BOSNIA AN D H E RZE GOV IN A SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE BOSNIA AND HERZEGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Report No. 148573-BA © 2020 International Bank for This work is a product of the staff of The World Bank with external contributions. The Reconstruction and Development / findings, interpretations, and conclusions expressed in this work do not necessarily re- The World Bank flect the views of The World Bank, its Board of Executive Directors, or the governments they represent. 1818 H Street NW Washington DC 20433 The World Bank does not guarantee the accuracy of the data included in this work. The Telephone: 202-473-1000 boundaries, colors, denominations, and other information shown on any map in this Internet: www.worldbank.org work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. 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Translations—If you create a translation ures, or images. of this work, please add the following dis- Third-party content—The World Bank claimer along with the attribution: This does not necessarily own each compo- REBALANCING BOSNIA AND HERZEGOVINA: AN UPDATE The Mostar Bridge, built by the Ottomans in the 16th centu- ry, is an iconic image of Bosnia and Herzegovina, its people, and their heritage. It spans the Neretva River to join the two sides of Mostar. It has been repaired or rebuilt many times over the years, but its distinctive identity is unchanged. It is time, now, to build and cross a new bridge to connect Bosnia and Herzegovina’s past to its future; to bridge the differences that have divided people and separated them from the prosperity they can achieve. Cover: Alica Jarikovic · Graphic design by: Kilka Diseño Gráfico Regional Vice President: Cyril Muller CURRENCY EQUIVALENTS IFC Vice President: Georgina Baker Exchange Rate Effective May 18, 2020 Country Director: Linda Van Gelder Currency Unit: BAM IFC Regional Director: Wiebke Schloemer BAM 1.80 =US$ 1 Regional Director: Lalita Moorty Fiscal Year 2020 Practice Managers: Gallina Vincelette / Salman Zaidi January 1 – December 31 IBRD Country Manager: Emanuel Salinas Munoz IFC Country Manager Thomas E. Lubeck Task Team Leaders: Edith Kikoni / Leonardo Lucchetti / Levent Karadayi / Lada Busevac CONTENTS Acknowledgements . . . . . . . . . . . . . . . . . . . . . . . . . 7 A. Rebalancing Growth: Pivoting to Private Investments Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . 8 and Exports for Job Creation . . . . . . . . . . 39 I. B. Investing in Physical Capital . . . . . . . . . . . 48 Country Context: Where Is Bosnia C. Strengthening Human Capital and Herzegovina Today? . . . . . . . . . . . . . . . . . . . . 15 and Basic Services . . . . . . . . . . . . . . . . . . . . 53 A. Unwieldy Institutions and Inefficient D. Managing Natural Assets Public Administration . . . . . . . . . . . . . . . . . 15 for Prosperity . . . . . . . . . . . . . . . . . . . . . . . . 58 B. Demographic Change . . . . . . . . . . . . . . . . . 18 C. Stalled Reforms and Lack of IV. Economic Transformation . . . . . . . . . . . . . 20 Prioritization for Fast, Long-Lasting, Inclusive Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 D. EU Accession: A Long Road Ahead . . . . . . 25 Appendix A: Indicators of Trust II. in Bosnia and Herzegovina . . . . . . . . . . . . . . . . . . 68 Economic trends: Growth and Jobs, Public Appendix B: European Commission Opinion Finances, Poverty and Shared Prosperity . . . . . 27 on Bosnia and Herzegovina’s Application for European Union Membership . . . . . . . . . . . . . . . . 70 III. Development Constraints: References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72 What Needs to Change? . . . . . . . . . . . . . . . . . . . . . 39 LIST OF FIGURES Figure 1. Government effectiveness and Figure 8: The SOE footprint is the largest among accountability lies below benchmarks . . . . . . . . . . . . . 17 all Western Balkan and most ECA countries . . . . . . . . 24 Figure 2: Satisfaction with public services is low Figure 9: Consumption is the main relative to spending levels. . . . . . . . . . . . . . . . . . . . . . . . 17 driver of growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Figure 3: Political instability is the most important Figure 10: Investment has failed to recover constrain to invest in BiH. . . . . . . . . . . . . . . . . . . . . . . . . 17 and lies below benchmarks . . . . . . . . . . . . . . . . . . . . . . 24 Figure 4: BiH among the highest population of Figure 11: Private investments remain emigrants in the world . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 below two-thirds of total investment . . . . . . . . . . . . . . 24 Figure 5: Many have left BiH . . . . . . . . . . . . . . . . . . . . . 19 Figure 12: Upgrading to higher content of high technology and skill content is only starting . . . . . . . 25 Figure 6: BiH’s population is aging and shrinking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Figure 13: BiH has one of the lowest levels of preparedness for accession in the region . . . . . . . . . . 26 Figure 7: The working age population is declining . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Figure 14: Growth has stabilized but it remains Figure 28. Micro and small firms are about below pre-crisis rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 95 percent of the business population . . . . . . . . . . . . . 42 Figure 15: BiH has a long journey Figure 29. Productivity does not to catch up to EU income levels. . . . . . . . . . . . . . . . . . . 28 exceed a third of the EU average . . . . . . . . . . . . . . . . . . 43 Figure 16: Low investment and labor force Figure 30. Productivity is declining participation are constraining growth . . . . . . . . . . . . . 29 in most industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Figure 17: BiH has one of the highest revenue Figure 31: Low value-added sectors created shares in the world . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 the most jobs between 2014 and 2017 . . . . . . . . . . . . . 44 Figure 18: Government spending to GDP Figure 32. Manufacturing firms face significantly is above norms by income level . . . . . . . . . . . . . . . . . . . 30 higher constraints in accessing financing than firms operating in retail or other services . . . . . . . . . . 47 Figure 19: Unemployment is the main concern in BiH . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Figure 33. BiH infrastructure quality is poor compared to regional and European peers . . . . . . . . . 48 Figure 20: Political connections are deemed the most important factor for success . . . . . . . . . . . . . . . . . 33 Figure 34. Coal is the primary energy generation in BiH . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 Figure 21. Many people are either unemployed or out of the labor force . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Figure 35. Access to pre-primary education is especially low . . . . . . . . . . . . . . . . . . . . . . . 54 Figure 22. Many people are either unemployed or out of the labor force . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Figure 36. Skills that employers seek are in short supply . . . . . . . . . . . . . . . . . . . . . . . . . . 54 Figure 23. Poverty has slightly increased in recent years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 Figure 37. Social assistance programs have low coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 Figure 24. Inequality has remained stagnant . . . . . . 37 Figure 38: …and their poverty Figure 25. Export growth has lagged . . . . . . . . . . . . . . 41 impact is limited . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 Figure 26: FDI is significantly lower in BiH than in Figure 39: Pollution in BiH cities the other countries in the Western Balkans . . . . . . . . 42 exceeds limits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 Figure 27: A large share of FDI has gone into services sectors, not GVCs . . . . . . . . . . . . . . . . . . . . . . . . 42 LIST OF TABLES Table 1: Social security contribution rates are particularly high in BiH . . . . . . . . . . . . . . . . . . . . . . . 30 Table 2: Summary of reform priorities . . . . . . . . . . . . . 64 LIST OF BOXES Box 1. Factors Contributing to Emigration . . . . . . . . . 21 Box 4. State Ownership of Airports . . . . . . . . . . . . . . . . 45 Box 2. State-Owned Enterprises Box 5: Reforms in Republika Srpska Railways in Bosnia and Herzegovina . . . . . . . . . . . . . . . . . . . . . . . 22 —a Model for State-Owned Enterprise Reform . . . . . . 50 Box 3. Sectors with Potential to Box 6. Past and Current Knowledge Gaps . . . . . . . . . . 63 Create Additional Growth and Jobs . . . . . . . . . . . . . . . 40 ACRONYMS BHAS BiH Agency for Statistics PFM Public financial management BiH Bosnia and Herzegovina PISA Program for International Student Assessment EC European Commission PPP Purchasing Power Parity ECA Europe and Central Asia RS Republika Srpska EU European Union SCD Systematic Country Diagnostic FBiH Federation of Bosnia and Herzegovina SEE South East Europe FDI Foreign Direct investment SOE State-Owned Enterprise GDP Gross Domestic Product UNCTAD United Nations Conference on Trade IEA International Energy Agency and Development IFC International Finance Corporation UN DESA United Nations Department of IMF International Monetary Fund Economic and Social Affairs ICT Information and Communications WB World Bank Technology WDI World Development Indicators KM Bosnian convertible mark WGI World Governance Indicators LFS Labor Force Survey WEO World Economic Outlook LITS Life in Transition Survey WHO World Health Organization MSME Micro, Small, and Medium Enterprise ZRS Republika Srpska Railways Company OECD Organization for Economic Cooperation and Development BENCHMARKING COVERAGE AND COUNTRY ACRONYMS The analysis in this report relies heavily on com- nia (EST), Latvia (LVA), Lithuania (LTU), Slovak parisons with neighboring countries and subre- Republic (SVK), Slovenia (SVN). gions that are similar in size, transition, legacy, • European Union (EU28): Austria (AUT), Bel- and reform requirements for continuing conver- gium (BEL), Bulgaria (BGR), Croatia (HRV), gence and making progress toward European Cyprus (CYP), Czech Republic (CZE), Denmark Union accession. (DNK), Estonia (EST), Finland (FIN), France The regional aggregates and country acronyms (FRA), Germany (DEU), Greece (GRC), Hungary used in this report are defined as follows: (HUN), Ireland (IRL), Italy (ITA), Latvia (LVA), Li- • Western Balkans (WB6): Albania (ALB), Bosnia thuania (LTU), Luxembourg (LUX), Malta (MLT), and Herzegovina (BiH), Kosovo (KOS), North Ma- Netherlands (NLD), Poland (POL), Portugal cedonia (MKD), Montenegro (MNE), Serbia (SRB). (PRT), Romania (ROU), Slovak Republic (SVK), • Seven Small Transition Economies of Europe Slovenia (SVN), Spain (ESP), Sweden (SWE), (STEE7): Bulgaria (BGR), Croatia (HRV), Esto- United Kingdom (GBR). 6 ACKNOWLEDGEMENTS This report was prepared by a World Bank Group Anya Vodopyanov, Lamija Marijanovic, Zuhra Os- team led by Edith Kikoni (Senior Economist) and manovic-Pasic; Elwyn Davies, Besart Avdiu; Lore- Leonardo Lucchetti (Senior Economist), together na Meco; Violane Konar-Leacy, Mirjana Galonja, with Emanuel Salinas Munoz (Country Manager), Igor Matijevic, Senka Eminagic; Dzenan Malovic; Levent Karadayi (Economist) and Lada Busevac Boris Janjalia; Magdalena Soljakova; Nenad Sof- (Senior Country Officer). The team from across ronic; Milica Sredanovic; Aleksandra Krstic; Samra the World Bank Global Practices, International Bajramovic, Sanja Tanic; Jasmina Hadzic, and Val- Finance Corporation, and Multilateral Investment entina Aleksic. Many other team members from Guarantee Agency included Mees van der Werf, across practice areas contributed to the inputs for Enrique Blanco Armas, Sandra Hlivnjak, Aparna this SCD Update. Bruce Fitzgerald and Ann Red- Krishnamurthy, Rishabh Sinha, Luis Alberto Portu- mond provided editorial services. gal Perez, Alen Mulabdic, Ekaterina Vostroknuto- va, Christoph Ungerer, Suzana Jukic, Leah LaBoy; The work was performed under the overall Trinidad Saavedra, Alexandru Cojocaru, Ana Maria guidance of Linda Van Gelder (Country Director), Oviedo, Trang Van Nguyen, Armanda Çarçani; Ru- Wiebke Schloemer (IFC Regional Director), Gallina vejda Aliefendic, Johanna Jaeger; Pieter Waalewi- Vincelette (Practice Manager), Salman Zaidi (Prac- jn; Igor Palandzic, Trandelina Baraku, Regassa tice Manager), Jamele Rigolini, Simon Ellis, Gi- Ensermu Namara; Janelle Plummer, Roxanne anfilippo Carboni, Lada Strelkova, Daria Lavrenti- Hakim; Ulrich Schmitt; Alexandra Christina Horst; eva, Carlos Silva-Jauregui, Oscar Calvo-Gonzalez, Mirey Ovadiya, Zoran Anusic, Meliha Kozaric Fan- and Marco Hernandez. ning, Alicia C. Marguerie; Ian Forde, Yoshini Nao- The team thanks Systematic Country Diag- mi Rupasinghe; Flora Kelmendi, James Gresham; nostic peer reviewers Simon Davies and Cesar Gary Claude Goliath, Debashree Poddar, Daniel Cancho for their insightful feedback. Helpful com- Kull, Silpa Kaza; Klas Sanders, Esma Kreso, Tuuk- ments and suggestions from Asli Demirguc-Kunt, ka Castren, Mirjana Karahasanovic; Janina Fran- Caren Grown, and Pablo Fanjzylber are also ac- co, Rome Chavapricha, Antonio Nunez; Rachel knowledged. Bernice Perks; Camille Bourguignon, Larysa Hre- bianchuk; Tania Priscilla Begazo Gomez; Graciela The team is grateful to the government of Bos- Miralles Murciego, Alessio Zanelli; Harald Jedlic- nia and Herzegovina, as well as private sector, civ- ka, Iva Hamel; Dilshod Khidirov, Silvia Mauri; il society, and development partners who partici- Megersa Abera Abate; Liljana Sekerinska; Natalija pated in the consultations and provided insightful Gelvanovska-Garcia; Mediha Agar, Zahid Hasnain, comments and suggestions. 7 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Executive Summary The citizens of Bosnia and Herzegovina (BiH) be taken for granted, because it relies heavily on aspire to a future of rising living standards; sources that are not sustainable in the long term good jobs; better infrastructure and public ser- (e.g., consumption and public sector spending). vices; a healthy, sustainable environment; and To secure the sustainability of growth, investment becoming members of the European Union (EU), levels, currently at 18 percent of gross domestic but BiH is far from reaching these aspirations and product (GDP), need to increase, as does labor faces the critical challenge of rapidly losing its productivity, which is low and declining. BiH’s in- population (arguably its most valuable resource). tegration with global markets is limited. Export Every year, thousands of people emigrate seeking levels, although slowly increasing, continue to be a better quality of life. The country cannot afford low for a small economy (38 percent), and two- to continue losing its people, and creating the thirds of exports are in low-value-added sectors. incentives for people to stay will require meet- Foreign direct investment (FDI) is low and concen- ing their wish for a better quality of life for them- trated in energy sectors, with only 4 percent going selves and their families. This is achievable, but it to export sectors. Fiscal revenues, at 44 percent requires decisive action by all stakeholders to ad- of GDP, are relatively high, but spending is not dress identified challenges. delivering quality public services and spending patterns (low public investment, high wage bill) BiH’s current development path will not cre- undermine growth. Although other countries in ate the opportunities that its population needs. the Western Balkans and Europe face similar de- It has managed to maintain macroeconomic sta- velopment challenges and economic conditions, bility—posting fiscal surpluses and decreasing its there is often a sense of deliberate policy effort to debt levels—but this is not enough. Although eco- remove the obstacles to growth and prosperity in nomic growth has been stable in recent years at other countries. To a large extent, this is missing approximately 3 percent, it is too low to underpin in BiH because of lack of substantive progress on a path to shared prosperity. Should BiH contin- much-needed reforms. ue to grow at the same rate, it would take more than 100 years to reach living standards enjoyed Poverty remains a troubling prospect, with in the EU. Moreover, even current growth cannot the conditions of the less well-off having de- 8 EXECUTIVE SUMMARY teriorated in recent years. The poverty rate in- better jobs, better education and healthcare, bet- creased slightly from 14 percent in 2007 to 16 ter public services, and a cleaner environment. percent in 2015, and considerable effort is needed With young people and families leaving the coun- to reduce it. A decline in consumption in people try, the remaining population is rapidly aging, and in the bottom 40 percent of the income distribu- very low birth rates mean that this trend is likely tion is behind the recent increase in poverty; con- to continue. sumption for this group decreased 0.9 percent BiH has a highly fragmented institutional annually between 2011 and 2015. The poor are structure that is expensive and inefficient. This more concentrated in rural areas, working in the complex institutional setup has important and agricultural sector, which has among the lowest costly consequences in terms of slow progress productivity of agricultural sectors in the region. in the economic transformation of the country, Recent economic growth has not translated into slow progress toward EU accession, and an un- more and better jobs, and unemployment is a ma- favorable environment for business. The public jor concern. Low labor force participation and high sector suffers from a combination of limited skills unemployment are in part the result of marked and excess staffing, which limits the efficiency of skill mismatches in the labor market, which is due spending and the quality of basic services. Lack of to low-quality education that does not meet em- well-functioning mechanisms for public-private ployers’ needs. Several groups have limited access dialogue decreases the already low trust in insti- to economic opportunities, with long-term unem- tutions. A deficient business environment and an ployment particularly high among young people unstable political setting constrain entrepreneur- and female labor force participation among the ship, encourage informality, and deter domestic lowest in the region. Ending poverty and boost- and foreign investment. In this context, substan- ing shared prosperity will require more and better tive reform of public administration to enhance its jobs and access to economic opportunities that responsiveness and accountability to BIH’s popu- can translate into higher incomes. Poor people lation is critical. have increasingly been receiving social assistance and pensions, which has prevented a greater in- BiH’s current development model is unsus- crease in poverty, but the targeting of some social tainable over the long term, and its institu- assistance programs is inaccurate, and coverage tions require upgrading, especially because it is is low. Moreover, the social assistance system exposed to a number of risks that could interrupt generates disincentives for formal employment. its pursuit of economic growth and shared pros- Improving the targeting, coverage, and design of perity. It is vulnerable to environmental shocks, these interventions could increase incentives to including drought, floods, and earthquakes, and participate in the formal economy and increase is vulnerable to the ongoing coronavirus pandem- their effects on poverty. ic, which poses the most serious social and eco- nomic challenge to the country since the global fi- Demographic trends have increased the ur- nancial crisis. It is testing healthcare systems, and gency to act. BiH is rapidly losing its most valu- measures to contain its spread are resulting in an able asset—its human capital. One-third of the economic slowdown and threaten the economic people from BiH live outside of the country, and security of many of its citizens, particularly those thousands are leaving every year, in search of a with low incomes. The expected economic slow- better quality of life for their families—including 9 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE down and the associated potential loss of jobs those of a mid-size European city. Economies and earnings will increase poverty in the country. of scale and better jobs and opportunities will Although it is not clear what toll the pandemic will only come from exporting to larger markets, ultimately take, a strong, coordinated institution- but BiH’s economy is inward focused. Exports al response will be required to contain its spread are low and of low added value, and most for- and ensure that the social and economic upheav- mal jobs are in sectors that do not compete al that the outbreak causes is not long-lasting. internationally (e.g., public sector, SOEs, cons- The 2015 Systematic Country Diagnostic truction, retail, local transportation). Althou- (SCD) identified the need to rebalance BiH’s gh these sectors have produced new jobs in economy in three dimensions. This update takes recent years, those jobs are often poorly paid stock of progress and argues that, although some and provide limited opportunities to leverage reforms have been initiated, progress has been the talent of BiH youth. well below expectations and that, to a large ex- To achieve higher, sustainable, equitable tent, the challenges identified in the 2015 SCD for growth, interventions will be needed in four BiH remain valid. areas: (i) rebalancing growth, (ii) investments 1. BiH must move from growth driven by public in physical capital, (iii) stronger human cap- sector spending to growth led by private sector ital, and (iv) natural resources management competitiveness and productivity. The public (Figure ES1). The challenges and opportunities sector is too large (often crowding out the pri- identified to reduce poverty and achieve shared vate sector) and often not efficient. Meanwhi- prosperity in the 2015 SCD (World Bank 2015) for le, although some companies in BiH have BiH are similar to those identified in this update. demonstrated ability to compete in global The public sector and consumption continue to arenas, the overall private sector is small and drive growth, and the country has seen only a uncompetitive, often hampered by a difficult slight shift in its orientation to the outside. The business environment, a small and shrinking complex institutional structure prevents decisive labor force, and infrastructure deficiencies. action in implementation of needed reforms, and concerns about the effect of demographic trends 2. BiH must move from an economy based on on the country’s development have increased. Ef- consumption to one based on investment. forts will be needed to achieve equitable growth. Consumption has contributed to economic Poverty increased after the global financial crisis, growth but has been largely fueled by remit- and inequality remains unchanged. A large share tances. Investment is essential to sustaining of the labor force is active in the informal sector. growth and increasing the potential of BiH’s Youth unemployment is high, and women have economy to create shared prosperity, more limited economic opportunities. BiH’s energy opportunities, and better jobs, but uncertain- sector depends heavily on coal, and that depen- ty, bureaucracy, and often unfair competition dence is likely to increase, raising concerns about from state-owned enterprises (SOEs) has sti- sustainability of growth. The previous SCD cate- fled investment. gorized priorities according to the likelihood that 3. BiH must move from an inward-looking eco- they would support the SCD objectives. In this up- nomy to an export-driven one. Its economy date, to clarify what interventions are needed, pri- and population are comparable in size with orities have been grouped according to the need 10 EXECUTIVE SUMMARY FIGURE ES.1: AREAS WHERE INTERVENTIONS ARE NEEDED TO ACHIEVE SUSTAINABLE, EQUITABLE GROWTH IN BOSNIA AND HERZEGOVINA Maintaining macro stability Rebalancing the Strengthening Investing in Managing natural economy human capital and physical capital assets for basic services prosperity • Trade • Education and skills • Transport • Agriculture and Land • Foreign Direct • Health • Information and Reform Investment • Social Assistance Communications • Forestry • Competition • Water and sanitation Technology • Climate change and Air • Taxes • Energy pollution • Business environment • Labor market policies • Access to nance to rebalance growth and improve management of ternational arenas. BiH’s professionals and trade the country’s assets to generate income (physical, workers are in demand in advanced economies, human, natural capital): (i) rebalancing growth where they excel in a wide range of sectors, but along the dimensions mentioned in the previous at home, an unnecessarily cumbersome business paragraph, with greater reliance on the private environment characterized by costly, time-con- sector and exports, (ii) larger, more efficient in- suming administrative processes of numerous vestment in physical capital, (iii) improvements in government agencies constrains companies. human capital and basic services, including man- These constraints limit the competitiveness of aging the additional challenges of ongoing demo- firms, discourage entrepreneurs from entering graphic changes; and (iv) managing natural assets the market, and encourage participation in the in- for prosperity, all discussed below. Underpinning formal economy. Unleashing the potential of the these core objectives is the need to preserve mac- private sector will require a change in the focus of ro stability, which is imperative to address the authorities from regulating and controlling firms structural bottlenecks identified in this update. to encouraging their growth. A more competitive Maintaining a strong focus on macro stability will private sector will also create more and better pri- also be instrumental in navigating the rising un- vate sector jobs, meeting the desires of citizens certainties over the near to medium term. for better employment and creating incentives for people, particularly youth, to stay in BiH. Rebalancing growth: pivoting to private in- vestments and exports. Some companies in BiH Investing in physical capital. Well-priori- have been able to thrive in highly competitive in- tized investments in enabling infrastructure will 11 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE be needed to increase connectivity and provide capital accumulation. Disadvantaged and low-in- public services. Deficiencies in infrastructure for come students are particularly vulnerable, as connectivity undermine the competitiveness of they may have a harder time coping with remote the economy. Energy production remains depen- learning strategies and are more likely to drop dent on highly polluting coal, and the potential out at the secondary and tertiary education lev- for cleaner, cost-effective renewable energy is not els. School closings also increase the burden on being tapped. Insufficient investment in facilities parents who need to stay home or make childcare and their operations has limited the quality, cov- arrangements, decreasing the labor supply. Over- erage, and sustainability of public services. De- coming these challenges will require managed ficiencies in digital connectivity limit the private continuity of services, including through further sector and communities. The government collects digitalization of learning, support for teachers to extensive revenues through taxes, but not enough deliver quality instruction, and greater flexibility is put back into the economy. Strategic, well-pri- in curricula and organization of instruction. oritized use of existing resources would address Managing natural assets for prosperity. By many existing investment gaps. better leveraging its natural resources, BiH can Strengthening human capital and basic help create opportunities for its population while services. Improving healthcare and education is enhancing environmental sustainability. BiH has essential for supporting productive lives for peo- valuable natural resources, from some of the ple in BiH. Human capital is being lost even for most pristine forests in Europe to very fertile land. those who stay in BiH, with close to 40 percent of Forestry and agriculture have been major sources the lifetime productivity of people in BiH lost be- of employment and contributed substantially to cause of deficiencies in healthcare and education. the economy, but BiH’s exports have been limited The quality of healthcare services is lower than to low-value-added products, from raw timber to in other countries that spend less. In education, generic crops, and the jobs in these sectors fre- deficiencies result in a large gap between skills quently offer low wages and limited long-term and competencies in demand in the labor market prospects. Better leveraging of natural resourc- and those taught at schools. Inefficient spending, es will require upgrading production processes, including on large numbers of nonteaching staff moving up value chains, and developing enabling at schools and administrative staff at hospitals, infrastructure. Poor environmental management limits the quality of education and healthcare. can have serious health and economic effects, Healthcare and educational reforms are possible which are most visible in very high levels of air by focusing on governance, quality of services, pollution and their damage to health. Climate and relevance of programs. The COVID-19 pan- change is damaging BiH’s economy and is predict- demic is placing an already fragile healthcare sec- ed to affect the country significantly in the future, tor under considerable additional strain, particu- primarily through the agricultural, water, and hy- larly in maintaining essential community services dropower sectors. while responding to the surge of coronavirus-re- The objective of this update of the 2015 SCD lated cases and minimizing risks for patients and is to increase the World Bank’s understanding healthcare personnel. Widespread school clo- of how to most effectively and sustainably re- sures in response to the pandemic will also lead duce poverty and boost share prosperity in to learning loss, posing long-term risks to human 12 EXECUTIVE SUMMARY TABLE ES.1: SUMMARY OF REFORM PRIORITIES Rebalancing growth, pivoting to private investments and exports for growth Putting BiH to work: reforming the labor market, reducing the cost of labor, increasing social protection Making it easier to do business: improving competitiveness, entrepreneurship, and the investment climate; maintaining financial stability and expanding access to finance Creating an efficient and effective public sector: reducing the size of the public sector including state-owned enterprises, while ensuring fiscal sustainability and improving public service delivery Investing in physical capital Investing in economic infrastructure for growth and inclusion: powering and connecting BiH to the world Strengthening human capital and basic services Boosting brains: improving education services and labor market skills Supporting healthy lives: improving healthcare services and sustainability of healthcare system Managing demographic change: adapting to and mitigating effects of aging, shrinking population Managing natural assets for prosperity Cleaning BiH: reducing pollution and protecting the environment Better leveraging natural resources for growth: agriculture and forestry Building resilience: helping BiH cope with adverse natural events BiH. SCDs focus on what is most important for a in BiH and have productive lives. Second, risks to country’s development agenda, discussing op- BiH’s sustainable growth have evolved, with sig- portunities for and constraints on rapid, inclu- nificant risks related to the COVID-19 pandemic sive, sustainable growth and implementation of having recently emerged. Third, environmental identified reforms and interventions (Table ES.1). risks and their effects on lives and the economy SCDs also help foster candid dialogue between have become more prominent, so this update the World Bank Group and a country’s authorities analyses them separately from other vulnerabili- and inform the World Bank’s programing exercise ties. Fourth, this update has taken renewed stock by identifying priorities for engagement. Progress of knowledge and data gaps. One knowledge gap in addressing the constraints and seizing the op- that has closed since the BiH SCD was released portunities identified in the 2015 SCD has been is related to SOEs and better education outcome limited. Accordingly, the development agenda (in data, where the analytical bases are improving. terms of opportunities, constraints, and priorities) Recent analysis of SOEs has underpinned the re- in this update remains largely the same as in the newed emphasis in the Update on the role of the 2015 SCD, with four significant differences. First, public sector in the economy (See section I.C on demographic trends (an aging population and the state of economic transformation), and im- high outward migration) have created a greater provements in data on education outcomes have sense of urgency to develop opportunities and allowed for more precise identification of chal- improve quality of life (including better health- lenges in the sector (See section III.C on strength- care and education) so that people can remain ening human capital and basic services). 13 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE This update develops earlier findings and pri- orities, reviews progress, and employs new data and analyses. It is structured in four sec- tions. Section I describes BiH’s current situation, focusing on cross-cutting, foundational themes and distinct characteristics that could shape de- velopment outcomes. Section II describes current economic trends and key outcomes. Section III considers development constraints and how they can be overcome with respect to private sector– led growth, physical capital, human capital, and natural assets and their management. Section IV offers an updated set of priorities—developed in consultation with other stakeholders—to chart a path for strong, lasting, inclusive growth. 14 15 I. Country Context: Where Is Bosnia and Herzegovina Today? Five years have passed since the first Systematic Country Diagnostic (SCD), and there has been limited progress in overcoming the identified obstacles to growth and shared prosperity. Fundamental obstacles that held Bosnia and Herzegovina (BiH) back then are still present: the country’s unique institutional setup and resulting governance challenges, demographic decline, and the unfinished economic transformation. The obstacles are difficult, but they are surmountable if there is enough commitment to overcoming them. The European Union (EU) accession process could have been better leveraged as an anchor for comprehensive reforms. BiH has a cumbersome institutional structure. A. Unwieldy Institutions The constitution created a highly decentralized and Inefficient Public country with a Council of Ministers at the central Administration level (often referred to as “the State” level). It de- lineated a governmental structure comprised of two Entities: the Federation of Bosnia and Herze- BiH’s complex, fragmented institutional govina (FBiH) and Republika Srpska (RS). FBiH has structure has reduced the quality of gover- 10 cantons each with its own government, and 79 nance; the efficiency and accountability of municipalities, while RS has 63 municipalities. Fi- the public sector; and the efficacy of policies. BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE nally, the constitutional architecture also includes limit accountability to citizens. Inefficient spend- the autonomous Brcko District. This structure ing also restricts the effectiveness of the public is overlaid on a small country of only 3.2 million sector. A high wage bill because of the oversized people—less than the population of many Euro- public sector and limited public spending limit pean cities. Such an unwieldy institutional struc- the efficiency of spending and decrease citizen ture would be as heavy a burden for any country. satisfaction with services (Figure 2) (See section II for a detailed discussion of how public finances Despite the structural shortcomings, much have failed to contribute significantly to growth.) of the system’s dysfunction can be traced di- Lack of well-functioning, inclusive mechanisms rectly or indirectly to a lack of political will. for public-private dialogue means that many seg- Highly complex systems of power-sharing can ments of society do not have a way to express work if certain norms prevail, such as a common their views, decreasing trust in institutions (Ap- commitment to maintaining the system, a coop- pendix A) (Balkan Barometer 2019). erative culture, etc. Goodwill and resolution could help to overcome the structural problems, but po- Deficiencies in the business environment im- litical agreement and cooperation have been dif- pede the potential of the private sector. Creat- ficult to broker. Decision-making is characterized ing a business environment conducive to growth is by lengthy deliberative and legislative procedures a critical responsibility of government. Many of the fraught with bargaining and uncertainty. Some countries in the region have renewed efforts to im- of the costliest consequences of this institutional prove the business environment, but authorities in structure have been insufficient progress in trans- BiH have failed to achieve significant results. BiH forming the economy, slower progress toward Eu- is one of the most difficult jurisdictions in Europe ropean accession than its neighbors, and an unfa- in which to do business because of unnecessarily vorable environment for businesses. cumbersome regulatory and administrative pro- cesses. This undermines entrepreneurship, en- The public administration is overstaffed, un- courages participation in the informal economy der resourced, and unaccountable. and corruption, and unnecessarily increases costs for the private sector. Deficiencies stem from a Public administration suffers from inefficient multiplicity of regulatory processes (e.g., the more spending, limited skills, and lack of account- than 700 licenses and permits that businesses may ability. Deficiencies in human resources stem- be required to acquire to operate) and lack of con- ming from hiring practices under which patron- sistency in application of laws and regulations. age can supersede professional qualifications There are only six countries in the world where it and merit limit the effectiveness of public ad- is more difficult to register a new business than in ministration (Figure 1) (SIGMA 2017; EC 2019; BiH (World Bank 2019a). (See section III.A on re- BTI 2018). Deficiencies in performance manage- balancing growth for a detailed discussion of the ment systems in public institutions—including business environment.) professional goal setting, rewards, promotions, disciplinary measures, and training—undermine Digitalization of administrative processes the responsiveness and accountability of public can help improve relationships between gov- servants. Unclear reporting lines between minis- ernment institutions, the business sector, and tries and other government institutions and du- citizens. Many countries in the region have mi- plication of functions dilute responsibilities and grated face-to-face interactions between citizens 16 I. COUNTRY CONTEXT: WHERE IS BOSNIA AND HERZEGOVINA TODAY? FIGURE 1. GOVERNMENT EFFECTIVENESS AND ACCOUNTABILITY LIES BELOW BENCHMARKS (Effectiveness) (Voice and Accountability) 1.5 1.2 1 1 0.8 0.5 0.6 0.4 0 0.2 -0.5 0 -0.2 -1 BiH WB6 STEE7 EU28 BiH WB6 STEE7 EU28 (w/o BiH) (w/o BiH) Source: WGI 2019. FIGURE 2: SATISFACTION WITH PUBLIC FIGURE 3: POLITICAL INSTABILITY IS THE MOST SERVICES IS LOW RELATIVE TO SPENDING IMPORTANT CONSTRAIN TO INVEST IN BIH. LEVELS. (Ranking of top business environment obstacles for firms) (Percent of respondents satisfied with quality and efficiency of public service delivery) 90 quality and e ciency of public service delivery), Political instability LITS (Percent of respondents satis ed with Tax rates 80 EST Informal competitors Poorly educated workers LVA SVK SVN simple average, 2016 70 Tax administration LTU Corruption BGR HRV Transport 60 KSV Electricity Licensing and permits 50 ALB SRB MNE Crime, theft and disorder MKD BIH Customs & trade regulations Access to nance 40 Courts Labor regulations 30 Access to land 20 25 30 35 40 45 50 0 5 10 15 20 25 General government expenditures to GDP (percent), Percentage of rms average 2012 to 2016 Source: EBRD LITS III, IMF WEO and WB staff estimates. Source: Enterprise Survey 2019. and authorities to online platforms, which reduc- Political instability reduces domestic and es time and money spent on administrative pro- foreign investment in the country. Uncertainty cesses, eliminates duplication of steps, removes associated with an unstable political environment opportunities for rent-seeking, and expedites re- can reduce investment and the pace of economic sponses. In BiH, attempts have been made to dig- development. In BiH, firms have identified politi- italize by providing one-stop shopping for busi- cal instability as the most important constraint on ness registration, but progress has been much investing in the country (Figure 3). Long delays slower than expected. in forming a government after elections in Octo- ber 2018 slowed much-needed reforms. Political 17 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE squabbling creates a negative perception of the The complex institutional and procedural frame- country, which undermines its attractiveness as work in BiH reduces the judiciary’s efficiency and a destination for foreign direct investment (FDI) fairness.1 As a consequence, trust in the indepen- because international investors seek political sta- dence of the judiciary is low and decreasing,2 and bility when deciding on investment destinations. deficiencies in the judiciary create significant (MIGA 2011). costs for businesses.3 Deficiencies in public financial manage- ment undermine the effectiveness of public ex- B. Demographic Change penditures. Public financial management (PFM) systems are important because they allow gov- BiH is rapidly losing its human capital, ar- ernments to translate policies into public goods guably its greatest asset. and services. Weak PFM systems constrain gov- Demographic trends are at the core of the de- ernments’ ability to provide good-quality public velopment challenges for BiH, which faces sev- services. Such systems in BiH are inadequate, and eral demographic trends that pose a significant laws are poorly implemented (EC 2019). Public threat to its ability to grow. These trends include finance and budget planning are weak, despite rapid outward migration, a rapidly aging popu- some improvements in the legislative framework. lation, a declining birth rate, and loss of human The public investment management system is capital due to deficiencies in healthcare and ed- poor, with limited links between budgets, invest- ucation. By 2050, BiH’s population is projected ment plans, and strategies at all government to drop by approximately 20 percent, from 3.2 levels. Procedural integration, data consolida- million to about 2.7 million, with approximate- tion, and auditing are weak. There is no strategic ly 30 percent of citizens being of retirement age. framework for public administration reform and Migration can also bring opportunities to BiH, in PFM for reform implementation, which could limit the form of remittances (8 percent of GDP) that BiH’s ability to benefit from EU support. can finance investment and a diaspora that can Deficiencies in the judiciary limit access to bring FDI, new skills, and knowledge. To be able justice to individuals and harm the business to realize this opportunity, BiH needs a conducive environment. Judicial institutions are vital to the business environment, but as discussed in the development of any country because they play a previous section, it has the worst business envi- critical role in fostering a healthy business envi- ronment in the Western Balkans. ronment, enhancing growth, increasing access to Half of BiH’s population has emigrated and public services (particularly for the poor), curb- it is likely that this trend will continue. Its peo- ing corruption, restraining abuse of power, and ple are highly talented, entrepreneurial, and hard- protecting individuals’ rights (World Bank 2017). 1 There are four sets of procedural rules in civil, criminal, and administrative matters for the courts and prosecutors’ offices covering the state, FBiH and RS, and Brcko District. Elements of judicial power (High Judicial and Prosecutorial Council and state-level court system) are not explicitly mentioned in the constitution, and there is no supreme judicial body with countrywide jurisdiction. This results in inconsistent case law and legal interpretations across the four levels (EC 2019). 2 A World Economic Forum index assessed the independence of BiH’s judiciary to be 2.2 (out of a maximum score of 7) and deteriorating. 3 It takes more than 900 days to settle claims through courts, at a cost of 36 percent of the claim value on average (World Bank 2019a). 18 I. COUNTRY CONTEXT: WHERE IS BOSNIA AND HERZEGOVINA TODAY? FIGURE 4: BIH AMONG THE HIGHEST FIGURE 5: MANY HAVE LEFT BIH POPULATION OF EMIGRANTS IN THE WORLD (Net migration per 1,000 population) (stock of emigrants) 60 ATG 10 Emigrants ( percent of population), 2019 50 BiH 0 -10 ALB 40 BRB JAM SYC -20 CPVARM MKD -30 30 TUV MDA SLV FJI MNE PRT MLT HRV TTO -40 GEO NRU BGR KAZ LTU 1980 -1985 1985 -1990 1990 -1995 1995 -2000 2000 -2005 2005 -2010 2010 -2015 2015 -2020 20 FSM STP BLZ URY ROU LVA CYPABW CAFLSO BLR MUS EST NZL EU COM AFG UKR LBN PLW DOM PRY SRB BHS POL 10 NIC SWZ MEX GNQ GRC HNDGTM NPL JOR LKA RUS HUNSVK CZE SVN GMB BTN COL MYS AUT NLD ITA GBR BEL DEU BGD COG PHL DZA ISR DNK TLS EGY AGO MNG BWA CRI GAB ARG CHLTUR PAN ESP FRABHR CAN AUS SAU COD TCD ETH NGAIND IDN BRACHN IRN OMN JPN 0 ALB BiH MNE 0 10.000 20.000 30.000 40.000 50.000 MKD SRB + KOS GDP per capita, PPP, 2018 (constant 2011 international $) Source: UN DESA 2019, WDI and WB staff calculations. Source: UN DESA 2019 and WB staff calculations. working, and as such, they are the most important experienced professionals—especially medical asset that the country has. Unfortunately, this po- professionals—also migrate. Most emigrants leave tential is often realized outside of the country as for Europe. In 2016 alone, 80,000 BiH citizens ob- half of the people from BiH already live overseas tained permits to work in EU countries. Germany (Figure 4)4 and the flow of migration continues and Austria together host over 436,000 BiH citi- (Figure 5). There is no simple solution to stem- zens. BiH’s neighbors—Croatia, Serbia, and Slove- ming the flow of emigration. As long as people in nia—also host large expatriate populations. BiH feel that the country cannot offer them ad- The population that remains in the country equate opportunities and quality of life for their is rapidly aging. Since 2015, BiH has had more families, emigration will continue (See Box 1). people aged 65 and older than younger than 15 Emigration is most prevalent among the (Figure 6). This trend is projected to worsen as young, working-age population. BiH’s emigra- births continue to fall. The number of births per tion is the highest in the region. Of those who left year has fallen by half since the end of the war, BiH in 2018, 30 percent were aged 18 to 35. The and the fertility rate 5 is 1.39, the lowest in the re- two ends of the educational spectrum—low and gion and one of the world’s 10 lowest. High emi- high—migrate in the largest numbers. The less gration rates of young people, who are most likely educated often have construction, mechanical, or to have children, compound this low fertility. This electrical skills, and they leave in such high num- has significant consequences for labor markets bers that shortages are emerging. Many more-ed- because fewer working-age people will have to ucated people leave straight after university, but support a higher burden of pensions (Figure 7). 4 An estimated 1.7 million people born in BiH live outside the country, equivalent to 48 percent of the remaining population (UN DESA 2017). 5 Children born or expected to be born to a woman during her lifetime. A rate of 2.1 is the replacement rate to maintain a stable population. 19 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE FIGURE 6: BIH’S POPULATION FIGURE 7: THE WORKING AGE IS AGING AND SHRINKING POPULATION IS DECLINING (Population, millions) (Working age population index, 2012=100) 5 105 4 100 3 95 2 1 90 - 85 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2012 2013 2014 2015 2016 2017 2018 KOS BIH MKD Total population 0- 14 MNE SRB ALB 15-64 65+ Source: UN DESA 2019 and WB staff calculations. Source: LFS 2018 and WB staff estimates. Similarly, this affects public spending (more on important shifts are necessary to restore balance: healthcare, less on education) and provision of moving from an economy led by the government public services (more lifelong learning and health- to one led by the private sector, changing the fo- care for older adults, less child healthcare and cus of growth from an inward orientation to an primary education). The rapid emigration could outward orientation, and moving from economic hollow BiH’s labor force and, given that emigrants growth based on consumption to growth based tend to be relatively highly skilled workers, may on investment. The need for this transformation further reduce already low productivity. is widely recognized, and there have been some attempts to move in that direction, but results of these efforts have fallen short. C. Stalled Reforms and Lack of Economic The first transformation needed: moving Transformation from government-led growth to a private sec- tor–driven economy. The public sector is a signif- icant source of jobs in the country (~29 percent of Transformation is stalled and outcomes are all workers). Such a large public sector is a drag unpredictable on the economy because it is costly and inefficient Unleashing the potential of BiH requires deep and shifts scarce resources away from more-pro- transformation in three main areas. As dis- ductive uses. State-owned enterprises (SOEs) are cussed in the previous SCD for BiH, the economy large employers and dominate many segments is out of balance in three important ways: the of the economy, including economic activities in public sector has an oversized role; consump- which government ownership does not seem to tion has driven growth, which has implications be justified (Figure 8). SOEs are highly inefficient, for sustainability; and the economy is not well consume budgetary resources that could be better integrated with regional or global markets. Three used in improving public services, have an aggre- 20 I. COUNTRY CONTEXT: WHERE IS BOSNIA AND HERZEGOVINA TODAY? BOX 1. FACTORS CONTRIBUTING TO EMIGRATION A 2018 Gallup poll found that 32 percent of BiH citizens were willing to emigrate and even more so for highly educated and young people, of whom more than half wanted to emigrate. The push factors. Unemployment is the greatest concern of people in BiH (Balkan Barometer 2019), which has among the top 10 highest rates of youth unemployment (World Development Indicators). Other factors are at play as well, with citizens concerned about the overall economic situation, crime, and corruption (Balkan Barometer 2019). Not only unemployed people leave. Many people with comparatively well-paying jobs reportedly leave the country in search of better living conditions for their families, including better healthcare, education, and environmental conditions. Political instability, distrust of institutions, inequality, institutional corruption, and lack of a sense of direction for the country also play a role in people’s decisions to emigrate (Figure B1.1).6 The pull factors. Wages in many EU countries are more than three times higher than in in BiH (SEE Jobs Gateway and OECD). The migration of healthcare professionals to Germany illustrates the pull of economic opportunity and wage differentials. Recent estimates project that Germany will employ 500,000 new nurses by 2030, and one of every six doctors trained in BiH is working in Germany. This is a substantial drain on the state, which spends approximately €150,000 to train a doctor and is unable to recover this investment because migrating doctors do not pay taxes in BiH. F I G U R E B 1 . 1 : OT H E R FACTO RS A PA RT F R O M U N E M P LOY M E N T P L AY A R O L E I N T H E D E C I S I O N TO EMIGRATE (2018 Balkan public sentiment index — Expectation index) 70 64 59 56 60 53 51 50 36 40 30 20 10 0 KOS SRB ALB MNE MKD BiH Source: Balkan Barometer 2019. Note: The index (range 0–100) is based on five perception questions and measures the current situation and future expectations regarding the general and economic situation and the individual situation of households. 6 6 Views expressed in consultations with private sector and civil society held during preparation of this report. 21 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE gate negative effect on the economy, and crowd Private investment is much lower (Figure 11) than out the private sector. BiH forgoes up to 3 percent in other countries in the region. FDI inflows have of GDP in potential income every year because of also been lower than in peers, but most impor- inefficiencies in the SOE sector (IMF 2019a). tantly, much of the investment that has reached the country is concentrated in sectors that do The second transformation needed: from an not necessarily contribute to sustainable, shared economy driven by consumption to one driv- growth or better jobs. Attracting and retaining in- en by investment. The share of consumption in vestment will require eliminating the numerous BiH’s GDP is one of the highest in the world. Con- hurdles in the business environment, reducing sumption (public and private) is the main driver of political instability, and leveraging the human growth (Figure 9) —so much so that growth is not capital remaining in the country better. sustainable. Conversely, investment levels remain low, at just above 18 percent of GDP (Figure 10). BOX 2. STATE-OWNED ENTERPRISES IN BOSNIA AND HERZEGOVINA State-owned enterprises (SOEs) have a larger footprint in Bosnia and Herzegovina (BiH) than in any other Western Balkan and most European and Central Asian countries. There are at least 550 SOEs in BiH, in almost all sectors and markets, but they are dominant in energy, mining, telecommunications, transportation, and utilities. Most are small and medium-sized municipal utilities, but entity-owned SOEs have the largest operations and account for most SOE employment. SOEs account for approximately 11 percent of employment and own 40 percent of fixed assets. They distort labor markets because average salaries are 40 percent higher than in the private sector, despite low productivity—less than half of the EU level. Addressing SOE sector governance is of paramount importance given the sector’s growing financial troubles and negative effects on society and the economy. The poor performance of SOEs affects the government’s ability to deliver on several of its key objectives and will continue to affect these objectives in the absence of reform: Fiscal sustainability: Most public companies, at all levels of government, lose money, and their debts are currently at €4 billion (26 percent of GDP). It is estimated that arrears on tax and social security contributions of SOEs are more than €600 million. Almost half of the companies are illiquid, and up to 15 percent are insolvent. By conservative estimates, direct and indirect financial support for SOEs at all government levels costs 5 percent of GDP each year, creating enormous fiscal pressure. Productivity and growth: SOEs, including those in commercial sectors, have low productivity (on average less than half of EU levels) and negative return on capital. The sector’s negative return on equity reduces BiH’s GDP by up to 3 percent and retards growth. This does not account for the additional loss in GDP due to crowding out of productive public investments as a result of continued financial support for struggling commercial SOEs. Private sector development and job creation: Public companies’ special access to financial and nonfinancial government support, despite their low return on equity and labor productivity, distorts markets and weakens the competitiveness and job creation potential of the private sector. 22 I. COUNTRY CONTEXT: WHERE IS BOSNIA AND HERZEGOVINA TODAY? BOX 2. Service delivery: The quality of basic public services that SOEs provide is poor, especially at the local level, and their large tax and social contribution arrears (4 percent of GDP in 2018) undermine the sustainability of other public service providers, such as pension and healthcare funds. Citizen satisfaction with public services—many of which SOEs provide—is the lowest in the region. BiH needs a systematic approach to SOE management that includes • Defining goals and criteria for ownership of companies: The rationale for public ownership of companies is not clearly defined. Similarly, they have no stated objectives or performance indicators, which significantly limits the potential to conduct oversight and assess performance. • Establishing fundamentals: Institutional arrangements and regulations will need to be refined to provide clarity in ownership and oversight. Updating laws on concessions and public-private partnerships will enable private investment in some sectors. Governance of SOEs will need to be strengthened, including mechanisms for appointments of independent board members. • Instituting subsidies and hard budget constraint: Hard budget constraints will be required to introduce incentives for efficiency and financial responsibility. Subsidies should be conditional on delivery of certain predefined public services in an open and transparent way. No longer tolerating SOE arrears will be critical as part of enhancing financial sustainability. • Developing policy options for SOEs with different profiles and sustainability: Companies with different combinations of profitability and relevance will require different policy approaches. For example, as shown to the right, companies that are relevant and profitable can be strengthened through corporate governance reforms and performance contracts, and those that are relevant but not profitable can undergo comprehensive restructuring to strengthen their financial and operational discipline and performance. Profit-generating Loss-making Relevant Strengthen Restructure Not Relevant Open to competition Phase out Source : IMF 2019a. 23 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE FIGURE 8: THE SOE FOOTPRINT IS THE FIGURE 9: CONSUMPTION IS THE MAIN LARGEST AMONG ALL WESTERN BALKAN AND DRIVER OF GROWTH MOST ECA COUNTRIES (Factors in Real GDP Growth, 2019e) (SOE Assets, percent of GDP, 2016) 120 6 5 100 4 3 80 2 60 1 0 40 -1 -2 20 -3 ALB BiH KOS MKD MNE SRB WB6 0 Consumption Investment POL ROU RUS CZE MDA HUN SRB HRV KOS EST BGR BIH UKR SVK LTU LVA Net exports Real GDP growth (%) Source: IMF 2019. Source: National statistical office data; World Bank staff esti- mates FIGURE 10: INVESTMENT HAS FAILED TO FIGURE 11: PRIVATE INVESTMENTS REMAIN RECOVER AND LIES BELOW BENCHMARKS BELOW TWO-THIRDS OF TOTAL INVESTMENT (Gross fixed capital formation, percent of GDP) (Private Investment, share of total investment) 40 90 35 WB5 UMC average (2015-18) 85 30 80 Growth Commission benchmark 25 75 20 70 15 65 60 10 BIH 55 5 50 0 45 KOS MNE ALB MKD BIH SRB WB6 STEE7 40 2000-2008 2009-2015 2015-2018 2000 2005 2010 2015 Source: WDI and WB staff estimates. Source: WDI and WB staff estimates. 24 I. COUNTRY CONTEXT: WHERE IS BOSNIA AND HERZEGOVINA TODAY? FIGURE 12: UPGRADING TO HIGHER CONTENT OF HIGH TECHNOLOGY AND SKILL CONTENT IS O N LY S T A R T I N G (Manufacture exports by level of skill (BiH export composition) and technology intensity, 2018) 100% 100 80% 60% 40% 50 20% 0% 0 MNE MKD 7STEE WB5 HRV SVN BGR EST LTU BIH ALB SRB SVK LVA 2010 2015 2019 Metals Minerals Msc. Manufactures Labour & resource-intensive + low-skill and technology-intensive Machinery Wood and Manuf. Chemicals Medium-skill and technology-intensive Footwear High-skill and technology-intensive Source: UNCTAD and WB staff calculations. Source: BiH Central Bank. The third transformation needed: moving BiH’s accession to the EU has lagged behind from an inward-oriented to an outward-orient- that of its neighbors. BiH is looking towards an ed economy. Although many countries in the re- EU future and has taken important steps towards gion have striven to enhance exports and improve this aspiration, but progress is required in several value addition, BiH still exports a high proportion areas to reach compliance with EU standards (Fig- of low-value-added products and raw materials ure 13). In its opinion issued in May 2019, the Eu- (Figure 12). These trends are a stark reflection ropean Commission (EC) argued that much work of the overall competitiveness of the private sec- remains to be done, especially on guaranteeing tor in BiH, and they matter because only through democracy, the rule of law, and stability of insti- higher-value-added production can the country tutions and reducing state presence in the econo- create the better jobs that the population desires my, deemed “still disproportionate.” The predom- and needs. inant message is that BiH’s fragmented politics undermine consistent, nationwide policymaking. The EC rates BiH as “moderately prepared” on D. EU Accession: A Long only two of the 35 chapters that must be complet- Road Ahead ed before a country can accede to the EU. Despite the alleged broad commitment of BiH politicians, The EU accession process could be a strong the political will to institute the wide-ranging re- catalyst for reforms and institutional upgra- forms needed seems to be lacking. The EC laid out ding, but limited progress in implementing a detailed list of fundamental shortcomings and reforms affects EU accession prospects. recommendations for reforms (Appendix B) and a 25 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE F I G U R E 1 3 : B I H H A S O N E O F T H E LOW E ST L E V E LS O F P R E PA R E D N E SS FO R ACC E SS I O N I N T H E REGION (Preparedness for Accession: Government effectiveness and regulatory quality, and politics and rule of law) 0.40 MKD Peers at accession Government E ectiveness and MNE 0.20 Regulatory Quality ALB SRB WB6 0.00 -0.4 -0.3 -0.2 -0.1 0.0 0.1 0.2 0.3 0.4 -0.20 KOS BiH -0.40 Politics and Rule of Law S ource : WGI 2017 diagnosis of what is constraining progress in BiH, and its recommendations are largely aligned with those of this report. 26 27 II. Economic trends: Growth and Jobs, Public Finances, Poverty and Shared Prosperity BiH has maintained macro stability with relatively low inflation and reasonable levels of public debt, but its growth model is unsustainable, with high reliance on consump- tion. Economic growth is well below what is needed for BiH to achieve higher living standards. Despite some rebalancing in recent years, economic policies discourage private initiative and investment, and the economy is inward looking. Poverty reduc- tion has stalled, and many people do not have formal employment—or any job at all. Unemployment has become an even higher concern to the population, creating incentives for people to leave in search of better opportunities elsewhere. policy mix conducive to growth. Its currency A. Strong, sustainable board has provided a credible basis for monetary economic growth is yet stability and low inflation, supported by prudent to be established fiscal policies. General government debt has been kept at sustainable levels, and fiscal balances have been strong, but the overall size of the fiscal To maintain macroeconomic stability, BiH sector is large—especially compared with those of needs to continue to establish an economic countries with similar per-capita incomes in other BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE FIGURE 14: GROWTH HAS STABILIZED BUT IT FIGURE 15: BIH HAS A LONG JOURNEY TO CATCH REMAINS BELOW PRE-CRISIS RATES UP TO EU INCOME LEVELS. (GDP growth rate, annual percentage) (GDP per capita relative to EU, international 2011 PPP dollars) 10 100 8 6 50 4 2 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 1995 2000 2005 2010 2015 2 7 12 17 22 27 32 37 42 47 52 57 62 67 72 77 82 87 92 97 102 107 -2 -4 BiH@3.4% (mediangrowth rate 2009-18) BiH@3% BiH@5% Source: WDI and WB staff estimates. Source: WDI and WB staff estimates. parts of the world—and fiscal risks are high. There (Figure 15). If growth accelerates and is sustained is ample scope to improve the quality and effec- at approximately 5 percent (as before the global tiveness of spending while lowering the level of financial crisis), convergence with the EU income expenditure to GDP. High taxes have constrained level could be achieved in three decades. growth by reducing private sector incentives and Consumption has driven growth, and low in- the level of formality in the economy. vestment and exports have constrained it. The BiH’s economy has been growing but not at contribution of consumption to growth started to a rapid enough pace to create the living stan- fall in 2017 as a result of reduced household and dards that the population desires. Real GDP government consumption. The investment rate has risen more than 3 percent annually since fell from 22 percent of GDP during the precrisis 2015—lower than the pre global financial crisis years to just above 18 percent after the crisis. In- rate of 5.6 percent (Figure 14). This is especially vestment rates fell similarly in other countries in troubling because BiH started from a low base the region but have recovered since, not so in BiH. after the disintegration of Yugoslavia, and out- The composition of investment in BiH also seems put declined an estimated 80 percent between to be tilted toward the public sector. In 2015, the 1989 and 1995 because of the war. BiH per capita private share of total investments in BiH was more GDP is one-third of the EU average. Although the than 10 percentage points below that of its peers. economy has been growing in recent years, at its The share of exports in GDP has increased from current pace it would take more than 100 years approximately 30 percent during the slump to 37 for BiH to achieve the EU’s average income level percent on average from 2013 to 2018. 28 II. ECONOMIC TRENDS: GROWTH AND JOBS, PUBLIC FINANCES, POVERTY AND SHARED PROSPERITY F I G U R E 1 6 : LOW I N V E ST M E N T A N D L A B O R FO R C E PA RT I C I PAT I O N A R E CO N ST RA I N I N G G R OW T H (Contributions to growth, percentage points) 7 5 3 1 -1 -3 -5 2000 -18 2000 -08 2009 -12 2013 -18 TFP K/Y HC P+L Source: WDI and WB staff estimates. Note : TFP, K/Y, HC and P+L represent contributions of total factor productivity growth, capital deepening, human capital growth and the joint effect of changes in population and labor force participation respectively. Higher investment, greater productivity, B. Public finances have and greater labor force participation will be needed to accelerate growth. Human capital not contributed has added an average 1.6 percentage points to enough to promoting growth since 2000 (Figure 16). Total factor pro- ductivity has contributed 1.1 percentage points sustainable growth annually, with the weakest effect from capital and equity. deepening. Limited labor force participation has constrained growth. To accelerate growth, great- BiH has among the highest revenues as a share er productivity, improvement in labor markets (to of GDP in the world. The government collects enable a larger share of the population to be eco- revenues at a much higher rate (44 percent of nomically active), and higher investment would GDP) than the averages of 35 percent in WB6 and be needed.7 Section III.A discusses how trade, FDI, 39 percent in STEE7 (Figure 17). This has contrib- an improved business environment, and innova- uted to positive fiscal indicators (sustainable fis- tion can help increase productivity, and section cal balances, declining general government debt), III.B discusses the need to improve the quality of but it is probably coming at the cost of stifling the infrastructure investments. economy. Recent estimates indicate that govern- ment revenues are higher than the country’s eco- nomic potential (Khwaja and Iyer 2013), in other 7 Reaching 5 percent annual growth would require an increase in total factor productivity of 3 percent (versus 2 percent in 2019) and that the investment rate reach 25 percent in the next 10 years. Labor markets could improve through expansion of participation in the labor force, especially for women. 29 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE FIGURE 17: BIH HAS ONE OF THE HIGHEST TABLE 1: SOCIAL SECURITY CONTRIBUTION REVENUE SHARES IN THE WORLD R AT E S A R E PA R T I C U L A R LY H I G H I N B I H (Revenue as percentage of GDP) 50 Social security Top individual Top corporate contributions standard rate income tax income tax Threshold total rate 40 Current (euro) rate rate VAT 30 ALB 35,672 20 15 23 27.9 20 BIH - FBiH 25,524 17 10 10 41.5 BIH - RS 25,524 17 10 10 33.0 KSV 30,000 18 10 10 10.0 10 MKD 32,462 18 10 18 27.0 MNE 18,000 21 9 11 33.8 0 SRB 68,099 20 15 15 37.8 WB6 average 34,960 19 11.5 14.5 29.7 HRV BIH SVN MNE SRB EST LTV BGR LTU ALB KOS STEE7 EU28 MKD WB6 SVK STEE7 average 21.3 17.1 26.14 37 EU28 average 21.5 21.5 38.4 36.7 2018 2012 Source: World Development Indicators and WB staff estimates. Source: National authorities’ data, Eurostat and WB staff esti- mates. FIGURE 18: GOVERNMENT SPENDING TO GDP IS ABOVE NORMS BY INCOME LEVEL (Expenditures as percentage of GDP, average 2016-2018) expenditure, 2016 - 18 (percent of GDP) 60 Average general government total 50 MNE BiH SRB 40 30 MKD KOS ALB 20 10 0 6 7 8 9 10 11 Ln GDP per capita 201 6 (PPP international dollars) Source: IMF WEO data and WB staff estimates. 30 II. ECONOMIC TRENDS: GROWTH AND JOBS, PUBLIC FINANCES, POVERTY AND SHARED PROSPERITY words, that high taxes are likely reducing growth. dates and duplication of functions, and lack of a Similarly, labor taxes are high, stifling entrepre- cohesive legal framework to serve as a consistent neurship, reducing employment, and forcing basis from which to provide services has harmed many into the informal sector. the quality of public utilities (See section III.C on strengthening human capital and basic services). Despite the high revenue collection public investment is low. BiH is not allocating enough Spending on social security is high and inef- resources to finance the capital investments that ficient. Pensions account for most social spend- the country requires. Deficiencies in connectivity ing, and there are three main shortcomings. First, within the country and with neighboring coun- efficiency: in BiH, pensions account for 10 percent tries and the EU hamper the country’s competi- of GDP, on par with the EU average (10.3 percent tiveness. Similarly, there are other areas where in 2016) but higher than in most former transition public investment is needed, including energy, countries. High pension spending is largely the as discussed in section III.B. Execution of public result of early retirements and large numbers of investment is poor, partly because high current people receiving disability or special pensions.8 spending (wages, pensions, transfers) crowds out Second, fairness: although one-third of all pen- public investment. sioners in BiH are younger than 65 (because of early retirement and special pensions), approx- A high proportion of taxes is used to cover imately 38 percent of elderly adults may not be government salaries. BiH’s public sector is large collecting any state pension at all. Third, sustain- in relation to its income level (Figure 18), which ability: each contributor supports more than 1.13 means that a high proportion of the taxes and rev- pensioners. This is one of the highest burdens per enues collected is used to cover salaries of pub- contributor in Europe. Low formal labor market lic servants. The public sector, with its multiple participation (itself exacerbated by high social layers, has an estimated 233,000 employees, and contributions) is partly responsible public sector wages account for 10.3 percent of GDP, compared with 8.9 percent in healthcare and Large arrears and SOEs create risks and 4.6 percent in education. undermine fiscal sustainability. Although over- all government debt has decreased (from 43.6 Money spent on public services has not im- percent of GDP in 2015 to 35.6 percent in 2018), proved their quality. Although significant re- significant fiscal risks arise from unmeasured sources are devoted to public services, more than off-budget liabilities and arrears and large liabil- in most other countries in Europe, the quality of ities of SOEs. The arrears in RS are mainly in the services provided is poor, with a high degree of healthcare sector—approximately 1.5 percent of dissatisfaction from citizens (see Figure 2). Many BiH GDP—whereas arrears in FBiH, mostly in can- countries are achieving similar satisfaction levels tons, are approximately 2.5 percent of BiH GDP, with lower spending levels. North Macedonia and mainly in unpaid pension and healthcare con- Albania, for example, are achieving a level of sat- tributions in SOEs. SOE liabilities are estimated isfaction in services delivery similar to that of BiH to be 26 percent of GDP (IMF 2019a) Many SOEs while spending much less than BiH. The absence are highly leveraged, and they will not be able to of central standards, poor interinstitutional coor- reduce debt without government support or bet- dination resulting from unclear institutional man- 8 Special pensions are provided to war veterans and survivors. 31 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE ter performance. Some with low liquidity rely on no pension, work-related rights, or health insur- short-run government support—implicit or ex- ance, and the jobs are mostly in agriculture or plicit. Their high employment levels are adding forestry and concentrated among people with to arrears, including to the social welfare system, primary education or less. Informality distorts and these will make privatization or restructuring the economy by creating a competitive disadvan- difficult. Without strong corrective action, these tage for formal firms and undermines growth be- growing fiscal risks threaten to undermine the cause the informal sector has lower investment public sector’s viability. and lower productivity. High informality also means that a few formal workers have to support Jobs are critical for people in BiH9 the rest of the population, which requires higher social security contributions, which further dis- Jobs are the main concern of the population in courages formal employment. BiH, and growth has not translated into more or better jobs. Unemployment is the most im- The public sector and SOEs may be crowd- portant problem for approximately 60 percent of ing out private firms from a limited talent pool. the population of BiH (Figure 19). An equally high It is estimated that the public sector and SOEs proportion of the population expects that their account for approximately one-third of employ- economic condition will deteriorate in the future ment in BiH—approximately 10 percentage points (Balkan Barometer 2019), a perspective that prob- higher than in the EU. Public sector jobs are high- ably contributes to decisions to emigrate in search ly sought after because they typically offer few- of better opportunities elsewhere. Although the er hours, better pay, and more job security than overall unemployment rate has decreased in BiH private sector ones, but they probably contribute in recent years, this is not due to job creation but to much less to the economic growth of the country. a decrease in the working-age population because In 2019, four out of five people preferred to work many have left the country. Consequently, BiH is in the public sector, a higher proportion than in the only country in the region where employment the rest of the Western Balkans (Balkan Barom- is still below pre-global financial crisis levels. eter 2019). The desire for public sector jobs de- prives the private sector of talent and skills that Although the labor force in BiH is shrinking are in high demand and underpin entrepreneurial because of demographic trends, much of the activities and growth prospects for firms. More- remaining labor remains underused. Many for- over, the interest in public sector jobs can cause mal jobs have been created in industries with very long-lasting damage as students place more em- low added value (restaurants, cafes, shops) and in phasis on seeking connections than on academ- micro enterprises, which have lower productivity ic attainment or economic relevance of studies and typically offer lower salaries and poorer ca- (Figure 20). As mentioned in the previous section, reer prospects than larger firms (See section III.A.). high public wages also decrease the efficiency of A large share of the working population public spending and ultimately its sustainability. works in the informal sector. The percentage of In the long term, overreliance on public sector people in informal jobs has remained constant— employment is fiscally unsustainable. approximately 25 percent. Informal workers have 9 Unless otherwise stated, labor market statistics reported are based on the 2018 Labor Force Survey (LFS). 32 II. ECONOMIC TRENDS: GROWTH AND JOBS, PUBLIC FINANCES, POVERTY AND SHARED PROSPERITY FIGURE 19: UNEMPLOYMENT IS THE MAIN FIGURE 20: POLITICAL CONNECTIONS ARE CONCERN IN BIH DEEMED THE MOST IMPORTANT FACTOR FOR SUCCESS (Top five concerns of people in BiH) (Percentage of individuals who think that political connections are the most important factor for success) 50 Brain drain / 13 45 emigration 40 Crime 22 35 30 Corruption 26 25 20 Economic situation 43 15 10 Unemployment 59 5 0 MKD BIH ALB CYP SRB XKX HUN GRC TUR BGR MNE SVN ITA ARM UKR EST LVA CZE RUS GEO BLR KAZ POL LTU ROU AZE MDA MNG KGZ DEU HRV SVK TJK 0 20 40 60 Source: Balkan Barometer 2019. Source: Life in Transition Survey (LITS) III. There are significant inefficiencies in the 100 citizens, 63 are neither working nor looking social protection system (social assistance, for a job, and seven are looking for a job but have unemployment benefits, maternity benefits, not found one (Figure 21). Of these seven, about health insurance) that discourage formal em- 80 percent have been looking for a job for longer ployment (World Bank 2018; 2019f). The social than a year. As such, barely 30 out of 100 were em- assistance system generates disincentives for for- ployed in 2018, placing BiH’s employment rate in mality through its linked delivery of health insur- the bottom 10 countries worldwide (World Devel- ance and unemployment benefits. The vast ma- opment Indicators). jority of those who are employed in the informal Despite being above regional standards, sector are registered as unemployed so that they wages are lower than in EU countries, which have health insurance. Moreover, BiH citizens may be driving the skilled youth to emigrate in who can work but are poor are not eligible for so- search of better paying jobs. Average monthly cial assistance transfers, which creates disincen- wages are high for regional standards—the high- tives for labor market participation. Finally, war est in the region after Montenegro. Government veterans’ benefits are generous and not targeted salary scales may contribute to inflating wages, to the less well-off, which decreases incentives and remittances may also put upward pressure for employment. on reservation wages and contribute to long-term A high proportion of people are not actively unemployment (World Bank 2018; 2019f). Despite employed, leading to an enormous loss of pro- being relatively high for the region, wages in EU ductivity. BiH has one of the lowest levels of par- peer countries are higher than in BiH (SEE Jobs ticipation of people in the labor force; for every Gateway and OECD). The migration of healthcare 33 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE FIGURE 21. MANY PEOPLE ARE EITHER UNEMPLOYED OR OUT OF THE LABOR FORCE (BiH Labor Market, 2018) Total population = 2.70 mn Aged < 15 = 0.31 mn or 11% of total population Working age pop. = 2.40 mn or 89% of total population Inactive population = 1.39 mn or 51% of total population Labor force = 1.01 mn or 37% of total population Unemployed = 0.19 mn or 7% of total population Employed = 0.82 mn or 30% of total population Self-employed = 0.15 mn or 5% of total population Family workers = 0.03 mn Employees = 0.65 mn or 1% of total population or 24% of total population General gov. employees = 0.19 mn or 7% of total population (*) Non-gov. employees = 0.45 mn or 17% of total population (*) Source : LFS 2018. Note : (*) are estimated. professionals to Germany described in Box 1 il- Because of limited labor market opportu- lustrates the pulls of economic opportunity and nities, women lose approximately 35 years of wage differentials. productive employment over their lifetime (World Bank 2018c). BiH has one of the lowest Unemployment is particularly high for youth, rates of female participation in the labor market which at 39 percent remains among the highest in in the region (Figure 22), and a disproportionate- the region. Youth unemployment and lack of eco- ly large share of highly educated women are un- nomic opportunities may exacerbate youth emi- employed. Childcare is limited, which is a signif- gration and skill mismatches in the labor market; icant barrier to female labor force participation. approximately 57 percent of young people ex- Wages for women are approximately 9 percent pressed that they wanted to emigrate, the highest lower than for men. There are also significant bar- rate in the region (Gallup World Poll). Long-term riers to women accessing productive assets, with unemployment is also of concern to youth. Seven gender gaps in property ownership and access to out of 10 unemployed youth looked for jobs for bank accounts (World 2017d). more than a year, again the highest in the region. 34 II. ECONOMIC TRENDS: GROWTH AND JOBS, PUBLIC FINANCES, POVERTY AND SHARED PROSPERITY FIGURE 22. MANY PEOPLE ARE EITHER UNEMPLOYED OR OUT OF THE LABOR FORCE (Activity Rate 15+ by gender, 2017) 70 60 50 Percentage 40 30 20 10 0 ALB BiH KOS MKD MNE SRB WB6 Female Male Source: LFS 2018 . Many of the people who remain in the coun- Resolving the jobs challenge will require ad- try lack the skills that are in demand. The low dressing shortcomings in supply of and de- activity rate of the working-age population and mand for jobs and labor market deficiencies the high unemployment rate are the results of On the demand side, the potential of the pri- mismatches between the supply of and demand vate sector needs to be unleashed by creating for skilled labor that restrict development op- a more enabling environment. Many factors portunities. This explains the situation in which hamper the creation of new enterprises and the a large number of people are unemployed while growth of existing ones. These range from a chal- employers are not able to find the skilled workers lenging investment climate and limitations in that they need (See section III.C). The structur- access to finance to political uncertainty, which al unemployment is a remnant of the unfinished undermines confidence in foreign and domestic economic transition—the challenge to create suit- investors. (See section I.A.) able jobs for the de-skilled transition generation. The generation that entered labor markets before On the supply side, it will be important to or during the transition and the war finds itself, increase the participation of the population in to a significant extent, with few opportunities labor, provide access to better jobs, and elim- that match their skills. Their education is partially inate incentives for informality. Increasing the outdated, and so are many of the skills acquired participation of people in the labor force will re- during their careers, and this situation is likely to quire better performing active labor market pol- persist as technological change reduces job cre- icies to help unemployed people find jobs and ation in traditional industries. enabling women to be economically active, in- cluding through more accessible child and elderly care. Providing access to better jobs will require 35 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE closing the gap between the skills and qualifica- sonal income tax could help increase progressivi- tions demanded in the job market and those that ty, but any reforms to labor taxes must take into the education system provides. (See section III.C.) account the financial sustainability of the social The fact that healthcare is provided for free to security system and ensure that the needed re- people registered as unemployed creates incen- forms do not create finance gaps in the healthcare tives for informal jobs and unnecessarily under- and pension systems. mines the effectiveness of employment bureaus as they spend time processing unemployment Poverty and inequality remain important benefits instead of helping connect jobseekers challenges in BiH to employers. De-linking provision of healthcare Poverty in BiH is a problem for a significant from certification of unemployment will help min- proportion of the population, rising from 14 imize these adverse effects. percent in 2007 to 16 percent in 2015 (the latest Introduction of progressive labour taxation year on record, Figure 23). Poor people are dis- can increase competitiveness and employ- proportionally concentrated in rural areas, where ment. Personal income taxes and social security the poverty rate is much higher (19 percent) than contributions are frequently perceived as major in urban areas (12 percent). This is troubling be- obstacles to formal employment in BiH. The tax cause 52 percent of the population of BiH lives wedge is considered to be as high as 42 percent in rural areas (World Development Indicators), in FBiH and slightly lower in RS. This has been fre- where jobs tend to be scarce and salaries low. Ap- quently cited as a major deterrent to employment proximately 40 percent of poor rural workers are and lack of competitiveness. In practice, this is employed in the agricultural sector, which has low not accurate because employees in FBiH receive, and declining productivity and competitiveness. in addition to their salaries, nontaxable allowanc- (See section III.D on managing natural resources es (for hot meals, vacations, transportation) that for prosperity.) Eradicating poverty and increas- can amount to approximately one-third of the av- ing prosperity in BiH will require more and bet- erage salary. If these nontaxable allowances are ter jobs and opportunities that can translate into considered, the tax wedge in FBiH falls from 42 higher incomes. percent to approximately 36 percent, lower than The reduction of consumption in poor fami- the average tax wedge in the EU28. At the same lies is behind the recent increase in poverty in time, the personal income tax rate—10 percent in the country. Growth was good for those at the both entities—is among the lowest in the region lower end of the consumption distribution in the and compares with an EU average of 38 percent. past; the bottom 40 percent expanded its con- Accordingly, rather than significantly reducing sumption between 2004 and 2007 (World Bank personal income tax and social security contri- 2015). In more recent years, the slight increase in bution rates, progressivity must be enhanced. In poverty has been the result of a decrease in con- both entities, personal income taxes and social sumption in the bottom 40 percent of the distribu- security contributions are the same for all em- tion—the World Bank indicator used to measure ployees, regardless of income. Initiatives to in- shared prosperity. Consumption of this group fell crease the personal tax deduction from Bosnian by 0.9 percent annually between 2011 and 2015 convertible mark KM300 to KM800 and subjecting (Figure 24). all income greater than KM800 to a 13 percent per- 36 II. ECONOMIC TRENDS: GROWTH AND JOBS, PUBLIC FINANCES, POVERTY AND SHARED PROSPERITY F I G U R E 2 3 . P O V E R T Y H A S S L I G H T LY I N C R E A S E D I N R E C E N T Y E A R S (Absolute poverty rate in BiH) (Absolute poverty rate by entity and area) Poverty rate (percent) 20 20 16 15 18 19 14 15 17 15 Poverty rate (percent) 15 10 13 14 12 5 8 10 0 FBiH RS Urban Rural 5 Entities Areas 0 2007 2011 2015 2007 2015 Source : WB staff estimates based on HBS 2007, 2011, and 2015. Note : Poverty rate based on the KM 205 monthly threshold. FIGURE 24. INEQUALITY HAS REMAINED STAGNANT (Gini index in BiH) (Annualized consumption growth in BiH) 50 Annualized growth rate 0 Gini coe cient 40 33 -1 33 30 -2 2007 -11 2011 -15 20 2007 2011 2015 Bottom 40 Top 60 All Source: WB staff estimates based on HBS 2007, 2011, and 2015. Social assistance has helped to ease the in- panding coverage of targeted social welfare pro- crease in poverty, but it does not provide ade- grams and eliminating or phasing out inefficient quate coverage for those who are less well-off. programs would have served poorer people bet- Social assistance programs and pensions have ter (discussed in greater detail in section III.C). become more widespread in recent years in BiH, Current inequality and limited future mobil- playing a meaningful role in supporting incomes ity dampen expectations of better living stan- of poorer people and avoiding what could have dards. Inequality in BiH has remained constant. been an even greater increase in poverty between The Gini Index, the standard indicator for measur- 2007 and 2015, but social assistance spending ing per capita household consumption inequality, does not provide adequate coverage to the poor, has remained at approximately 33 points since which limits its effect on poverty reduction. Ex- 2007 (Figure 24).10 Stagnant inequality is the re- 10 A Gini index equal to zero means perfect equality, while a Gini index equal to 100 means complete inequality. 37 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE sult of a similar reduction in consumption be- Gender gaps in accessing public services such tween the bottom 40 percent and the top 60 per- as education and healthcare have nearly closed. cent (Figure 24). Moreover, three-quarters of BiH Women’s access to services such as child- and citizens (one of the highest ratios in the region) elder care is limited, decreasing their labor force believe that the gap between the rich and the participation. There are also significant differenc- poor has become larger (LITS III). Expectations of es in entrepreneurship, partly as a result of so- intergenerational mobility are also low, with only cial norms and women’s limited exposure to the 37 percent of the population (the lowest in the re- business world. Women held only 21 percent of gion) thinking that their children will have better national parliament seats in 2018, the lowest in lives than themselves. the region (World Development Indicators). More than half of women experienced some form of do- Simulations indicate that poverty reduc- mestic violence in 2013 (Cancho and Elwan 2015). tion will be slow.11 With moderate consumption Poor, rural, young, and Roma women are most growth of 2 percent annually, such as has been vulnerable to violence. Although legislation is to a the case since 2015, and maintaining the distri- large extent gender neutral, with laws to promote bution of consumption constant, it is likely that gender equality, inconsistencies in the system poverty will be halved (to 8 percent) by 2030.12 limit full implementation of these regulations, More robust consumption growth is needed to de- leaving room for discrimination. The lower female crease poverty further and more rapidly; poverty labor force participation represents the waste of would likely be 3 percent in 2030 with consump- BiH’s main, scarce asset, human capital, and lim- tion growth of 5 percent. Predictions for the future its women’s ability to benefit from and participate are pessimistic, with approximately 40 percent of in the economy. citizens believing that their financial situation will worsen within the next year, by far the highest The Roma have limited basic services and percentage among the Western Balkan countries economic opportunities (Robayo and Millan (Balkan Barometer 2019). Moreover, it is likely 2019). Approximately 1.7 percent of the popu- that the expected economic slowdown and asso- lation are Roma. Challenges start early in life for ciated loss of jobs and earnings due to the glob- this group; the net pre-primary enrollment rate al coronavirus outbreak will increase poverty, as was 3 percent in 2017, the lowest in the region. well as dampening perceptions of the future in The Roma have limited employment prospects, the country. with only 11 percent employed, the lowest in the region. They also have unmet needs for medical Large gender gaps, particularly in economic care, largely because they lack health insurance. opportunities and access to productive assets There are also substantial gaps in access to elec- such as land and financing, affect women’s tricity, water, sanitation, and waste collection. employment and capital (World Bank 2017d). 11 The lack of welfare data after 2015 prevents us from reporting a more recent poverty estimate. 12 The 2016-2018 period is nowcasted based on actual private consumption growth, whereas the 2019-2030 period is projected based on 2 percent and 5 percent private consumption growth rates. Both nowcasting and predictions assume a pass-through of 0.87. 38 39 III. Development Constraints: What Needs to Change? To achieve higher, more sustainable, more eq- A. Rebalancing Growth: uitable growth, interventions will be needed in four areas: rebalancing growth, physical Pivoting to Private capital, human capital, and natural resources Investments and management. To clarify what interventions are needed, priorities have been grouped accord- Exports for Job ing to the need to rebalance growth and better Creation management of the country’s assets to generate income (physical, human, and natural capital): A much-needed transformation to a social and (i) rebalancing growth, with greater reliance on economic model that is driven by a bigger, more the private sector and exports, (ii) more, more-ef- vibrant, internationally competitive private sector ficient investments in physical capital, (iii) im- has not visibly started. As a small economy, BiH’s provements in human capital and basic services, economic progress depends greatly on the ability including managing the additional challenges to integrate with larger markets, but exports re- that ongoing demographic changes present; and main low, uncompetitive and with limited value (iv) managing natural assets for prosperity. The addition. Political instability and a uniquely chal- following four sections describe in detail the main lenging business environment have discouraged challenges in each of these areas. investment—domestic and foreign—translating to low productivity and outdated production process- es. Unfair competition from SOEs and high taxes is stifling the private sector. BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE BOX 3. SECTORS WITH POTENTIAL TO CREATE ADDITIONAL GROWTH AND JOBS Manufacturing, particularly in wood and textiles, has shown the greatest promise over the years and has attracted the largest share of foreign direct investment. There are also significant competencies in services, particularly trade, tourism, and transportation and logistics. Although domestic trade (wholesale and retail trade is reflected in household consumption driving output so far in BiH, export-focused production and greater global value chain integration can unlock the next phase of growth. Transportation infrastructure supports trade connectivity and facilitation. For a strategically located country such as BiH, upgrading and expanding transportation infrastructure offers opportunities for further investment, particularly through public-private partnerships. Energy and utilities infrastructure are also in the spotlight, with European multilateral organizations providing financial support in parallel with rising interest from foreign investors, especially Chinese firms. The financial sector’s resilience in the face of BiH’s challenging economic and political climate has increased recently owing to high levels of foreign ownership, improving asset quality, and recent improvements to the regulatory framework. The nonbank financial institution segment remains underdeveloped and, therefore, has potential to expand and diversify sources of finance in BiH. With a small domestic market, BiH can raise aspirational peers, and they have been growing employment and growth only by producing at the slowest pace of all WB6 countries (Figure goods and services for export markets. 25). Although exports to EU and Eastern Europe have increased, BiH’s exposure to fast-growing The success of some BiH companies in internation- markets—in East Asia, for example—is negligible. al markets suggests that BiH has significant po- Two-thirds of BiH’s exports are low-technology or tential to become a highly competitive economy. resource-based products,13 and this percentage From high quality wood furniture to information has not increased since 2007. Export quality is low technology services, success stories demonstrate on average and has been declining over the past the enormous potential of BiH’s entrepreneurs decade. In turn, low value addition and techno- and workers, but these success stories illustrate logical content of exports is linked to low salaries islands of competitiveness scattered throughout and the quality of the jobs these sectors can offer the country, rather than the norm. Unleashing the (Figure 12). competitive potential of BiH’s entrepreneurs and enterprises will be essential to creating more op- Increasing the volume and quality of exports portunities and better paying jobs. (See Box 3 for will require integrating into European and sectors that display potential to create additional global value chains, attracting export-oriented growth and jobs). This section describes current FDI. BiH receives the least FDI (as a percentage of trends and shortcomings. GDP) of its peers (Figure 26). Moreover, more than 40 percent of FDI in the past two decades was in Exports are low in volume and still high- the energy sector, with a limited effect on job cre- ly dependent on low-value-added products. ation. Export-oriented FDI accounted for less than Exports have accounted for 38 percent of GDP 4 percent of all foreign investment in BiH. Global since 2015 (approximately half of that of BiH’s value chains and efficiency-seeking FDI can help 13 Mostly footwear, raw wood and wood products, leather, apparel, metals, and vegetables. 40 III. DEVELOPMENT CONSTRAINTS: WHAT NEEDS TO CHANGE? FIGURE 25. EXPORT GROWTH HAS LAGGED (Export growth index, 2000=100) 800 4500 700 4000 600 3500 3000 500 2500 400 2000 300 1500 200 1000 100 500 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 BiH MNE ALB SRB (RHS) MKD Source: WDI and WB staff calculations. small economies accelerate export and income ciencies in infrastructure. BiH’s free trade agree- growth (IMF 2019c), exposing firms to internation- ments with its major trading partners (EU, Turkey, al technologies, knowledge, and international Central European Free Trade Agreement mem- standards that can spur productivity. BiH had rela- bers) have proven beneficial for BiH’s exporters, tively high participation in global value chains be- but there are other barriers to BiH’s exporters, fore the financial crisis, but participation plunged ranging from nontariff measures and weak trade in 2018 to the lowest level since 2000. Moreover, facilitation to poor logistics, weak border man- backward integration has been low and has fur- agement, and infrastructure deficiencies. These ther declined, indicating that global value chain shortcomings create unnecessary costs for ex- participation remains in the low-value-added and porters and undermine the competitiveness of final assembly stages of production. In contrast, BiH’s products. These deficiencies can be largely other countries in the region have had progressive addressed through decisive actions from author- integration into global value chains. For BiH to at- ities to eliminate unnecessary regulatory and ad- tract efficiency-seeking FDI and join global value ministrative burdens. Addressing infrastructure chains, enabling factors must be in place, includ- deficiencies for connectivity will require more and ing stable political and economic environment better prioritized public investment. (See section and availability of a work force with adequate ed- III.B. on investing in physical capital.) ucation and skills. Investment incentives, which countries often use to attract FDI, have been inef- The hoped-for development of the private fective and expensive. sector has not been achieved. Nontariff barriers to trade undermine BiH’s Micro enterprises, which typically have lower competitiveness. Tariffs are not significant, but productivity and competitiveness, dominate there are other barriers to trade, including defi- the enterprise sector. There are some 35,500 41 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE F I G U R E 2 6 : F D I I S S I G N I F I C A N T LY L O W E R I N FIGURE 27: A LARGE SHARE OF FDI HAS GONE BIH THAN IN THE OTHER COUNTRIES IN THE INTO SERVICES SECTORS, NOT GVCS WESTERN BALKANS (Sectoral breakdown of FDI, 2016-18) (FDI, percent of GDP) Mining and Extractives 15 Agriculture 2% 1% 10 Manufacturing 5 33% Services 0 56% Electricity, water MNE SRB ALB MKD KOS BiH and sanitation Services 2014 2018 Construction 6% 2% Source: WDI. Source: BiH Central Bank. FIGURE 28. MICRO AND SMALL FIRMS ARE ABOUT 95 PERCENT OF THE BUSINESS POPULATION (Composition of the enterprise sector and employment according to firm size) 80 70 60 50 40 30 20 10 0 Micro Small Medium Large share of total number of active enterprises (2018) share of persons employed by active enterprises (2018) Source : BHAS 2018 firms in BiH, of which 95 percent are small (10-49 ployment and are large enough to compete in in- employees) and micro (<10 employees) enterpris- ternational markets and join global value chains. es and account for almost half of employment in Labor productivity is low and declining, and the country (Figure 28). Conversely, there are far the labor force is underused in activities with too few medium-sized firms, which is important low productivity. A BiH firm is one-sixth to one- because medium-sized firms typically boost em- third less productive than the average EU firm 42 III. DEVELOPMENT CONSTRAINTS: WHAT NEEDS TO CHANGE? FIGURE 29. PRODUCTIVITY DOES NOT EXCEED A FIGURE 30. PRODUCTIVITY IS DECLINING IN THIRD OF THE EU AVERAGE MOST INDUSTRIES (Value added per worker, 2016, EU28 = 100 percent) (Average annual growth of value added per worker) Wholesale and Retail -2.0 (relative to EU28=100 percent) 60 -0.6 Value added per worker Water and Sewage 50 Transport and Storage 1.8 40 Real Estate Activities -5.5 30 Mining 6.4 20 10 Manufacturing 1.7 0 ICT -4.7 Mining Commerce Manufacturing ICT Transport Electricity, Gas, Steam -0.7 and Air Conditioning Construction -0.9 Administrative and support service -5.0 BiH STEE7 Average Annual Growth in Value Added per Worker 2014-2017 Source: Eurostat and WB staff calculations. Source: Eurostat and WB staff calculations. (Figure 29). Furthermore, productivity has de- within three years, the lowest among peers. In ab- clined; between 2014 and 2017, overall productiv- solute terms, BiH has the fewest micro, small, and ity declined approximately 1 percent per year (Fig- medium-sized enterprises per 1,000 inhabitants of ure 30). This low productivity is partly the result its Western Balkan peers (8.8, versus 26.5 in North of the large share of employment in low-technol- Macedonia and 50.9 in Serbia). A cumbersome ogy industries such as food and low-value-added business environment, lack of required skills and services (retail, restaurants). Only 10.9 percent of knowledge to start a business, unequal access to employment is in high- or medium-high-technol- opportunities (with a widespread perception that ogy industries (e.g., electrical or pharmaceutical political connections are paramount to success in products), less than half than in peer countries business), limitations in access to finance, and an and one-third of the EU average. education system in which socioeconomic skills needed to succeed in business are not sufficiently Entrepreneurship is lower than in peer coun- addressed discourage entrepreneurship. tries. A low and declining share of the population engages in entrepreneurial activity. The propor- Limited innovation contributes to the low tion of adults in early-stage entrepreneurial activ- productivity of the private sector. Innovation ities dropped from 7.4 percent in 2014 to 4 percent can take place through invention of new technol- in 2017, compared with Estonia’s 19 percent. New ogies and processes or adoption of existing ones business formation is also low, averaging just over to improve the operations of firms or the quality one new registration per 1,000 active population of their products. There is ample room for tech- in 2016, compared with six in Montenegro. Fewer nology adoption in BiH because many firms have than 5 percent of adults intend to start a business outdated technologies, but only 15 percent of 43 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE FIGURE 31: LOW VALUE-ADDED SECTORS CREATED THE MOST JOBS BETWEEN 2014 AND 2017 (Employment growth according to value added per worker, 2014-2017) Higher value addition Higher employment growth Source: Eurostat and WB staff calculations Source: Eurostat and WB staff calculations. Note : The size of the bubble represents employment in that industry. firms in BiH have adopted technologies existing in SOEs continue to stifle the private sector. other countries (Enterprise Survey 2019), and only The state’s footprint in the economy is sizeable 38 percent of firms introduced new or improved and may deter medium-sized firms from enter- products or services in the previous three years. ing the market. BiH is the only country in central, Innovation at the technology frontier is even rarer. eastern, and southeast Europe where the SOE BiH has the lowest rate of trademark applications footprint appears to have increased between 2005 and the second lowest rate of patent applications and 2016—and nontrivially so (IMF 2019b). SOEs of its Western Balkan peers. Patent applications often have significant privileges that the private from local residents are mostly by individuals, sector does not government financing, limited not firms, which suggests that there is limited re- accountability, no payment of taxes or dividends, search and innovation activity among firms. The ability to pay generous wages above productivity, national innovation system is underfunded and which crowds out the private sector from a limit- lacks a clear strategic direction and institutional ed talent pool). SOEs often fail to capitalize on the coordination, and its support programs for firms potential of the sector in which they operate and are largely outdated and have limited effect. Busi- may hinder development of important sectors ness investment in research and development is (Box 4). This preferred treatment diverts scarce limited (29 percent of total expenditures, versus resources (labor, land, capital) from the private 69 percent in Slovenia and 47 percent in Croatia). sector to SOEs. (See section I.C for a detailed dis- Cooperation in innovation activities within and cussion of SOEs). between firms (an important channel for knowl- edge transfer) is limited. 44 III. DEVELOPMENT CONSTRAINTS: WHAT NEEDS TO CHANGE? BOX 4. STATE OWNERSHIP OF AIRPORTS Bosnia and Herzegovina (BiH) is well placed geographically to act as a hub between Western Europe and the other Balkan states. Its transportation infrastructure sector is largely unsaturated, leaving room for major investments. Its airports need to be modernized and expanded to become more efficient, enhance its regional connectivity, support tourism and economic growth, and provide accessibility for the diaspora. BiH is underusing its tourism potential for many reasons, including limited transportation connectivity. Although there is an increasing trend in international tourist arrivals, the current level is far below potential. The hospitality industry is on the rise, primarily driven by private sector efforts, but connectivity (air, road, and rail infrastructure) lags, constraining tourism growth. In terms of air connectivity, BiH’s international passenger market is the smallest of the region, although it grew at higher rates than those of most of its neighboring countries from 2010 to 2018. Since 2013, Tuzla has established itself as the country’s second international gateway, behind Sarajevo, accounting for more than 30 percent of the country’s international seats in 2018. Almost all of the growth in BiH’s international market between 2010 and 2017 is from the activity of low-cost carriers, which have grown approximately 48 percent per year during this period, whereas legacy carriers have experienced stagnant 0.8 percent annual growth over the same time span. Robust factors such as the country’s prospects for accession into the EU and its strong tourism potential should continue to drive faster growth and potential for greater profitability. However, regional competitors are progressing faster. As of 2018, Sarajevo airport was serving 24 international markets, while Belgrade had increased its reach to 68 and Zagreb to 47. Twenty-three airlines are providing international services from Sarajevo airport, whereas neighboring Belgrade operates with 37, and Zagreb with 32, which indicates better connectivity and diversity of origins and destinations. Although minor enhancement projects are ongoing of Sarajevo airport, financed by the state-owned operating company, much larger investments are necessary to upgrade the facilities to meet International Civil Aviation Organization standards (especially safety), improve services to airlines and passengers, increase capacity to accommodate future growth, and maintain environmental protection standards. The limited fiscal resources and lack of expertise is slowing the pace of required investments. The government should consider introducing private sector participation in airport operations, specifically for Sarajevo and Tuzla airports (possibly bundled together in one package), to mobilize private sector financing and expertise and free up public funds so that they can be used where they are more needed. Given constrained fiscal space and operational challenges, private sector financial and technical participation would enable rapid expansion of activities and improvement in quality of services. Source : IFC sector analysis 45 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE The business environment in BiH is challen- petition from informal competitors, which is the ging, undermining the private sector. third most important obstacle for firms in BiH (En- terprise Survey 2019) Employees of informal firms Doing business in BiH is difficult because of the lack labor security that laws provide, as well as burden that the authorities have placed on the social contributions. private sector. There are only six countries in the world where starting a business is more difficult than in BiH.14 Companies in BiH must navigate Lack of access to finance limits the potential more than 1,600 different procedures at all levels of the private sector. of authorities countrywide. Firms wishing to op- Commercial banks in BiH do not contribute erate across the country must obtain a variety of sufficiently to meet the financing needs of the licenses, approvals, and consents, many of them private sector. The financial sector is dominat- duplicated. There are 355 business-related licens- ed by banks with good liquidity, strong risk aver- es, permits, approvals, and consents required in sion, increasingly conservative policies from their FBiH, 319 in RS, and an additional 102 at the state parent companies and insufficient incentives or level of BiH. Cantons (in FBiH) and municipalities capacity for new or innovative approaches to fi- add a further 161 and 94, respectively. Although nance firms in BiH. Banks dedicate a large share corporate income taxes are harmonized, each of their lending to consumer credit and lending to Entity has its own business registration require- SOEs, limiting the amount of credit available for ments, and each administrative level has the private sector investment and micro, small, and power to establish business laws and regulations. medium-sized enterprises. Within FBiH, each of the 10 cantons has different Some sectors are particularly affected. Man- business regulations and administrative proce- ufacturing has significant potential to contrib- dures. These are just some angles of the complex ute to economic growth and job creation, but 16 business environment, but there are multiple percent of manufacturing firms identify access- other areas in which unnecessary administrative ing finance as a major constraint, significantly burden and red tape create real obstacles for new higher than firms operating in retail and services entrepreneurs setting up businesses and existing (Figure 32). Firms operating in manufacturing firms trying to grow. provide collateral for 262 percent of the value of A difficult business environment fosters in- the loan—versus 123 percent required of borrow- formality. Although the complexity of the busi- ers operating in retail. Nineteen percent of micro, ness environment discourages potential entre- small, and medium-sized enterprises consider ac- preneurs from setting up businesses altogether, cess to finance to be a major or severe obstacle, it also creates incentives for some entrepreneurs which is linked to their own limitations and banks’ to operate informally. In turn, informality greatly incentives.15 There are significant gender biases; hinders the economy and society. Almost half of 80 percent of companies managed by women, but formally established firms in BiH face unfair com- only 65 percent managed by men, were required 14 Starting a business in BiH takes on average longer than 80 days; business owners must go through 13 different procedures and face sig- nificant costs (14 percent of income per capita). Conversely, authorities in many countries have recognized the need to enable entrepre- neurs to establish a business in less than one day, with one procedure (often online) and at no cost (World Bank Doing Business 2020). 15 Smaller enterprises with incomplete or insufficient formal documentation or lacking collateral tend to be excluded. Banks are not inter- ested in serving the micro-loan segment of the market because opportunities for cross-selling of products and services are limited. 46 III. DEVELOPMENT CONSTRAINTS: WHAT NEEDS TO CHANGE? F I G U R E 3 2 . M A N U F A C T U R I N G F I R M S F A C E S I G N I F I C A N T LY H I G H E R C O N S T R A I N TS I N A C C E S S I N G FINANCING THAN FIRMS OPERATING IN RETAIL OR OTHER SERVICES (Value of collateral needed and percentage of firms identifying access to finances as a major constraint) 300 262 20 16 181 15 200 123 10 9 100 5 3 0 0 Manufacturing Retail Services Value of collateral needed Firms identifying access to nance as a major constraint Source: Enterprise Survey 2019. to have collateral to qualify for loans. Female en- adequate support instruments. Increasing pri- trepreneurs have little access to assets such as vate sector access to finance in BiH will require land, which is the collateral that financial institu- strengthening credit information systems,16 elimi- tions traditionally prefer, and are disadvantaged nating shortcomings in the legal framework,17 lim- in raising startup capital. iting the crowding out of the private sector from bank credit by SOEs, and further developing non- Increasing the private sector’s access to bank financial institutions18. finance will require concerted efforts rather than directed lending. There is often the per- Financial inclusion is behind that of regional ception that deficiencies in access to finance can peers and the country’s income level, indicat- be addressed through directed lending (govern- ing income and gender gaps. Fifty-nine percent ment-imposed quotas on bank lending to spe- of the adult population has an account, compared cific sectors) or direct government participation with the developing European and Central Asian in provision of credit (e.g., through development average of 65 percent (Global Findex Survey 2017). banks), but the experience of BiH and other coun- Account penetration is also low relative to BiH’s tries in the region has demonstrated the signif- income level.19 The income and gender gaps are icant limitations and potential effects of these high, with the poorest 40 percent of the popula- approaches—with directed lending leading to tion lagging by 11 percentage points and the gap high nonperforming loans and subject to political between female and male access approximately 4 influence in allocation of credit and development percentage points. banks often lacking clear strategic objectives and 16 The credit bureau information covers only 14 percent of adults in BiH, versus 67 percent in peer economies. 17 It takes more than 900 days on average to settle claims through courts, at a cost of 36 percent of the claim (World Bank 2019a). This makes lenders reluctant to lend, which in turn increases the collateralization requirements for new loans. 18 Microfinance, leasing, and factoring have potential to address financing needs of specific market segments, but deficiencies in legal and regulatory frameworks hinder their development. 19 On average, 73 percent of adults have an account at a formal financial institution in upper-middle-income countries. 47 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE F I G U R E 3 3 . B I H I N F RA ST R U CT U R E Q UA L I TY I S P O O R CO M PA R E D TO R E G I O N A L AND EUROPEAN PEERS (Global Competitiveness Index, 2019) 80 60 40 20 0 Overall Road Railways Sea Air BiH WB6 STEE7 EU28 Source: World Economic Forum, Global Competitiveness Indicators. Note: quality of infrastructure: range 0-7. B. Investing in Physical my close to the large EU market, good connectivi- ty is essential for the economy’s competitiveness, Capital but the quality of the transportation infrastruc- ture is much poorer than that of its peers (Fig- The SCD identified the need to invest in physical ure 33), characterized by poor road quality, due capital, highlighting its critical role in connecting to underinvestment, inadequate maintenance, BiH with countries and clients in the region and be- and poor project selection and implementation yond. This update finds that BiH has continued to (Atoyan 2018), and low road density (34 km per severely underinvest in infrastructure, even though 100 square km of land area, versus 41 in WB6 and the country has benefitted from a high level of reve- 111 in EU) (Eurostat). nue collection. Consequently, a deteriorating trans- Investment in the road network has been portation infrastructure continues to limit connec- well below the country’s needs. Investments tivity. Low investment and insufficient competition are required to upgrade and maintain the existing continue to hinder digital connectivity. In energy, network (to substantially improve the quality of dependence on coal for electricity generation has roads) and to develop new roads and highways. increased, at a high cost to the economy and pollu- The budget for repairing and improving the exist- tion to the environment. ing network is well below what is needed. More- over, the agencies in charge of roads are inefficient BiH transportation infrastructure is not in and poorly run and face high costs, all of which line with the country’s needs. have led to unsustainability. Priorities for invest- The poor state of the road infrastructure in- ment in new highways and roads are to complete creases travel time and costs for people and the expressway and motorway links that make up firms, limiting connectivity and the country’s the extensions to the Trans-European Transport competitiveness. Because BiH is a small econo- Network and other routes prioritized through 48 III. DEVELOPMENT CONSTRAINTS: WHAT NEEDS TO CHANGE? the South East Europe Transport Observatory. Of ciency, and develop new forms of business. In BiH, these, completion of corridor Vc20 is the most im- much of this potential is unrealized because of de- portant. For the national, regional, and local road ficiencies in infrastructure, regulations, and skills. networks, the priority is selective rehabilitation of Shortcomings in competition have resulted the existing network with a focus on crucial bridge in underinvestment and undermined quality of and tunnel assets. service in telecommunications. Although there Railways have the potential to contribute are 68 internet services providers in BiH, because of to greater connectivity, but they need to be regulatory barriers,21 the two government-owned improved. Railways are used to transport goods incumbents control approximately 55 percent of much more than in the rest of the Western Balkans the market, resulting in poor quality service and (Eurostat), which demonstrates their potential, underinvestment in coverage22 and in introduction but outdated rolling stock and rails and, most im- of new technologies.23 A market structure along portantly, inefficient operations severely hamper ethnic and geographical lines—with each network railways, with unsustainable costs stemming from operator having a de facto monopoly in a part of unnecessarily large numbers of employees. Recent the country—impedes market development. efforts to improve the railways in RS have the po- Sharing infrastructure between operators tential to address the shortcomings in the sector could lower costs and use publicly owned assets and can be a model for other transportation SOEs. more efficiently. Infrastructure sharing between (See Box 4 on restructuring RS Railways). operators (including utilities from other sectors such as electricity) would be an effective way to Developing digital connectivity will require lower the costs of infrastructure investments, in- better policies and competition. crease connectivity, and increase energy efficien- Digital connectivity and technology have major cy. The national electricity transmission operator, unrealized potential in BiH. With digital technol- Elektroprenos-Elektroprijenos, has 5,233 km of in- ogy, countries around the world are accelerating stalled fiber optic networks and several intercon- socioeconomic development, connecting citizens nections with neighboring countries. Commercial- to services, and creating opportunities for new izing this infrastructure could more efficiently use industries and better jobs. Technology is also pro- these publicly owned assets and advance broad- foundly affecting how governments operate and band development throughout BiH at relatively interact with their citizens, opening the door to low cost (Gelvanovska-Garcia 2019). greater transparency and more efficient service delivery. Telecommunications allows firms to serve markets better, lower costs and increase effi- 20 Part of the United Nations International E-road network connecting Hungary and eastern Croatia to Bosnia and Herzegovina and the Adriatic Sea. 21 BiH is the only Western Balkan country that requires individual licensing for electronic communication services. This is not in line with EU legislation, and more generally, BiH has not harmonized its regulations and legislation with EU directives on electronic communications. 22 Most urban areas have been covered, although expansion to less profitable areas is constrained, with penetration varying from a low of 36.2 percent in Liva Canton to a high of 87.1 percent in Sarajevo Canton. 23 BiH lags other countries in the region and is the last to have issued 4G licenses (April 2019). Advancement toward 5G will require invest- ments in well-developed, widespread fiber optic networks. 49 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE B OX 5 : R E F O R M S I N R E P U B L I K A S R P S K A R A I LW AYS — A M O D E L F O R STAT E - O W N E D E N T E R P R I S E REFORM The World Bank prepared a railways policy note in 2016 to describe the condition of the railway sector in Bosnia and Herzegovina, assess the policy options for modernizing it, and help chart a course ahead. The Republika Srpska Railways (ZRS) was found to be in a very difficult financial situation. If something was not done quickly, it was likely that spiraling costs, the increase in debt, and the shift of traffic to the roads due to lack of adequate maintenance of infrastructure and rolling stock would lead to bankruptcy. The situation of ZRS could be summarized as follows: It owes more than Bosnian convertible mark (KM)60 million to its employees; more than KM80 million to the tax administration; and more than KM140 million to domestic and international creditors. It has excessive staff costs, accounting for two-thirds of operating costs, because of overstaffing. (ZRS productivity levels were 20 percent of the EU average and 40 percent of those of Croatian railways). The number of passengers is declining, and its financial costs are high, transporting fewer than 500 paying passengers daily for a total cost of approximately KM20 million per year. (Each passenger return trip costs almost KM100, costs to a large extent that government subsidies or consequent underinvestment in infrastructure and maintenance cover.); It has very good freight intensity (tons/route-km), similar to the EU average, and good financial health but is facing fierce competition from road haulage. Failure to maintain the quality of tracks and services and keep freight rates competitive will lead to a decline in freight traffic. Without reforms, the government would have had to transfer significant amounts to the railway company, ignoring the underlying problems. The RS government requested World Bank support to restructure ZRS to achieve long-term sustainability. The reform has three components. 1. Financial restructuring: including payment of outstanding debts to employees and the tax administration and ownership restructuring, with the RS government regaining complete ownership of the company and taking responsibility for all debts to international creditors. 2. Workforce restructuring: reducing staff by approximately 1,000 (one-third) over a four-year period with a fair and transparent scheme of compensation informed by full consultation with trade unions. This will bring labor productivity in ZRS in line with that of Serbia, albeit only half that of Croatia. 3. Organizational restructuring: implementation of several organizational reforms, including a new financial management and accounting system to ensure transparency and proper use of funds, preparation of a market and freight strategy, preparation of an asset management plan to optimize investments, and a modern information management system to control and reduce costs. Contracts between ZRS and the RS government will be established that will specify the subsidy to be received and the level of service to be provided for passenger services and infrastructure investments, creating a clear, transparent framework for public investment and allowing authorities to invest in passenger services. Component 1 has been largely completed; significant progress has been made on component 2, with a reduction of approximately 700 staff members; and component 3 is just starting. Lessons for other state-owned enterprise reform efforts include the need for strong government support and leadership in driving the reforms; careful design and close monitoring of staff reduction activities to avoid reversion; and efficient and proactive public communication and outreach about the reforms, in particular related to staff reduction. 50 III. DEVELOPMENT CONSTRAINTS: WHAT NEEDS TO CHANGE? BiH’s economy is the most carbon and ener- Beyond the substantial harm to the environ- gy intensive in the region, hindering its sus- ment and health of the population, reliance on tainability and competitiveness. A more coal comes at a long-term monetary cost to the diversified, low-carbon mix supported by a country. Coal is seen as providing energy secu- greater role of the private sector is required. rity and reducing costs, and BiH plans to replace obsolete lignite plants and meet demand growth The energy sector is a potential source of with four to six new coal-fired power plants.27 It growth, but it is unlikely that the country’s is estimated that the two main energy produc- strategy will unleash this potential. The energy ers in 2017 received €23.3 million in direct coal sector accounts for 6 percent of GDP and a signifi- subsidies and a further €177.6 million in indirect cant portion of exports, with nearly one-third of its subsidies because the cost of carbon (externali- power generation exported. The sector benefits ty cost of coal burning) is not factored into pro- from abundant domestic energy resources (with duction costs (Miljević et al 2019). The country is still untapped potential for renewable energy) effectively subsidizing pollution. Moreover, these and a relatively low cost of power generation, but coal plants may jeopardize BiH’s ability to meet policies that result in limited choices of sources of its renewable energy and energy efficiency tar- energy and limited investments limit the sector’s gets under the Energy Community Treaty, which potential. Deficiencies in energy infrastructure commits BiH to limiting emissions for existing and undermine the economic potential of the country, new large combustion plants and is expected to and this damage will increase as demand grows.24 require sizeable investments (estimated at €105- BiH’s energy sector depends greatly on coal, 350 million) in emission control equipment for and it is likely that recent investment decisions existing plants. Some studies have estimated that will increase this dependence, at a time when the cost of electricity in new coal-fired thermal most European countries are moving away from power plants would be close to €60/MWh, which it. Although BiH has vast potential for renewable is higher than the estimated cost for a unit of ex- energy (including hydro, solar, and wind), in 2017, isting hydropower plant (€30/MWh), although a coal accounted for 61 percent of primary energy more-levelized cost of energy comparing the two generation (Figure 34). Indigenous low-cost lig- technologies would be needed ( Ibid) nite has offered affordable, reliable energy but at Inexpensive coal comes at the cost of hid- a high environmental and social cost. The energy den subsidies (including externalities of coal sector is the leading contributor to greenhouse burning) and other costs in mining. Coal mining gas emissions and a major source of air pollu- provides an estimated 13,000 direct jobs across tion,25 and BiH is the most carbon-intensive econ- 14 operating mines, but mine productivity is low, omy in the region.26 24 One-quarter of companies in BiH identify deficiencies in electricity supply as a major constraint on growth. Deficiencies range from high cost and long delays to obtain connections to the network to electricity outages generating losses and costs of back-up generators; 63 percent of firms experienced more than one electricity outage per month, lasting on average 3.6 hours. Thirty percent of firms had bought an electricity generator to address reliability of electricity supply (Enterprise Survey 2019). 25 Carbon dioxide from solid fuels is 78 percent of total emissions, significantly higher than in other Western Balkan countries (12-65 percent) 26 With 0.56 kt of carbon dioxide emitted per dollar of GDP, more than three times the EU average WDI, accessed June 10, 2019; latest avail- able data are from 2014. 27 BiH Framework Energy Strategy until 2035. Parliament approved a guarantee in April 2019 for a coal-fired unit at Tuzla, largely financed by a loan from the Export-Import Bank of China, and three other plants are in preparation. 51 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE FIGURE 34. COAL IS THE PRIMARY ENERGY GENERATION IN BIH (Sources of primary energy supply, percent, 2017) 70 60 50 40 30 20 10 0 Coal Oil Biofuels and Hydro Gas Wind, solar waste Source: IEA, Energy Balances, 2019. largely because of outdated mining methods and pending on growth. Approximately €3 billion in high labor costs that require substantive subsi- investments will be required to modernize power dies. Addressing reliance on coal for energy gen- generation plants, install emission control equip- eration will require a strategy that includes the ment, and build new capacity in the next 20 years mining sector, its financial sustainability, and op- (Nikolakakis et al. 2019). In addition, total invest- portunities to help some of the labor force transi- ment needed to develop the electricity transmis- tion to other industries. sion network is estimated to be €350 million.28 There is considerable potential for private invest- Substantive investments will be required ment in cost-competitive renewable energy, but to meet existing and future demand. More several factors limit private participation, includ- than half of the thermal power plants date from ing political instability, an incomplete regulatory the 1960s and 1970s, and at least 30 percent of framework, public sector influence, and a lengthy thermal capacity is slated to be closed in the next permitting process. decade. The deterioration, loss of capacity, and decreasing efficiency threaten the security and re- Electricity prices are below the cost of sup- liability of the energy supply. Because the largest ply, undermining the ability to support public electricity off-taker in the country, the aluminum investment. In 2017, households paid less than smelter in Mostar, accounting for approximate- half the average price of residential customers in ly 12 percent of annual average consumption, the EU, and business tariffs were the second low- was taken off the grid in 2019, earlier long-term est of all EU and Western Balkan countries. As a demand projections are likely to change. Some result, the power sector had a revenue shortfall of estimates indicate that demand could change 3 percent to 4 percent of GDP from 2011 to 2014. between 1 percent and 14 percent by 2029 de- Cost-recovery tariffs will be necessary to fund the 28 Framework Energy Strategy of BiH until 2015, published in 2017. 52 III. DEVELOPMENT CONSTRAINTS: WHAT NEEDS TO CHANGE? large investment needs and ensure the financial cover all of those in need, and poverty remains an sustainability of the sector. Tariff reforms and tar- important challenge. geted assistance for vulnerable populations will be important. Quality education is limited and unequal29 Increasing energy efficiency can help man- The education system does not equip students age the increasing demand and reduce en- in BiH with the skills, competencies, and qual- vironmental effects. Residential, public, and ifications that are in demand in the labor mar- commercial buildings account for approximate- ket (Figure 35). More than one-quarter of BiH cit- ly half of energy consumption, much of which is izens considered that the skills they learned did wasted because of poor insulation and inefficient not meet the needs of their jobs in 2018, one of heating and lighting. Demand in residential and the highest in the region (Balkan Barometer 2018). public buildings can be reduced up to 60 percent Fifty-eight percent of firms believe that the educa- through cost-effective refurbishments, but these tion system does not impart the skills needed in mechanisms to support energy efficiency have the current labor market (World Bank, 2016-2017 not been adopted on a national basis STEP Employer Survey). These outcomes reflect deficiencies at all levels of education. C. Strengthening Human Low enrollment in early childhood educa- tion undermines critical foundations for chil- Capital and Basic dren in BiH. Fewer than 20 percent of children in Services BiH have access to early childhood education, sub- stantially less than in peer countries (Figure 36). Since the SCD in 2015, the loss of human capital has This is a major concern because global evidence become a major concern and source of urgency to demonstrates the importance of early childhood act in BiH. In addition to the loss stemming from education for development of basic cognitive demographic trends, deficiencies in healthcare and and socioemotional skills. The limited availabili- education significantly undermine the potential for ty of facilities dampens the economy (because it people in BiH to have healthy, productive lives and limits the ability of mothers to participate in the create incentives for people to emigrate to coun- labor market) and exacerbates social inequality, tries that can offer not only better jobs, but also because children with access to early childhood better quality of life. The education system fails to education typically live in urban areas, with both equip students with skills that are in demand in the parents in paid jobs, whereas those in rural areas job market, which further contributes to high levels and with single parents have less access. of inactivity. Lack of access to care facilities for chil- The quality of education outcomes needs to dren and elderly adults limit the ability of women be enhanced. Students in BiH lose the equivalent to participate actively in the economy. Deficiencies of 3.1 years of schooling because of the poor qual- in the healthcare system have become more prom- ity of education. Only 40 percent to 50 percent of inent, undermining not only the quality of services 15-year-olds in BiH have basic proficiency in read- provided to the population, but also BiH’s fiscal sus- ing, math, and science, well below 76 percent of tainability. Social assistance does not adequately same-age students in EU (PISA 2018). In turn, poor 29 This section draws heavily from World Bank (2018e, 2019d) and World Bank and European Commission (2019a) 53 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE F I G U R E 3 5 . S K I L L S T H AT E M P L O Y E R S S E E K A R E I N S H O R T S U P P LY (Extent to which graduating students possess skills businesses need) 7 6 5 4 3 2 1 0 CHE USA NLD FIN DEU ISL SWE IRL AUT BEL LUX CAN NOR CYP MLT GBR PRT EST AZE FRA CZE GRC ESP SVN SRB ALB ITA UKR LVA RUS MNE ARM KAZ TUR HUN BGR LTU POL MKD MDA GEO KGZ ROU BiH HRV DNK TJK SVK Source: World Economic Forum, 2018. F I G U R E 3 6 . A C C E S S T O P R E - P R I M A R Y E D U C AT I O N I S E S P E C I A L LY L O W (Enrollment rates by education level) 100 80 60 40 20 0 Pre -primary Primary Lower Secondary Upper Secondary BiH ALB MKD MNE SRB Source: WB Human Capital Project (World Bank 2018e) and WB staff calculations. Note : Pre-primary refers to adjusted net enrollment rate. All others are total net enrollment rate, except for lower secondary and upper secondary in North Macedonia, which are net enrollment rate and adjusted net enrollment rate, respectively. quality education translates into lower productiv- a concern; the achievement gap between students ity; children born and raised in BiH today will lose from the top and bottom income groups is equiv- almost 40 percent of their lifetime productivity alent to almost 1.5 years of schooling (PISA 2018). because of deficiencies in healthcare and educa- The low quality of the educational system tion.30 Unequal access to quality education is also stems from deficiencies in institutions and in- 30 Based on the World Bank Human Capital Index (World Bank 2018e). This index measures the amount of human capital that a child born today can expect to achieve by age 18 and compares the productivity of the next generation of workers against a benchmark of complete education and full health. The amount of human capital that a child born in BiH will accumulate by the age of 18 translates into a produc- tivity level of approximately 62 percent of what it would be if they received complete education and full health. Despite being higher than the average accumulation of human capital of its income group, it is lower than other countries in the region (Albania and Serbia) and many other countries in Europe and Central Asia. 54 III. DEVELOPMENT CONSTRAINTS: WHAT NEEDS TO CHANGE? adequate use of resources. The decentralized the quality of healthcare in BiH is low or very low and fragmented setup of the education system in (World Bank and EC 2019b). In a multi-country sur- BiH detracts from a shared vision and objectives vey in 2016, only 48 percent were satisfied with the and translates into high administrative costs. healthcare system, the lowest in the region (LITS III). Pre-university financing is based on the number of Inefficient use of resources and deficiencies classes rather than the number of students, which in governance in the sector result in poor-qual- translates into inefficiencies and nontransparent ity healthcare. BiH allocates a high proportion use of resources. Public spending per student in of resources to healthcare (~8.9 percent of GDP in primary and secondary school is high (~25-30 per- 2017, remarkably high for a lower-middle income cent of per capita GDP), but peer countries obtain country and close to the EU average (10 percent)), better outcomes with lower spending. There are but quality of healthcare and satisfaction of the marked differences in per-student spending be- population are below those in other countries tween entities because of the decentralized struc- that spend less, for several reasons, including ture of the system, and primary and secondary fragmentation and lack of synergies among en- education have grown less efficient over time. The tities (and cantons in FBiH),32 deficient financial number of students has declined over the past 10 control of hospitals and healthcare centers, and years, but the number of teachers has increased in limited accountability of authorities and hospital RS and some cantons, resulting in class sizes be- management for results. low international benchmarks, especially in pri- mary education. As a result of this oversupply of Discontent is also widespread among health- teachers, the amount of money spent on salaries care professionals, with over-worked doctors in pre-university accounts for approximately 90 and nurses often working without basic inputs percent of spending on education (roughly con- (while substantive resources are often spent on sistent across cantons), much higher than the 78 non-medical staff), hiring practices that are non- percent to 80 percent in EU and OECD countries. In transparent and create opportunities for corrup- addition, a high proportion of salaries is spent on tion, and lack of incentives for good performance non-teaching staff, which accounts for one-third or high qualifications. Consequently, BiH is fast of staff in primary schools, higher than in better losing precious human capital because doctors performing education systems. In turn, the large and nurses educated in the country at significant expenditures on salaries means that there are few cost to the economy emigrate in search of better, resources that can be invested in quality facilities, fairer working conditions. teaching materials, and training for teachers. Inefficiency in healthcare spending threat- ens fiscal sustainability. Despite the large amount Healthcare in BiH is deficient because of of resources devoted to healthcare, the system is inefficiencies in the sector.31 running a deficit, and debt to suppliers and public bodies (e.g., tax authorities) runs into hundreds of Deficiencies in healthcare are one of most im- millions of dollars. Poor budget planning and exe- portant concerns for the population. Seven- cution and inefficiencies in spending are endemic. ty-eight percent of the population considers that 31 This section draws on information from World Bank (forthcoming). 32 Responsibility for providing health insurance and health care services lies with Ministries of Health in each entity and, in the Federation, in each canton. 55 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Population aging will reduce revenues as people risks to patients and healthcare personnel. Addi- retire, financed mainly from payroll contributions tional resources may need to be targeted at BiH’s from formal sector employees. At the same time, migrant, displaced, and other vulnerable popula- demand for healthcare will rise, threatening the tions. Cash assistance to affected households and financial sustainability of the sector. businesses is also likely to be necessary, as well as proactive, evidence-based community engage- Not much has been done to reduce the effect ment to allay unnecessary concerns and support of noncommunicable diseases despite their business continuity. enormous cost to the country. Noncommuni- cable diseases, the main cause of death and dis- ability, are becoming more common as the pop- Spending on social assistance is high, but cove- ulation ages and will place a growing burden on rage is low, especially among the less-well off.33 the healthcare system in coming years that BiH’s Spending on social assistance is very high in unhealthy lifestyle will exacerbate; approximately BiH, but resources are not used efficiently. BiH 40 percent of adults are smokers (World Develop- allocates 2.9 percent of GDP to social assistance, ment Indicators), one of the highest rates in the one of the highest spending levels for social assis- Western Balkans. Smoking is estimated to cause tance in Europe, but the system is inefficient, with more than 9,000 deaths per year in BiH and cost more than 20 central and local ministries with the economy close to KM1 billion, but authorities separate administrative systems in each of the have failed to implement effective policy tools, two entities. This decentralized structure, which such as banning smoking in public places and is poorly coordinated, generates extensive admin- raising tobacco taxes, despite evidence demon- istrative and regulatory inefficiencies and signifi- strating clear population health and economic cant inequalities between entities and cantons. gains (Fuchs Tarlovsky et al. 2019). Some social assistance programs are not suf- The healthcare system also faces significant ficiently targeted, and coverage is low among pressures from the ongoing COVID-19 pandem- those most in need. Approximately 60 percent ic. Substantial resources are needed to address the of social assistance spending is on war veterans. unfolding pandemic, including strengthening sys- This is a very high proportion and leaves limited tems for real-time disease surveillance (which may resources for other segments of the population in necessitate additional laboratory infrastructure, need. Moreover, these benefits are not sufficient- equipment, reagents, and other goods); ensuring ly targeted to benefit the poorest veterans; more adequate response capacity through trained, well- than 20 percent of the overall assistance for veter- equipped frontline healthcare workers; extending ans is given to the 40 percent of beneficiaries with quarantine and clinical care facilities (which may the highest income, whereas less than 20 percent necessitate refurbishment of intensive care units of War Veteran Allowance program34 spending is and inpatient facilities in hospitals); and provid- on the poorest 20 percent of the veterans. As for ing vaccines and therapeutics when they become the rest of the population, fewer than half of the available. At the same time, essential community poorest citizens receive social assistance—less services need to be maintained while minimizing than in peer economies (Figure 37). The child al- 33 This section is largely based on Vandeninden and Ovadiya (2018). 34 A program available only in RS. 56 III. DEVELOPMENT CONSTRAINTS: WHAT NEEDS TO CHANGE? FIGURE 37. SOCIAL ASSISTANCE PROGRAMS F I G U R E 3 8 : … A N D T H E I R P OV E RTY I M PACT I S HAVE LOW COVERAGE LIMITED (Percentage of bottom quintile receiving social assistance (Increase in poverty in the absence of social assistance programs) programs, percentage points) 80 16 60 12 40 8 20 4 0 0 BiH Low-income Lower-middle-inc. Upper-middle-inc. High-inc. BiH Low-income Lower-middle-inc. Upper-middle-inc. High-inc. Source: Vandeninden and Ovadiya (2018). Source: Vandeninden and Ovadiya (2018). lowance, which has among the highest coverage population in BiH is connected to the public water of the less well-off, reaches only 14 percent of the supply network, and only 31 percent is connected poorest quintile. to the public sewage network. Only 15 percent of the wastewater produced in the country is treat- As a result, social assistance has a small ef- ed before it reaches the country’s rivers. Of all fect on poverty reduction. Simulations show the water mobilized for citizen consumption, 59 that spending on social assistance reduces pov- percent is lost through leaks in the network. Ap- erty by only an estimated 4.6 percentage points— proximately 66 percent of the population receives well below the average effect of social assistance municipal solid waste collection and disposal in upper-middle-income countries (Figure 38). services, although disposal methods vary, and This is because most benefits do not cover the there is generally limited recycling. Inadequate poor adequately and because, even when they treatment of solid waste and wastewater creates do, the benefits are too low to help beneficiaries enormous risks for BiH’s population and damages escape poverty the country’s natural resources and environment. Open dumping and burning of solid waste results Public water and sanitation services need to in soil, air, and water pollution. be improved.35 Much has been invested in improving public Public water and sanitation services are criti- services in BiH, but provision of these services cal for quality of life of the population and to remains limited and unsustainable. Over the preserve natural resources, but access to these past decade, development partners have invest- services is limited in BiH. Only 58 percent of the ed more than €400 million36 in BiH in infrastruc- 35 This section is largely based on World Bank (2017c, 2019b). 36 This figure does not include solid waste management. 57 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE ture for provision of public services.37 Although vision, and eventually setting tariffs closer to the this investment has enabled various facilities to cost of the service, which will require strong sup- be built (e.g., sanitary landfills, water networks, port from entity authorities. wastewater treatment plants), the operational and financial sustainability of these facilities is limited, with several already derelict and many D. Managing Natural more at risk of going out of service. Many of the Assets for Prosperity existing regional sanitary landfills need to start planning and designing for additional waste dis- BiH benefits from significant natural resources, but posal because of inefficient use, increasing vol- this has not been leveraged to enhance growth and umes of waste, and initial lack of financing to ex- create better jobs. The contribution of agriculture pand beyond the first cell. and forestry, two traditionally significant sectors in the economy, to growth and employment has been Institutional and policy deficiencies have decreasing, and they produce products with limit- limited public services. According to the consti- ed value added. Pollution is reducing living stan- tution of BiH, it is the responsibility of municipal dards, health, and productivity. Climate change is authorities to provide public services, creating affecting the country, with agriculture, water, and a multiplicity of actors—with 119 water utilities hydropower being the most vulnerable sectors. operating in BiH. Accordingly, very few municipal authorities have the ability to ensure adequate operation of these facilities. The fact that tariffs Agriculture is a valuable sector, but it is ope- on public services are below the cost of providing rating below potential. the services—thus requiring transfers and sub- Agriculture and the agri-food industry remain sidies from local government budgets—further relevant for BiH’s economy. Agriculture account- undermines financial sustainability. In the case ed for 6 percent of GDP in 2017 and 19 percent of of solid waste management, even when regional employment. The sector’s contribution to the sanitary landfills are available, there is lack of en- economy is larger when considering agri-food forcement to use them, and the system faces high production and related services. Agri-food is the transportation costs. most important manufacturing industry in BiH. Ensuring the quality, supply, and sustain- It leads in terms of turnover (23 percent of man- ability of public services will require active ufacturing turnover) and employment, as well as leadership of entity authorities. Although it geographic footprint in rural areas. makes sense to place responsibility on authorities Agricultural productivity is among the lowest closest to final users, in reality, provision of pub- in the Western Balkans and declining. Agri-food lic services is a resource-intensive task in which exports have been increasing, reaching almost economies of scale are essential. Addressing defi- 10 percent of total exports, but these are mainly ciencies in the sector will require exploiting econ- low-value-added products. The average value add- omies of scale across municipalities, establishing ed per worker in agriculture in BiH is only one-fifth performance standards for quality of service pro- of that in the EU28,38 and it ranks second lowest 37 Including international financial institutions and bilateral donors. 38 $5,648 in BiH, versus $26,854 in the EU28 in 2017. 58 III. DEVELOPMENT CONSTRAINTS: WHAT NEEDS TO CHANGE? in the Western Balkans after Albania. The value of Agri-food exports have grown, but smallholders agricultural output per hectare is the lowest of the are not well integrated into export markets. Western Balkan countries. In turn, the sector can- not offer competitive salaries or attractive jobs. Forestry is underdeveloped but offers un- Employment in agriculture has decreased approx- realized prospects to add value imately 23 percent since 2012, and it is likely that BiH’s forests are important natural resources attracting a labor force under current conditions in that could be better leveraged for growth while the sector will prove difficult over time. ensuring their preservation. Forests cover more Land fragmentation, outdated technologies, than 60 percent of the country and are among the and shortcomings in infrastructure affect pro- most pristine in Europe. Forests can be import- ductivity. Many European countries have been ant sources of growth, but they are underused. able to leverage agriculture as a source of growth Although wood accounts for almost 20 percent of and jobs, but this has required transformation of BiH’s exports,40 much of what is exported is raw the sector into one that is highly competitive and timber and other low-value-added items, which driven by high value addition. In BiH, fragmenta- means that producers outside of BiH benefit from tion of farm land39 undermines the competitive- the high quality of the wood and capture its val- ness of the agricultural sector, which decreases ue by manufacturing finished products. There is the potential for investment and introduction of a furniture industry in the country, but outdated modern farming techniques. The absence of pro- production processes and designs limit its poten- ducer organizations or farmers’ cooperatives pre- tial. Mountain areas have high tourism potential, vents aggregation to achieve economies of scale. but this also remains underused. Unsustainable production practices are common, Forests and trees can also help mitigate cli- irrigation coverage is low, and there is little sup- mate change and risks from extreme climate port or technical assistance for better agro-envi- events. Forests provide protection against floods ronmental practices. Most of BiH’s croplands are (by reducing the risk of rock falls, avalanches, in regions with limited access to regional markets and mudslides) and natural cooling in urban and and poor infrastructure, including transportation, peri-urban areas and support climate-smart agri- electricity, and digital connectivity. culture through shade tree cropping and fodder Weak standards compliance and market in- production for livestock. tegration further reduce agricultural potential. With better policies, knowledge, and public Weak compliance and control mechanisms and and private investments, the sector has the po- services related to food safety and sanitary and tential to grow and be competitive in EU mar- phytosanitary standards also constrain agricul- kets. Leveraging BiH’s forests means not export- tural competitiveness. Compliance with export ing higher volumes of raw wood, but developing product quality requirements is low and most of- value addition while ensuring preservation of this ten achieved by large, well-equipped producers. important natural resource.41 There is a need for 39 More than half of holdings are less than 2 hectares. 40 Including wood, furniture, and closely related construction materials. 41 For example, Forest Stewardship Council certification encourages responsible management, transparency, and financial sustainability. The certified area in BiH increased from 1.65 million hectares in 2015 to 1.87 in 2019, which has permitted more exports, most notably 59 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE an overriding FBiH forest law to enable equitable Heating, Industry, and an aging automobile revenue sharing, decentralized management, and fleet are creating high levels of air pollution. improved accountability. The absence of a forest Heating is the largest source of emissions, espe- law makes tenure uncertain and prevents access cially residential heating. In addition, BiH’s indus- to debt financing of operations. A forest inventory try consumes much more energy than that of peer would allow national-level strategic planning for countries and uses this energy much less efficient- this important sector. In the private sector, there ly, producing major emissions of greenhouse gas- is a need to increase mechanization and use of es43 and contributing to high levels of air pollution modern technology to confront labor shortages, in industrial areas. The combustion of solid fuels professionalize the industry, and make it more for domestic heating and cooking, the prevalence competitive. This will also allow growth of ex- of coal-fired power plants, and industry contrib- ports of high-value products such as furniture and ute to air pollution. These emissions are not ex- emergence of supply chains. pected to decline markedly as long as solid fu- els—mainly low-grade wood and coal—dominate Air pollution is affecting living standards, fuel sources and are burned in inefficient stoves health, and productivity, particularly for the and boilers. The transportation sector’s contri- bottom 40 percent. bution to air pollution is relatively small, but its relevance is greater when people’s exposure to air Air pollution is having serious health and eco- pollution is considered. In contrast to heating-in- nomic effects. Cities in BiH have some of the duced air pollution, transportation pollution per- highest concentrations of health-damaging fine sists throughout the year and is especially severe particulates in Europe (Figure 39). Air pollution in urban centers because of factors such as severe can cause lower respiratory infections; tracheal, traffic congestion, inefficient transportation sys- bronchial, and lung cancer; ischemic heart disease; tems, and aging vehicle fleets. stroke; chronic obstructive pulmonary disease; and death. Approximately 3,300 people in BiH die prematurely every year as a result of exposure to Climate change is threatening the economy, air pollution, with Sarajevo and Banja Luka carry- and the agricultural, water, and hydropower ing approximately 16 percent of this health burden. sectors are most vulnerable. Overall, 9 percent of annual mortality is attribut- BiH has had extreme weather events, including able to air pollution, estimated to cost $1 billion to severe winters and flooding and extreme tem- $1.8 billion, equivalent to 5.9 percent to 10.5 per- peratures and droughts. Since 2000, there have cent of GDP in 2016.42 These cost estimates are con- been five drought years (2000, 2003, 2007, 2011, servative and do not include costs associated with 2012), which have lowered river levels, affect- hospital stays, illness, or loss of work days. ing hydropower generation; reduced agricultural crops; and raised food prices. BiH is also exposed within Europe, using acceptable silvicultural practices and replanting. Forest Stewardship Council standards also apply to financial sus- tainability and sound use of financial resources under a responsible management regime with clear accountability. 42 These cost estimates do not include Brčko District. 43 The greenhouse gas emissions intensity of BiH’s economy is three times as high as the EU’s; emissions per purchasing power parity of $1 of GDP was 0.6 kg of carbon dioxide equivalent, whereas the EU average was 0.2 kg in 2014. The high greenhouse gas intensity of BiH’s economy is symptomatic of energy and industrial inefficiencies. 60 III. DEVELOPMENT CONSTRAINTS: WHAT NEEDS TO CHANGE? FIGURE 39: POLLUTION IN BIH CITIES EXCEEDS LIMITS (Air pollution in selected European cities) 90 80 Annual average ambient 70 60 PM2.5 ( g/m3) 50 40 30 EU PM 2.5 Limit Value 20 WHO PM 2.5 AQG Value 10 0 Tetovo Tuzla Lukavac Tetove Pljevlja Ilidza Zenica Skopje Sarajevo Korce Novi Sad Podgorica Belgrade Tirana Ljubljana Warsaw Bucharest So a Zagreb Vilnius Athens Budapest Brussels Nicosia Prague Berlin Paris Riga Rome Bratislava Vienna Amsterdam Luxembourg Copenhagen Lisbon Iz-Zejtun London Madrid Dublin Helsinki Stockholm Tallinn Source: WHO Global Air Quality Database. to floods. The worst flood in BiH since its inde- are expected for private property and for infra- pendence was in 2014, affecting 1 million people structure, for example in the water, energy, and and causing 25 deaths and close to $450 million transportation sectors. It is also likely that agri- in damage. Flooding in 2010 caused three deaths cultural losses will increase, as will effects on hu- and close to $95 million in damage. On average, man health due to heat exposure, floods and vec- flooding affects approximately 100,000 people tor-borne diseases. and 3.4 percent of GDP per year. In addition to Agriculture, water, and hydropower are the extreme weather events, BiH has also had several sectors most vulnerable to climate change. earthquakes, which cause substantial damage; an There is abundant water, but irrigation infrastruc- average earthquake affects approximately 40,000 ture is limited; only 0.65 percent of arable land is people and 1.1 percent of GDP (World Bank 2017b). irrigated. More hot days, less rainfall, and drier Climate change is predicted to affect BiH summers will increase the probability of droughts significantly. Climate models predict that mean and reduce river flows, which will in turn wors- seasonal increases in temperature will average en water quality and supply. There will be more 1°C by 2030, with rainfall becoming less regular. floods in the fall and winter, and more erratic riv- Temperature increases will be more pronounced er discharges could also affect hydropower. Low in inland areas, and it is likely that there will be river flows could halt production of hydroelectric a marked increase in high temperature extremes power and reduce energy security and electricity and meteorological droughts. Extreme weather exports. Greater peak flows in the event of floods will harm more people, and higher asset losses could damage the hydropower infrastructure. 61 62 IV. Prioritization for Fast, Long-Lasting, Inclusive Growth The priority areas for BiH remain largely the • Risks stemming from climate change and en- same as those identified in 2015. As mentioned vironmental deterioration (and their effects on earlier, progress in addressing the priorities iden- the population and the economy) are analyzed tified in the SCD has been limited, so the factors in more detail, given their greater prominen- that were considered critical to the development ce. Under the SCD in 2015, these factors were agenda of BiH in 2015 remain critical. The main analyzed as sources of vulnerabilities, aggre- changes in terms of priorities in this update are as gated with other sources, including fiscal vul- follows. nerabilities. Analysis undertaken after the SCD has helped to inform priorities. • More prominence is given to the loss of hu- man capital (including through demographic • Improving the business environment and ex- changes and deficiencies in healthcare and panding access to finance were treated as two education). Demographic changes were also different priority areas under the SCD in 2015, discussed under the SCD in 2015, although but a deeper, more diversified financial sector lack of progress on actions to promote growth makes it easier to do business in the country, and inclusion and worsening of demographic which fosters growth for the most vulnerable trends interacted, making this challenge more groups. As such, this SCD grouped both ele- relevant and adding a sense of urgency to act. ments under the same priority area. In addition, analysis undertaken after the SCD The World Bank’s analytical work (Box 6) in allowed factors undermining the effectiveness the country informed the update, which was val- of the healthcare and education systems to be idated in consultations with stakeholders in BiH identified and helped inform priorities. (government, private sector, civil society, devel- opment partners). IV. PRIORITIZATION FOR FAST, LONG-LASTING, INCLUSIVE GROWTH B OX 6 . PA ST A N D CU R R E N T K N OW L E D G E G A PS Since the completion of the 2015 Systematic Country Diagnostic (SCD), the World Bank has worked to fill some knowledge gaps through substantive investment in analytical work. Although the SCD helped identify challenges and priorities for Bosnia and Herzegovina’s (BiH’s) development, the subsequent analytical work has helped provide better understanding of the effect of these challenges on people and the economy and of the root causes of these challenges and the options to address them. This analytical work was particularly helpful in informing priorities for healthcare, education, public sector reform, state-owned enterprises (SOEs), the environment, private sector development, and efficiency of public services. Two knowledge and data gaps identified under the 2015 SCD were filled: better knowledge of SOEs44 and better education data with the recently published 2018 Program for International Student Assessment results. This update identifies areas in which additional knowledge and data will be needed to better inform priorities and policy options: • To better understand the performance over time of the poorest 40 percent of the population and of the population in general, more broadly available household data, including information on income, will be needed. • To better understand trends in and obstacles to rebalancing toward private sector-led growth, better and more regularly available data on firm performance, including employment, will be needed. • To better understand the effect on economic performance and fiscal sustainability of demographic trends on BiH, more information and analysis will be needed on migration and the aging of the population. Ten areas were selected.44The priorities identi- Rebalancing growth, pivoting to private in- fied (Table 2) are necessary to overcome the main vestments and exports for growth development constraints by rebalancing growth, Putting BiH to work: BiH’s high tax burden in- investing in physical capital, strengthening hu- creases the cost of labor and constrains formal man capital and basic services, and managing sector employment. High taxes are particularly natural assets. Ten priority areas identified previ- hitting low-income groups and shifting prefer- ously (World Bank 2015) are still relevant today. ences toward the informal sector, which leads to This update has focused on the rapid population lower growth and income convergence. Moreover, decline and added it as a priority, and it grouped better working conditions in the government and business environment and access to finance into SOEs has skewed preferences toward jobs in the one priority. As in the previous SCD, the need to public sector. Reducing labor costs will increase preserve macro stability underpins these core pri- competitiveness and shared prosperity and re- orities, and it will be imperative to address struc- duce incentives for informality. It is also crucial to tural bottlenecks identified. Maintaining a strong reorient active labor market programs to address focus on macro stability will also be instrumental the needs of the private sector and toward those in navigating the rising uncertainties in the near to who need to transition from SOEs. The social as- medium term. sistance system discourages formal employment 44 IMF (2019) helped to fill this knowledge gap identified in the 2015 SCD. 63 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE TABLE 2: SUMMARY OF REFORM PRIORITIES Rebalancing growth, pivoting to private investments and exports for growth Putting BiH to work: reforming the labor market, reducing the cost of labor, increasing social protection Making it easier to do business: improving competitiveness, entrepreneurship, and the investment climate; maintaining financial stability and expanding access to finance Creating an efficient and effective public sector: reducing the size of the public sector including state-owned enterprises, while ensuring fiscal sustainability and improving public service delivery Investing in physical capital Investing in economic infrastructure for growth and inclusion: powering and connecting BiH to the world Strengthening human capital and basic services Boosting brains: improving education services and labor market skills Supporting healthy lives: improving healthcare services and sustainability of healthcare system Managing demographic change: adapting to and mitigating effects of aging, shrinking population Managing natural assets for prosperity Cleaning BiH: reducing pollution and protecting the environment Better leveraging natural resources for growth: agriculture and forestry Building resilience: helping BiH cope with adverse natural events through its linked delivery of health insurance and the most cumbersome regulatory and adminis- unemployment benefits. In addition, the social trative environments in Europe, and the volume protection system does not encourage work; cit- and added value of exports is low, partly because izens of BiH who are poor but can work are not el- of low and declining productivity. To improve igible for social assistance transfers. Targeting of the business environment, BiH should focus on social assistance transfers is inaccurate for some harmonizing, streamlining, and simplifying busi- programs, and coverage is low, in particular for ness regulations. To increase the effectiveness of poorer people. This raise concerns about inter- product markets BiH should support regulations generational transmission of poverty, given that to ensure competition neutrality including SOE households with more children are more likely to reforms; eliminate distortionary labor policies; be poor. Improving the targeting, coverage, and and encourage a diversified, deep financial sec- design of social protection interventions could tor. A better administrative environment for firms decrease incentives to informality and inactivity would benefit from the digital transformation of and strengthen the poverty impact of social assis- government services for businesses, including tance interventions. e-signature, e-registration of businesses, and e-construction permits. To support a more out- Making it easier to do business: A better busi- ward-oriented economy, BiH could reduce bottle- ness environment will be necessary to enhance necks at borders and between entities, streamline the role of the private sector, increase reliance on investment regulations, and develop more effec- investment to support growth, and foster a more tive investment promotion institutions. outward-looking economy, but BiH has one of 64 IV. PRIORITIZATION FOR FAST, LONG-LASTING, INCLUSIVE GROWTH Creating an efficient, effective public sec- try’s competitiveness. Road and railway quality is tor: The efficiency and productivity of the public poor, affected by underinvestment by financially sector, including SOEs, must be increased while weak SOEs and inefficiencies in spending. Much ensuring fiscal sustainability and improving pub- of BiH’s energy infrastructure is obsolete. BiH’s lic service delivery. BiH’s complex, fragmented economy is the most carbon and energy inten- institutional structure has reduced the quality of sive in the region, requiring rebalancing toward governance, the efficiency and accountability of a diversified, low-carbon mix with a greater role the public sector, and the efficacy of policies. BiH for the private sector. Well-prioritized invest- has a high tax burden, but citizen satisfaction with ments in enabling infrastructure will be needed service delivery is low, and public investment is to enhance connectivity and provision of public insufficient; money is being spent on a high pub- services. Reforms in the energy sector include lic wage bill, large transfers to inefficient SOEs, support for a cleaner energy mix, tariff and sub- and social programs that have a limited effect on sidy reform to foster private sector investments poverty. A difficult set of reforms will be necessary and ensure a financially viable energy sector, up- to create a more efficient, more effective public grading the transmission network, and increasing sector. SOE reform will need an adequate institu- energy efficiency through sustainable financing tional and regulatory framework for stronger SOE and implementation mechanisms. Digital devel- governance, supervision, and accountability and opment could contribute to greater productivity tailored policy options for companies, including and service delivery and create new opportuni- restructuring, privatization, and liquidation. SOEs ties for growth but will need a stronger legal and that remain under government ownership will regulatory framework and more competition. The need corporate governance principles for their transportation sector would benefit from stronger management. Transparent, merit-based pay and SOEs (as discussed above), greater efficiency and employment practices in the public sector will im- predictability through enhanced collaboration prove the quality of the civil service. A comprehen- between entities in BiH and across borders, fully sive tax policy and administration reform program leveraging the potential of public-private part- should include a reduction in taxes on tradables nerships for economic infrastructure, and invest- (especially labor), greater progressivity, lower pa- ments in less-polluting infrastructure (rail, water- ra-fiscal fees, amendments to corporate income ways, public transportation). tax laws to encourage investment in production of goods and services, harmonization of tax legisla- Strengthening human capital and basic ser- tion across entities, and stronger revenue admin- vices istration. Other important reform areas include Boosting brains: Access to good quality educa- the public financial management framework and tion is necessary for poverty reduction; education management of arrears and other off-budget lia- highly correlates with probability of obtaining a bilities for better fiscal risk management. job and the well-being of the poorest 40 percent of the population, but education in BiH is not pro- Investing in physical capital ducing graduates with the necessary learning and Investing in economic infrastructure for growth skills, which results in lower productivity in adult- and inclusion: BiH’s transportation infrastruc- hood. Challenges start early in life, with very low, ture has been deteriorating, reducing the coun- unequal access to pre-primary education. Given 65 BOSNIA AND HERZ EGOVINA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE the global evidence of the importance of early reduce overstaffing in nonmedical functions, im- childhood education for developing foundational prove fairness in hiring, and better reward perfor- cognitive and socioemotional skills and its poten- mance. Decisive actions to reduce noncommuni- tial for positive externalities in terms of female la- cable diseases (including those related to the high bor force participation, funding could be reorient- incidence of smoking) will be required to reduce ed across levels of education to increase access to the high mortality and economic cost stemming pre-primary education. Improving teacher quali- from those diseases. ty in basic education is also critical to improving Managing demographic change: Demograph- children’s learning outcomes. Lack of compara- ic trends pose serious challenges for BiH; people ble data on learning outcomes and absence of a are emigrating for better opportunities and quality state-wide student assessment system to mea- of life overseas, birth rates are declining, and the sure these outcomes hinders regular performance population is aging rapidly. Because emigrants monitoring. Spending is decentralized and input tend to be young, highly skilled workers, emigra- based, which creates inefficient service delivery, tion has important implications for BiH’s already which is reflected in small, declining class sizes low productivity. Moreover, an aging population and student-teacher ratios. Some fiscal space may harm the labor market, public spending pri- could be created by introducing a per-capita orities, and fiscal sustainability. BiH will need to funding mechanism that takes the changing de- adapt to this changing reality. The demograph- mographics into consideration while rebalancing ic changes may have broader fiscal implications, spending away from staffing. Finally, firms com- with a shrinking labor force having to finance pub- plain about skills mismatches in the labor market. lic services for an aging society, but there are gaps As such, it is crucial to ensure alignment between in data and knowledge needed to inform interven- secondary and tertiary education curricula and tions. Improving the knowledge base by develop- instruction with labor market skills demands. ing a system to track immigration and emigration Supporting healthy lives: Even though BiH and regularly analyzing the effect of demographic devotes considerable resources to healthcare, change on delivery of basic services (e.g., fewer quality is not commensurate with cost. Deficien- schools and more healthcare for elderly adults) cies in healthcare are a major concern to people and its fiscal effect will help fill these knowledge in BiH, and inefficiencies in the sector affect the gaps. Emigration significantly affects the health- performance and morale of medical staff. Increas- care sector, because many healthcare workers ing the efficiency of the healthcare sector is not leave BiH in search of better employment pros- about increasing spending but about spending pects overseas. Job quality and career and train- more efficiently. A better-performing sector will ing opportunities must be improved to decrease require better governance with clear oversight incentives for doctors and nurses to leave. Popula- of expenditures, assessment of performance of tion aging will disrupt the financial sustainability medical centers, and clear accountability for re- of the healthcare system. Increasing sustainabil- sults. Reducing the fragmentation of the system ity may require financing the healthcare system and increasing collaboration between entities through general tax revenues in addition to payroll will also be necessary to reduce duplication of contributions from employees in the formal econ- facilities and increase efficiency. More-objective, omy. The harm to labor markets could be mitigat- merit-based staffing practices will be required to ed with conscious efforts to increase female labor 66 IV. PRIORITIZATION FOR FAST, LONG-LASTING, INCLUSIVE GROWTH force participation (e.g., through improved child gard to electricity generation will be required to and elder care services) and investments in the reduce reliance on coal, including encouraging skills and productivity of the labor force. Emigra- use of cost-efficient renewable energy sources. tion can also bring benefits in the form of remit- Better leveraging natural resources for tances that can finance investment or the knowl- growth: Agriculture and forestry make a signifi- edge and skills that a successful diaspora can send cant but rapidly declining contribution to growth home. An investment climate that attracts invest- and jobs. Both sectors have low productivity, and ment and puts these new knowledge and skills to their exports are largely low-value-added com- use will maximize benefits. modities. Unlocking the potential of these sectors will require addressing the obstacles that prevent Managing natural assets for prosperity private investment, fostering adoption of new Cleaning BiH: In addressing these challenges, BiH technologies in production and management pro- will require not only investments, but also policy cesses, and supporting access to markets. and institutional reforms. In recent years, efforts Building resilience: Floods in 2014 highlighted to reduce damages from garbage and sewage the exposure of BiH to adverse natural events, at have been focused on building sanitary landfills an enormous cost to society and the population. and wastewater treatment plants. Going forward, Going forward, the focus should be on prepared- a focus on enhancing the financial sustainability ness, rather than reconstruction. This will require of these services and the operational efficien- having an adequate national strategy for disaster cy of the utilities that are in charge of providing risk management in place; improving risk moni- them will be required. Highly polluting heating toring, assessment, and warning capacities; and methods, industrial activity, and reliance on coal investing in the infrastructure needed to reduce for electricity generation has reduced air quality. the effect of floods. Similarly, it will be important Increasing energy efficiency in public and private to ensure that forest and land management prac- buildings will be necessary to alleviate air pollu- tices reduce vulnerability to natural hazards (in- tion in cities. A substantial policy change with re- cluding wildfires). 67 68 APPENDIX A: INDICATORS OF TRUST IN BOSNIA AND HERZEGOVINA In 2019, the Balkans Barometer found low levels know). Narrowing of trust is a coping strategy that of trust in Bosnia and Herzegovina (BiH) and little helps people feel safer and, in the BiH context of public interest in participating in governance. Ap- political, religious, and ethnic diversity, inevita- proximately 60 percent of respondents had little bly contributes to more constrained communities trust in courts, parliament, or the government. There were also declines in broad-based trust Perceptions of political parties, the judiciary, cus- (when fewer people trust not only acquaintances, toms, and medical and healthcare services were but also strangers) since the ‘honeymoon’ period more negative than in other Balkan countries ex- just after the war, contributing to shrinking space cept Albania. Trust is important for long-term sta- for intercommunity engagement. Tuzla appears bility and well-being, and this Systematic Country to be an exception to this trend. Diagnostic update included an analysis of the Willingness to discuss trust and cohesion and factors contributing to trust. The study reviewed interest in doing so varied according to context 16 studies of trust since the Dayton Peace Agree- and war experiences. Participants from all groups ment and was enriched by new research in four thought that discussion of the war remained a contrasting locations: the ethnically homogenous significant barrier to intercommunity trust. In Mo- communities of Pale and Lubeški; the divided star, for example, participants indicated that they community of Mostar; and the multiethnic, cohe- know that the absence of trust between groups sive Tuzla. Discussions focused on how people re- is a problem, but they would like to be left alone gard the system within which they live and what to build trust over time; in Tuzla, where multicul- factors help or hinder two kinds of trust: narrow turalism is better established, participants seem and broad based. less guarded in discussing trust; and in the ethni- When citizens discuss trust, they generally cally homogeneous community of Pale, residents refer to their beliefs in how reliable, committed, feel safer when travelling elsewhere or socializing caring, truthful, or capable another person, group with other ethnic groups. or institution is. Participants in three locations de- Lack of economic opportunities and unem- scribed growing levels of narrow trust (increasing ployment inhibit intercommunity trust and trust belief in the reliability, truthfulness, and capabil- in administrative services. For many, the eco- ity of the people, groups, and institutions they nomic challenges of day-to-day life are a major APPENDIX A obstacle to taking time to develop social net- where there are concerns about performance works across groups so as to build trust through and corruption), citizens can build confidence association and contact, including business. Par- to engage on other issues and government ac- ticipants in all locations thought that it would be tors to respond. positive to see overall trust increase. Proposed • Addressing concerns about the media will be solutions varied according to location, but there critical. Respondents feel that the media—in were three themes: different forms—is being used to manipulate • Depoliticizing the service delivery and the func- them along political, religious, and ethnic lines. tions of government would help reestablish People are concerned about how to avoid the- trust in service institutions. Participants had a se channels being used to divide them and dis- strong desire to separate politics and services: seminate false information. They seek support “We just want everyone to do their job,” and to develop media literacy skills so that they are “Politics should be kept out of institutions.” All better able to assess the reliability of informa- locations wanted to see service staff selected tion and to be less vulnerable to manipulation. on merit rather than political affiliation. The- A healthy, cohesive society requires broad- re is potential to pilot trust-building initiatives based, inclusive trust, which can help create bet- through local services in many locations. ter social and economic networks. At the same • There is reluctance to engage on any govern- time, a degree of mistrust or doubt can help stim- mental function, but a dialogue between users ulate active citizen engagement with government and providers would allow users to be heard. officials to develop greater accountability. If citizens and government officials have a dia- Source: Rapid Participatory Assessment of Trust in Bosnia and logue on specific services (e.g., public health, Herzegovina, ECA Social, 2019 69 70 APPENDIX B: EUROPEAN COMMISSION OPINION ON BOSNIA AND HERZEGOVINA’S APPLICATION FOR EUROPEAN UNION MEMBERSHIP Acquis: As part of its effort to accede to the Euro- extensive legislative authority and the power to pean Union (EU), Bosnia and Herzegovina (BiH) remove public officials. The Commission’s opin- needs to adopt the EU’s acquis communautaire ion holds that international supervision is “in- (body of law). BiH’s complex institutional set-up compatible with the sovereignty of Bosnia and results in frequent disputes over distribution of Herzegovina and therefore with EU membership.” power between the state and substate entities, Governance: Vital national interest vetoes and limiting their effectiveness and hindering imple- entity voting, which can delay legislation, re- mentation of the acquis. The European Commis- duce the effectiveness of BiH’s parliaments. The sion encourages BiH to “ensure legal certainty on opinion describes BiH’s institutions as leading to the distribution of competences among the levels “significant issues related to coordination and of government” and implement a national frame- harmonization of the country’s policy stances, no- work of acquis. BiH has no procedure that would tably with respect to the alignment with and im- allow the state to prevent or remedy breaches of EU law by lower levels for which the entire coun- plementation of legislation stemming from the EU try could be held liable. acquis.” It deems the government’s capacities for policy and planning to be “insufficient” at all lev- Dayton Agreement: BiH’s constitution contains els. The Commission advises significant strength- ethnicity- and residence-based provisions on ap- ening of BiH’s 14 executives or a pooling of re- pointment, composition, and decision-making sources and capacities to meet the obligations of procedures of the head of state and the executive EU membership. and legislative bodies. It reserves certain electoral rights for citizens from the ‘constituent peoples’— Judiciary: The Commission judges BiH’s con- Bosniaks, Croats, and Serbs—excluding others. stitutional and legislative framework to be inade- This conflicts with the European Convention on quate because it does not guarantee the account- Human Rights, which requires equality for all cit- ability, autonomy, efficiency, and independence izens, and reforms will be needed. The constitu- of the judiciary. It advises BiH to provide the Judi- tion also established the Office of the Internation- cial and Prosecutorial Council and the state-level al High Representative, which has been granted court system with explicit constitutional status to APPENDIX B guarantee judicial independence and prosecu- common, and sanctions are poor deterrents. The torial autonomy. The opinion noted that several Commission advises BiH to adopt legislation on decisions of BiH’s Constitutional Court are not conflict of interest and whistle-blower protection, enforced. It encourages greater independence strengthen the anticorruption and law enforce- and professionalism of Constitutional Court judg- ment bodies, and align legislation and strengthen es and improving their eligibility criteria and ap- public procurement. pointment procedures. Economy: The Commission sees BiH as being Corruption: The opinion holds that “corruption “at an early stage of establishing a functioning is widespread and all levels of government show market economy and of becoming competitive signs of political capture directly affecting the within the [European] common market.” Conflict daily life of citizens, notably in healthcare, educa- between stakeholders and politicization of struc- tion, employment, and public procurement mat- tural reforms have delayed progress. The govern- ters.” According to the Commission, insufficient ment’s role in the economy is substantial because harmonization of legislation across entities and weak institutional cooperation hamper the fight it absorbs significant resources for public employ- against corruption. There are significant gaps and ment, inefficient public enterprises, and social fragmentation in the policy, institutional, and le- security transfers. The internal market is small gal framework to prevent corruption. Financial and highly fragmented, and political stalemates investigations and asset seizures are largely inef- and unpredictable policy hobble the business en- fective, and prosecutors are not sufficiently pro- vironment. Corruption, weak rule of law, and red active. High-level corruption convictions are un- tape raise the costs of private enterprise. 71 72 References Agency for Statistics of Bosnia and Herzegovina, and agency (English). 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