends to regressive as students at higher levels of education tend to come from wealthier families. A relatively large part of the government's education spending benefits a small number of persons from wealthier families. [Does Latvia exhibit a similar pattern? Introduce here evidence from the expenditure-incidence analysis See MILANOVIC]. Latvia Public Ji,XIPelilO Review 4 Education Table 3. Incidence of Public Expenditures on Education in selected ECA Countries Pre-school Primary Secondary Higher Latvia Bottom 20 % Top 20 % Romania (1997) Bottom 20 % - 21.0 26.0 10.0 Top20% - 10.0 12.0 24.0 Bulgaria (1997) Bottom 20 % 23.0 21.0 16.0 11.0 Top20% - - - - Note: expenditures for education are marked in bold when not pro-poor. Source: Vandycke (2000) State funding of higher education is poorly targeted Academic merits determine whether students will have their education financed by the central government or will have to pay fees. An entry exam, which is organized by each educational establishment, serves to measure academic potentiaL Cross-country evidence suggests however that success on this examination is often related to the socio-economic status of students. In other words, students who perform well academically, are often those who come from well-off backgrounds (and urban areas). Subsidizing these students amounts to finance those who can afford to pay for higher education, at the expense of those who do not have the financial means to do so. At present, public subsidization of higher education is not targeted at students in need. Vocational education does not adequately meet the needs of the labor market. Scattered evidence suggests that vocational education poorly prepares students for employment in a modern economy. The 1998 Labor Force Survey shows that 37 percent (14.4% vocational, 12.5% technical secondary, and 9.3% secondary specialized) of job seekers had a vocational education degree. Ayear after, the share of job seekers with vocational education had increased by 2.1 percentage points (and 1.2 for technical secondary, and 0.3 for secondary specialized). Moreover, the cost per student in the vocational education system is large. Latvia Public Expenditure Review 5 Education III. Public Expenditures and Budget Formulation Public Spending on Education The Latvian government is a direct provider of educational services on a large scale. At the general education level, the government provides 99 percent of education services. In higher education, public education establishments supply education to 87 percent of students. In addition to its direct role in the market for education, the government influences the demand for educational services through the provision of scholarships, grants and living allowances, and student loans, and the regulatory framework it establishes for private and public education2 • Table 4. Public Spending on Education, 1995-2000 1995 1996 1997 1998 1999 2000 (actual) (actual) (actual) (actual) (preliminary.) (proposed) (in millions ofL VL) Total education spending (OJ 161.8 162.5 184.9 246.5 262.7 (as a share ofGDP) 6.9 5.7 5.6 6.9 7.2 (as a share of government spending) 17.0 14.7 13.9 15.9 15.4 Central government 87.2 56.5 74.0 78.6 94.3 Basic budget 78.7 56.5 73.2 73.4 94.1 Special budget 8.4 0.0 0.8 5.1 0.2 Local governments (municipalities) 75.4 128.4 172.5 184.2 Basic budget 56.8 128.4 170.4 183.0 Special budget 18.6 0.0 2.1 1.1 (in percentage) Central government 53.7 30.6 30.0 29.9 Basic budget 48.4 30.6 29.7 27.9 Special budget 5.2 0.0 0.3 2.0 Local governments (municipalities) 46.3 69.4 70.0 70.1 Basic budget 35.0 69.4 69.1 69.7 Special budget 11.3 0.0 0.9 0.4 Memorandum Items: NominalGDP 2349.2 2829.1 3275.5 3589.5 3662.3 4177.6 Government spending 952.0 1103.6 1331.8 1553.5 1706.9 1740.7 Sources: Ministry of Finance; and staff estimates. (OJ includes user fees collected by higher educational establishments. 2 Latvia adopted a Law on Education in 1991. A 1995 Latvian Concept ofEducation provided the basis for the subsequent changes in the laws related to education. The 1998 Law on Education regulates the education system as a whole and the types and levels of education and educational institutions. The Law on Higher Educational Establishments was adopted in 1995, and the Law on General Education and Law on Vocational and Professional Education in 1999. The ministry of education and sciences developed a strategic program for education development in Education 1998-2003. Latvia Public Expenditure Review 6 Education Over the last four years, nominal public spending on education increased by two-thirds (Table 4). As a share ofGDP, education spending increased from 5.7 percent in 1996 to 7.2 percent in 1999 (15.4 percent of the consolidated budget), which is much higher than the regional average of 4.4 percent. Education is the second largest function in the consolidated budget, after Social Security and Welfare. Per student spending on education is large. Preliminary estimates suggest that per student public education spending has increased from LVL 347 in 1997 to LVL 476 in 1999 (Table 5). This means that per student spending on education may be as much as 7 times more than per capita spending on health. Table 5. Public Spending on Education by Type ofInstitutions, 1996-99 1996 1997 1998 1999 (in millions ofLVL) Public spending on education 162.6 184.9 246.5 262.7 Pre-school and general education 75.4 128.4 172.5 184.2 Preschool 19.9 29.6 33.1 General education 108.5 142.9 151.1 Vocation and higher education 87.2 56.5 74.0 78.6 (in LVL per year) Spending per student (0) 312.0 347.0 455.0 476.0 Pre-school and general education 177.0 300.0 403.0 432.0 Preschool 291.0 448.0 508.0 General education 301.0 395.0 418.0 Vocation and higher education 922.0 543.0 648.0 624.0 Sources: Ministry of Finance, Bank and Fund staff estimates (0)excluding students from private higher education establishments, but including students paying fees in public higher educational establishments The administration and financing of educational institutions is shared between the local (or municipalities) and the central governments (line ministries). Municipalities (pagasts and metropolitan cities) are responsible for most public preschools and general education schools. Higher education institutions have substantial autonomy in the governance and financing of higher education, but are partly financed from the central government budget. The central government provides most of the funding for special schools (e.g. for children with special needs, i.e. children with disability or gifted children) and the vocational schools. These schools are under the responsibility of the ministry of education and other line ministries Administration and Financing of General Education Every municipality has to provide children residing in its territory with the possibility to acquire pre-school and primary education at a school which is closest to the place of residence. It has also to provide youth with the opportunity to acquire secondary education. Latvia finances a distinct education system to serve Latvian and Russian-speaking children. Typically, a municipality may run Latvia Public Expenditure Review 7 Education two general schools, one for Latvian children and another for Russian-speaking children3 • Students have the freedom to attend school in another municipality. Their education would be financed through inter-municipal contracts. Pre-schools and general education schools are financed by both the central government and the municipalities: • The Central government finances salaries and social insurance of teachers (in general education only) according to policies and norms established by the Cabinet of Ministers. It also provides funding for textbooks. These funds are budgeted as a line item on the ministry of education budget and allocated to School Boards based on a per-student basis. • Municipalities provide financing for learning materials, maintenance and repair of school buildings, technical (non-instructional) school personnel (cleaning, maintenance and security), student meals, and utilities (heating and electricity) in general education and all pre-school related expenses. The Cabinet of Ministers establishes certain minimum levels of funding to ensure a degree of consistency of provision across the country. Schools are financed from three sources: local taxes, general purpose grants (categorical transfers and the equalization fund) and earmarked grant for teachers' salaries and social insurance. 1. General Purpose Grants (Categorical Transfers and Equalization Fund). Centrally collected revenues from taxes on personal and corporate income, imports, retail sales and specific goods are shared with municipalities according to a pre-established formula. • All revenues from the personal income tax are returned to the municipality in which the taxpayer resides. • All other revenues are retained by the central government, and partly used to fund a system of categorical transfers to municipalities and a revenue equalization fund. The categorical transfers are intended to provide sufficient funds to allow local governments to fulfill nationally mandated minimum service standards for education, health care and social protection. The equalization fund allows municipalities to provide minimum levels of local amenities such as street lighting. Neither of these two transfers is earmarked for education. 2. Earmarked Grant. In 1999, the earmarked grant for teachers' salaries (for general education only) amounted to LVL 67 million. Since 1996, earmarked funds are not transferred directly to individual municipalities (except in the case of metropolitan cities), but are allocated as a lump sum to regional School Boards (26) (Box 1). The target allocation to each regional School Board is based on a minimum wage established by the Cabinet of Ministers per teaching position. The number of teaching positions in each region (and therefore the amount of the lump sum target allocation to the region) is a calculated figure, but is 3 The 1998 Law on Education provides for the gradual implementation of portions of Article 9 that requires education to be acquired in Latvian. As of September 1, 1999, the requirements are in effect for higher education establishments. Institutions with language of instruction other than Latvian must start implementing programs for national minorities and begin the transition to instruction in Latvian. On September 1, 2000, teaching in Latvian must start in grade 10 of all state and municipal general schools, and in the first year of state and municipal vocational schools. Latvia Public Expenditure Review 8 Education not based on the actual number of teachers. The number of teachers is calculated on the basis of one teacher per 21 students, multiplied by coefficients reflecting the number of hours and complexity of the study plans at each level, regional characteristics (urban/rural) and other variables. Schools develop budgets for each new school year, taking into consideration teacher study plans (reflected in hours and content), minimum and maximum class sizes. Regional School Boards are responsible for reconciling the difference between the total teacher wage bill projected for schools within the region, and the central government's earmarked grant. Each School Board is in tum responsible for distributing resources to municipal schools. The allocation to school is made on a per student basis (capitation financing). School directors are responsible for daily operation of their schools, including hiring and dismissals of teachers, setting salaries in line with the required state minimum levels. Directors have also the authority to generate additional non-budgetary resources for the school by reaching out parents, sponsors and donors. Box 1. Regional School Boards Regional School Boards function within the authority of regional councils composed of the chairmen of the elected councils of each of the municipalities within the region. By law, heads of School Boards must be professional educators. Regional School Boards can have direct supervisory responsibility for some schools (e.g. boarding schools, vocational schools, or specialized schools for students with special needs). The regional Board's main functions are to provide technical assistance and support to schools. The formal responsibilities defined in the Law on Education are limited. The ministry of education delegated to these regional entities the responsibility for a wider range of functions, such as in-service education and instructional support for individuals schools. Among their responsibilities, School Boards: (a) undertake efforts to improve the qualification of teachers within the regions; (b) coordinate and provide methodological support; (c) organize education for adults; and (d) assist schools by providing teaching and methodological materials. The most important function of School Boards is to allocate funds from the state budget to schools within the region, for teachers' salaries and social insurance. Administration and Financing of Higher Education Following Latvia's independence, higher educational establishments were granted autonomy in governance and financing. The Law on Education and the 1995 Law on Higher Education Establishments provide these institutions with substantial autonomy from the State. Autonomy encompasses the authority to establish the content and forms of study, supplementary conditions for students admission, basic directions of scientific and research work, and the organizational and administrative structure. Within the limits established by the Cabinet of Ministers, institutions have autonomy in hiring of staff and setting their compensation rates. Subsidies from the central government represent 60 percent of their income and are used at the discretion of the educational establishment. There are significant variations in state funding among public educational establishments: 40 percent of them derive at least 80 percent of their income from the central government and 10 percent do not benefit from subsidies at all. These variations may reflect differences in student demand. At the University of Riga (with a total of22 758 students), 30.9 percent of students are budget-sponsored, while at Riga Technical University, 78 percent of students are budget-sponsored. Variations in state funding may also reflect national priorities. For example, Latvia Public Expenditure Review 9 Education the rate of budget-sponsored students is quite high at the National Academy of Defense of the Republic of Latvia (100 percent), the Latvian Academy of Music (98.5 percent), the Latvian Maritime Academy (94.6 percent), and the Police Academy of Latvia (86.7 percent). There are two types of students (Figure 2): Figure 2. Proportion of Fee-based and Budget-sponsored Students, 1997-2000 • Budget·sponsored student. The 100% proportion of budget-sponsored students has been increasing over time. In 2000, 80% more than a third of higher education 60% students was directly financed by the central government through the 40% normative scheme (Box 2). The central government budget provides funding 20% for tuition and fees for students 0% receiving state-financed loans. In the 2000 budget, the provision for students loans was LVL 6.8 million. • Fee.paying (full or partial) student. The level of student fees is determined by the schooL Fees for a full-time bachelor student may vary between LVL 200 and LVL 1,000 per year. Evening students do not pay fees, and correspondence students pay between LVL 150 and LVL 300 per year. Box 2. Normative Financing in Higher Education The Law on Higher Education Establishments stipulates that the per student allocation (or subsidy) is based on a "normative minimwn expenditure per student" (LVL 580}-tbis allocation covers public utilities, taxes, infrastructure maintenance, purchase of equipment and inventory, research and artistic crelltivity as well as salaries of staff. Moreover, two coefficients are defmed to account for cost differentials: a) kl reflects the type of program (e.g. social science, environment etc ..) and b) k2 reflects the type of education (academic, scientific degrees, professional qualification). The Cabinet of Ministers establishes the optimal values for k'"\ and k'" 2. Based on the actual budget allocated for higher education, a real value for each of these coefficients, kl and k2' is computed- k\ and k2 is below k*\ and k*2' but increases over time to reach k* I and k*2' The actual per student allocation is computed using the "normative minimwn expenditure per student", multiplied by the coefficients, kl and k2 • The actual per student budget allocation is also adjusted for the type of students (full-time, evening, correspondence). Allocation per correspondence (evening) student is only 10 (25) percent of the allocation per full-time student. Latvia Public Expenditure Review 10 Education Administration and Financing of Vocational Education Out of the consolidated budget for education, 10 percent is spent on vocational education (Table 6). In 1998, the total budget for vocational education in Latvia was LVL 29.1 million, out of which 83 percent was financed by the central government budget. Other sources of financing include municipalities, schools, and in the case of private schools, student fees. The ministry of education provides budgetary support for wages and social insurance, while the municipalities pay for utilities, materials and maintenance. The responsibility for providing vocational education is shared among 4 ministries. The ministry of education has the responsibility for the largest number of schools: 53 schools, including 44 vocational schools and 9 professional schools. The ministry of agriculture, for instance, has the responsibility of 38 schools, provides 1,663 teaching and non-teaching positions and serves 13,062 students. Table 6. Vocational Education Budget, 1998 Total Spending % from State % of own budget income (in millions of (percent) (percent) LVL) Ministry of Education 12.87 86.17 13.83 Ministry of Agriculture 11.64 76.89 23.11 Ministry of Welfare 1.65 95.76 4.24 Ministry of Culture 2.91 95.19 4.81 Municipalities Private and others Institutional Capacity for Budget Management The annual budgeting process is incremental. Typically, the previous year budget allocation is used as a reference point and adjusted at the margin every year. Under this budgeting procedure, the budget allocation is simply rolled over years after years, and is not re-examined in a medium-term strategic framework. Practically, the education budget takes the form of a set of basic expenditures, supplemented with a list of "priority programs". In the year 2000, the ministry of education submitted a request for supplementary funding to the basic budget for LVL 35 million, as a list of 30 "priority programs". Out of this list, only the first three "priority programs" were actually funded. The discrepancy between what is requested and what is obtained can be large. In the 2000 budget, the 3 "priority programs" amounted to less than a third of what was initially requested. The remaining 27 "priority programs" would simply be re-submitted the following year. Although itemized as "priority programs", they are neither prioritized, nor programmatic. First, the list of "priorities" mostly reflect hard-core commitments. For instance, in the budget 2000, the first item on the list was" teachers' pay reform" (L VL 11.4 million). In this case, the spending was imposed by a Cabinet of Ministers regulation and locked in almost the full amount of the additional funding that could be obtained with respect to last year's budget. Other "priority" items were squeezed in. No account was taken of relative priorities. Latvia Public Expenditure Review 11 Educatiou Second, the list of "priorities" takes the programmatic format, but is de facto a list of input categories items. Input norms are used to compute per student allocations. The focus on inputs as a basis for allocating resources has major shortcomings: first, program performances are judged in terms of spending more or less than appropriated in the budget, but not in terms of outcomes of spending on this program. Second, the tasks cannot be ranked into priority. In fact, all tasks can be considered as priorities, and given basis for absolute budget funding requirements. Finally, the funding responds to a short term, rather than long term strategic vision of the financial needs in the education sector. Box:: 3. Fra.gmentadon.• of Pro~l' . am Responsibili.'ty:among Lbl@Miniltries "",,»\ ".11\';;-,,, Th~,proSf,aIIlresporiSjl>ility fo~~educatioHi~ fra~~nted a~.~ mi~trie~s~r~the . onsib~il¥for voCational~ation .. In:~~~99. !h~:~tl~ .......... edu~~9n and s~j~~s~t61 .. on~catio~,.,The·.~jnq~rwas distn]p~datll()JljJbe . ).cUtmre(QP~centj.!he cabiQe(Qf~~t~·lU.ld Wture"~orinsta~" $pCnt21perc ... b~get on e only 30 peral~were.~gagedjtt agnculs~es);;" 'f;,' Figure 3, Central Governm ent Spending on Education by Ministry, 1999 Ministry of Culture 6% Others Ministry of 5% Welfare 6% Ministry of A gric u It ure 21% Education 62% Latvia Public Expenditure Review 12 Education IV. Program Expenditures and Efficiency During the 1990s, the Latvian government undertook significant reforms to improve the efficiency of the education system. One of the most significant reforms has been the decentralization of the administration and financing of general education. Although benefits of education reforms may only be visible in the medium term, there is some evidence that the education system suffers from serious inefficiencies. The Role of Decentralization Theoretically, the decentralization of education spending can lead to increased public sector efficiency and accountability (Box 4): 1. Increased allocative efficiency, as decentralization can ensure the best match between local preferences and supply of good. 2. Increased technical efficiency, as a differentiated production of public goods by local governments can result in increased experimentation, innovation and ultimately technical progress in the production of public goods. 3. Increased accountability, as local constituencies can ensure that local governments will bear the costs and benefits of their fiscal decision. In Latvia, the current decentralized setting does not provide the incentives structure that induces different actors in the education system to respond to changes in the environment in a way that constantly propels the system towards greater efficiency. For instance, the decentralized structure does not provide the right incentives to optimize the general education schools network and respond to the shrinking school-age population through the consolidation of schools. The capitation financing scheme should provide the adequate incentives to optimize the use of available budgetary resources at the regional (and school) leveL Under this scheme, municipalities are given, through regional School Boards, flexibility to allocate resources as they see fit to improve the quality and cost-effectiveness of the services they offer. In the past, funding for education was allocated on the basis on input norms. Municipalities with the most school buildings and teachers generally received the most money. Now, however, Latvia is allocating public resources for general education on the basis of the "money follows the student" principle. The scheme is insufficient to entail the optimization of the general education schools network. In theory, the School Board has the authority to reallocate funds among schools and incentives to optimize the school network. In practice, there are three constraints: • Political economy constraint. The regional School Board function within the authority of regional Councils composed of the chairmen of the elected councils of each municipality. In a country where access to a nearby school has always prevailed, the closure of a school is not an attractive policy option for a mayor. • Fiscal constraint. A municipality which closes down a school would be penalized at least twice: first, it would not receive its share of central government earmarked grant for teachers' salaries; and second, it would have to incur additional spending in terms of transportation of children to the neighboring municipality. This additional spending would be entirely borne by the municipal budget. The closure of a school could however reduce spending on maintenance, repair of school buildings and others. This could free up resources for other spending. Further study of municipal budgets is required to conclude on the (net) financial gains of closing down a school. Latvia Public Expenditure Review 13 Education • Implementation constraint. In some regions, the allocation to schools is not per-student based, but depends on the School Board. Some School Boards may distribute resources in such a way as to preserve the school network, at the expensive of efficiency. Box 4. Assumptions under which decentralization leads to superior outcomes Efficiency gains from decentralization rests on at least two assumptions: 1. Informational advantages. Local constituencies are better able than the central government to identify local community preferences, as they are endowed with superior information; 2. Adequate incentives structure. The central government is able to set an adequate incentives structure such that the self-interested local government behaves according to the central government's objectives. The set of incentives is an important determinant of the effectiveness with which different levels ofgovernment are able to carry OYer their mandates. Unless there is a mechanism to enforce incentives, decentralization can lead to inferior outcomes. Greater accountability under a decentralized setting rests on a key set of assumptions: 1. Clear division of responsibility. 2. Powers and revenues that match responsibilities. 3. Well-designed transfer mechanism. Decentralization can also foster citizens' participation to the public life, as people perceive a correspondence between taxes they pay and the level and quality of public service they receive. Finally, decentralization can improve governance and reduce rent extraction. The decentralization process is often complemented by reforms aimed at granting school autonomy. Typically, schools management, allocation of resources, and election of the school director are shifted directly to schools-or a board consisting of elected teachers, parents and students. These reforms have often been undertaken in response to concern for poor school performances, with the hope that bringing decision-making closer to major stakeholders, would improve efficiency and effectiveness of instruction. Inefficiencies in Education Expenditures 1. Wrong Input mix • Low utilization capacity of general education schools. The Latvian education system includes a large number of very small rural schools. In 1999, two-thirds of rural schools enrolled fewer than 75 students. The substantial decrease in enrollment rates in rural areas has further exacerbated the under-utilization of facilities and staff. • Excessive number of general education teachers, relative to international standards. The student/teacher ratio in both rural and urban areas is low by international standards. The student/teacher ratio in general education is 12: 1 in urban cities and 10: I in rural areas, compared to 15:1 in OECD countries. Excess number of teachers, relative to OECD standards, prevail in both rural and urban areas. In rural areas, 27 percent of schools have less than 9 students per teacher, and 67 percent have between 10 and 12 students per teacher. In urban areas, the student/teacher ratio is low as well, albeit to a lower degree: 15 percent of the schools have 10 to 12 students per teacher and 72 percent of schools have 13 students per teacher. Latvia Public Expenditure Review 14 Education 2. Poor Information on education outcomes The governance and administration of general education is highly fragmented, making policy and qualitative reforms difficult to coordinate. Detailed information on the system, its financing and its outcomes is not readily available and cannot be used to support decision-making in the sector. 3. Misallocation of public resources across levels of education The allocation of public spending across levels of education should reflect the most efficient use of public resources and should propel the transfer of costs to private beneficiaries whenever possible. In higher education, this means that a large share of the burden of financing should be imposed to the beneficiaries. The current system of finance relies on tax revenues collected from all Latvian in order to pay for the provision of a valuable asset to less than 5 percent of the population. Moreover, the beneficiaries of public spending on higher education are drawn primarily from the relatively well-off. Since the system of higher education finance imposes a large share of the burden on the budget, rather than on students, public resources for other levels of education (and general education in particular) are smaller. 4. Poor flexibility and market relevance of vocational education Early specialization, especially in the narrowly defined vocational tracks, is inconsistent with the market needs for flexibility in learning. It does not make sense to teach a large number of students highly specific vocational skills that are rendered rapidly obsolete by the technological change characteristic of a dynamic modem economy. Moreover, it is very costly to run highly specialized schools. They cost more than general academic schools that often do a better job at preparing students for the market. 5. Excessive fragmentation of the education function among line ministries Excessive fragmentation of program responsibility among line ministries leads to non­ transparency. The fragmentation of program responsibility implies that line ministries are competing separately for public resources. Line ministries act independently and do not coordinate among themselves. This structure leads to non-transparency in the overall budget allocation, and education programs with different objectives and standards. Moreover, equity among teachers may be at stake. For instance, a teacher in a vocational school can get a different salary depending on whether his school is under the ministry of agriculture or the ministry of education, although he may teach the same subject. 6. Poor budget formnlation procedure. Poor budget formulation procedure undermines the ability of the education sector to adequately plan education spending. Poor budget preparation process undermines the budget negotiation process at the Cabinet of Ministers and increases the risk of a political breakdown during the budget approval. In this respect, Latvia provides an interesting illustration. Over the last 12 months, four ministers of education were appointed, the stumbling block being essentially in the budget approval. The short duration of these assignments encouraged work, within the ministry of education, on an ad hoc basis and undermined the continuity and commitment to past reforms. Latvia Public Expenditure Review 15 Education v. Policy Recommendations A Set of challenges In the medium term, policies in the education sector should address a set of challenges: first, how to adjust the general education schools network to the shrinking school-age population. Second, how to finance a higher education system that is rapidly moving from an elite to a mass education system; and third, how to scale down the vocational education schools network. What is the best incentives structure? Education reform in Latvia depends fundamentally on progress in addressing problem that cut across all dimensions of the Latvian policy-far beyond education. In this respect, developing a viable sub-national regional structure should be a priority. The large number of small pagasts, and the poor incentives structure to deliver efficient educational services have profound implications on the quality of educational provision. A decentralized structure can provide the right incentives that induces different actors in the education system to respond to changes in the environment in a way that constantly propels the system towards greater efficiency. In Latvia, however, this structure has emerged as an impediment to an efficient general education system. At the federal level, the weak ministry of education poses a serious challenge to the undertaking of much-needed reforms in higher and vocational education. What can be done? 1. Rationalization ofthe number of general education schools The objective is to increase efficiency through the rationalization of the general schools' network and institutions, while preserving an equitable access to education. This could be achieved through (i) the creation of rural schools' clusters with appropriate transportation services; and (ii) the creation of educational districts (associations of educational institutions) or school clusters to provide a range of educational services for the local population. A selected number of rural schools should be either consolidated or closed down. Consolidated schools would attract children from neighboring schools by providing them with a better quality of education and an adequate bus transportation. These schools would be accessible within reasonable time by public transportation. Non-viable schools should be partially closed down: they could continue to provide initial education and be reconverted into kindergartens and community centers. The closure of small schools could help reduce the costs in general education. This approach has however to be weighted against higher transportation costs and expenditures on renovation and furnishing of the surviving school. A mechanism could be designed whereby municipalities that run schools below a given number of students per teacher could receive additional central government funding to organize bus transportation. At the central government level, savings (from the reduction in the number of teachers and the closure of some schools) could be transferred to the ministry of transportation budget to finance bus transportation in selected rural areas. The option of school consolidation as a means of improving efficiency may not be relevant whenever schools have to be preserved to ensure an equitable access for the poor rural families and minorities. A multi-grade system of instruction can provide a cost-effective alternative to school consolidation in rural areas. The practice of multi-grade teaching has been found effective when Latvia Public Expenditure Review 16 Education teachers have been properly trained to teach classes comprised of students of different grade levels, when teachers have been provided with proper teaching materials, and when students have appropriate, specially designed textbooks. In urban areas, several territories could be consolidated into one educational district, that wiould be managed by one civil servant appointed by the head of the region. This head could appoint directors of schools and ensure that the local interests are aligned with the state educational policy. The consolidation of several territories would enable the creation of a solid educational system within the district, including pre-schools, general education, as well as some specialized institutions. 2. Rationalization of the wage bill In the short term, cost-saving measures could be implemented by: (a) expanding the number of hours in the teachers' work week with appropriate remuneration, since Latvia teachers work fewer hours per week that those in most of the neighboring European countries; and (b) decreasing the total number of teachers and increasing the class size, since the student/teacher ratios are extremely low by Western European standards. The reduction in excess staffing should be done while preserving the quality of education and adequately compensating those who must leave the education sector. Experience in other ECA countries suggests that a step-by-step approach is politically and socially desirable. An up-front reduction in staffing would lead to an undesirable outcome; good teachers would leave the profession and lower quality teachers of highly specialized teachers would stay. Therefore, an attestation mechanism could be designed to select high-quality teachers. Once the attestation is implemented on a national scale, teachers' wages would be brought up to nationally competitive levels, and severance pay (as well as training and opportunities for self-employment) would be granted to those who leave the education sector. An increase in the wage level of teachers may not be optimal in the short tenn. Currently, the average teacher's pay is similar to the country average. For instance, in October 1998, the last period for which the average workweek is available, a secondary education teacher earned LVL 125 per month and worked 133 hours per month, comparing favorably with the average of the economy of LVL 122 per month and 148 hours per month. In the medium tenn, employment conditions for teachers should be re-examined. The emphasis should be on retaining highly qualified teachers and attracting teachers who have some specific skills (language, business), but for whom the pay scale may not be competitive. 3. Statistics and monitoring Ensuring the availability of reliable perfonnance financial and administrative infonnation is a pre-requisite to beginning a productive dialogue on the need for and expected outcomes of education refonn. The student assessment system should be strengthened to measure relevant learning outcomes. Lavia recently introduced a unifonn system of quality monitoring, which is based student achievement in core subjects for students graduating from general education. The exam (ISEC) is centrally administered, compulsory and required for pursuing education. Results of this exam are currently used to assess the adequacy of the general curriculum. These results could be used to infonn the ministry of education on perfonnance differential among schools and could help to target investments in human resources, to schools which perfonned poorly. Latvia Public Expenditure Review 17 Education Accountability of municipalities in the public delivery of education could be increased through the introduction of: (i) a regional education statistical system; (ii) a publicly available information on school performances. 4. Promotion of cost recovery and income-based scholarship in higher education The financing of higher education should be transparent and cost recovery should be encouraged. Moreover, htition fee exemptions should be mostly awarded on equity grounds. The system of student loans ("crediting system") should also be expanded. Consideration should be given to the adoption of income-contingent repayment schemes and mechanisms to enforce the repayment of student loans. Reducing government subsidization of higher education will allow a larger share of educational resources to be spent on general education. 5. Restructuring of the vocational education schools network The objective is to improve the flexibility, quality and market relevance of vocational education. This could be achieved through: (i) the rationalization of the number of vocational education schools; (ii) the creation of Knowledge Centers; and (iii) the modernization of the curricula in key professions. The restructuring of the vocational education schools network should include the closures of non-viable schools, some horizontal and vertical amalgamation, and the creation of clusters of vocational schools accessing multi-function, Knowledge Centers. These centers would be equipped with simplified and relatively primitive pieces that display principles of design and action, rather than mimic state-of-the-art technology. These centers would pool together knowledge in a priority profession and deliver it to a cluster of schools. Its functions would be to: (i) provide training to skilled workers in key professions that are needed to spur regional economic development and (ii) support the on-going rationalization ofthe schools network. The curriculum should be modernized to respond to labor market signals and to the changing conditions in Latvia today. Until recently, all vocational schools trained their students for specific jobs rather than teaching them a set of skills that could be utilized in a variety of occupations across a number of fields. The curriculum should be adjusted by introducing courses on core skills within job families and transferable work-related key competencies. 6. Build-up institutional capacity of the ministry of education The excessive fragmentation of the education function among line ministries is poorly adapted to a modem budget system. At present, the ministry of education is however inadequately endowed to handle total education spending. A step-by-step approach is desirable to achieve consolidation and rationalization in the education budget. As a first step, substantial investment in terms of staffing and skills would be required. The objective would be to develop the management capacity of the ministry of education. Subsequently, the education budget as a whole should be streamlined. Cost-effectiveness of study programs offered under the line ministries should be re-assessed. Two criteria should help gauge program cost­ effectiveness: first, the relevance of the program for market needs (and national priority). In higher education, this means that some programs should either be transferred to the private sector or remain accessible on a fee-basis (with special provision for students in need). Second, the transparency in the cost per student. The use of normatives should be expanded to proxy the cost per student in vocational Latvia Public Expelldltur Review 18 Education education. The use of norms in vocational education should also induce authorities to reduce enrollment in vocational education and expand enrollment in general education. 7. Improvement in the budget formulation procedure Methods of modern budget management should be introduced [Development in Volume 1 of the PER]. This means: • output budgeting, i.e. planning and analysis of budget expenditures linked to specific types of services; • performance and budget evaluation, i.e. assessment of goals achievements • benchmarking, i.e. comparative analysis of expenditures efficiency and distribution. Latvia Public Expenditures Review Education Annex Latvia Education Matrix of Issues and Recommendations Issue Recommendation Outcome General Education 1. Low utilization capacity of general Rationalize the number of general education Modernization of general education schools education schools school through: network through higher quality in rural (i) creation of rural schools' clusters areas and more efficient use of resources in (ii) creation of education districts urban areas 2­'Excessive number of teachers Rationalize the wage bill using a step-by-step Promotion of highly-qualified teachers, relative to international standards approach: remunerated by a competitive pay scale. (i) selection of teachers through an attestation mechanism (ii) revision of the pay scale or re-training 3. Poor information on learning Introduce: Improvement in learning outcomes through outcomes in general education (i) regional education statistical system a better targeting of scarce public resources schools (ii) publicly available information system on for general education towards schools with school performances low performances Hi2her Education 4. Excessive allocation of public (i) promote the cost recovery in higher Efficient and equitable allocation of spending to higher education, education expenditures across levels of education relative to other levels of education (ii) introduce scholarship based on income Latvia Public Expenditures Review Education Issue Recommendation Outcome ~ationalEducation 5. Poor flexibility and market relevance Restructuring of vocational education schools Improvement in the quality and relevance of of skills acquired in vocational network through: vocation education (and stronger links with education (i) rationalization of the number of vocation social partners to make graduates more education schools employable. (ii) creation of knowledge centers Lack of relevant skills is a major cause of (iii) modernization of the curricula in key unemployment professions Institutional Capacity for Bud2et Mana2ement 6. Excessive fragmentation of the (i) structural adjustment of the ministry of Improvement of the management capacity education function among line education of the education function ministries (ii) consolidation of the education function into the ministry of education 7. Poor budget formulation procedure Introduce modern budgeting procedure (output Improvement illthe budget preparation budgeting, performance and budget evaluation, process and benchmarking) - ... - .... - .... - .... -~ .... -~ .... - .... - ­