NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Navigating challenges, embracing opportunities NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE A © 2023 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. 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TABLE OF CONTENTS Executive summary 6 CHAPTER 1: Updated Country Context: North Macedonia Today 12 Economic growth has slowed relative to peer countries 13 Weak productivity and slow human capital formation are a drag on growth and employment 19 Firm productivity remains low and stagnant due to misallocation of resources 22 High-productivity firms create highquality jobs 27 Poverty and inequality have significantly decreased in recent years 29 Despite recent progress, some groups and regions are still lagging 31 North Macedonia still faces significant labor market challenges 34 CHAPTER 2: Recent Emerging Challenges and Opportunities 37 The COVID-19 pandemic plunged North Macedonia into a recession, and subsequent shocks have prevented a swift recovery 38 North Macedonia is rapidly losing its human capital 40 Climate change is already eroding country’s growth prospects, while energy security is a new challenge 41 The EU accession process is a powerful driver of reforms for growth 43 CHAPTER 3: Constraints to Growth and Prosperity in North Macedonia 44 Removing constrains for faster growth 46 Addressing constrains for more inclusive growth 55 Confronting the constrains for sustainable growth 64 CHAPTER 4: Priorities for Faster, More Inclusive, and Sustainable Growth 71 HLO I: More accountable service delivery to citizens 73 HLO 2. Strengthened human capital formation and closing opportunity gaps for all 75 HLO 3. Induced creation of better paid jobs 79 HLO 4. Strengthened household resilience to climate change and lowered carbon intensity and air pollution 83 Annex 1: Boxes 87 References 91 LIST OF FIGURES Figure 1. Economic growth has been moderate relative to peer countries… 14 Figure 2. …lagging the averages both for structural and aspirational peers 14 Figure 3. Convergence with the EU income level is slow 15 Figure 4. But increasing GDP growth to 3.5 percent a year would converge with the EU27 within a generation 15 Figure 5. Growth was consumption-intensive before and after the pandemic… 16 Figure 6. …but net exports helped mitigate the shock during the pandemic 16 Figure 7. Return on investment is still low in comparison to peers 16 Figure 8. Low number of new exporters in sectors with higher value-added signals weak economic transformation of the economy 17 Figure 9. The services sector has led the growth 18 Figure 10. Employment in the agricultural sector has steadily declined 18 Figure 11. The contribution of TFP to growth has been low or negative since 2011… 19 Figure 12. …and labor productivity remains weak despite recent improvements 20 Figure 13. Higher employment rate led per capita GDP growth 20 Figure 14. Job growth has recently surged in the professional services and ICT sectors… 21 Figure 15. …where wages are relatively high 21 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 1 Figure 16. The reallocation of labor across sectors has contributed little to productivity growth 22 Figure 17. A relatively large share of workers is employed in less-productive sectors 22 Figure 18. Before the pandemic, firm productivity in North Macedonia was already lower than in peer countries… 23 Figure 19. …and it plummeted after the pandemic outbreak 23 Figure 20. Productivity varies widely across firms, especially in the services sector 24 Figure 21. In general, larger firms are not more productive than smaller firms 24 Figure 22. From 2018 to 2020, within-firm productivity growth was negative across multiple sectors 25 Figure 23. The rate of firm entry in North Macedonia is below that of peer countries 25 Figure 24. Many high-growth firms are in services; only a few are in manufacturing 26 Figure 25. North Macedonia has fewer “gazelle” firms than peer countries 26 Figure 26. Firms in lagging sectors provide a large share of employment and are not exiting the market 27 Figure 27. Employment and net job creation by within-industry tend to be low with the most productive firms 28 Figure 28. Most service-sector jobs are in small and medium firms, while most manufacturing jobs are in large firms 28 Figure 29. Micro and small firms create most service-sector jobs, while large firms create most manufacturing jobs 28 Figure 30. More-productive firms tend to offer higher wages 29 Figure 31. The poverty rate has fallen substantially, but a large share of the population remains vulnerable to falling into poverty 30 Figure 32. North Macedonia has experienced one of the largest reductions in income inequality worldwide… 30 Figure 33. ...and faster income growth among poorer households has driven a steep decline in the poverty rate 30 Figure 34. Despite recent gains, public expectations for the future are pessimistic 31 Figure 35. Further poverty reduction will require considerable effort 31 Figure 36. Gender disparities are stark in the labor market 32 Figure 37. Indicators of public acceptance of LGBTI communities are low 33 Figure 38. Poverty rates are higher in the north of the country 33 Figure 39. Job opportunities and earnings were the main drivers of poverty reduction 34 Figure 40. Both total and youth unemployment decreased considerably in recent years 35 Figure 41. Unemployment remains among the highest in ECA 36 Figure 42. Workers lose approximately 23 years of productive employment 36 Figure 43. In 2020, more firms closed, and net job creation declined 38 Figure 44. Few firms entered the SEZs in 2020 but net job creation remained positive within SEZs 38 Figure 45. Rising inflation threatens to erase recent gains in poverty reduction 39 Figure 46. Populating is getting older and shrinking 41 Figure 47. North Macedonia’s performance on several governance indicators is above the income group peers, but control of corruption remains a problem 46 Figure 48. Surveys indicate that bribes are more common to obtain contracts, electricity connections, or construction permits than with peers 47 Figure 49. Perceptions of the efficiency and integrity of the judiciary are broadly negative 48 Figure 50. North Macedonia scores poorly on indicators of governance, public-sector integrity, and corruption… 48 Figure 51. …and the gap between North Macedonia and its EU peers on governance indicators is wide 48 Figure 52. Digital governance systems could be much improved 50 Figure 53. The quality and coverage of infrastructure remain below EU standards 50 Figure 54. Political instability, access to finance, and transport are bigger business obstacles than with the peers 51 Figure 55. North Macedonia’s firms invest less than their peers in greening their operations 51 Figure 56. Because the quality of the business environment either supports or hinders firm-level productivity… 52 Figure 57. …improving the business environment can yield significant productivity gains 53 Figure 58. Machinery, electronics, and chemicals have driven export growth, though gains have slowed in recent years 54 Figure 59. The growth of goods exports exceeded the average for structural peers, but service exports have untapped potential 54 2 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 60. Deeper trade agreement can increase exports, especially in sectors with many large firms 54 Figure 61. Human capital accumulation is among the lowest in ECA 56 Figure 62. Standardized test scores highlight the low quality of education in North Macedonia… 57 Figure 63. …and reveal deep disparities between students from different economic backgrounds 57 Figure 64. The quality of higher education is relatively low 57 Figure 65. Spending on tertiary education in North Macedonia is relatively low 58 Figure 66. Peer countries obtain better education outcomes at similar or lower spending levels 58 Figure 67. In addition to their enormous human cost, NCDs greatly reduce economic productivity 60 Figure 68. North Macedonia has the world’s highest rate of cigarette consumption per capita 60 Figure 69. North Macedonia’s level of per capita public health spending is among the lowest in the region… 61 Figure 70. …while OOP health expenditures are relatively high and rising 61 Figure 71. Most social assistance benefits are received by lower-income households 62 Figure 72. Social assistance programs can help mitigate the impact of rising food and energy prices 62 Figure 73. Rising indebtedness due to high primary deficits 65 Figure 74. Large room for efficiency improvements of the education spending 65 Figure 75. Electricity production is mainly based on coal 66 Figure 76. The energy mix remains emission intensive 66 Figure 77. Macedonians tend to be less attuned to the benefits of upgrading their heating systems than do their regional peers 67 Figure 78. North Macedonia is less resilient to climate change than the average EU country 68 Figure 79. Reliance on exports from emissions-intensive sectors remains high 69 Figure 80. A large share of the workforce is employed in high emissions “brown” jobs 69 Figure 81. Potential output trajectories before and after COVID-19 87 Figure 82. A modest correlation can be observed between firm-level and light information from satellite pictures 88 LIST OF TABLES Table 1. HLO 1: More accountable service delivery to citizens 73 Table 2. HLO 2: Strengthened human capital formation and closing opportunity gaps for all 76 Table 3. HLO 3: Induced creation of better paid jobs 80 Table 4. HLO 4: Strengthened household resilience to climate change and lowered carbon intensity and air pollution 83 LIST OF BOXES Box 1. Potential output before and after COVID-19 87 Box 2. Using satellite data to assess spatial economic activity 88 Box 3. Data and knowledge gaps 89 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 3 ACKNOWLEDGEMENTS This report was prepared by a World Bank Group core team led by Leonardo Lucchetti and Sanja Madzarevic Sujster (both Senior Economists), and included Joana Madjoska, Monica Paganini, Carlos Gustavo Ospino Hernandez, and Anita Bozinovska. Contributions are gratefully acknowledged by team members from across the World Bank Global Practices and the International Finance Corporation: Alanna Simpson, Aleksandar Stojanov, Ali Hamandi, Ana Krsteska, Anna Fruttero, Axel Baeumler, Bojana Naceva, Charles Hurpy, Chiara Broccolini, Cveta Peruseska-Joncevska, Daniel Garrote Sanchez, Daniel Kull, Dominik Koehler, Fatima Karout, Federica Secci, Fiona Collin, Gozde Isik, Hafida Sahraoui, Ivan Krofak, Jonathan Karver, Levent Karadayi, Luan Aliu, Magdalena Soljakova, Manual Jose Sanchez, Mattia Makovec, Mediha Agar, Megha Mukim, Mirjana Popovic, Mirko Dunner, Nadia Badea, Natalija Gelvanovska, Nga Thi Viet Nguyen, Noriko Oe, Rhedon Begolli, Sarah Coll- Black, Silvia Mauri, Svetlana Vukanovic, Tatjana Markovska, Tatyana Shadrunova, Trandelina Baraku, Yoshini Naomi Rupasinghe, and Zoran Anusic. Administrative support from Armanda Carcani, Jasminka Sopova, Martha Mora, and Karem Edwards is gratefully acknowledged. The work was performed under the overall guidance of Xiaoqing Yu (Country Director); Massimiliano Paolucci (Country Manager); Ary Naim (IFC Regional manager); Salman Zaidi (Practice Manager); and Jasmin Chakeri (Practice Manager). The team received advice and support from Richard Record, Indhira Santos, and Ramon Munoz (Program Leaders, World Bank). The team also benefitted from guidance and feedback from the SCD Central Team—Alexandru Cojocaru (Senior Economist) and Samuel Freije-Rodriguez (Lead Economist); and the OPCS Team—Kamer Karakurum Ozdemir (Senior Economist). The team thanks peer reviewers Ana Maria Oviedo, Emilija Timmis, and Paolo Di Lorenzo (Senior Economists) for their insightful comments. Sean Lothrop and Florencia Micheltorena edited the report, and Suzana Jukic helped with data. A Systematic Country Diagnostic (SCD) is an analytical report produced by the World Bank for member countries prior to the start of a new Country Partnership Framework (CPF) cycle. The SCD identifies the most important constraints and opportunities facing a given country as it strives to end extreme poverty and promote shared prosperity. The World Bank produced its first SCD for North Macedonia in 2018. This 2023 SCD update builds on that analysis and provides an update given the latest data and developments, emerging opportunities, and challenges. The SCD Update reflects the views of a diverse range of members of the society across North Macedonia that have shared inputs through an extensive consultation process carried out both in-person and online between April 24 and May 4 of 2023. The World Bank carried out 12 in-person consultation sessions in Skopje, Tetovo, Bitola, and Shtip in the format of roundtable discussions and site visits. Representatives of the public sector—including central and local government, the National Bank of the Republic of North Macedonia, the private sector, academia, donors, civil society organizations, international financial institutions, European Union, and UN agencies have participated in consultations. Additionally, around 114 Macedonian citizens shared their views through an online questionnaire posted on social media channel composed of multiple-choice and open-ended questions. The questionnaire was published on a dedicated webpage for consultations: Consultations: North Macedonia Systematic Country Diagnostic Update 2023 (worldbank.org). The majority of the inputs collected through this consultation process validated the findings of the SCD but emphasized governance, accountability, and the rule of law as high priority objectives for the country’s development (see Wordle summary). 4 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE ACRONYMS/ABBREVIATIONS ALMP Active labor-market programs NATO North Atlantic Treaty Organization CBAM Carbon Border Adjustment Mechanism NBFIs Nonbank Financial Institutions CPF Country Partnership Strategy NBRNM National Bank of the Republic of North Macedonia DRM Disaster Risk Management NEET Not in Education, Employment and Training ECA Europe and Central Asia NDC Nationally Determined Contributions ECEC Early Childhood Education and Care OECD Organization for Economic Cooperation and Development EGD European Green Deal OOP Out-of-pocket EIB European Investment Bank PCG Partial Credit Guarantee EU European Union PHC Primary Healthcare EUR Euro currency PIM Public Investment Management EU-SILC EU Survey of Income and Living PISA Programme for International Student Conditions Assessment EV Electric Vehicle PIT Personal Income Tax FDI Foreign Direct Investments PMR Product Market Regulation GDP Gross Domestic Product PPP Purchasing Power Parity GHG Greenhouse Gas PPPs Public-Private Partnership GMA Guaranteed minimum assistance PPS Purchasing Power Standards GNI Gross National Income R&D Research and Development GVC Global Value Chain RER Regular Economic Report HCI Human capital index SCD Systematic Country Diagnostic HLO High-Level Outcome SEE Southeast Europe Catastrophe Risk CRIF Insurance Facility HR Human Resources SEZ Special Economic Zones ICT Information and Communications SILC Statistics on Income and Living Technology Conditions IFC International Finance Corporation SMEs Small and Medium-sized Enterprises IFMIS Integrated Financial Management SOEs State-Owned Enterprises Information System IMF International Monetary Fund SSO State Statistical Office IT Information Technology TEN-T Trans-European Transport Network LGBTI Lesbian, Gay, Bisexual, Transgender, TIDZ Technological and Industrial and Intersex Development Zones LiTS Life in Transition Survey TFP Total Factor Productivity LPI Logistics Performance Index TFPR Revenue-based TFP LTS Long-Term Strategy on Climate Action USD US dollar LULUCF Land Use, Land-Use Change and VAT Value-added Tax Forestry MIGA Multilateral Investment Guarantee VET Vocational Education and Training Agency MKD North Macedonia denar WDI World Development Indicators MLSP Ministry of Labor and Social Policy WHO World Health Organization MSMEs Micro, Small and Medium-sized Enterprises NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 5 EXECUTIVE SUMMARY 6 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE The central development narrative issue of population decline and emigration. remains mostly unchanged Numerous factors contribute to the wave of emigration, encompassing political The 2018 North Macedonia SCD evaluated polarization, corruption, eroded trust in public the country’s economic development and institutions, perceptions of socioeconomic recognized its impressive progress in reducing inequality, persisting intergenerational poverty and advancing shared prosperity. poverty, low-quality healthcare and education Between 2002 and 2018, income per capita systems, and alarming levels of air pollution. doubled, and the country rose from lower- middle-income to upper-middle-income It is an imperative for the country to curb status. In the wake of the global financial the outmigration of its citizens by providing crisis, a sustained increase in the incomes of incentives that fulfill their yearnings for an households in the bottom 40 percent of the improved quality of life. To facilitate accession distribution halved the headcount poverty negotiations and expedite convergence with rate to about 20 percent, and years of inclusive standards of government effectiveness in growth drove one of the world’s steepest the EU, significant strides must be made in declines in inequality. progressing in the rule of law and safeguarding fundamental rights, while intensifying efforts While this assessment was broadly positive, in judicial and public administration reform, it also highlighted challenges that could and in the fight against corruption and make progress difficult to sustain unless organized crime. Further, North Macedonia structural reforms were advanced including should rely on utilizing more efficiently the within the European Union (EU) accession country’s current natural, human, and social negotiations context. The SCD presented capital, seize the opportunities of the EU three complementary pathways for North accession negotiation process to transform Macedonia to achieve faster, more inclusive, the economy, and build resilience against and sustainable growth: (i) increasing climate threats and future economic shocks productivity; (ii) enhancing job opportunities to prevent setbacks. In its short history, the for all; and (iii) achieving sustainability country has achieved important progress, through effective governance, fiscal prudence, including gaining independence, joining enhanced environmental management and NATO, attracting large foreign investments resilience to natural hazards. Five years through a competitive business environment, later, these same pathways remain central and launching the transformation of its to inclusive growth and poverty reduction in social and energy sectors since 2018. These North Macedonia. successes were built on a broad consensus on the country’s future development. Going North Macedonia envisions a future forward, it is imperative for all stakeholders characterized by higher productivity and to take joint and consensual decisive action in better paid jobs; enhanced infrastructure navigating existing challenges and embracing and public services that allow a more emerging opportunities. Ensuring policy balanced regional development; a sustainable continuity would improve predictability for environment and higher resilience to shocks; private capital mobilization required to boost and, ultimately, being a member of the EU. growth and job creation going forward, Unfortunately, the country lags on these gradually reducing the important role the aspirations and grapples with the pressing state has played in the economy since 2020. NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 7 The evolving economic and social population, and emigration among younger context presents challenges as well generations is accelerating the process of as opportunities demographic aging. Most emigrants are between 20 and 39 years old—the prime of Since 2018, economic growth has continued their working lives—and they tend to cluster to benefit lower-income households, but at the two extremes of the educational the poverty rate is still relatively high, and spectrum, having either very low or very about one-third of the population remains high levels of educational attainment. To vulnerable to shocks. Almost 400,000 people induce young workers to stay, Macedonian lived in poverty in 2019—the latest year for firms need to narrow the wage gap with EU, which income data are available.1 Employment which in turn will require productivity gains, growth and rising wages have driven poverty trade integration, and increased innovation. reduction, but deep disparities persist However, informality remains prevalent, and between urban and rural areas. The overall many firms are disconnected from the global unemployment and youth unemployment economy. rates have both declined substantially since 2018, but they remain among the highest in The disruptions caused by Russia’s invasion of Europe and Central Asia (ECA), and long- Ukraine, including rising food and energy prices, term unemployment at 80 percent of total exacerbated structural weaknesses in North unemployment has remained fairly constant. Macedonia’s economy. While the country’s Income inequality has declined considerably resilience to the crisis appears stronger than but is still higher than in other Western Balkan expected, its long-run potential growth rate countries such as Albania and Kosovo. continues to decline, driven by low and falling productivity and a chronic shortage of skilled Despite North Macedonia’s considerable labor. Financial sector resilience is also being progress, surveys indicate that public tested, while the country returned temporarily perceptions of the country’s future economic to coal-fired power generation, undermining prospects remain pessimistic. In 2022, about progress on its climate commitments. 66 percent of respondents to the Balkan However, the long-awaited launch of the Barometer survey reported being unsatisfied EU accession process in 2022 represents an with the economic situation, and about 40 opportunity for North Macedonia to align its percent believed that the economy would laws and institutions and benefit from faster worsen in the coming year. These shares were convergence with the EU. among the highest in the Western Balkans. This pessimism reflects the fact that slightly Convergence with the EU income level has more than half of people of working-age have improved slowly: North Macedonia’s per jobs, while at the current GDP growth rate capita GDP rose from 34.4 percent of the more than 235,000 people in North Macedonia EU27 average in 2009 to 41.5 percent in 2021, will still be poor in 2030. but this gap must be narrowed further to stem the tide of emigration among young workers. Economic growth has been insufficient to Moving from middle-income to high-income close the gap in living standards with advanced status will require boosting productivity, European countries, which continues to inclusion, and sustainability while reducing encourage many young Macedonians to dependence on fossil fuels and energy emigrate abroad. North Macedonia has one intensity—all in a context of narrower fiscal of the largest diasporas in ECA relative to its space, rising costs of capital and persistent 1  At the time of the publication the last Survey of Income and Living Conditions was from 2020 which depicts income data from 2019. 8 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE global economic uncertainty. However, frequently thwart reform efforts. Inadequate some geopolitical trends may benefit North budget allocations and inefficient spending Macedonia: the post-pandemic emphasis on on education and health result in poor nearshoring/friend-shoring has already led to human development outcomes, both by the an increase in foreign direct investment from, standards of the EU and other Western Balkan and exports to, EU and NATO member states. countries. Russia’s invasion of Ukraine has accelerated EU enlargement decisions, and grant support Productivity is essential to spur growth to facilitate the implementation of the EU and create more high-paying jobs, yet acquis and the Green Agenda is rising. productivity indicators in North Macedonia are low and declining. Microenterprises are However, the current political polarization responsible for 88 percent of economic would need to be overcome to establish a output, but these firms struggle with weak broad consensus on key development and competitiveness, limited capacity for strategic goals and mobilize the resources innovation and exports, insufficient access to necessary to achieve them. Moving forward finance, and low productivity. Unfortunately, with the stalled reforms in financial, tax, most jobs are locked in such low-productivity competition, education, and governance firms. Foreign firms, especially automakers areas is more urgent than ever given the sourcing components, generate a significant uncertainty of the geopolitical context and number of jobs, but their spillover on the the competitive pressures the country is faced national economy is limited, and they are with even within the CEFTA region. Effective mostly tax-exempt. State aid stifles structural governance is critical to North Macedonia’s transformation in the agricultural sector continued economic and social transformation and contribute to an inefficient allocation and requires a professional, non-politicized, of productive factors. The agriculture and and competent public administration that food sector has the potential to increase its provides high-quality services to all citizens, productivity and create better jobs, but that designs evidence-based policies, and has potential is not fully explored at present. the ability to carry forward the demanding Focusing on deepening trade integration, EU accession process that would lead to more effective state aid and competition transformational changes of the country. policy, digitalization, business environment and governance reforms would change the Several constraints prevent North role of the state from its interventionist role Macedonia from achieving faster, in the economy to the guarantor of the level- more inclusive, and sustainable playing field. growth Despite advances in infrastructure, inadequate Weak governance and control of corruption modernization and poor maintenance of the continue to undermine North Macedonia’s road and rail network continue to hinder development. Low administrative capacity, economic development and slow regional political disagreements over high-level policy economic integration. At least one-fifth of objectives, the politicization of the public firms regard the quality of transportation sector, and frequent changes in ministerial infrastructure as subpar, with logistics and leadership undermine service delivery and connectivity problems contributing to high slow the implementation of reforms. Strategic trade costs. Digitalization can enhance planning is not aligned with budgeting and productivity across all economic sectors, public investment programs, policy reversals and can transform the labor market, increase are common, and entrenched interests government transparency and accountability, NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 9 and enhance the quality and accessibility of 2019. Major risk factors such as high blood public services. However, while the country pressure, tobacco use, and unhealthy diets are has made considerable progress in expanding prevalent, and North Macedonia has one of the digital connectivity since 2018, North world’s highest rates of tobacco consumption Macedonia’s information technology sector per capita. Ambient air pollution also imposes and digital infrastructure still lag far behind a major health burden, accounting for about the average for the EU. 1,600 premature deaths each year. The reform of the education system is launched Social assistance programs have made a but needs to accelerate. The system is not significant contribution to poverty reduction, adequately equipping graduates with the particularly during recent crises, but the skills demanded by the labor market, making coverage of means-tested programs is limited. it difficult for young people to secure jobs. In a context of increasingly frequent economic Due to unemployment and underemployment, shocks, the efficiency of the social protection the average Macedonian loses an estimated system is critical to ensuring continued 23 years of potential productive employment. progress on poverty reduction. To strengthen Moreover, limited access to early childhood their impact, these programs should be education and childcare contributes to one further consolidated and expanded. Gender of the lowest rates of female labor-force inequalities remain significant, and women participation rate in ECA at 44 percent. While have less access to economic opportunities the country has made progress in improving and productive assets. Eliminating the gender human capital development, a child born in gap in employment and entrepreneurship North Macedonia today can still expect to could boost annual GDP by 16 percent. In achieve just 56 percent of what his/her lifetime addition, minority groups such as the Roma, productivity would have been had he/she youth, LGBTI, and communities in remote enjoyed complete education and full health rural areas often have very limited access to (also among the lowest in ECA). While average the labor market, social services, and essential scores on the Program for International infrastructure, including water, sanitation, Student Assessment (PISA) have improved transportation, and energy provision. since 2015, Macedonian students continue to underperform relative both to EU students A combination of financial tightening, and those in most Western Balkan countries. demographic aging, and the intensifying A child who starts school at age four can effects of climate change are narrowing the expect to complete 11 years of education by available fiscal space and raising sustainability age 18, given the enrollment and completion concerns. The public debt stock has reached rates, however, this number falls to 7.3 years 60 percent of GDP, and the deficit significantly when adjusted for learning quality. exceeds the pre-pandemic average. Public expenditure efficiency is weak, while Health outcomes have improved, but the mandatory spending accounts for 80 percent management of noncommunicable diseases of total public spending. Fiscal revenues, remains a challenge, and the provision of health equal to 33 percent of GDP, are among the services is neither as efficient nor as equitable lowest levels in the region and well below the as it could be. About 55 percent of the 2022 EU average. Balkan Barometer survey respondents expressed dissatisfaction with the quality of Climate-change adaptation will be vital to health services, and while child and maternal enhance resilience to environmental shocks, health improved, noncommunicable diseases while decarbonization will become increasingly accounted for 95 percent of all deaths in critical to international competitiveness as 10 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE the global transition to low-carbon growth total) from emission-intensive sectors remains accelerates. North Macedonia is one of the high. Mitigation efforts made in the EU (CBAM most climate-vulnerable countries in the ECA and the Supplier Due Diligence Act) will region, as environmental degradation and impact trade, competitiveness, and the influx extreme weather events pose a serious threat of FDI for carbon-intensive goods. Levying to its aging and poorly managed infrastructure. comparable carbon pricing to producers at The current institutional arrangements for home instead of paying to the EU budget disaster prevention, preparedness, and would boost fiscal revenues and set signals on response are inefficient, both at the national the right pathway. and sub-national levels, and the country’s water and wastewater infrastructure are in Priorities for reducing poverty and urgent need of investment. North Macedonia’s promoting shared prosperity growth has been highly carbon-intensive, as lignite dominates energy supply. Energy The analysis presented in the SCD update intensity is almost three times higher than highlights four High-Level Outcomes (HLOs) the EU average, while heating based on solid needed to achieve faster, sustainable, and fuels is the leading cause of air pollution in inclusive growth, as well as 12 priorities that large urban areas including Skopje. North are crucial to poverty reduction and shared Macedonia is one of the countries most prosperity in North Macedonia. The following affected by ambient air pollution in the world, recommendations will inform the upcoming costing approximately an estimated 6.9 Country Partnership Framework (CPF) percent of GDP. Further, reliance on exports between the World Bank Group and the (40 percent of total) and jobs (5 percent of Government of North Macedonia. Sustainable, Inclusive, and Resilient Growth: High-Level Outcomes and Priorities HLO 4: Strengthened HLO 2: Strengthened HLO 1: More HLO 3: Induced household resilience to human capital accountable service creation of better paid climate change and formation and closing delivery to citizens jobs lowered carbon intensity opportunity gaps for all and air pollution Mitigate the impact of Close the gaps in the political instability Endow people with transport, energy, and Accelerate through establishment quality and relevant other connectivity decarbonization and of medium-long term skills throughout the infrastructure for ensure energy security strategic and spending life cycle international and priorities intranational connectivity Reduce disincentives Secure rule of law and Scale up adaptation to and remove barriers to build professional Increase financial climate change and labor market public institutions that intermediation and improve preparedness, participation, are accountable to inclusion response and recovery especially for women citizens from natural disasters and youth Ensure fiscal sustainability by Improve efficiency Improve the Improve public and reducing fiscal risks, and access to quality competitive private financial improving the public services for environment and resilience to natural efficiency of spending, vulnerable and in foster innovation disasters and enhancing revenue rural reas mobilization NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 11 CHAPTER 1 UPDATED COUNTRY CONTEXT: NORTH MACEDONIA TODAY North Macedonia is an upper-middle income country that began accession negotiations with the European Union in 2022. Since 2020, countercyclical macroeconomic policies have partially alleviated the impact of the pandemic and other concurrent crises on households and firms, enabling the country to rebound to its pre-crisis growth rate in early 2022. North Macedonia has shown considerable resilience in the face of multiple shocks, but it continues to struggle with underlying weaknesses, including an inefficient, import-dependent energy sector and persistently high rates of poverty and vulnerability. Amid rising external headwinds and unresolved domestic challenges, the potential GDP growth rate has fallen to less than 2 percent per year. Even prior to the pandemic the country’s growth performance lagged peer countries, and at its current growth rate it will take several generations for North Macedonia to reach the average EU income level. 12 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE To achieve its development goals, North Macedonia will need robust, sustained, employment- intensive growth. The labor force is shrinking due to a combination of demographic aging and emigration, and wages will need to rise to increase labor-force participation. Promoting an efficient allocation of resources can increase productivity, employment, and wages, and structural reforms can help shift capital and labor to more-productive sectors. At the firm level, greater competition can help bolster resilience and promote technological uptake. Over the past 15 years, the country has made important strides in improving the welfare of lower-income households, but poverty remains a significant challenge. Women, young people, members of the Roma ethnic group, and the LGBTI community continue to experience poor social and economic outcomes, and many rural areas remain economically marginalized. Job opportunities have expanded, and earnings have risen—particularly among households at the bottom of the income distribution—but unemployment and inactivity remain pervasive, underscoring the need of faster, more-inclusive growth. Economic growth has slowed relative The growth rate of real per capita income was to peer countries moderate even before the pandemic. Between 2017-19, the annual growth of per capita GDP After more than a decade of macroeconomic (at PPP, constant 2017 international USD) stability marked by deepening integration averaged 2.6 percent, somewhat above the into global value chains (GVCs), an improving 2.2 percent ECA and 2.3 percent EU average. business environment, and sustained inflows Real GDP per capita (in PPP, constant 2017 of foreign direct investment (FDI), North international USD) in North Macedonia Macedonia was hit hard by the pandemic. reached $17,129 in 2022—above the average The average annual GDP growth rate slowed for structural peers, but less than half the from 2.5 percent in 2011-152 to 1.7 percent average for aspirational peers which indicates in 2016-2022 (Figure 1 and Figure 2). The a large income convergence gap. pandemic precipitated North Macedonia’s deepest recession in two decades, causing Convergence with the EU countries has a 4.7 percent contraction that was broadly been slow. In 2011, North Macedonia’s per in line with the average for structural peers. capita GDP was 26.8 percent of Germany’s, Despite substantial government support, the and by 2021 it had reached just 30 percent economy’s heavy dependence on energy (Figure 3). Structural peers fared somewhat imports hampered its recovery in late 2021, better in terms of convergence speed (4.1 and output did not reach its pre-pandemic pp). Meanwhile, per capita GDP among North level until early 2022, when Russia’s invasion Macedonia’s aspirational peers rose from of Ukraine touched off a new economic shock. an average of 59.7 percent to 67 percent 2  This growth rate was above the level of aspirational peers (Croatia, Estonia, Latvia, Lithuania, the Slovak Republic, and Slovenia) but below the level of structural peers (Albania, Bosnia and Herzegovina, Georgia, Armenia, Moldova, and Serbia). NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 13 Figure 1 Figure 1. Economic growth has been moderate relative to peer countries… (Average annual GDP growth rate per capita, 2016-22, Percent) 7 6 5 4 3 2 1 0 -1 -2 TKM UKR AZE AND LUX BLR KGZ DEU CHE NOR FRA AUT KAZ ISL ESP BEL SWE ITA SMR FIN RUS NLD GRC DNK MKD SVK CZE PRT MLT MNE LVA EST ALB BIH SVN UZB CYP BGR TUR HUN LTU SRB UVK MDA POL GEO ROU ARM HRV TJK IRL Source: Authors’ calculations based on data from national authorities, WDI, WEO, and Eurostat. Source: Figure 2. …lagging the averages both for average of 74 percent among aspirational Figure 2. Lorem structural ipsum dolor and aspirational sit amet peers peers and EU countries. During this period, (Annual real GDP growth rate, 2016-22, Percent) consumption contributed 135 percent of 4.0 GDP growth in North Macedonia, while the 3.5 contribution of net exports was negative on 3.0 3.0 average. Fueled by rising remittances, strong credit growth, and a sustained increase in 2.0 1.7 wage rates, private consumption added to 1.0 a widening external imbalance. As imports rose, exports also increased due to increasing 0.0 integration into the global economy, including North Aspirational Structural Macedonia Peers Peers via export-oriented FDI in the automotive industry. During the pandemic, net exports Source: Authors’ calculations based on data from national authorities, WDI, WEO, and Eurostat. helped offset the collapse of domestic Source: World Bank. demand. Output contracted by 4.7 percent as containment measures and weak consumer of Germany’s per capita GDP. At its pre- confidence caused a sharp drop in personal pandemic average annual per capita GDP consumption and investment (Figure 5). growth rate of 3.5 percent, it would take 40 The government ramped up spending by years for North Macedonia to converge with close to 10 percent to save jobs and firms the EU27 average GDP per capita at PPS. and soften the blow to the economy. Fiscal However, with the current annual per capita support packages totaling about 6.5 percent growth rates at 2 percent it would take over of GDP included liquidity lines and interest- three generations (Figure 4). free loans for firms, loan repayment deferrals, basic consumption vouchers, wages and Domestic demand drove growth over the social security contribution payouts, and past ten years, while net exports remained more tailored support for hard-hit sectors negative. Consumption represented close to of the economy.3 At the same time, import- 90 percent of GDP from 2017, well above the intensive production and consumption waned, 3  The realization of measures included in the first four packages from 2020 amounted to EUR 704 million. 14 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 3. Convergence with the EU income Figure 4. But increasing GDP growth to 3.5 level is slow percent a year would converge with the EU27 (GDP Per Capita in PPP, 2017 Prices, as a share of within a generation Germany’s) Figure 3 Figure 4 of Convergence of GDP Per Capita with EU27) (Simulation 70 110 Aspirational 100 60 MKD@4.5% MKD@3.5% Peers 90 50 80 40 North 70 Macedonia 30 60 MKD@2.0% 20 Structural 50 Peers 10 40 2021 4 8 12 16 20 24 28 32 36 40 44 48 52 56 60 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Source: Authors’ calculations based on data from WDI Source: Authors’ calculations based on data from WDI. and Eurostat. Source: Source:EU27 growth rate at 1.16 percent a year. Note: and despite weak external demand net weakened its contribution to growth. The exports reduced the decline in output by 2.5 gross investment-to-GDP ratio averaged 32 percentage points. As consumption plunged, percent in 2016-22, with investment in fixed household savings accumulated during 2020, assets slowing while inventories rose. The laying the foundation for a recovery in 2021. share of private investment in fixed assets increased from 73 percent in 2010-15 to 77.1 Consumption and investments led the post- percent in 2016-22. Historically, construction pandemic rebound, while the contribution has accounted for almost 60 percent of gross of net exports remained negative. Economic investment, though this share has gradually growth turned positive again in 2021, but real declined since 2018 as investment in machines, output did not exceed its 2019 level until early equipment, and R&D has expanded. The focus 2022. As movement restrictions were lifted, of construction investment also shifted from pent-up demand drove a surge in private residential buildings to other types of facilities consumption. Meanwhile, government support and infrastructure, including roads, schools, programs started to phase out. Exports hospitals, and production halls. However, low regained their footing, but imports bounced investment returns (Figure 7) highlight how back stronger due to supply shortages and weak market competition, inefficient public rising commodity prices, which worsened investment management, administrative the trade balance and dragged down growth barriers to private investment, and integration by 4.2 percentage points on average (Figure into less capital-intensive segments of GVCs 6). Stronger FDI inflows, remittances, and contribute to the misallocation of production services exports helped offset the widening factors. trade deficit in goods, but after hovering around 3 percent of GDP for three years, the Diversification, greater domestic spillovers, current account deficit reached 6 percent of and increased services exports could GDP in 2022. strengthen the contribution of trade to growth. Trade openness increased over the Despite recent improvements in its structure, last decade, driven by the expansion of goods the relatively low rate of return on investment exports. However, North Macedonia’s services NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 15 Figure 5. Growth was consumption-intensive Figure 6. …but net exports helped mitigate before and after the pandemic… the shock during the pandemic Figure 5 and contributions, Percent) (GDP growth Figure 6 and contributions, Percent) (GDP growth 6.0 10 5.0 4.0 5 3.0 2.0 1.0 0 0.0 -1.0 -5 -2.0 -3.0 -4.0 -10 2000 - 2009 2010 - 2019 2020 - 2021 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Consumption Gross investment Consumption Gross investment Net exports GDP growth Net exports GDP growth Source: Authors’ calculations based on data from national Source: Authors’ calculations based on data from national authorities. authorities. Figure 7. Return on investment is still low in which helped to cushion the impact on comparison to peers the trade balance. While the extent of (Rate of 7 Figure return on Investment, Percent) North Macedonia’s participation in GVCs is 30 comparable to the average for structural and aspirational peers, the country is classified 25 as a limited manufacturing exporter,5 and 20 moving into more skill-intensive services 15 and advanced manufacturing exports will be necessary to access higher levels of the value 10 chain, while strengthening linkages between 5 export-oriented firms and the broader 0 domestic economy will be vital to increase the MKD HRV GEO SVK EST economic benefits of trade. 2010-2015 2016-2021 2010-2021 Limited trade diversification impedes North Source: Authors’ calculations based on data from national Source: authorities and WDI. Macedonia’s economic transformation and undermines its export-led growth strategy.6 exports have fared worse than those of most The top 5 percent of exporting firms account structural and aspirational peers, representing for more than 80 percent of total exports, and just 14 percent of GDP since 2011, highlighting market concentration has been increasing the untapped potential in services. In 2020, over time, suggesting a low number of new the shock of the pandemic led to a decline entrants. Most exporters are in the machinery in North Macedonia’s GVC-related exports, and electronics industry (15 percent in 2020), but the most import-dependent sectors were where the number of new exporting firms also those most affected by the pandemic,4 increased by just 0.5 percent per year. The 4  Machinery and equipment manufacturing and mechanical equipment. 5  According to the World Bank Taxonomy of GVC Participation (2020). 6  World Bank (2022a). 16 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 8. Low number of new exporters in sectors with higher value-added signals weak economic transformation of the economy 8 Figure annual (Average growth rate of exporters between 2010 and 2020, Percent) 1400 84-85 Mach/Ele Number of exporters in 2020 1200 90-97 Miscellaneous 1000 72-83 Metals 39-40 Plastic/Rubber 800 50-63 44-49 Wood 28-38 Chemicals 06-15 Vegetable Textiles, 600 Clothing 400 86-89 Transportation 25-27 Minerals 200 16-24 Foodstuffs 68-71 Stone/Glass 41-43 Hides, Skins 0 64-67 Footwear 01-05 Animal -2.0% -1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% -200 Average annual growth rate of exporters between 2010 and 2020 Note: The bubbles represent the value of exports in 2020 of each sector. Source: Authors’ calculations based on customs firm-level transactions data. largest increase in new exporters was observed However, the services sector was especially in the chemicals sector (2.5 percent between affected by pandemic-related restrictions, 2010 and 2020). Meanwhile, the number which caused a decline of over 4 percentage of new exporters in traditional industries points in sectoral value added in 2020. such as textiles and footwear, vegetables, Although manufacturing experienced a robust and foodstuffs did not significantly increase recovery, industrial activity was hindered by (Figure 8). While large exporters seemed to declines in mining and construction output. have longer survival rates, the probability Post-crisis growth was driven by information of a small exporters surviving for five years and communications technology (ICT), which was about 50 percent, and only half of micro saw a surge in demand due to the pandemic- exporters survived for longer than a year. Most induced shift to hybrid or remote work.7 new exporters were micro or small firms that Despite substantial government subsidies, tended to export one product to one market, agriculture’s contribution to value added and their share in total exports remained low. was negative throughout the period. Sectoral Overall, North Macedonia exports a smaller employment patterns mirrored the dynamics total number of products to a smaller number observed before the pandemic, with wholesale of markets than the average for peer countries, and retail trade, transport, and tourism services suggesting limited diversification. being the main contributors to employment growth, followed by manufacturing. After Before and after the pandemic, the services the pandemic, employment in ICT surged, sector was the primary contributor both to while the rest of the private sector struggled real value-added and employment. From 2017 to return to the employment levels observed to 2019, sectors such as wholesale and retail in 2019. Employment growth, which had trade, transport, and tourism accounted for reached a decade high of 5.1 percent in nearly half of the growth in real value added, 2019, contracted by 0.3 percent in 2020 followed closely by manufacturing (Figure 9). and by 6.5 percent in 2021-22. Despite an 7  The draft labor law currently being prepared includes flexible labor contracts for gig economy and remote work. NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 17 Figure 9. The services sector has led Figure 10. Employment in the agricultural the growth sector has steadily declined (Sectoral10 Figure contribution to value-added growth, Percent) (Sectoral contribution to employment growth, Percent) Other services Other services Public administration and … Public administration and … Professional, scientific and … Professional, scientific and … Real estate activities Real estate activities Financial and insurance … Financial and insurance … Information and … Information and … Wholesale and retail trade; … Wholesale and retail trade; … Construction Construction Manufacturing Manufacturing Mining and quarrying … Mining and quarrying … Agriculture, forestry and … Agriculture, forestry and … -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 Other services Other services Public administration and … Public administration and … Professional, scientific and … Professional, scientific and … Real estate activities Real estate activities Financial and insurance … Financial and insurance … Information and … Information and … Wholesale and retail trade; … Wholesale and retail trade; … Construction Construction Manufacturing Manufacturing Mining and quarrying … Mining and quarrying … Agriculture, forestry and … Agriculture, forestry and … -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 Other services Other services Public administration and … Public administration and … Professional, scientific and … Professional, scientific and … Real estate activities Real estate activities Financial and insurance … Financial and insurance … Information and … Information and … Wholesale and retail trade; … Wholesale and retail trade; … Construction Construction Manufacturing Manufacturing Mining and quarrying … Mining and quarrying … Agriculture, forestry and … Agriculture, forestry and … -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 2017-2019 2020 2021-2022 2017-2019 2020 2021-2022 Note: The 2021-22 labor data are not directly comparable with the previous years due to the changes in the survey sample following the census results. Source: Authors’ calculations based on official employment data from national authorities. increase in employment in higher-value- Government support played a crucial role in added industries like ICT, most jobs remained mitigating job losses during the pandemic, concentrated in less skill-intensive and less but the impact of the crisis lingers. From technologically sophisticated activities such March 2020 to April 2021, the government as wholesale trade, retail, and assembly- implemented six support packages aimed based manufacturing. Formal employment in at minimizing the economic repercussions agriculture has been consistently declining of the pandemic. These packages included since 2018 (Figure 10). measures to sustain employment, such as 18 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE subsidies for social security contributions, opportunities. Over the past two decades, wage payments, and other forms of financial potential output growth has fallen by nearly assistance for both the public and private 50 percent, driven by diminished levels of total sectors. Sectors heavily affected by the factor productivity (TFP) and human capital. pandemic, including accommodations and The decline in the structural component food service, sports, arts, and entertainment, of growth, which is closely linked with the also received support.8 Estimates suggest that economy’s long-term productive capacity, has employment-retention measures protected been particularly pronounced in the last ten between 60,000 and 80,000 jobs that would years. The structural component of growth fell have otherwise been lost.9 The transport, from 3.5 percent in 2003–2008 to 2.2 percent manufacturing, hospitality, and agriculture in 2013–2019 and reached a historic low of sectors experienced the most significant 1.7 percent after the onset of the pandemic job losses. Although employment gradually (Box 1). By contrast, aspirational peers started to recover in the third quarter of 2020, experienced less severe scarring to potential it remained below pre-pandemic levels at output growth, which remained close to the the end of 2022, as an increasing number of end-2019 level despite the pandemic. Low workers exited the labor force. or negative rates of TFP and human capital formation have been significant drags on Weak productivity and slow human growth in North Macedonia for over a decade. capital formation are a drag on An analysis of productive factors reveals that growth and employment GDP growth is driven by capital accumulation, with a lesser contribution from the growth The economy faces challenges stemming of the labor supply (Figure 11). By contrast, from low productivity and human capital, the contribution of TFP, which measures the which hinder growth and limit employment productive efficiency of capital and labor, Figure 11. The contribution of TFP to growth has been low or negative since 2011… Figure 11 to GDP growth, in percentage points, by factors of production) (Contribution 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Capital Stock Labor Human Capital per Labor Total Factor Productivity Real GDP Note: Labor productivity is calculated using the annual growth of value added per worker. A steep improvement in Source: productivity in 2022 is explained by a drop in employment following the census-adjusted labor force survey. Source: Authors’ calculations based on data from national authorities and Eurostat. 8  Around 33 percent (€190 million) of the planned support measures (with fiscal implications) were set to alleviate the impact of the pandemic on the labor market, according to a SAO Report, May 2022. The realization of labor market measures included in the six packages was more than 90 percent. Part of the government support for social security contributions and wages (€37 million) was implemented with the assistance of the World Bank (CERC component of LRCP) that enabled job-retention at 26992 firms (more than 1/3 of the firms in the country) as recipients. 9  FinanceThink (60,000), National Employment Strategy 2021-2027 (80,000). NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 19 Figure 12. …and labor productivity remains weak despite recent improvements Figure (Labor 12 productivity index, 2009=100) 140 After COVID-19 135 130 Before COVID-19 125 120 115 110 105 100 95 90 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Aspirational peers EU27 MKD Note: Labor productivity is calculated using the annual growth of value added per worker. A steep improvement in Source: productivity in 2022 is explained by a drop in employment following the census-adjusted labor force survey. Source: Authors’ calculations based on data from national authorities and Eurostat. Figure 13. Higher employment rate led per marginal labor productivity continues to capita GDP growth lag peer countries. Expressed in terms of (Shapley decomposition of per capita GDP growth, 2017- Figure 13 value added per worker, the country’s labor 22, Percent) productivity currently stands at just 18 percent of the EU27 average despite recent gains Change in Share of Working Age Population (Figure 12). Among aspirational peers, value added per worker increased by 22 percent Change in Participation Rate between 2012 and 2022, while value added per worker in North Macedonia rose by 26 Change in Employment rate percent. From 2017 to 2022, labor productivity made a minor contribution to the growth of Change in Productivity GDP per capita, which was instead driven by -0.5 0.0 0.5 1.0 1.5 2.0 rising employment rates until the onset of the pandemic (Figure 13). Note: Labor productivity is calculated using annual growth of value added per worker. Source: Authors’ calculations based on data from national Although labor productivity is low, robust authorities. Source: government support has contributed to has been weak or negative. Moreover, human the steady growth of real wages. From capital formation has not contributed to 2017 to 2022, average real wages rose by growth in the last five years. Learning losses approximately 9 percent. This increase was resulting from the pandemic may further bolstered by government policies geared reduce productivity and lifetime earnings, towards enhancing living standards and exacerbating inequality.10 minimizing the prevalence of under-the- table “envelope wage” practices. Wage The period leading up to the pandemic was growth remained resilient even amid the marked by significant employment gains, pandemic, propelled by public sector pay which made a substantial contribution to raises and hikes in the minimum wage, even as economic growth, but North Macedonia’s productivity slumped. The minimum wage has 10  World Bank (2023a). 20 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 14. Job growth has recently surged in Figure 15. …where wages are relatively high the professional services and ICT sectors… (Average annual employment growth, Percent, and (Average annual employment growth and value added average monthly net wage per employee, MKD, 2017–22) Figure per 142017-22, Percent) worker, Figure 15 15 15 Information and Information and communication 10 Professional, scientific, technical communication 10 Professional, scientific and technical Employment growth, in % Employment growth, in % and administrative activities activities; Administrative and support service activities 5 5 Trade, transport, tourism Trade, transport, Financial and Financial and tourism insurance activities insurance activities Manufacturing 0 0 Construction -5 -5 Manufacturing -10 -10 Agriculture Agriculture -15 -15 -0.5 0 0.5 1 1.5 2 2.5 15000 20000 25000 30000 35000 40000 45000 50000 Value added per worker Average net wage, in MKD Note: The size of the circles represents the size of the industry in terms of employment. Source: Authors’ calculations based on data from national authorities. risen steadily since 2017, more than doubling recording improvements in productivity—have to 20,175 MKD (about €330) by March 2023. increased by 5 percent since 2017, reaching The most recent increase was due to changes more than twice the average wage in nominal in the indexation mechanism11 in the March terms (Figure 14). The ICT sector also saw 2022 minimum wage law.12 Encouragingly, the the largest increase in employment, though influx of private investment, primarily foreign, it only accounts for about 3 percent of total and the resulting rise in wage premiums to employment. The agriculture, manufacturing, attract labor, pushed manufacturing wages to trade, and tourism sectors, which suffer from nearly 90 percent of the average wage. The low productivity and low wages, collectively manufacturing sector even reported above- account for 49 percent of total employment average wage growth during the pandemic.13 (Figure 15). The trade, tourism, and transport sectors also experienced significant wage hikes. Structural transformation can bolster growth and employment, thereby enhancing Despite these gains, many jobs are still labor productivity. Improvements in labor concentrated in sectors characterized by productivity can be achieved either through low value added and low wages. Real wages structural shifts in employment from lower- in the ICT sector—one of just two sectors to higher-productivity sectors, or by driving 11  The minimum wage is now adjusted every March based on 50% of CPI growth and 50% of average wage growth in the previous year. In addition, the minimum wage cannot be lower than 57% of the average net wage in the year prior to the adjustment. The previous indexation mechanism was based on 33% of average wage growth, 33% of CPI growth, and 33% of real GDP growth in the previous year. 12  To counter the rise in labor costs, the government offered financial support to employers in the form of payments proportional to the wage prior to the adjustment, or proportional to the increase in social security contributions due to the adjustment. Starting from September 2017, the government subsidized employers with payments from 500–2000 MKD per employee (proportional to the wage prior to the increase in the minimum wage) for the first six months and for 50% of the amount paid in the next six months. From March 2022, employers were compensated for the increase in social security contributions that result from the rise in the minimum wage in the amount of 1,197 MKD. Employers were also stimulated to raise wages additionally with subsidies for social security contributions for wage increases between 600 and 6000 MKD. The measure was active from November 2019 until October 2022. 13  This wage growth was largely due to government wage and social security contributions. NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 21 Figure 16. The reallocation of labor across sectors Figure 17. A relatively large share of workers has contributed little to productivity growth is employed in less-productive sectors (Shapley decomposition of labor productivity growth by (Sectoral employment and labor productivity, 2019) Figure sector 16 and intersectoral reallocation) Figure 17 Sectoral Productivity (2015 US$),2019 2.0 40,000 1.5 35,000 1.0 30,000 (percentage points) 1.2 Agriculture Annual Change 0.5 25,000 0.0 0.3 Industry 20,000 -0.5 Services -0.5 15,000 -1.0 -0.9 10,000 Intersectoral reallocation -1.5 5,000 -2.0 0 2017-2022 0 20 40 60 80 100 Productivity Change = 0.1 Cummulative Sectoral Shares of Employment, 2019 Agriculture Industry Services Aspirational Peers Note: Labor productivity is calculated using the Source: annual growth of value added per worker, taking Note: Colored boxes represent North Macedonia; outlined into consideration changes in the employment rate, boxes aspirational peers. Labor productivity is calculated the participation rate, and the share of working-age using real value added per worker. population. The intersectoral reallocation effect captures Source: Authors’ calculations based on data from WDI productivity increases associated with shifts in labor from and Eurostat. less-productive (e.g., agriculture) to more productive (e.g., manufacturing, services) sectors. Source: Authors’ calculations based on data from national authorities. productivity enhancements within sectors. substantially lagged peer countries. Data However, North Macedonia has garnered derived from the Central Registry indicate that minimal benefits from structural employment the growth of firm productivity was close to shifts, as the intersectoral reallocation of labor zero between 2015 and 2020, with a revenue- contributed just 0.3 percentage points to based measure of TFP (TFPR) declining by productivity growth between 2017 and 2022 an average of 1.6 percent across all firms. The (Figure 16). Furthermore, labor productivity most recent World Bank Enterprise Survey, across all sectors continues to lag significantly which dates from 2019, reveals the extent to behind the averages of North Macedonia’s which value added per worker and TFPR in aspirational peers (Figure 17). In the wake of North Macedonia both fell below the average the pandemic, most sectors have not seen of neighboring countries (Figure 18). Over any improvement in value added per worker.14 the last five years, average TFPR growth in With productivity at a standstill, disposable the services sector has been lower than in incomes will only increase if individuals work manufacturing. During 2020, TFPR growth longer hours. dropped by 3.8 percent for manufacturing and 6.8 percent for services (Figure 19). Firm productivity remains low and stagnant due to misallocation of Firm-level productivity varies significantly in resources North Macedonia, reflecting differing levels of technology usage, management skills, Even prior to the pandemic, firm productivity employee expertise, product quality, and in North Macedonia was stagnant and pricing across industries. These variations 14  The recent reduction in agriculture employment was stronger than the value-added decline which drove the productivity increase. 22 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 18. Before the pandemic, firm Figure 19. …and it plummeted after the productivity in North Macedonia was already pandemic outbreak lower than in peer countries… (Growth in TFPR and value added per worker) (Average value added per worker and average TFPR of Figure 18 firms, 2019) manufacturing Figure 19 45 4 10 40 3.5 5 35 3 Percent change 30 2.5 0 1,000 US$ 25 2 Log 20 1.5 -5 15 1 10 -10 5 0.5 0 0 -15 HRV HUN POL BIH SRB KOS LTU MNE MDA MKD ALB GEO 2015 2016 2017 2018 2019 2020 Manufacturing - Value added Manufacturing - per worker growth TFPR growth Value added per worker TFPR, rhs Services - Value added per Services - worker growth TFPR growth Source: Authors’ calculations based on data from the Source: Authors’ calculations based on data from the World Bank Enterprise Surveys. World Bank Enterprise Surveys. in productivity indicate the potential for exhibit lower productivity levels than their considerable gains from the reallocation of smaller counterparts (Figure 21). Specifically, resources from less-productive to more- the median large firm (employing 100 or more productive industries. North Macedonia’s workers) is 3 percent less productive than the productivity gap is wide, with firms in the 90th median medium-sized firm (employing 10 to percentile being four times more productive 99 workers) and 14 percent less productive than those in the 10th percentile (Figure 20). than the median small firm (employing less The retail and wholesale trade sector exhibits than 10 workers). a particularly stark disparity: a firm in the 90th percentile is over eight times as productive as Low productivity growth in North Macedonia one in the 10th percentile. In the manufacturing is largely due to productivity changes in sector, the largest variations occur in the existing firms (within-firm productivity), automotive and transport manufacturing as opposed to capital and labor moving industries (4.2 times) and the construction, to more productive firms (between-firm computers, and machinery industries (3.9 productivity). A decomposition of TFPR times). growth based on firm registry data for 2011- 20 reveals that the within-firm component Surprisingly, many large and medium-sized made a negative contribution, on average, firms in North Macedonia are less productive to productivity growth during 2018-20. This than smaller ones. When factors of production trend highlights the limited extent to which are efficiently allocated, more-productive firms are upgrading their internal capabilities, firms should expand by taking on additional including their capacity to innovate, adopt labor and capital, generating economies of new technologies, or improve managerial scale that further increase their productivity. practices. Low rates of within-firm productivity In North Macedonia, however, this is not the growth may reflect the high uncertainty, case, as many large and medium-sized firms slowing activity, and financial constraints NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 23 Figure 20. Productivity varies widely across experienced during the pandemic.15 However, firms, especially in the services sector the between-firm component made a positive Figure 20 ratio between the 10th and the 90th (Productivity contribution to productivity growth over percentile, 2015-20) the period, which may reflect gains in TFPR Retail achieved by reallocating production factors Wholesale trade Water supply, sewerage, waste to more-efficient firms (Figure 22). The highly IT, programming, consulting volatile distribution of the between-firm and Motor vehicles, transport man. within-firm components across sectors is a Publishing and media Other services key feature of TFPR growth. The contribution All firms of the between-firm component over the Construction last few years may indicate a self-selective Computers, machinery, electrical environment in which the least-productive Administrative and support Other manufacturing (furniture, repair) firms were compelled to exit the market, Professional/technical services especially during the COVID-19 pandemic. Metals, materials, petro, pharma Textiles, apparel and leather Wood, paper and printing In advanced economies, firm entry and exit Education significantly contribute to productivity Food, bev., tobacco manufacturing growth, but in North Macedonia their impact Restaurants, cafes, catering Telecommunications is much weaker. Launching new firms can Accommodation enhance overall productivity by spurring Health research and development or by promoting Transport 0 5 10 market competition. Similarly, the exit of Ratio (90th/10th percentile) underperforming firms due to competitive Source: Authors’ calculations based on national business pressures can lead to more efficient resource registry data. allocation. Unfortunately, the rate of firm entry in North Macedonia falls short of the Figure 21. In general, larger firms are not average rates for neighboring countries and more productive than smaller firms the OECD (Figure 23 and Box 2). This lack Figure 21 (Distribution of TFPR by firm size, 2015-20 average) of market dynamism can be a roadblock to productivity growth. From 2018 to 2020, the 1.5 net contribution of firm entry to productivity growth was marginal when compared to the contributions of the between-firm and 1 within-firm components. Moreover, relatively Density productive firms are exiting the market, while less productive ones remain. .5 North Macedonia has relatively few high- growth and “gazelle” firms, particularly in 0 -5 0 5 the manufacturing sector, when compared to aspirational peer countries. High-growth TFPR (log) firms, defined as those with an average annual Small (0-9) Medium (10-99) Large (100+) employment growth rate exceeding 10 percent Source: Authors’ calculations based on national business over a three-year period, are instrumental registry data. 15  World Bank (2020b). 24 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE in driving productivity growth in developed have sustained average annual employment economies. In North Macedonia, 83 percent growth rates of at least 20 percent. In North of high-growth firms are medium-sized. Macedonia, only 0.20 percent of firms with However, just 2.7 percent of manufacturing over 10 employees qualify as “gazelles” (Figure firms and 9.5 percent of service firms meet this 25). Though few in number, these firms have criterion, far below the average for aspirational played a crucial role in job creation: from 2016 peers (Figure 24). “Gazelles” are young firms to 2020, they represented 6 percent of all employing more than 10 individuals that have formal jobs, including 26,858 jobs in wholesale been operating for fewer than five years and and 21,099 jobs in textiles. 16 Figure 22. From 2018 to 2020, within-firm productivity growth was negative across multiple sectors Figure 22 of TFPR growth by industry, including net firm entry 2018-20) (Decomposition 30 20 10 0 -10 -20 -30 -40 -50 Food, bev., tobacco manufacturing Textiles, apparel and leather Wood, paper and printing Metals, materials, petro, pharma Computers, machinery, electrical Motor vehicles, transport man. Other manufacturing (furniture, repair) Electricity, gas, steam and air Water supply, sewerage, waste Construction Wholesale trade Retail Transport Accommodation Restaurants, cafes, catering Publishing and media Telecommunications IT, programming, consulting Professional/technical services Administrative and support Education Health Dynamic (entry/exit) Within Between Aggregate Source: Authors’ calculations based on national business registry data. Figure 23. The rate of firm entry in North Macedonia is below that of peer countries (New 23 as a percentage of total firms, 2019 ) firms Figure 15 35 30 25 20 15 10 5 0 HUN POL BRA EST FRA LTU DEU LVA SVN KOR ROU SVK MKD HRV SRB CZE BGR Entry Exit Source: For North Macedonia, authors’ calculations based on firm registry data. For other countries, OECD structural and demographic business statistics (DSBS). 16 Latest data available for country comparison.  NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 25 Figure 24. Many high-growth firms are in services; only a few are in manufacturing (Firms with 3-year average employment growth rates of 10% or more as a share of 10+ employee firms, 2019) Figure 24 18 16 14 12 10 8 6 4 2 0 MKD DEU LTU LVA SVK HUN ESP POL FRA EST HRV SVN ITA ROU CZE Manufacturing Services Source: For North Macedonia, authors’ calculations based on firm registry data. For other countries, OECD structural and demographic business statistics (DSBS). Figure 25. North Macedonia has fewer “gazelle” firms than peer countries Figure 25 (Gazelles as a percentage of all firms with 10 or more employees, 2019) 3 2.5 2 1.5 1 0.5 0.2 0 HUN TUR PRT LVA LTU SVK ESP LUX ITA CZE FRA ISL NZL NOR ROU MKD Source: For North Macedonia, authors’ calculations based on firm registry data. For other countries, OECD structural and demographic business statistics (DSBS) Over the past decade, numerous fewer firms that have experienced positive underperforming firms have continued to revenue growth. Underperforming firms are operate in North Macedonia. From 2018 to slow to adopt new technologies, and they 2020, the motor vehicles manufacturing, may contribute to resource misallocation health, transportation, and tourism sectors by absorbing productive factors that could experienced a decline both in revenue and be employed more effectively elsewhere. productivity (Figure 26). These sectors, Moreover, the COVID-19 pandemic weakened which account for most jobs in the country, market competitiveness by exacerbating have lower average productivity levels and barriers to entry.17 17  World Bank (2020b). 26 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 26. Firms in lagging sectors provide a large share of employment and are not exiting the market Figure (Share of 26 firms with 3-year average positive and negative revenue growth) 100% 9 90% 8 80% 7 70% 6 60% 5 50% 4 40% 30% 3 20% 2 10% 1 0% 0 Telecommunications Water supply, sewerage, waste Administrative and support IT, programming, consulting Computers, machinery, electrical Construction Retail Professional/technical services Other manufacturing (furniture, repair) Wholesale trade Education Metals, materials, petro, pharma Agriculture Food, bev., tobacco manufacturing Mining Wood, paper and printing Textiles, apparel and leather Transport Publishing and media Electricity, gas, steam and air Other services Restaurants, cafes, catering Accommodation Health Motor vehicles, transport man. Tour agency Other primary (forestry, fishing) Employment share (negative rev. growth), lhs Employment share (postive rev. growth), lhs TFPR (positive rev. growth), rhs TFPR (negative rev. growth), rhs Source: For North Macedonia, authors’ calculations based on firm registry data. For other countries, OECD structural and demographic business statistics (DSBS). High-productivity firms create high- Although many jobs have been created within quality jobs productive sectors, the economy still faces challenges in generating highly productive The growth rate of formal employment has employment. During the 2011-20 period, many risen gradually for several years. In 2019, industries exhibiting positive productivity 54.7 percent of the working-age population growth also reported negative employment was employed, the largest share since 2006.18 growth—even after accounting for the impact However, the increase in formal employment of the pandemic—which suggests that high- did not generate a proportionate surge productivity firms are not always associated in productivity, as many of the new jobs with high rates of employment growth (Figure were in low-productivity firms. A shortage 27). Over the past decade, the structure of of productive job opportunities can lead employment has evolved in line with the to resource misallocation and productivity economy’s structural transformation. This losses over time, underscoring the need for change is evident in the declining share of improvements in management skills as well workers in agriculture, the stable share of as technical, quality-assurance, and sales workers in manufacturing, and the increasing competencies.19 share of workers in the services sector, which now employs over 55 percent of the workforce. 18  National Employment Strategy 2021-2027 with employment action plan 2021-2023. Government of the Republic of North Macedonia. 19  World Bank (2020b). NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 27 Figure 27. Employment and net job creation by within-industry tend to be low with the most productive firms Figure 27 and net job creation by within-industry TFPR quantile, 2018-20) (Employment 300 7 600 16 Net job creation (x1,000) 14 Net job creation (x1,000) 6 250 500 Employment (x1,000) Employment (x1,000) 5 12 200 400 4 10 150 3 300 8 2 6 100 200 1 4 50 100 0 2 0 -1 0 0 1 2 3 4 5 1 2 3 4 5 Low High Low High productivity Manufacturing productivity productivity Services productivity firms firms firms firms Employment Employment change Employment Employment change Source: Authors’ calculations based on national firm registry. Figure 28. Most service-sector jobs are Figure 29. Micro and small firms create most in small and medium firms, while most service-sector jobs, while large firms create manufacturing jobs are in large firms most manufacturing jobs (Employment shares by sector and size, percent) (Shares of net job creation by new entrants and Figure 28 Figure 29 incumbent firms, 2016-20) 100% 100% 90% 32.5 28.0 80% 31.7 80% 59.0 54.0 70% 57.5 59.5 59.0 60% 60% 35.0 37.0 50% 34.6 40% 40% 25.4 31.0 63.0 30% 20% 29.6 32.0 30.4 14.6 20% 29.5 34.0 9.0 5.9 3.6 0% 1.0 10% 19.0 - 9.5 9.1 0% -20% -3.0 2016 2020 2016 2020 Entry Incumbent Entry Incumbent Manufacturing Services Manufacturing Services One worker (1) Small (2-9) One worker (1) Small (2-9) Medium (10-99) Large (100+) Medium (10-99) Large (100+) Source: Authors’ calculations based on national business registry data. The wholesale trade, motor vehicles, and the services sector was led by wholesale and metals industries have been key contributors retail. Most manufacturing jobs were in highly to employment growth. Between 2011 and productive new and incumbent firms, while 2020, the motor vehicles and metals industries most service jobs were in low-productivity drove job creation in the manufacturing incumbent firms. In 2020, manufacturing firms sector (Figure 28 and Figure 29). These with more than 100 employees accounted industries were increasingly integrated into for almost 60 percent of all jobs, whereas GVCs and benefitted from special economic in the services sector medium and small zones (SEZs) job-promotion subsidies, and firms provided 37 and 34 percent of jobs, exemptions on payroll, corporate, and indirect respectively. Over the 2016-20 period, around taxation. Meanwhile, employment growth in two-thirds of new service jobs were created 28 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 30. More-productive firms tend to offer higher wages Figure 30 and the average level of wage within-industry TFPR quintile, 2018-20) (Employment Average wage, thousands (MKD) 160 400 300 450 Average wage, thousands 140 350 400 250 350 120 300 200 300 Thousands Thousands 100 250 250 80 200 150 200 60 150 100 150 40 100 100 20 50 50 50 0 0 0 0 1 2 3 4 5 1 2 3 4 5 Low High Low High productivity Manufacturing productivity productivity Services productivity firms firms firms firms Employment Average wage, rhs Employment Average wage, rhs Source: Authors’ calculations based on national business registry data. by newly established small and medium firms, the poverty rate. Progress since the global while small firms accounted for 59 percent of financial crisis has been remarkable, with the new jobs among incumbent firms too. Firms poverty rate20 dropping from about 41 percent in SEZs created 11,000 jobs, of which 6,500 in 2009 to about 19 percent in 2019. Over the were in motor vehicles firms and about 3,000 past decade, more than 440,000 people have in textiles and apparel. However, in the textile seen their incomes rise above the poverty line and apparel industry, many existing jobs in (Figure 31). Nevertheless, poverty rates remain firms outside of SEZs migrated to firms within relatively high by regional standards, with SEZs, and jobs gains in SEZs did not fully more than 395,000 people living in poverty in offset job losses during the pandemic. 2019. While the share of people that are not at risk of falling into poverty has increased Higher-productivity firms are linked to significantly since 2009 (light blue area), higher wage rates, and productivity growth in 2019 about one-third of the population is positively correlated with wage growth. remained vulnerable to falling into poverty in Although more-productive firms account for the event of an economic shock (yellow area). a smaller share of employment than their less- productive counterparts, they tend to pay North Macedonia has experienced some of higher wages. From 2016 to 2020, the most- the most inclusive income growth globally, productive services firms paid wages that leading to a notable decrease in inequality. were 28 percent higher than those paid by the Since 2009, growth has been largely pro- least-productive services firms (Figure 30). poor. The average income of the bottom 40 percent of the population increased by an Poverty and inequality have average of 6 percent per year between 2014 significantly decreased in recent years and 2019, outpacing the average income growth rate by around 0.8 percentage points, Economic growth since 2009 has significantly which yielded one of the largest shared- benefited less well-off households, prosperity premiums globally (Figure 32).21 contributing to a considerable decline in Income inequality decreased substantially, as 20  The poverty rate is measured at the upper-middle-income poverty line of $6.85/day in 2017 PPP terms. 21  The shared-prosperity premium is the difference between the income growth of the bottom 40 percent and the income growth of the overall population. NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 29 the Gini index fell from approximately 42.8 the period, with redistribution responsible for in 2009 to 33.6 in 2019, though no further the remaining third (Figure 33). progress has been made in recent years as inequality has slightly increased between 2018 Despite recent gains, North Macedonia still and 2019.22 Income growth accounted for faces considerable challenges related to about two-thirds of poverty reduction during income inequality and intergenerational poverty. In 2019, the Gini index was still high Figure 31. The poverty rate has fallen relative to other Western Balkan countries substantially, but a large share of the population such as Albania and Kosovo. According to remains vulnerable to falling into poverty the Life in Transition Survey III (LiTS III), (Evolution of poverty and vulnerability in North Figure 312009-19) Macedonia, over 70 percent of the population believes that the disparity between the rich and 100 poor has widened—the largest share in the 23.9 Western Balkans. Moreover, just 38 percent 80 49.0 of respondents believe that children born % of the population 60 35.2 today will lead better lives than the current generation. Self-reported life satisfaction 40 31.9 is also low relative to peer countries, and 20 40.8 attitudes toward the future are pessimistic. 19.1 In the LiTS III, only 35 percent of respondents 0 express satisfaction with their lives, while 2011 2012 2017 2013 2015 2018 2016 2019 2014 2010 2009 according to the Balkan Barometer 59 percent Poor (Income US$13.7/day US$6.85-US$13.7/day situation in 2022, and 41 percent anticipated Source: Author’s calculation based on 2009-2019 income the situation would worsen in the coming year, data from SILC. among the most pessimistic outlooks in the Figure 32. North Macedonia has experienced Figure 33. ...and faster income growth among one of the largest reductions in income poorer households has driven a steep decline inequality worldwide… in the poverty rate (Correlation between shared prosperity premium and (Growth incidence curve (GIC), 2009-19) Figure 32 inequality reduction, circa 2012-17) Figure 33 Annual average change in Gini coefficient 8 Annualized Growth Rate (2009-2019) 0.015 0.010 0.005 6 0.000 MKD -0.005 4 -0.010 -0.015 2 -6 -4 -2 0 2 4 6 1 49 25 43 67 79 85 37 55 73 13 19 31 61 91 7 Shared prosperity premium (p.p.) GIC Annualized mean growth Source: World Bank (2020a). Source: Author’s calculation based on 2009-2019 income data from SILC. The GIC shows the annualized growth rate of per capita household income for every percentile of the income distribution (Ravallion and Chen 2003). 22  This is based on the World Bank harmonized data so it may differ from the SSO numbers. The Gini index is a statistical measure of inequality, with lower values representing greater equality. 30 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 34. Despite recent gains, public Figure 35. Further poverty reduction will expectations for the future are pessimistic require considerable effort (Share of respondents who are dissatisfied with the (Poverty projections under two growth scenarios) economic situation and share who expect the economy Figure to worsen34in the next 12 months, 2022) Figure 35 80 45 40.8 Percentage of the population 40 60 35 Poverty rate (%) 30 25 19.1 40 20 14.9 15 20 10 11.4 5 0 0 BiH MKD ALB SRB MNE KOS 2009 11 13 15 17 19 21e 23f 25f 27f 29f The economy will get worse Dissatisfied with economic situation Growth = 2% Growth = 5% Source: Balkan Barometer (2022). Source: Author’s calculation based on 2009-19 income data from SILC. Note: Actual data: 2009-19. Nowcast: 2020-22. Forecasts are from 2023-30. Western Balkans (Figure 34). The challenge North Macedonia continues to grapple with of poverty reduction remains daunting. Even significant gender inequalities, especially with economic growth averaging a robust 5 women’s limited access to economic percent from 2023 onward, and an equitable opportunities and productive assets.23 distribution of incomes, more than 235,000 Considerable improvements have been made individuals would still be living in poverty in the institutional, legal, and policy frameworks by 2030 (Figure 35). At the current average for gender equality, but implementation growth rate of 2 percent, poverty reduction poses a persistent challenge. Gender gaps, would be even slower, underscoring the need especially those linked to healthcare and both for faster and more inclusive growth. education access, have narrowed over the past two decades, but women continue to Despite recent progress, some shoulder a disproportionate share of unpaid groups and regions are still lagging domestic work, including childcare, which adversely affects their ability to earn income Promoting social inclusion is essential or obtain additional education. A limited to reduce poverty in North Macedonia. supply of high-quality childcare increases Vulnerable groups such as rural households, the opportunity cost of work and negatively women, young people, members of the LGBTI affects women’s participation in the labor community, people with disabilities (PWD), force. Approximately 87 percent of children and the Roma population face substantial under age four do not receive formal childcare, challenges in accessing basic services and far above the EU average of 65 percent, and economic opportunities. Ensuring that these childcare quality indicators also lag. The groups have equitable access to economic female labor-force participation rate is among opportunity will be vital to continue reducing the lowest in ECA (Figure 36), and together poverty and to enable them to fully contribute with employment rates and average wage to economic growth. (about 8 percent lower than for men) are 23  World Bank (2023b). NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 31 Figure 36. Gender disparities are stark in the labor market Figure (Labor 36 participation rate by gender (% of population age 15+), circa 2021) force 100 North Macedonia 80 LFP rate (%) 60 40 20 0 IMN AND GRL ISL UZB BLR AZE KAZ SWE NLD ARM CHE NOR GBR EST LUX DNK IRL CYP LTU FIN AUT DEU SVK RUS GEO LVA SVN PRT LIE ESP KGZ ALB HUN FRA CZE BEL SRB POL BGR UKR MNE HRV GRC MKD ROU BIH ITA MCO MDA TJK TUR KOS Male Female Source: WDI (last update 09/16/2022). behind those of men. Women are less likely adolescents and adults who are neither to start a business due to limited information employed nor enrolled in education is about regarding entrepreneurial opportunities, 40 percentage points higher than the share of fear of failure, and less confidence in their their non-Roma counterparts. Just 46 percent competences and expertise. By eliminating of Roma between the ages of 20 and 64 have gender inequalities in the labor market, North a paid job, 13 percentage points lower than Macedonia could increase its annual GDP the rate for the general population. In surveys, by more than 16 percent.24 Violence against about 12 percent of Roma respondents report women is also prevalent, with more than half feeling discriminated against when seeking of women reporting having suffered some healthcare services, and fewer than 70 percent form of gender-based violence since the age have health insurance. Roma communities also of 15. Roma women are particularly vulnerable face higher rates of housing deprivation and and report far higher rates of gender-based overcrowding and have less access to clean violence. Parliamentary representation quotas water. Consequently, poverty and vulnerability were introduced in 2006, but women remain rates are especially high among the Roma. In underrepresented at the ministry and mayoral 2021, three out of four Roma individuals were levels, as well as in political life, positions of at risk of poverty. power, and decision-making more broadly. Discrimination based on sexual orientation The Roma community, which makes up about and gender identity and expression, and sex 9.6 percent of North Macedonia’s population, characteristics (SOGIESC) is widespread faces significant challenges in accessing in North Macedonia. Surveys indicate that basic services and economic opportunities.25 LGBTI individuals often face violence and Just 2 percent of Roma children attend early discrimination, and their perception of childhood education or receive professional social acceptance is relatively low.27 Various childcare, significantly below the EU barriers prevent them from achieving their average of 44 percent. The share of Roma 26 full potential in education and employment, 24  Cuberes and Teignier (2015), and Pennings (2021). 25  World Bank (2018b) based on the Council of Europe estimates. The 2021 census points to a lower share of 2.5 percent but is likely underreported. FRA (2022). 26  FRA (2022). 27  World Bank (2018b). 32 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 37. Indicators of public acceptance of Figure 38. Poverty rates are higher in the LGBTI communities are low north of the country (Perceived acceptance of LGBTI people, index scores) (Poverty headcount at $6.85/day poverty line in 2017 Figure 37 Figure PPP terms38 by region, 2009-19) 2 60 Index of Perception of General 1.94 Acceptance of LGBTI People 1.72 1.69 1.68 2 Southeastern 1.52 1.47 1.43 40 Northeastern Southwestern 2019 1 Polog Skopje 20 Total 1 Eastern Pelagonia Vardar 0 0 SVN HRV MNE ALB BIH MKD KOS 0 20 40 60 2009 Note: 1 = Very low acceptance 2 = Low acceptance 3 = Source: Author’s calculation based on SILC 2009-2019. High acceptance 4=Very high acceptance Source: World Bank (2018). accessing physical and mental healthcare, The labor-market integration of PWD in North and participating in other aspects of socio- Macedonia is limited. About three-quarters of economic and political life. In 2018, North PWD are inactive in the labor market.31 This Macedonia had one of the lowest scores in exclusion perpetuates economic inequality the Western Balkans on the LGBTI Perception by denying them opportunities for income of Acceptance Index (Figure 37). In addition, generation, financial independence, and upward 9 percent of LGBTI respondents reported mobility. Consequently, these individuals and experiencing violence within the past year, their households rely on disability benefits the highest rate among the 31 participating and various social assistance programs EU countries. In 2021, large shares of LGBTI relatively more.32 Recent analysis indicates respondents reported frequently concealing that community-based services in the country their identity (52 percent), hearing negative suffer from fragmentation, lack of coordination, comments about LGBTI individuals at incompleteness, underdevelopment, and their workplace (37 percent), receiving exclusionary practices.33 Additionally, there personal negative comments (13 percent), is a scarcity of services and programs and experiencing workplace discrimination focused on prevention, early detection, early within the past five years (12 percent).28 The treatment, and rehabilitation. The country also international experience suggests that the lacks consistent and comparable statistics social exclusion of LGBTI people could entail on PWD. Public sentiment emphasizes the significant economic costs.29 The annual wage need for the government to take substantial loss related to SOGIESC-based exclusion was action regarding PWD. Over 90 percent estimated to be over 0.5 percent of the 2021 of individuals believe that the government GDP.30 should take proactive measures to ensure 28  World Bank (2023c). 29  Badgett, Park, and Flores (2018). 30  World Bank (2023c). 31  Own calculations based on SILC (2020). 32  Own calculations based on SILC (2020). 33  Kochoska et al. (2022). NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 33 improved housing conditions for persons with Figure 39. Job opportunities and earnings disabilities and to facilitate equal access to were the main drivers of poverty reduction (Contribution of income components and employment employment opportunities for them.34 Figure 39 to mean income growth, 2009-19) Figure 40 Poverty rates remain elevated in rural areas 60 Share of adults and in the northern regions of the country. 50 55,1 53,7 Share of occupied adults income Labor The recent decline in poverty rates has not Percentage Labor income per occup adult 40 been sufficient to eliminate these geographical Pensions per-adult 30 disparities. The gap in poverty rates between 32,2 32,0 31,4 Non-labor income Public transfers per-adult rural and urban areas has narrowed but remains 20 large at about 11 percentage points. Since Household transfers per-adult 10 2009, there has been no significant change Other income per-adult 0 in regional poverty rankings (Figure 38). Outflow per-adult 2009 20 Poverty rates in the Polog and Northeastern -15 -10 -5 0 5 10 Unemp Percentage points Long-te regions still exceed 30 percent, versus less than 10 percent in the Eastern, Southeastern, Source: Author’s calculation based on 2009-2019 income data from SILC. Pelagonia, and Vardar regions. Despite having one of the highest poverty rates, the Polog region has contributed the most (about one- percent), the poor population’s unemployment third) to overall poverty reduction. Due to rate (38 percent) is much higher than that of their larger populations, the northern regions the non-poor (13 percent). Nevertheless, labor are also home to a higher concentration of earnings were the primary source of income people living in poverty: in 2019, three out of for the poor in 2019, accounting for about four individuals in poverty lived in the Polog, two-thirds of household income in the lowest Northeastern, and Skopje regions. quintile. Job growth and wage increases have been responsible for more than 90 percent North Macedonia still faces of the reduction in poverty observed since significant labor market challenges 2009 (Figure 39). The increase in labor earnings overlapped with recent hikes in the Expanding employment opportunities and minimum wage, but a more detailed analysis rising labor income have driven poverty would be necessary to establish a causal link. reduction, but labor-market challenges persist. Increased pension payments also played a role In the 2022 Balkan Barometer, unemployment in poverty reduction, albeit to a lesser degree was the primary concern for about one-quarter than labor-market gains, while the impact of of North Macedonia citizens. Expectations social assistance programs was limited due to for future work prospects were also bleak, their low coverage rates and fragmentation. with 37 percent of respondents expressing uncertainty about their job security over The inactivity rate is relatively high, with more the next 12 months—the largest share in the than a third of the working-age population Western Balkans. About two-thirds of the poor (15-64 years old) remaining out of the labor population is between the ages of 15 and 64, market since 2009. Combined with the high underscoring the importance of employment unemployment rate, about 45 percent of and wages to poverty reduction. Despite the working-age population was non-active similar labor-force participation rates among in 2022—indicating a major loss of potential the poor (56 percent) and non-poor (62 productivity. Rates of inactivity are particularly 34  Balkan Barometer (2022). 34 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 40. Both total and youth unemployment decreased considerably in recent years Figure 40 and long-term unemployment, 2009-21) (Total, youth, 60 90 80 55.3 50 55.1 53.9 53.7 53.1 70 51.9 48.2 47.3 46.7 45.4 40 60 Percentage Percentage 50 36.4 35.7 35.6 30 32.5 40 32.2 32.0 31.4 31.0 29.0 28.0 26.1 20 30 23.7 22.4 20.7 20 17.3 16.4 10 15.7 14.4 10 0 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Unemployment (lhs) Youth Unemployment (lhs) Long-term Unemployment (rhs) Source: State statistical office. high among workers over 55 and women. by 52 percent—one of the largest percentages In 2022, the unemployment rate reached its globally and in the Western Balkans after lowest level in a decade (Figure 40), but it was Bosnia and Herzegovina (57 percent). still high by regional standards (Figure 41) and many of the unemployed had been jobless for A large share of the workforce is employed over a year. Long-term unemployment has in the informal sector. Although informality stayed broadly constant since 2009, with has declined significantly in recent years, it about 80 percent of the 93,000 unemployed remains relatively high. The State Statistical workers being out of work for over a year, the Office reports that North Macedonia has made highest long-term unemployment rate in the significant strides in reducing informality over Western Balkans. the past decade, with the informality rate dropping from about 27 percent in 2009 to Unemployment is especially acute among about 12 percent in 2022.36 Nevertheless, young people. In 2022, about 57 percent of informality remains relatively high, and in the population cited inadequate employment 2022 almost 85,000 workers were employed opportunities as the most significant problem without pensions, health insurance, or other facing young Macedonians.35 Gender gaps are benefits. High rates of informality could also prevalent among young workers, and in impede long-term growth, as the informal 2022 the youth unemployment rate was far workforce tends to have less education and higher for women (38 percent) than for men lower productivity. (29 percent). Lack of economic opportunities for the youth poses serious long-term Wages in North Macedonia are low relative challenges, including the loss of human capital both to the EU and the Western Balkans. In due to inactivity and emigration. According 2022, average monthly gross wages were to the Gallup World Poll’s Potential Net above the levels of Albania and Kosovo Youth Migration Index, if all potential young but below those of Serbia, Bosnia and emigrants left North Macedonia, the population Herzegovina, and Montenegro. Moreover, between the ages of 15 and 29 could decrease wages in North Macedonia, and the Western 35  Balkan Barometer (2022). 36 This decline is mostly due to the improvement of the national accounts’ methodology used for assessing the informality, i.e. closing the reported data gaps rather than measuring non-reported. NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 35 Figure 41. Unemployment remains among the Figure 42. Workers lose approximately 23 highest in ECA years of productive employment Figure 41 (Total and youth unemployment rates, circa 2021) (Average42 Figure years of productive employment lost, circa 2021) 50 40 35 40 North 30 26 26 Average years of employment lost Unemployment Macedonia 23 30 20 19 19 18 20 14 15 20 10 10 0 0 0 10 20 30 40 50 MKD AUT HUN BLG HRV ALB SRB MNE BIH KOS Youth Unemployment [15-24] [25-54] [55-64] Source: WDI (last update 09/16/2022). Source: Author’s calculation based on SSE Jobs Gateway. Note: Methodology based on Arias et al. (2014).38 The average years of employment potentially lost is equal to the share of total working years for the age group, multiplied by one minus the employment rate for the same age group. Balkans in general, were significantly lower between the ages of 15 and 24 loses about than those of EU countries such as Bulgaria, eight years of productive employment (Figure Hungary, Croatia, and Austria.37 The wage 42). This loss is estimated at about 11 years for gap with the EU likely drives skilled workers workers ages 25-54 and six years for workers to emigrate in search of better employment ages 55-64. Overall, the average worker in opportunities. According to the Gallup World North Macedonia loses an estimated 23 years Poll’s Potential Net Brain Gain Index, the adult of productive employment throughout their population with four or more years of post- lifetime.38 secondary education or the equivalent of a bachelor’s degree or higher could decrease by about 39 percent if all potential emigrants decide to leave the country, one of the highest rates globally. These labor-market challenges result in an enormous loss of productive working years. Despite recent progress, North Macedonia ranks poorly in many labor-market outcomes, with low labor-force participation rates, high unemployment rates (especially among young workers), high rates of long-term unemployment, and a large share of workers employed in the informal sector. Due to a lack of high-quality jobs, the average worker 37  SEE Jobs Gateway Database. 38  Arias, Sanchez-Paramo, Davalos, Santos, Tiongson, Gruen, Andrade Falcao, Saiovici, and Cancho (2014). 36 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE CHAPTER 2 RECENT EMERGING CHALLENGES AND OPPORTUNITIES Since the 2018 SCD, North Macedonia has encountered numerous challenges. The COVID-19 pandemic led to a severe economic downturn, which hindered progress on reducing poverty, and an ongoing energy crisis and inflationary pressures have disrupted the post-pandemic recovery. Recent shocks have had an especially negative effect on lower-income households, which have a limited capacity to cope with rising consumer prices and heating costs. Meanwhile, a high rate of emigration, a rapidly aging population, and a declining fertility rate are weakening growth and productivity. However, the EU accession process represents a significant opportunity for North Macedonia to deepen its economic integration with major European markets, boosting employment growth and raising living standards. The EU-supported green and digital transitions have the potential to boost productivity and environmental sustainability, but require accelerating reforms and substantial investments, as well as careful policy action to mitigate the impact of the transitions on those at risk of being left behind. Increased levels of EU funding are becoming available to help achieve these objectives, but strategic planning and institutional capacity need to strengthen to maximize the gains. NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 37 The COVID-19 pandemic plunged The pandemic-induced crisis also appears to North Macedonia into a recession, have reversed recent progress on poverty and subsequent shocks have reduction. The current estimates suggest prevented a swift recovery that the headcount poverty rate increased by more than 1 percentage point during the year. The COVID-19 pandemic pushed the economy The government implemented emergency into its worst recession since independence. support measures—including subsidies and GDP declined by 4.7 percent during 2020, social security contributions for private firms, with negative effects across all sectors, except and cash benefits and vouchers for vulnerable agriculture and ICT sectors. The outbreak individuals—which partially mitigated the of the health crisis, together with the slow negative impact of the crisis on poverty and opening pace for EU accession negotiations, household wellbeing. additionally lowered the appetite for structural reforms and discouraged foreign and domestic Just as poor households were beginning investors. The COVID-19 pandemic had a to recover from the pandemic-induced significant impact on the private sector. The crisis, Russia’s invasion of Ukraine caused number of firms leaving the market in 2020 was energy and food costs to spike, driving a significantly higher than in the previous years broad increase in inflation and disrupted the (Figure 43). Specifically, 4,006 manufacturing recovery. Inflation poses an especially acute firms and 15,994 service firms closed their threat to lower-income households, which operations. Additionally, net job creation spend a larger share of their budgets on decreased compared to the level observed in food and energy and have fewer mechanisms 2019. The COVID crisis have also discouraged to cope with rising prices. The inflation foreign direct investment. However, the rate experienced by households in North creation of firms within special economic zones Macedonia’s lowest income decile is about 3.8 (SEZs) remained positive in 2020 in comparison percentage points higher than the average to that outside of SEZs (Figure 44). and 6.6 percentage points higher than the Figure 43. In 2020, more firms closed, and net Figure 44. Few firms entered the SEZs in job creation declined 2020 but net job creation remained positive (Firm entry and exit, and net job creation, in thousands) within SEZs Figure 43 Figure 44 (Firm entry and net job creation, SEZ vs. non-SEZ) 10 25 25 7 5 20 6 20 0 5 15 15 -5 4 10 10 -10 3 5 5 -15 2 -20 0 0 1 -25 -5 -5 0 2015 2016 2017 2018 2019 2020 2015 2016 2017 2018 2019 2020 Inside TIDZ - Entry_rhs Entry Exit Net job creation, rhs Outside TIDZ - net job creation, thousands Inside TIDZ - net job creation, thousands Source: Authors’ calculations based on Central Registry Source: Authors’ calculations based on Central Registry data. data. 38 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 45. Rising inflation threatens to erase recent gains in poverty reduction Figure 45 (Simulated welfare percentage changes after the combined food and energy price increases) 5 Income loss due to food and energy shock (%) 0 -5 -10 -15 1 3 5 7 9 1 3 5 7 9 1 3 5 7 9 1 3 5 7 9 1 3 5 7 9 1 3 5 7 9 ALB BIH KOS MKD MNE SRB Deciles of welfare distribution Food + Energy Shock Doubling Social Assistance Source: World Bank staff simulations based on most recent household surveys. Note: The figure shows the percentage change in welfare at each percentile of the welfare distribution. rate among households in the top decile.39 As energy prices remain elevated, heating Nationwide, households report having a has become an especially serious challenge limited capacity to protect themselves from for lower-income households. Evidence price shocks. In 2021, about half of survey shows that many households may be respondents stated that they would be negatively affected by the energy crisis and unable to cope with unexpected expenses— that prevalence of such need extends far the highest share in the Western Balkans beyond households who are currently eligible after Montenegro40—and in 2022, four out for support based on current definitions of of five were unsatisfied with current price energy poverty. Spending on electricity, solid levels.41 Simulations show a 10-percent overall fuels, gas, and oil accounts for a larger share of reduction in household income due to rising total household spending in North Macedonia prices, with especially acute losses among than in other Western Balkan countries. The lower-income households (Figure 45). Social average household spends about 13 percent transfers can help mitigate the negative of per capita income on energy, though this impact of higher prices, especially among share ranges from just 7 percent among the poorest and most vulnerable households, households in the top quintile to 16 percent but the ability of existing programs to among households in the bottom quintile.42 In protect other households from welfare losses 2020, more than one-quarter of households is much more limited. As it confronts an reported having difficulty heating their unstable external economic and geopolitical home,43 including 43 percent of households climate, North Macedonia will need to further in the bottom quintile compared to 11 percent consolidate and expand targeted social in the top quintile. In addition, around one- assistance programs to mitigate the impact third of households reported falling behind of shocks more effectively. on their utility bills in 2020, but this figure 39  World Bank (2023d). 40  Eurostat. 41  Balkan Barometer (2022). 42  Author’s calculation based on 2019 HBS survey. 43  Eurostat. NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 39 masks a vast disparity across income groups. survey, about one-quarter of respondents About 65 percent of households in the bottom cited unemployment as their most significant quintile reported paying their utility bills late challenge, and 37 percent were uncertain that or accumulating arrears, compared to just they would be able to keep their jobs in the 13 percent in the top quintile. In 2022, the coming year—the highest share in the Western government introduced almost universal Balkans.47 Higher wages in neighboring EU support for households to retain their countries, coupled with general pessimism electricity prices low through the block tariffs. about the domestic economic outlook, To target better such household support in create strong incentives to emigrate. North the future, adopting an official definition of Macedonia’s score on the Balkan Public energy poverty can facilitate the formulation Expectation Index fell from 59 percent in 2017 of a targeted program aimed at providing to 42 percent in 2022, the second-lowest support to a broader range of energy poor score in the Western Balkans after Bosnia households. and Herzegovina. Other factors that may encourage emigration include corruption, North Macedonia is rapidly losing its lack of trust in public institutions, negative human capital perceptions of socioeconomic inequality, high rates of intergenerational poverty, poor- North Macedonia’s diaspora is among the quality healthcare and education services, and largest worldwide, and emigration rates high levels of air pollution. remain high. About one-third of the population lives abroad, most in Germany, Switzerland, Despite North Macedonia’s vast diaspora, Italy, Austria and Slovenia.44 Emigrants tend to remittances make a limited contribution be between 20 and 39 years old, at the peak of to household income. Remittances often their labor productivity, and most have either function as an informal social protection very low or very high levels of education.45 mechanism and can even lift households out of According to the Potential Net Brain Gain poverty. In the Western Balkans, remittances Index, the size of the adult population with at constitute 10 percent of aggregate GDP. least four years of post-secondary education or In North Macedonia, however, remittances the equivalent of a bachelor’s degree or higher accounted for only 3.5 percent of GDP in 2021, could decreased by as much as 39 percent the smallest share in the region.48 if potential emigrants choose to leave the country, one of the highest rates in the world.46 North Macedonia’s population is rapidly aging. By 2025, the number of people over age 65 One of the main push factors for emigration is projected to exceed the number under 15. from North Macedonia is the lack of The fertility rate fell from about 2.2 children employment opportunities in the country, per woman in 1991 to about 1.3 in 2020, the while higher wages in EU countries act as fourth-lowest rate in ECA and well below the a significant pull factor. Unemployment, replacement rate of 2.1.49 Demographic aging particularly among young workers, is a is likely to worsen over the medium and long major concern for the population. In a 2022 term as the birth rate continues to decline 44  UN Migration Statistics. 45  World Bank and WIIW (2018). 46  Gallup World Poll. 47  Balkan Barometer (2022). 48  World Development Indicators, Last Updated: 03/01/2023. 49  Represents the number of children that would be born to a woman if she were to live to the end of her childbearing years and bear children in accordance with age-specific fertility rates of the specified year. World Development Indicators, Last Updated: 03/01/2023. 40 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 46. Figure 46 Populating is getting older and shrinking 2002 2020 85+ 85+ 80 - 84 80 - 84 75 - 79 75 - 79 70 - 74 70 - 74 65 - 69 65 - 69 60 - 64 60 - 64 55 -59 55 -59 50 - 54 50 - 54 45 - 49 45 - 49 40 - 44 40 - 44 35 - 39 35 - 39 30 - 34 30 - 34 25 - 29 25 - 29 20 - 24 20 - 24 15 - 19 15 - 19 10 - 14 10 - 14 5-9 5-9 0-4 0-4 -10 -5 0 5 10 -10 -5 0 5 10 % of population % of population Male Female Male Female Source: State Statistical Office. and large-scale emigration continues.50 A of new skills, FDI, and more. However, there long-delayed population census conducted is evidence that North Macedonia has not in September 2021 found that the population been able to fully leverage these advantages had fallen by about 10 percent since 2002 to due to the ongoing departure of skilled about 1.8 million people (Figure 46). By 2050, young emigrants and the underutilization of the population is projected to decline by remittances. another 11 percent, and more than one-quarter of Macedonians will be over the age of 65.51 Climate change is already eroding country’s growth prospects, while These demographic trends have deep negative energy security is a new challenge implications for growth and productivity. As the population shrinks and ages, skilled North Macedonia is highly vulnerable to labor may be in short supply despite high climate change. The country faces both unemployment rates. Brain drain can lead to sudden and slow-onset hazards due to the significant gaps in vital sectors and impede the increasing intensity and frequency of storms, country’s ability to capitalize on investments changes in precipitation patterns, and rising made in its human capital. Demographic temperatures. The country is at high risk aging will also intensify pressure on North of urban and river flooding, landslides, and Macedonia’s social protection system and the wildfires, while water scarcity and extreme provision of public services, as fewer working- heat hazards pose more moderate but still age people will need to support an increasing significant risks.52 The total cost of the 23 number of retirees, while an older population disaster events recorded since 1990 exceeded rises increasing pension and healthcare costs. US$409 million in direct damage, excluding On the other hand, migration can also offer the loss of human lives.53 The average annual significant opportunities for a country, such damage to critical infrastructure from climate- as an increase in remittances, acquisition related hazards could quintuple by 2080, 50  United Nations, DESA, Population Division. World Population Prospects 2022. 51  United Nations Department of Economic and Social Affairs (UN DESA), Population Division. 52  Global Facility for Disaster Reduction and Recovery Think Hazard platform: https://thinkhazard.org/en/report/241- fyr-of-macedonia 53  World Bank (2018a). NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 41 with a major flood or other natural disaster adopted the National Energy and Climate potentially derailing economic growth, Action Plan in accordance with the EU damaging agricultural incomes and, or Energy and Climate Package 2030 and the destroying critical infrastructure.54 Therefore, Strategy for Low Carbon Europe. Moreover, North Macedonia urgently needs to accelerate as a signatory to the Sofia Declaration on the the implementation of climate-change Green Agenda for the Western Balkans, which adaptation and mitigation measures. is aligned with the EU’s Green Deal, North Macedonia has committed to working towards Poor environmental management practices the 2050 target of a carbon-neutral continent. are exacerbating the erosion of the country’s In October 2020, the European Commission natural resources. Despite withdrawing only announced An Economic and Investment 25 percent of renewable water resources, the Plan for the Western Balkans, which sets frequency and severity of droughts are on the out a substantial investment package to rise, resulting in significant damage not only support inclusive growth and the regional to agriculture—which contributes up to 12 green transition. The government must also percent of the GDP—but also to sectors such incorporate the most recent EU legislation on as tourism. Lack of control over wastewater industrial emissions, establish an air-quality disposal from industry, mining, households, standard for daily PM2.5 concentrations, and and agriculture are the leading cause of pass a dedicated climate law. The authorities water pollution, while only 77 percent of the must also strengthen the public sector’s population has access to safe drinking water institutional capacity for policymaking, and a mere 5 percent of wastewater is safely implementation, and absorption of EU funds. treated.55 The current rate of environmental The institutional arrangements for disaster degradation is likely to amplify the impacts of prevention, preparedness, and response future climate change. at the national and sub-national levels are inefficient, and the sovereign financing The government is pursuing ambitious gap associated with disaster response and mitigation targets while attempting to recovery from disasters is growing as the safeguard energy security. The country limited uptake of disaster insurance increases submitted the enhanced Nationally costs liabilities. Finally, the EU Carbon Border Determined Contributions (NDC) in 2021 as Adjustment Mechanism (CBAM) is expected the second national climate pledge to the to adversely affect the terms of trade for United Nations Framework Convention on carbon-intensive goods exports to the EU Climate Change (UNFCCC).56 The Long- unless North Macedonia levies comparable Term Strategy on Climate Action and Action carbon prices on domestic producers. With Plan foresee ambitious mitigation targets energy intensity of GDP almost three times and adaptation priorities.57 As a Contracting higher than the EU average, a significant Party to the Energy Community Treaty, share of exports and employment in emission- North Macedonia has adopted the National intensive sectors, and Europe as a key export Strategy for Energy Development until 2040 market, the country already faces questions and committed to significantly reduce local regarding its future competitiveness and FDI pollutants by 2027. The country has also attractiveness. 54 Ibid. 55 In March 2022, The Government signed a €70 million investment grant with the EIB under the Western Balkans Investment Framework (WBIF) to build a wastewater treatment plant in Skopje. 56  The updated NDC include 51 percent reduction in GHG emissions relative to 1990 levels, or 82 percent reduction in net terms. 57  https://unfccc.int/sites/default/files/resource/MKD_LTS_Nov2021.pdf 42 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE The EU accession process is a EU partners providing vaccines, opening powerful driver of reforms for growth transportation routes for goods during the pandemic, safeguarding reserve buffers after The government’s reform agenda is oriented Russia’s invasion of Ukraine, providing crisis toward EU accession. North Macedonia applied support grants in 2020 and 2022, and securing for EU membership in 2004 and became an energy supplies during the recent energy EU Candidate Country in 2005. The European crisis. EU support, along with assistance Commission has been recommending the from international financial institutions, has opening of accession negotiations since 2009, bolstered the country’s resilience in the face but North Macedonia’s name dispute with of unprecedented shocks. Greece was only resolved in 2018. In June of that year, the EU Council opened accession The negotiation process for EU accession will negotiations, highlighting the need for further offer even more significant benefits. Aligning progress in the fight against corruption and domestic legislation with the EU Acquis will organized crime, judicial reform, improvements improve standards and norms, facilitating in the intelligence and security services, and investment and improving legal predictability. capacity-building in the public administration, Developing professional and accountable among other priority areas.58 However, a institutions will help ensure effective dispute with Bulgaria prevented the screening governance and strengthen the rule of law. process from starting until 2022. The annual Many previous EU entrants experienced the progress report for 2022 acknowledged the most substantial improvements in these areas progress made in strengthening the rule of law during the pre-accession period. Cohesion and protecting fundamental rights, but further grants would promote more balanced efforts are needed, as the country remains regional development, while the EU Green only moderately prepared in those areas.59 Agenda and its supporting grant funding to the Western Balkans would facilitate a just The economic benefits of closer integration low-carbon transition. Having a committed with the EU are already apparent. FDI from and professional negotiation team with EU member states currently accounts for 64 representatives from all parts of society percent of North Macedonia’s total FDI stock, that is capable of effectively communicating and inflows from the EU have increased by 7 the benefits of reforms to the public would percent per year since 2018. Seventy-seven enable the transformational change necessary percent of the country’s exports go to the to complete the accession process within a EU, rising by 9 percent per year since 2018. decade, allowing the current generation of The number of tourist nights spent by EU young people to enjoy the benefits of income citizens has increased by 28 percent per year convergence with the EU. since 2018, and EU tourists now account for half of all tourist nights. EU grants to North Macedonia through IPA I and II amounted to €1.3 billion, and IPA III envisages an allocation 60 percent higher than that received so far. Solidarity support from the EU during recent crises has been highly valuable, with 58 https://www.consilium.europa.eu/en/policies/enlargement/republic-north-macedonia/ 59 https://neighbourhood-enlargement.ec.europa.eu/system/files/2022-10/North%20Macedonia%20Report%20 2022.pdf NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 43 CHAPTER 3 CONSTRAINTS TO GROWTH AND PROSPERITY IN NORTH MACEDONIA North Macedonia has made important strides in enhancing its business environment and has successfully attracted foreign investment. However, persistent weaknesses in the institutional and policy framework impede productivity growth. The domestic economy continues to lack the dynamism necessary to reach higher-income status, a challenge reflected in its low and declining productivity indicators. Firms owned by domestic investors, predominantly micro, small, and medium-sized enterprises, have exhibited weak or stagnant productivity growth in recent years. These businesses primarily serve the domestic market, with few links to regional or global value chains, and their progress on digitization and the green transition tends to lag that of their regional peers. To address its productivity challenge, North Macedonia must continue to attract FDI to facilitate technology upgrading while implementing an ambitious strategic governance, infrastructure, regulatory, and firm-level reform agenda. Rooting out corruption, nepotism, and conflicts of interest are critical to restore trust in institutions, improve tax compliance, and slow or reverse emigration among skilled workers. Focusing on deepening trade integration, 44 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE more effective state aid and competition policy, digitalization, and business environment reforms would change the role of the state towards an enabler and the guarantor of the level-playing field. By implementing comprehensive and transformative reforms, North Macedonia can boost its productivity, stimulate economic growth, and deepen its integration into regional and global markets. The education system in North Macedonia is failing to equip graduates with the skills demanded by the labor market, resulting in high rates of youth unemployment and long-term unemployment. Access to education has improved in recent years, but education quality remains persistently low, resulting in a significant loss of human capital. The health system is another significant concern for Macedonians, and in surveys many citizens express dissatisfaction with the services they receive. Noncommunicable diseases (NCDs) are a growing concern due to demographic and lifestyle factors, as well as the heavy economic cost they entail. Poor-quality care delivered by an underfunded health system, especially at the primary level, is a major contributor to the mounting burden of NCDs. Meanwhile, low levels of public health spending also result in high out-of-pocket (OOP) costs. The government overhauled its social protection system in 2019, increasing its impact on poverty reduction and strengthening its ability to respond to crises. While poverty-targeted programs effectively reach lower-income households, there is scope to expand their coverage among the poorest. Reforms to the social services are devolving greater responsibility on local service providers and transforming the role of the Ministry of Labor and Social Policy (MLSP). Although previous reforms strengthened the sustainability of the pension system, a recent change in pension indexation has widened the system’s deficit. Bringing the public debt and fiscal deficit down after the consecutive crises requires efforts to mobilize additional domestic revenues, make spending programs more efficient, and bolster public finance management. This is critical given significant gaps in spending outcomes in social and infrastructure sectors, as well as low compliance and low effective tax rates that are unable to cover for the increasing needs of the country to meet the citizens’ expectations and comply with the EU standards across sectors. North Macedonia’s energy mix remains heavily dependent on coal and petroleum, resulting in significant greenhouse-gas emissions and air pollution. As the economy expands and energy demand grows, the environmental and health consequences of North Macedonia’s reliance on fossil fuels will become increasingly severe. The residential sector is the primary contributor to ambient air pollution due to traditional heating sources that use inefficient and highly polluting solid fuels. Small particulate (PM2.5) air pollution is one of the leading causes of illness and death globally, and in North Macedonia its damaging effects on public health impose economic losses estimated at about 7 percent of GDP. The country is highly vulnerable to climate change and natural disasters, and adaptation policies are crucial to enhance resilience. Decarbonizing production will also be critical for North Macedonia to remain competitive and gain access to tightly regulated EU markets. As the low-carbon transition will cause changes in employment, the government must support workers in carbon- intensive sectors as they move into more sustainable jobs. NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 45 REMOVING CONSTRAINS area of control of corruption is below the FOR FASTER GROWTH worldwide peers of upper-middle income countries (Figure 47). Moreover, the World Weak institutions and low Justice Project’s Rule of Law Index, which administrative capacity remain key utilizes surveys of households and experts, constraints on growth has shown a deterioration in the quality of regulatory enforcement, the judiciary, and Despite extensive reform efforts over control of corruption.60 In the 2019 Enterprise the last two decades, North Macedonia Survey, about 17 percent of surveyed firms continues to struggle with corruption. Driven reported giving gifts to secure government in part by the goal of EU membership, the contracts, and 10 percent of firms admitted government has significantly improved the to paying bribes to establish an electricity quality and transparency of public institutions connection (Figure 48). These findings and administrative processes since 2002. highlight the continuing challenges North Reforms have been made in areas such as Macedonia faces in its fight against corruption. public financial management, anti-corruption Further reforms and measures to strengthen measures, the judiciary, procurement, and transparency, accountability, and integrity in public administration, and service delivery. public institutions and business practices will Nevertheless, the country’s performance on be essential for the country’s economic future the Worldwide Governance Indicators in the and its prospects for EU accession. Figure 47. North Macedonia’s performance on several governance indicators is above the income group peers, but control of corruption remains a problem Figure 47 (Percentile rank among all countries in the world) Percentile Rank (0-100) Upper middle income 2021 Voice and Accountability North Macedonia 2021 Political Stability and Upper middle income 2021 Absence of VIolence/Terrorism North Macedonia 2021 Government Upper middle income 2021 Effectiveness North Macedonia 2021 Regulatory Upper middle income 2021 Quality North Macedonia 2021 Upper middle income 2021 Rule of Law North Macedonia 2021 Control of Upper middle income 2021 Corruption North Macedonia 2021 0 20 40 60 80 100 Source: Worldwide Governance Indicators, 2021. 60  World Justice Project (2022). 46 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 48. Surveys indicate that bribes are percent of citizens and businesses believe the more common to obtain contracts, electricity courts are independent, and just 30 percent of connections, or construction permits than citizens and businesses have a positive view with peers Figure of the general efficiency of the courts (Figure (Share of48 firms expected to give gifts, percent) 49). A striking 90 percent of citizens and 20 businesses perceive corruption to be present 18 within the judiciary, a sentiment shared by 16 14 64 percent of judges and prosecutors. These numbers underscore the need for further % of firms 12 10 reform and more robust anti-corruption 8 measures within the judicial system. 6 4 2 North Macedonia must professionalize its 0 MKD Structural peers Aspirational peers public service, regulatory agencies, and 10 check and balance institutions. Although to secure government contract to get an electrical connection to get a contruction permit in meetings with tax officials the public administration has cultivated a to get a water connection to get an operating license skilled workforce, turnover rates are high, Source: Enterprise Survey 2019. and political influence at both central and local levels remains a significant concern. The Law on Administrative Servants and the Law The country has made some progress in the on Public Sector Employees aim to establish areas of judiciary and fundamental rights, uniform rules for public-sector employees including through strengthened judicial at the central and local levels, but merit- independence, but enforcement and the based recruitment, promotion, and dismissal fight against corruption remain weak. The processes fall short of the intended standards country is in the final stages of implementing of professionalism. Regulatory agencies its 2017-2022 Judicial Reform Strategy, under have legally defined mandates and general which the authorities have enacted new laws guarantees for their independence, but their and introduced new methodologies to assess practical independence is often questionable. the work of judges and prosecutors, and According to the OECD’s 2021 SIGMA policymakers are in the process of drafting a report, the country’s job-classification-based new strategy. Both the EU and the government remuneration system allows for a reasonable remain committed to judicial reform, but the seniority progression and limited performance- implementation of new rules has been uneven, related bonuses. However, the rudimentary and concerns about the judiciary’s impartiality job classification system does not adequately and politicization persist. While the State distinguish responsibility levels, leading to Commission for the Prevention of Corruption potential unfair pay differences. Several salary continues to perform its duties proactively, supplements linked to unclear criteria have corruption remains prevalent in many areas been established to benefit certain public and is an issue of concern. The efficiency ratings entities and staff groups, undermining the of the courts, based on actual court cases, are transparency of compensation. Moreover, only 47 percent and 37 percent for citizens women are underrepresented in top and businesses, respectively. Many citizens management positions, accounting for just and businesses have negative perceptions of 14 percent of all management staff in 2022. the independence and efficiency of the courts, Finally, key institutions have yet to determine with many believing corruption is rife within how to address absenteeism among public the judiciary. According to a recent regional employees or issues involved in determining justice survey by the World Bank, only 25 their final job positions. NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 47 Figure 49. Perceptions of the efficiency and integrity of the judiciary are broadly negative Figure (Share of49 firms expected to give gifts, percent) % of tatget groups’ representatives perceiving general Perceived presence of corruption in judiciary independence of courts as good % of citizens and business % of judges and prosecutors representatives believing the believing the corruption is corruption is present in justice present in judiciary in North system Macedonia 25% 22% 30% 60% 38% 92% 88% 57% 71% citizens businesses lawyers judges prosecutors citizens businesses judges prosecutors Source: ECA Regional Justice Survey, Country Report for North Macedonia, 2022. Figure 50. North Macedonia scores poorly Figure 51. …and the gap between North on indicators of governance, public-sector Macedonia and its EU peers on governance integrity, and corruption… indicators is wide Figure 50 of government conduct) (Perceptions Figure 51 (Overall governance score, various years) 100 4.5 1.0 90 4.1 4 0.9 80 3.5 0.8 70 3 0.7 3 60 2.6 2.6 2.7 0.6 2.5 50 2.3 0.5 Governance 2 40 0.4 gap 1.5 Median - New EU 30 0.3 20 1 0.2 Member States 25 - 75th percentiles 10 0.5 0.1 0 0 0.0 ALB BIH KOS MKD MNE SRB 2022 5 years Join EU 5 years before after joining Very negative Negative Neutral joining EU EU Positive Very positive No answer North Scores (right axis) Macedonia New EU Member States Source: Balkan Barometer 2022, Business Opinion Survey. Source: World Bank staff simulations based on World Note: All respondents - N=1203, scores are on a scale of Governance Indicators. 1 to 5 where 1 means very negative and 5 very positive, share of total, %. Negative perceptions of governance and decision-making in the public sector, the public integrity can erode trust, leading to highest percentage in the region. lower investment levels, tax compliance, and electoral and civic participation. In North North Macedonia’s governance indicators lag Macedonia, 59 percent of companies report those of aspirational peers, and insufficient having a negative or very negative perception improvements could impede the country’s of governance, public integrity, and corruption. EU accession. Policymakers must redouble These perceptions are reflected in the their efforts to catch up with peers, as the country’s score on the Balkan Barometer 2022 countries that joined the EU in 2004 had Business Opinion Survey, which was the worst higher governance indicators during the pre- in the region (Figure 50). Similarly, 38 percent accession period than North Macedonia today of surveyed businesses in North Macedonia (Figure 51). Poor governance and limited have a negative view of transparency and administrative capacity, particularly at the 48 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE municipal level, negatively affect the delivery economic consequences. Although 81 percent of public services. Weak public institutions of households have internet access, connection and political volatility—including frequent speed and quality are highly variable, and only changes in leadership and politicized hiring— 42 percent of the population has access to 4G. undermine governance quality and slow Furthermore, concerns persist regarding the reform implementation, resulting in inefficient independence of national regulatory bodies. spending, inadequate public infrastructure North Macedonia also faces more significant and services, and the perception of unequal challenges than its regional peers in terms of treatment by the authorities. affordability, which disproportionately affects lower-income households and exacerbates the Digitalization and transport digital divide. In addition, a shortage of skilled infrastructure can boost productivity workers and a significant gender gap in the and service delivery ICT labor force and leadership positions hinder the growth of the ICT sector and impede the Digital governance systems have become overall development of the digital economy. increasingly important in the wake of the COVID-19 pandemic. The government aims The country’s lagging infrastructure is reflected to accelerate the comprehensive digital in its weak digital governance. According to transformation of the public administration by the GovTech Maturity Index, North Macedonia strengthening foundational elements such as outperforms its Western Balkan peers only in information and communication technology the indicator for public service delivery, which (ICT) architecture, the policy and regulatory measures the maturity of online public service frameworks, and the quality of digital skills. In portals with a focus on citizen-centric design 2019, the government adopted the National and universal accessibility. On the indicators Operational Broadband Plan for 2019-29, and for core government systems, digital citizen the authorities are currently working on a engagement, and GovTech enablers, North long-term ICT strategy that will include a plan Macedonia trails both its peer countries and for developing digital skills. The Ministry of the EU27 member states (Figure 52). Information Society and Administration and other stakeholders have already prepared a Despite annual public investment levels Public Administration Reform Strategy and of over 5 percent of GDP, the quality and Action Plan covering ICT capacity-building coverage of infrastructure in North Macedonia in the public sector and the introduction fall short of EU standards. The 2019 World of modern systems for human resource Economic Forum’s Global Competitiveness management, professional development, report indicates that the country performs and regulatory reform. The second area is poorly in terms of air connectivity, efficiency Information society, covering: infrastructure of train services, and overall quality of and support; eServices, where some progress transport infrastructure (Figure 53). has been made,61 eCitizens, and single-point- Inadequate upgrades and maintenance of of-services; and open data. However, the the road and rail network continue to hinder country’s underdeveloped and underutilized economic development and impede the high-speed broadband infrastructure has country’s regional integration. About 20 resulted in a significant digital divide among percent of firms regard the quality of transport the population, with negative social and infrastructure as poor, with logistical and 61  www.uslugi.gov.mk NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 49 Figure 52. Digital governance systems could Figure 53. The quality and coverage of be much improved infrastructure remain below EU standards (GovTech Figure 52Maturity Index, 2022) (Transport Figure 53 infrastructure and connectivity indicators) Overall transport 1 80 infrastructure 70 0.9 60 0.8 50 40 0.7 30 Airport Quality 0.6 20 connectivity of roads 0.5 10 0 0.4 0.3 0.2 0.1 0 Efficiency of air Efficiency GTMI CGSI PSDI DCEI GTEI transport services of train services EU WeBa North Macedonia ALB BIH MKD MNE SRB CZ HUN Source: https://www.worldbank.org/en/programs/ Source: World Economic Forum, The Global govtech/2022-gtmi. Competitiveness Report 2019. Note: GTMI: GovTech Maturity Index; CGSI: Core Government Systems Index: PSDI: Public Service Delivery Index; DCEI: Digital Citizen Engagement Index; GTEI: GovTech Enablers Index. connectivity issues leading to increased trade strategy. Road agency of North Macedonia costs.62 While North Macedonia has invested is in process of implementing a road asset in developing the road sector and completing management system which should help missing EU TEN-T Corridor links, progress has the implementation of first performance- been slow. TEN-T Corridor X missing links based contracts in the road sector and to have been successfully completed at south of prioritize regular and periodical maintenance North Macedonia toward Greece, but Corridor interventions. Municipal infrastructure— linking East and West is significantly delayed. including water, wastewater, urban transport, Significant governance bottlenecks exist at street lighting, and solid-waste management— the planning, appraisal, and costing stages remains underdeveloped (at 64 percent of of the public infrastructure project cycle. The regional average) and requires significant country currently lacks a legal or regulatory investment. The local own-source revenue framework providing policies, standards, contribution to the expenditure takes up or procedures for appraising investment only a small percentage.  Being coupled with projects. For projects implemented through fragmented and insufficient central fiscal structured financing instruments, such transfer, this inadequate spending resulted in as PPPs, no guidelines currently exist for significant backlog of municipal infrastructure economic analysis of projects. A new PPP and services such as that only 66 percent of law, currently being drafted, aims to address urban population is connected to sewerage this issue. The decentralized and fragmented (dropping to 11 percent for rural settlements), public investment system, differentiated a non-revenue water reaches 70 percent, through funding source, results in a lack of and almost no local budget is allocated for oversight of the project portfolio and its critical DRM services such as fire-fighting contribution to the national development assets, equipment as well as regular cleaning/ 62  According to the Balkan Barometer 2021, 79 percent of firms thinks that cross-border transaction costs are high— the largest among the Western Balkans. 50 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE maintenance of riverbeds. Urban transport but limited with very little activity. Weak faces challenges in many cities, and the regulation (lacking necessary definitions about transport sector has been responsible for factoring), lack of funding, low awareness, greatest share of the increase in GHG emissions and disadvantageous tax treatment limit the in the country in recent years, primarily from growth of factoring. Seven leasing companies daily commuting. E-mobility remains low. mainly provide car leasing and are not North Macedonia also lags in waste disposal, targeting MSMEs. Leasing could potentially relying on polluting and inefficient landfills play an important role in financing MSMEs, while recycling is almost nonexistent. including those in the agricultural sector. Leasing companies are required to pay VAT Deficiencies in the business on interest income, a cost that is passed on environment undermine competition to consumers, making the product even less and inhibit productivity growth competitive. In the 2019 Enterprise Survey, firms ranked access to finance as their top five Micro, small, and medium enterprises (MSMEs) obstacles for doing business (Figure 54).63 that lack real estate collateral have limited Credit constraints pose an especially acute access to finance. The depth of the financial challenge among smaller, younger firms and sector measured by private sector credit to those located outside of Skopje. Subsequent GDP stands at 55 percent in North Macedonia, surveys conducted to capture the impact of which is in line with regional averages while the pandemic reveals that access to finance significantly below EU averages. Availability gap widened as more firms are experiencing of alternative financial products which can decreased liquidity and delayed payments. On cater to the MSME sector, such as leasing, average, banks provide 35 percent of firms’ factoring and financial companies are present external investment financing. However, banks Figure 54. Political instability, access to Figure 55. North Macedonia’s firms invest less finance, and transport are bigger business than their peers in greening their operations obstacles than with the peers (Percent of firms reporting investment measures (Percent of firms reporting the biggest obstacle they adopted over the last three years) Figure face) 54 Figure 55 30 60 25 50 20 40 % of firms % of firms 15 30 10 20 5 10 0 0 MKD Structural peers Aspirational peers MKD Structural peers Aspirational peers Political instability Improvements to lighting systems Practices of competitors in the informal sector Heating and cooling improvements Inadequately educated workforce Machinery and equipment upgrades Access to finance Waste minimization, recycling and waste management Transport Energy management Upgrades of vehicles Tax rates Water management Air pollution control measures Source: World Bank Enterprise Survey 2019. Source: World Bank Enterprise Survey 2019. 63 The OECD SME Policy Index 2022 (https://www.oecd-ilibrary.org/development/sme-policy-index-western- balkans-and-turkey-2022_af7604c6-en) suggests that access to finance pressures eased. NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 51 only lend to MSMEs with at least three years of North Macedonia’s firms are less likely to business records and good financial accounts, undertake green investments than their peers, a condition that micro firms, small firms, and especially investments in waste management, startups typically cannot meet. Large loans recycling, and machinery, equipment, and require hard collateral equal to the loan’s vehicle upgrades (Figure 55). A recent analysis value, which micro and small firms often lack. shows that energy-efficiency investments Banks rarely lend against movable collateral could reduce energy consumption among because of limitations in the law on contractual North Macedonia’s firms by about 30 percent pledges, problematic enforcement, and the while cutting greenhouse-gas emissions and non-existent secondary market. Women face generating as much as 1.7 percent in total a significant disadvantage as they encounter cost savings.64 With public-sector support, additional constraints in accessing funds, targeted loans could help improve the energy lack strong business networks, and receive efficiency of firms. limited support for unpaid domestic work and childcare. Moreover, a smaller share of women An analysis of the business environment’s compared to men have formal institutions impact on firm productivity underscores account ownership. Public interventions, such the need for deeper reforms. For example, as a well-designed partial credit guarantee power outages and informal competition scheme, could ease collateral requirements decrease productivity by 0.6 and 0.5 percent, and stimulate bank lending to MSMEs. The respectively. Conversely, facilitating access Development Bank introduced such a scheme to foreign technology and providing access in late 2020 in response to the pandemic, but it to credit lines can improve productivity has yet to reach its full capacity. Building firms’ for the median firm by 0.8 and 0.5 percent, financial management and overall managerial respectively (Figure 56). Simulations indicate skills would make them more bankable and that improvements to the business climate increase their access to finance. could significantly boost productivity. For Figure 56. Because the quality of the business environment either supports or hinders firm-level productivity… Figure 56 (Impact of the business climate on firm productivity, regression coefficients to TFPR) Firm uses foreign technology 0.8 Firm has access to credit line 0.5 Firm is foreignly owned 0.3 Firm is exporting 0.3 Firm offers training 0.02 Number of tax inspection visits -0.06 Number of competitors -0.08 Manager's time in bureacuracy -0.2 Number of days to get an operation permit -0.2 Number of days to clear customs -0.2 Firms affected by crime -0.4 Firms competing with informal competition -0.5 Number of power outages -0.6 -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6 0.8 1 Source: Author’s calculations based on data from the World Bank Enterprise Surveys 2009-2013-2019 for North Macedonia. Total factor productivity (TFPR) is measured using deflated output and inputs and the Levinsohn-Petrin method. Given the lack of capital data for the 2013 Survey, imputation approaches have been applied to run the regressions. Control variables for the size and sector of firms have been used. 64  World Bank (2023d). 52 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 57 …improving the business environment can yield significant productivity gains Figure 57. (Percent of firms reporting investment measures adopted over the last three years) Number of days to clear customs 0.6 Number of days to get an operating permit 0.3 Number of power outages 0.2 Number of tax visits 0.2 Number of firms competing against informal firms 0.12 Managers'time in bureacuracy 0.002 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 Source: Author’s calculations based on data from the World Bank Enterprise Surveys 2009-2013-2019 for FYR North Macedonia. Total factor productivity (TFPR) is measured using deflated sales and inputs and the Levinsohn-Petrin method. Given the lack of capital data for the 2013 Survey, imputation approaches have been applied to run the regressions. example, reducing the number of days for trade agreement.65 The survival rate for customs-clearance procedures could increase North Macedonia’s exports is the third lowest firm-level productivity by 0.6 percent. in the region after Albania and Moldova. Similarly, reducing the number of days needed Export relationships tend to persist longer to secure an operating permit and minimizing for primary-sector products and in markets power outages could raise productivity by where North Macedonia has an active regional 0.3 and 0.2 percent, respectively (Figure 57). trade agreement. On average, only half of These findings underscore the importance of medium and small exporters endure over the targeted policies and interventions aimed at long term, but larger exporters have higher improving the overall business environment to survival rates. Service exports have stagnated foster productivity growth. and continue to underperform their potential (Figure 59). These patterns highlight the need Deepening the trade integration and for a diversification strategy to boost export trade policies would lead to export performance and resilience. boost and diversification The government’s strategy of using tax North Macedonia’s FDI-supported export- incentives to spur exports and attract FDIs oriented growth strategy is showing signs needs to be redesigned to improve its of fatigue, and the COVID-19 pandemic and effectiveness, better stimulate job creation, Russia’s invasion of Ukraine have highlighted and incentivize linkages with the local important weaknesses. While the strategy economy. Generous tax incentives, which cost has yielded gains, a lack of diversification— 5 percent of total tax revenue between 2017 both in terms of markets and products—is and 2020, were primarily granted to firms weakening the country’s export performance operating in Technological and Industrial (Figure 58). The survival rate of exports is low, Development Zones (TIDZs). In 2020, these especially products not covered by a regional firms accounted for one-third of exports 65  World Bank (2022a). NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 53 Figure 58. Machinery, electronics, and Figure 59. The growth of goods exports chemicals have driven export growth, though exceeded the average for structural peers, but gains have slowed in recent years service exports have untapped potential 58 Figure in (Exports USD million) Figure (Trade in 59 services and GDP pc) 12,000 Vegetables Minerals 10,000 Foodstuff Transportation 8,000 USD Million Textiles Metals 6,000 Other Services 4,000 Chemicals 2,000 Mach/Elec 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Source: World Bank staff, and SSO. 2020 Source: WDI and SSO. but represented just 3 percent of total Figure 60. Deeper trade agreement can employment. Moreover, tax incentives have increase exports, especially in sectors with not generated substantial spillover effects many large firms (A percent Figure 60increase in exports by firms for a 10-percent on the rest of the economy. Foreign firms increase in the number of provisions in the Deep RTA) continue to source only around 10 percent of Footwear & Headgear their inputs from domestic suppliers. While Plastics-Rubbers tax incentives have boosted the profitability Chemical & Allied Industries of FDI-financed firms in the TIDZs, they were Miscellaneous not sufficient to overcome general investment Foodstuffs Textiles hurdles, indicating that the firms attracted Raw Hides, Skins, Leather, & Furs have low profit margins. These low margins Machinery & Electrical could threaten the medium-term sustainability Metals of their operations in the TIDZs, as they may Vegetable Products choose to move to more lucrative investment Mineral Products Animal & Animal Products locations. Transportation Wood & Wood Products Deep trade agreements (DTAs) have Stone & Glass played a significant role in diversifying -0.4 -0.2 0 0.2 0.4 the economy by boosting exports across Note: All the coefficients are statistically significant except various sectors. The DTAs signed by North for Raw Hides, Skins, Leather & Furs, and Miscellaneous. Source: Authors’ estimations based on gravity model. Macedonia in recent years have increased exports, facilitated the entry of domestic firms into new markets, and encouraged of resources towards more-productive firms. country’s participation in GVCs.66 However, DTAs have had a clearly positive impact on the impact of DTAs has been asymmetric, manufacturing (including agribusiness), but favoring larger firms and manufacturers, their effect on agriculture and other parts which has inhibited the efficient reallocation of the primary sector has been weaker. 66  World Bank (2022a). 54 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE The largest gains have been generated in job creation, unemployment remains a major footwear and headwear, chemical products, challenge, and North Macedonia has one of and textiles (Figure 60). the highest rates of youth unemployment in the ECA region. In surveys, about one in six A strong trade strategy is essential for a small, Macedonians cites inadequate employment landlocked country like North Macedonia. opportunities as the biggest problem facing This strategy should facilitate climbing the young people,68 and it takes the average GVC ladder and expanding diversification in graduate 2.5 years to secure a stable or agriculture, agribusiness, services, and more satisfactory job. The employment challenges complex manufacturing. Greater diversification facing young Macedonians are also reflected would accelerate job creation, increase in the high rates of young population that does business survival, and strengthen the resilience not study, work, or receive training (NEET). of the economy. To foster sustainable export Only half of Macedonians between the ages of growth, North Macedonia needs to implement 15 and 29 are active in the labor market, and trade policy reforms, which could include: the country presents the second highest share (i) streamlining border procedures and of idle in Europe. enhancing interagency coordination to reduce customs-clearance delays and trade costs with Only half of North Macedonia’s firms report its major trading partners; (ii) facilitating labor being able to find workers with the necessary mobility within the Western Balkans to boost skills, and less than 10 percent report being trade in services; (iii) addressing remaining in contact with educational institutions.69 gaps in transport infrastructure, including the Meanwhile, about one-quarter of Macedonians rail network; (iv) deepening and expanding its feel that the skills they learned in the free trade agreements and aligning its tariffs education system did not prepare them for with the EU; and (v) revising tax exemptions their current jobs.70 The mismatch between in line with the EU Acquis to promote export the skills the education system imparts and readiness, foster human capital development, those the labor market demands greatly and promote innovation. State aid and diminishes the productivity of Macedonian incentive programs should be adjusted to workers. In addition, while female students enable firms to access higher-value-added are overrepresented in all levels of the school segments of priority value chains. system, girls often face difficulties in utilizing their acquired skills as they tend to be ADDRESSING CONSTRAINS underrepresented in the labor market. FOR MORE INCLUSIVE GROWTH The government is working to accelerate human capital formation,71 but its efforts to The toll of limited quality of date have achieved limited gains. A child education born in North Macedonia today can expect to be just 56 percent as productive as she could The education system in North Macedonia have been given complete education and full does not effectively equip graduates with the health. This share is among the lowest in the skills needed to succeed in the labor market.67 Western Balkans and the ECA region (Figure Despite considerable progress in boosting 61). Low levels of productivity are caused 67  Based on World Bank (2023e). 68  Balkan Barometer 2022. 69  STEP Survey. 70  Balkan Barometer 2022. 71  Defined as the skills, knowledge, and health that individuals acquire and accumulate throughout their lives. NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 55 Figure 61. Human capital accumulation is among the lowest in ECA 61 Index (HCI) scores, indicating the average lifetime productivity of a child born in 2020) FigureCapital (Human 0.9 0.8 0.7 0.6 0.5 HCI 0.4 0.3 0.2 0.1 0.0 TJK MKD KOS GEO AZE ARM BIH MDA ROU KGZ BGR UZB KAZ UKR MNE ALB TUR SVK SRB RUS HUN LUX GRC BLR LTU LVA HRV ITA ESP ISL AUT DEU CZE POL DNK CYP CHE BEL FRA PRT NOR SVN EST GBR NLD IRL SWE FIN Source: The Human Capital Project (World Bank 2021). primarily by weak educational outcomes. socioeconomic inequalities, as many children Although a child in North Macedonia can from lower-income households start primary expect to complete 11 years of schooling by school without the necessary literacy and age 18, if we adjust for learning quality, this numeracy skills. Although primary enrollment only translates to 7.3 years of schooling, is almost universal, and secondary enrollment indicating a significant loss of human capital. is above 80 percent, the gross tertiary More than one-third of Macedonians report enrollment rate is just 43 percent, well below being completely or mostly dissatisfied with the levels of peer EU countries. the education system, the second largest share in the Western Balkans.72 Recent efforts to improve education access have not led to better learning outcomes. Over the years, education access has Education quality remains low, with no increased at all levels, including pre-school significant improvements observed in recent and tertiary education. However, despite years. On the 2018 PISA, more than half of concerted efforts to improve coverage and 15-year-olds failed to demonstrate basic quality in recent years, pre-primary enrollment proficiency in science, mathematics, and (age 4 and older) remains relatively low at 42 reading, far short of the 2020 EU target of 15 percent, below the levels of other countries in percent or fewer. While the country has made the region, the EU average, and the 2020 EU progress since 2015, students’ performance target of 95 percent. Access is also unevenly is still below the average score for the EU distributed; less than 10 percent of children and most Western Balkan countries (Figure from households in the poorest quintile attend 62). In addition, more than 40 percent of preschool, compared to over half of children 10-year-olds cannot read and understand a from wealthier households. Underinvestment simple text by the end of primary school, far in early childhood education (ECE) and above the 11 percent average for ECA.73 There childcare negatively impacts human capital are also significant disparities in learning formation, and a lack of childcare options outcomes between students from different is one of the main reasons behind the low socioeconomic backgrounds. For example, rate of female labor-force participation. the PISA 2018 revealed that the learning gap Uneven access to preschool exacerbates between students from the top and bottom 72  Balkan Barometer 2022. 73  Human Capital Project (2020). 56 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 62. Standardized test scores highlight Figure 63. …and reveal deep disparities the low quality of education in North between students from different economic Macedonia… backgrounds (PISA 2018 results, North Macedonia and peer groups) (2018 PISA equity profile, North Macedonia) Figure 62 Figure 63 500 Top 20% ESCS Botton 20% 400 City Location Town 300 Score Female Gender Male 200 Language Same as test at home other 100 School Private type Public 0 Reading Math Science 300 320 340 360 380 400 420 MKD ECA EU OECD Score Source: World Bank (2019). North Macedonia: PISA 2018. Washington, DC: World Bank. Figure 64. The quality of higher education is relatively low 64 Figureeducation (Higher quality index) 35 Quality index of tertiary education EU Average 30 25 20 LIC & MIC ECA Average 15 10 5 0 MNE BIH MDA AZE ALB MKD KAZ ARM GEO UKR MLT LVA SVK ROU BGR LTU POL BLR TUR SRB HUN HRV CZE RUS SVN CYP EST Source: World Bank Fall 2020 Economic Update. ECA. income quintiles was equivalent to almost two the number of higher education providers years of schooling (Figure 63). is increasing despite demographic decline and rising emigration rates, raising further The quality of higher education in North concerns about the quality and value of the Macedonia is among the lowest in ECA (Figure services they offer. Limited investment in 64). Inadequate institutional management academic talent, research capacity, and core and planning capacity contribute to the poor infrastructure in North Macedonia’s universities performance of higher education. Institutional pose significant challenges to improving the governing bodies fail to regularly assess their quality of higher education. own effectiveness and the performance of their institutions against strategic plans and As a share of GDP, North Macedonia spends operational targets, weakening performance slightly more on education than its regional monitoring and accountability. Moreover, peers but far less than other EU countries. NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 57 Figure 65. Spending on tertiary education in Figure 66. Peer countries obtain better North Macedonia is relatively low education outcomes at similar or lower (Spending on tertiary education, 2018 (% of GDP)) spending levels Figure 65 Figure 66 (PISA 2018 results and government spending) 1.2 530 510 Slovenia 1 Latvia PISA score (average) 490 Lithuania Croatia Slovakia 0.8 470 450 0.6 Bulgaria 430 Montenegro 0.4 410 Albania 390 North Macedonia 0.2 370 0 350 Estonia Serbia EU-27 Slovenia Croatia Bulgaria Slovakia North Macedonia Lithuania Latvia Albania Montenegro 0 5 10 15 20 25 30 General Government spending per student at secondary, as % of GDP pc Source: UNESCO Institute for Statistics (UIS) and World Source: PISA database and World Bank staff calculations. Bank staff own calculations. Public spending on education in North Health challenges and their impact Macedonia fell from about 5.1 percent of GDP on human capital and productive in 2010 to 4.0 percent in 2020, 1.4 percentage years points below the average for other small Eastern European countries and 1 percentage The status of the health system is an important point less than the EU27 average (Figure 65). concern for the population.74 According to a The efficiency of resource allocation in pre- recent survey, about one in five Macedonians primary, primary, and secondary education considers the health system to be one of is low, and comparator countries have been the most important problems facing the able to achieve better learning outcomes economy—the highest share in the Western with similar or even lower levels of education Balkans. About 55 percent of the population spending (Figure 66). Education spending at is completely or mostly dissatisfied with the these levels is dominated by current spending, quality of health services.75 with few resources devoted to capital investment. Capital investments accounted Maternal and child health outcomes have for just 4.4 percent of total spending between improved, but immunization rates are low. 2018 and 2021, far below the average of 7 The number of deaths per 1,000 live births percent for regional peers. Moreover, salaries has steadily declined, and between 2015 and and other compensation represent about 75 2019 the neonatal mortality rate fell from 9.6 percent of total spending on pre-university to 3.9 deaths per 1,000 live births, the infant education, and this share rises to 80 percent mortality rate dropped from 11.4 to 5.3 deaths in primary education. Funding also varies per 1,000 live births, and under-five mortality dramatically across local governments, and plunged from 13.0 to 6.1 deaths per 1,000 live students in one part of the country may attend births. Additionally, the incidence of stunting a school that receives five times more funding in children has decreased significantly since than a school in another part of the country. 2010, falling to less than 5 percent in 2020, 74  Based on World Bank (2023e). 75  Balkan Barometer 2022. 58 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE the lowest rate in the Western Balkans. The the most trusted source of medical advice maternal mortality rate fell from 13 deaths per among the vaccinated. Messages highlighting 100,000 live births in 2000 to 7 in 2017, the the effectiveness of COVID-19 vaccines in latest year for which data are available. This protecting both vaccinated individuals and maternal mortality rate is the second lowest their families and friends were found to increase in the Western Balkans and the lowest among willingness to get vaccinated by almost 40 the other seven small transition economies of percent in North Macedonia, highlighting Eastern Europe (STEE7). Vaccines play a critical the potential impact of a tailored appeal to role in protecting public health and reducing specific concerns related to vaccines. poverty,76 but anti-vaccination movements and public mistrust pose significant threats to The growing challenge of managing NCDs the gains made in children’s health. Coverage underscores that the health system is not rates for most vaccines ranged from 92 to 98 adequately responding to the evolving needs percent in 2019, except for MCV1 and RCV1, of the population. The burden of NCDs is which dropped to 75 percent and had declined high and will continue to increase as the significantly since the early 2000s. population ages. By 2050, more than one in three Macedonians will be over the age of 60. North Macedonia’s low vaccination rate In 2019, NCDs accounted for 96.1 percent of increases the risk of a COVID-19 resurgence. all deaths in the country, with cardiovascular COVID-19 vaccination rates have stagnated diseases responsible for 61 percent, cancer at about 41 percent, the lowest rate in the for 20 percent, chronic respiratory diseases region after Bosnia and Herzegovina and for 5 percent, and diabetes for 5 percent.80,81 well below the EU average of 75 percent.77 Cerebrovascular diseases were the primary Among the unvaccinated, about 60 percent cause of diminished disability-adjusted life reported being unwilling to take a vaccine, years (DALYs) in 2019. NCDs also impose of which about 44 percent were concerned a considerable economic cost, as early about side effects (the highest in the region), retirement, disability, and premature death while approximately about 27 were unsure of reduce the number of productive years for the vaccine’s efficacy.78 A recent World Bank the average Macedonian. These costs are not survey found that Macedonians are more distributed equally across age groups. People likely to get vaccinated if they believe that between the ages of 20 and 49 account for vaccination is important to protect others, that 18 percent of total premature deaths due to their friends and family are getting vaccinated, NCDs but they represent about 48 percent of and that the government’s response has productive years lost (Figure 67). High blood been effective.79 According to the survey, pressure, tobacco use, and an unhealthy diet the most trusted source of health advice are the primary risk factors driving mortality among the unvaccinated is family members, and disability in North Macedonia. About while doctors, nurses, and pharmacists are 58 percent of the population is overweight, 76  A recent study assesses the health and household economic impact of distributing 10 different vaccines (measles, hepatitis B, human papillomavirus,  among others) in 41 low- and middle-income countries. The study finds that increasing access to these vaccines can prevent approximately 36 million deaths and about 24 million cases of medical impoverishment (Chang, et al. 2018). 77  Our World in Data. 78  Balkan Barometer 2022. 79  To support the vaccination in the Western Balkans, the World Bank conducted a survey during July–August 2021 in Kosovo, North Macedonia, and Serbia. Due to advertising targeting, only four regions (Polog, Skopje, Vardar, and Pelagonia) were included in the North Macedonia sample. Thus, the surveys are not nationally representative. 80  https://databank.worldbank.org/reports.aspx?source=2&series=SH.DTH.NCOM.ZS&country=MKD 81 https://www.euro.who.int/en/countries/north-macedonia/publications/primary-health-care-organization,- performance-and-quality-in-north-macedonia-2019  NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 59 Figure 67. In addition to their enormous Figure 68. North Macedonia has the world’s human cost, NCDs greatly reduce economic highest rate of cigarette consumption per capita productivity (Ranking of countries based on the number of cigarettes Figure 67life years lost to NCDs annually, 2017) (Productive Figure 68person per year: age ≥ 15, 2019) smoked per # of cigarettes per person per year 1.500 4.500 3.000 4.000 Yearly premature deaths 2.500 MKD Productive years lost 3.500 1.000 3.000 2.000 BiH 2.500 SRB 1.500 2.000 ALB 500 1.500 1.000 1.000 500 500 0 0 0 0 20 40 60 80 100 20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64 Ranking of countries Years of premature deaths from NCDs (per 100k) Productive year lost (rhs) Source: World Bank (2023e). Source: Authors calculation based on The Tobacco Atlas. and 24 percent is obese. Smoking is also (5.2 percent). Per capita public health a significant issue, with 35 percent of the spending in North Macedonia is also lower population smoking, and North Macedonia than in comparable countries (Figure 69). In has the world’s highest number of cigarettes 2019, OOP payments accounted for about 40 smoked per person per year at over 2,500 percent of current health spending, higher (Figure 68). Excise taxes are one of the most than the averages for the Western Balkans, effective ways to reduce tobacco consumption the STEE7, and the EU (Figure 70). Faced and have been shown to yield clear health with high costs and low quality of care, many and economic benefits.82 However, taxes on Macedonians forgo essential health services, tobacco are low in North Macedonia, and the resulting in a lack of timely treatment that country has the lowest cigarette prices in increases the burden of NCDs and heightens the region and when compared to the EU. In the risks posed by infectious diseases such as addition to tobacco use and unhealthy lifestyle, COVID-19. air pollution (PM2.5) imposes a considerable health burden in North Macedonia, where it Inefficient management of chronic diseases causes about 1,600 premature deaths each at the primary healthcare level has led to high year.83 rates of referrals and hospital admissions. The fragmented primary care network and the Public spending on health remains low and limited capacity of general practitioners and inefficient, contributing to a high level of out- other primary healthcare professionals have of-pocket (OOP) spending. Public spending increased referrals to secondary and tertiary on health has fallen from about 5 percent of facilities, resulting in high rates of avoidable GDP in 2003 to 4.8 percent in 2022, below the hospital admissions. Public spending averages for the EU (6 percent), the STEE7 (5 continues to focus on hospital care, with less percent), and the Western Balkan countries funding going to primary and preventive care. 82  Fuchs, Gonzales Icaza, and Paz (2019). 83  Fine inhalable particles with diameters 2.5 micrometers and smaller. 60 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 69. North Macedonia’s level of per Figure 70. …while OOP health expenditures capita public health spending is among the are relatively high and rising lowest in the region… (Out-of-pocket payments as a share of current spending on health, 2019) 69 spending per person in USD PPP, 2010–19) Figure health (Current Figure 70 5,000 45 4,500 current spending on health 40 EU28 OOPs as a percent of 4,000 35 3,500 30 USD PPP 3,000 STEE7 25 2,500 20 2,000 Western Balkans 15 1,500 1,000 10 MKD 500 5 0 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 MKD Western Balkans STEE7 EU28 Source: World Bank health nutrition and population Source: WHO Global Health Observatory Database, 2022. statistics, 2022. Note: The United Kingdom is included in EU averages Note: The United Kingdom is included in EU average through 2019; no data are available for Kosovo; 2018 is through 2019; Kosovo is not included in GHED. the latest available year for Albania. Inefficient service delivery, high referral rates, introduced for those age 65 and above; and underdeveloped prevention services an educational allowance was created; the contribute to the accumulation of arrears in coverage of the existing child allowance was the health sector. Arrears in the health sector extended; and the parental allowance program rose from 0.5 percent of GDP in 2016 to 0.66 was transformed into an income-tested percent in 2022. Large and mounting arrears program. In 2019, social assistance programs are a systemic challenge that threatens the reached more than one-third of households sustainability of health financing. in the poorest quintile, a higher rate than in many Western Balkan countries but still much Extensive reforms have strengthened lower than the 53 percent average for ECA, social protection, but coverage indicating that there is still scope to improve remains relatively low coverage among the less well-off. Means- tested and categorical-benefits programs In 2019, the government launched a are effectively targeted to lower-income comprehensive reform effort aimed at households, and over 90 percent of least- consolidating its fragmented and overlapping resource social assistance benefits go to social assistance programs.84 Prior to the households in the bottom 40 percent of the reforms, social assistance spending was income distribution, one of the highest rates relatively low, dispersed across multiple in ECA (Figure 71). programs, and skewed toward non-means- tested programs. The reform replaced Social assistance programs make a significant several programs with a single means-tested contribution to poverty reduction, particularly guaranteed minimum assistance (GMA) during times of crisis. The effectiveness of scheme designed to expand coverage and North Macedonia’s social assistance programs provide more adequate benefits. In parallel, has increased since 2019, and simulations a new means-tested social pension was indicate that the reforms have reduced the 84  Based on World Bank (2023e). NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 61 Figure 71. Most social assistance benefits are Figure 72. Social assistance programs can received by lower-income households help mitigate the impact of rising food and (Distribution of least-resource social assistance benefits, energy prices 2019) Figure 71 Figure 72 (Simulated effect of a food and energy price spike on the poverty rate) 100 25 23.1 Percentage of population 22.4 22.3 80 20 19.1 60 15 % 40 10 9.2 8.4 7.5 7.5 20 5 5.2 4.6 4.2 3.4 0 0 Q1 Q2 Q3 Q4 Q5 Preshock Postshock Doubling Doubling combined GMA and expanding coverage Quintile Poverty headcount Poverty gap Poverty gap sq. Source: World Bank staff estimates based on HBS 2019 Source: World Bank simulations based on 2019 data. consumption data from the HBS and income data from the SILC. Note: Poverty is based on the upper middle income class poverty line of $6.85/day in 2017 PPP. The figure simulates the change in the overall consumption surplus in response to the y-o-y food and energy price increases combined as of July 2022 and assumes an elasticity of -0.25. poverty rate by approximately 2.2 percentage risks and promoting well-being. In North points.85 Moreover, the GMA played a vital role Macedonia the importance of social services in the government’s response to the COVID-19 is poised to grow as the population ages. The pandemic, and the number of beneficiaries Ministry of Labor and Social Policy (MLSP) is rapidly increased to mitigate the impact of the now responsible for setting standards, quality crisis on household welfare. As climate change assurance, and financing, while municipalities intensifies, social assistance will become identify the types of social services to be increasingly crucial to respond to shocks. offered, which are then provided in partnership Simulation analysis reveals that government with nongovernmental organizations. The interventions can partially alleviate the impact MLSP has reformed licensing of organizations of higher food and energy prices on extremely and staff and expanded the menu of services. poor households. Increasing benefit amounts A case-management system has been and/or expanding the coverage of the GMA introduced that will help create an integrated could help offset the decline in income and assessment of needs and vulnerabilities, which consumption caused by a price shock (Figure will allow social workers to tailor the range 72). Because these measures are targeted of services and benefits provided based on to extremely poor households, they may individual and household needs. In parallel, significantly reduce the depth and severity individual employment plans are now being of poverty while having little effect on the used to improved coordination between poverty rate. Social Work Centers and Employment Centers to support the activation of social assistance The government has initiated a comprehensive beneficiaries. Early experience highlights the reform of social services. Social services are growing demand for social services for the critical to build human capital by mitigating elderly, specifically in-home care, as a large 85  Simulations were done using a $5.5/day poverty line in 2011 PPP. 62 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE share of grants to municipalities and service short-term fiscal risks but implicit liabilities providers for social services were requested stemming from aging population and decline in for home-based care for the elderly. However, working age population are growing. Without there is a need to improve access to these further reforms the number of pensioners services and strengthen coordination with the would surpass the number of contributors health system to help ensure that the service by 2053, while the pension deficit will remain provided to elderly people respond to their at 3 percent of GDP despite further erosion changing needs as they age. of pension adequacy to below 35 percent replacement rate. Although the pension system appears to effectively reduce poverty, its equity Reforms implemented by the Employment and coverage could be improved. North Service Agency (ESA) have contributed to Macedonia and Kosovo are the only Western stable employment growth in recent years. Balkan countries that have a multi-pillar Prior to 2020, total spending on labor- pension systems. The poverty rate among the market support equaled 0.4 percent of GDP, elderly was about 15 percent, just below the well below the averages for the EU28 (1.2 EU27 average (16 percent) in 2019.86 However, percent) and the STEE7 (0.6 percent). The elderly people living in poverty are less likely ESA provides a range of employment services to receive pensions, with coverage rates and active labor-market programs (ALMPs) ranging from 80 percent in the lowest income focused on individuals under age 29, the long- quintile to 98 percent in the top quintile. term unemployed, and GMA beneficiaries. The The government introduced a means-tested ESA offers training programs, wage subsidies, social assistance program for the elderly in internships, self-employment support, and 2019, which may boost coverage among the public works programs. While the coverage less well-off. Spending on pension benefits of ALMPs has steadily increased, with a focus amounted to 8 percent of GDP in 2022, low on wage subsidies and self-employment by the standards of comparable countries; yet support, the effectiveness of these programs the pension system generates a significant is uncertain. In 2018, the ESA introduced deficit. Total pension expenditures in 2022 the novel Youth Guarantee program, which (with second pillar transition cost and health provides all individuals between the ages of 15 contributions) stood at 9.9 percent of GDP, and 29 with an offer of employment, continued with contribution revenues at 6. percent of GDP education and training, or participation in an generating overall deficit of around 4 percent ALMP within four months of registering as a of GDP. The central government budget covers job seeker. In 2020, more than 25,000 young the deficit, consuming resources equivalent to people were registered in the program. Within what the country spends on education each four months, about 35 percent of participants year. Although reforms prior to 2019 set the were either employed or participating in an system on a sustainable path, the more recent ALMP. However, more evidence is needed policy actions, including ad-hoc increases in to assess the effectiveness of the Youth 2019, and introduction of a more generous Guarantee program. An activation strategy for pension indexation pattern in 2021 increased GMA beneficiaries has been developed jointly the medium and long run pension system’s with the EU, but the ESA has not received fiscal risks. Increased pension contribution an increase in funding or human resources rate in 2020 and 2021, and recent strong for several years. In fact, the number of ESA growth in contribution base cushioned the counsellors has steadily decreased, outpacing 86  Eurostat (2019). NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 63 the decline in the number of jobseekers. As a near-universal energy subsidy and reduced a result, the caseload ratio (the number of the VAT rate on electricity and food. registered jobseekers per counsellor) has risen, undermining the ESA’s effectiveness. Despite While the government’s crisis-response these challenges, the ESA has continued to measures supported growth, preserved jobs, expand its services, piloting and implementing and protected household welfare, they also the Youth Guarantee at the national level while increased fiscal sustainability risks as growth developing the GMA-beneficiary activation slowed and financing conditions tightened. strategy. Public and publicly guaranteed debt reached 59.6 percent of GDP in 2022, up 10 percentage CONFRONTING THE points from 2019 (Figure 73). Meanwhile, the CONSTRAINS FOR fiscal deficit averaged 6.4 percent of GDP SUSTAINABLE GROWTH during 2020-22, including the off-budget deficit of the state road enterprise. Further Fiscal space needs to be restored to fiscal risks stem from the price indexation safeguard resilience to future shocks of pensions and minimum wages, which influence wages in the public sector, as well North Macedonia’s strong track record of as the renewed accumulation of public-sector sound macroeconomic policies and financial- arrears and the high debt levels of state- sector stability has supported one of the owned enterprises (SOEs).87 North Macedonia world’s most inclusive economic expansions. has run higher fiscal deficits than its EU27 and Prior to 2020, the public debt stock remained WB6 peers, with a 10-year average deficit of moderate at less than 50 percent of GDP, 4.2 percent of GDP. while declining external imbalances kept the external debt stock, both public and private, at For a small, open economy with a pegged about 70 percent of GDP, with most external exchange-rate regime, fiscal policy is the debt being intercompany debt. Pre-pandemic primary instrument for managing the business macroeconomic policies built up adequate cycle. Consequently, creating and maintaining buffers to enable a countercyclical fiscal fiscal buffers is vital to respond to shocks. response, which mitigated the impact of the Signs of expenditure inefficiency in key areas, shock. While the economy fell into recession in including education, health, infrastructure, and 2020, contracting by 4.7 percent, it rebounded agricultural subsidies, suggest that the same by early 2022. The government provided output levels could be achieved at a lower fiscal subsidies to firms to protect jobs, keeping cost.88 For example, cross-country evidence employment relatively stable. In 2022, Russia’s indicates that North Macedonia’s current level invasion of Ukraine created a second shock, of public education spending could yield 11 which was magnified by North Macedonia’s learning-adjusted years of schooling instead heavy reliance on imported energy, the high of the current seven (Figure 74). In addition, energy-intensity of its growth model, and broad tax exemptions, compliance challenges, the fact that half of households reported and widespread informality weaken the tax being unable to cope with unexpected costs system, and there is scope to increase tax in 2021—the highest share in ECA. To shield revenue by improving collection efficiency, households from the impact of rising food and reducing the regressivity of the tax structure, energy prices, the government implemented and broadening the tax base. 87  At end-2022, the pension deficit stood at 3 percent of GDP (without the transitional cost), arrears at 3.2 percent of GDP, and guarantees to SOEs at 8.7 percent of GDP. 88  World Bank (2023e). 64 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 73. Rising indebtedness due to high Figure 74. Large room for efficiency primary deficits improvements of the education spending (Percent 73 Figure of GDP) (Data envelopment analysis) 70 0.0 14 SRB, 1.00 HRV, 0.90 -1.0 12 Percentage of population 60 -2.0 ALB, 0.84 50 -3.0 10 BGR, 0.89 % of GDP 40 -4.0 8 -5.0 30 6 -6.0 -7.0 4 MKD, 0.60 20 -8.0 10 2 -9.0 0 -10.0 0 3 4 5 6 7 8 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Domestic debt Foreign debt Guarantees Fiscal deficit (rhs) Spending: Public, 2010-20 Source: MOF, World Bank staff calculations. Source: WDI. Note: Data envelopment analysis is a methodology for identifying the efficient frontier of production possibility set. Using this efficient frontier, an efficiency score is derived for each spending area. It suggests that North Macedonia is 40% below the efficiency frontier. Economic growth has been highly particularly diesel, are major contributors to energy-intensive energy use in North Macedonia. Electricity and wood fuel are the main sources of energy North Macedonia’s energy-intensive economy consumed by households. Only Skopje has relies heavily on fossil fuels.89 The country’s an operational district heating system, which energy intensity is almost three times higher serves about one-quarter of households in the than the EU average. Coal and petroleum city. products accounted for more than 70 percent of the primary energy supply in 2021, and the North Macedonia’s transition to a cleaner electricity generation mix included coal (39 energy mix is still in its earliest stages. The percent), gas (29 percent), and hydropower country’s heavy reliance on coal and petroleum (26 percent).90 About 70 percent of North products creates significant environmental and Macedonia’s electricity is produced by the social externalities, including greenhouse-gas state-owned company Elektrani na Severna emissions and air pollution. While emissions Makedonija (ESM), which owns two large have decreased slightly in recent years as coal-fired thermal power plants at Bitola and natural gas has replaced a share of the coal Oslomej. In recent years, imported natural used for power generation, the energy mix gas has marginally offset the use of coal for remains highly emissions-intensive (Figure electricity production (Figure 75). Imports 76). Fuel combustion is responsible for 70 account for over half of energy consumption, percent of North Macedonia’s greenhouse-gas making North Macedonia one of the most emissions. Electricity production is the largest vulnerable countries in the region to energy source of emissions, accounting for about price hikes. The transport sector is the largest 40 percent, followed by transportation (20 consumer of energy, followed by households, percent), and waste management (11 percent). industry, commerce, the public sector, and The transport sector’s share in total emissions agriculture. Coal and petroleum products, doubled between 2007 and 2019, due to rising 89  Based on World Bank (2021a).  90  Our World in Data based on BP Statistical Review of World Energy (2022). NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 65 Figure 75. Electricity production is mainly Figure 76. The energy mix remains emission based on coal intensive Figure 75production by source) (Electricity Figure 76 (Share of greenhouse gas emissions by sector) 8 14 7 12 6 10 5 8 TWh 4 6 3 4 2 1 2 0 0 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 Coal Gas Oil Hydropower Waste Manufacturing and construction Wind Solar Bioenergy Transport Electricity and heat Other Source: Our World in Data based on BP Statistical Review Source: Our World in Data based on Climate Analysis of World Energy (2022). Indicators Tool (CAIT). rates of vehicle ownership, limited alternative particularly poor air-quality indicators. In 2016, transport modes, and the prevalence of the average PM2.5 concentrations in Tetovo older vehicles with few emissions controls. and Skopje reached six and four times the As economic growth further increases target level established in the WHO guidelines, demand for electricity and transportation, the respectively. Ambient air pollution from PM2.5 environmental costs of an emissions-intensive is one of the leading causes of illness and death energy mix are expected to rise. worldwide, as it elevates risks of lung cancer, chronic obstructive pulmonary disease, heart North Macedonia suffers from some of the disease, and stroke. Exposure to PM2.5 air highest rates of ambient air pollution in pollution causes an estimated 1,600 premature ECA.91 In a 2022 survey, about three out of deaths in North Macedonia each year. In 2016, four respondents described pollution as a the economic cost associated with increased serious or very serious problem, the highest mortality due to air pollution was estimated rate in the Western Balkans.92 Multiple factors at 5.2–8.5 percent of GDP, while the excess contribute to ambient air pollution, including health and medical costs amounted to another the use of coal, firewood, and other solid 7 percent of GDP. fuels for domestic heating and cooking, the country’s numerous coal-fired power plants, The residential sector is the main contributor weak pollution standards for the industrial to PM2.5 emissions, driven by traditional sector, and an aging and growing vehicle heating practices that rely on inefficient fleet. Air quality is especially poor during technologies and heavily polluting solid fuels. the winter, when particulate concentrations Poorer households are especially likely to burn in much of the country significantly exceed wood, coal, or other solid fuels for heat, and the global air quality guidelines established their willingness to endure the consequences by the World Health Organization (WHO). highlights both their sensitivity to fuel prices Major cities, such as Tetovo and Skopje, have and their limited access to more advanced 91  World Bank (2019). 92  Balkan Barometer (2022). 66 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 77. Macedonians tend to be less attuned to the benefits of upgrading their heating systems than do their regional peers 77to upgrade heating technology and attitudes towards sustainable heating) (Intentions Figure 100% Share of traditional heating 80% respondents 60% 40% 20% 0% Intend to Improves Could afford Reduces Improves Understand Know others upgrade home value to upgrade energy bills health the costs who have (<=2yrs) <5 yrs upgraded BiH KSV MKD SRB Source: World Bank (2022b). heating technologies. Efforts to promote the to encourage investments in cleaner, more use of cleaner, more sustainable, energy- efficient technologies. efficient heating systems must be informed by structural and behavioral factors— Climate-change adaptation including not only economic concerns but policies will be crucial to enhance also psychological and cultural attachments resilience, while decarbonization to traditional practices. A recent World Bank will be necessary to improve study93 found that among households that competitiveness and ensure used traditional heating sources, 40 percent sustainability were unwilling to upgrade their heating technology, while 21 percent were unsure North Macedonia is one of the most about whether to upgrade. Respondents in vulnerable countries in ECA to the adverse North Macedonia were less likely than their effects of climate change. The country is peers to recognize the benefits of upgrading highly exposed to floods, droughts, wildfires, their heating systems, and relatively few and extreme heat, as its aging and poorly intended to upgrade their systems within the managed infrastructure struggles to cope next two years (Figure 77). This reluctance with the intensifying effects of climate to upgrade seems to be driven mainly by change. The population is highly aware of affordability concerns, the perceived difficulty the adverse effects of climate change, with of the upgrading process, competing about 76 percent considering it a serious or household budget priorities, and low levels of very serious problem—the highest share in the trust in the institutions designed to support Western Balkans.94 The average temperature these transitions. Insights from behavioral is projected to increase by about 1.9°C by science suggest that pro-upgrading programs 2050 and by 3.8°C by 2100. North Macedonia should strive to influence the attitudes, faces a high risk of flooding, especially in beliefs, and preferences of the population Skopje. A 100-year flood would affect about 93  World Bank (2022b). 94  Balkan Barometer (2022). NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 67 Figure 78. North Macedonia is less resilient to climate change than the average EU country (Notre Dame Global Adaptation Initiative Climate Change Country Index) Figure 78 65 60 Albania ND-GAIN Index 55 Bosnia and Herzegovina North Macedonia Montenegro 50 Serbia Europe excl. WB6 45 40 1995 2000 2005 2010 2015 2020 Source: University of Notre Dame. Notre Dame Global Adaptation Initiative. 20 percent of the national economy, more experience more frequent and intense dry than in any other ECA country. Earthquake spells. Precipitation levels are projected to risk is also significant, particularly in the Polog drop by 5 percent by 2050 and 13 percent by area. A 250-year earthquake could affect more 2100, further straining the country’s limited than 40 percent of the country’s population water resources. North Macedonia receives and cause damages equal to as much as just 3,000 m3 of rainfall per capita per year, 50 percent of GDP.95 North Macedonia’s less than half the 7,000 m3 average for the resilience indicators96 have improved in recent Danube basin, and its water resources are years but remain well below the levels of unevenly distributed. The country’s water most European countries (Figure 78). Climate and wastewater-management infrastructure change, extreme weather events, and other are outdated, with most systems installed natural disasters can adversely affect health, more than 50 years ago. Agriculture, nutrition, learning, skills development, and hydropower, industry, and municipal users employment outcomes. These shocks have compete for access to the country’s limited especially negative implications for poor and water supply. Rising temperatures and longer marginalized groups, which tend to be more dry spells are likely to significantly increase exposed to their effects and have less capacity demand for irrigation, further intensifying to protect themselves from welfare losses.97 competition between agriculture and other Developing and implementing adaptation sectors. As droughts and floods become policies is vital to bolster resilience to natural more severe, rainfall becomes more erratic, disasters and mitigate the vulnerability of the and crops become more vulnerable to pests country and its population. and diseases, wheat yields could fall by as much as 21 percent between 2000 and 2025 Investing in climate-resilient infrastructure is and by 25 percent between 2040 and 2050, crucial to safeguard North Macedonia from while maize production could drop by 56 the effects of drought and ensure long-term percent and 86 percent over the same period water security. Due to climate change, the unless adequate adaptation measures are put eastern part of the country is expected to in place. 95  World Bank (2016). 96  Notre Dame Global Adaptation Initiative Climate Change Country Index. 97  World Bank (2022c). 68 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Figure 79. Reliance on exports from Figure 80. A large share of the workforce is emissions-intensive sectors remains high employed in high emissions “brown” jobs (Carbon-intensive exports as share of total exports in (Share of brown and jobs changing tasks (%)) terms of value (%)) Figure 80 70 20% 60 18% Jobs changing tasks 15% 50 13% 40 10% 30 North Macedonia 8% 20 5% 10 3% 0 0% 2010 2010 2010 2010 2010 0% 2% 4% 6% 8% 10% 2016 2019 2016 2019 2016 2019 2016 2019 2016 2019 2016 2019 2013 2013 2015 2013 2013 2013 Brown Jobs ALB BIH KOS MNE MKD SRB W. Europe NMS EU W. Balkans E. Eur. Turkey Georgia Central Asia Total Source: World Bank (2021). Source: Garrote-Sanchez and Makovec (2021). North Macedonia must also prioritize North Macedonia imposes a similar carbon- decarbonization to enhance its economic pricing policy on domestic producers.99 competitiveness and safeguard its energy security.98 With major global The low-carbon transition can pose markets tightening emissions standards, significant social and political challenges. a development model based on coal and The shift toward sustainable energy sources other fossil fuels is no longer economically can displace workers in high-emissions viable. The EU is a global leader in climate industries. To prevent an increase in structural action, and North Macedonia’s access to the unemployment, the authorities must address common market—and to financial assistance the mismatch between the skills of the existing from the EU—will hinge on its decarbonization workforce and the demands of employers in efforts. The European Commission’s proposed low-emissions industries.100 Consequently, EU Carbon Border Adjustment Mechanism climate-change mitigation requires sustained (CBAM) provides a concrete indication of investments in education, training, and the the costs that countries following a business- retraining of displaced workers. In North as-usual growth model may face. In the past Macedonia, up to 6 percent of workers may decade, North Macedonia has generated over be at risk of losing their jobs amid the low- 40 percent of its export revenue from carbon- carbon transition, among the largest shares intensive sectors, and its dependence on these in ECA (Figure 80).101 For older workers sectors has risen over the last three years nearing retirement age, the cost of investing (Figure 79). As the EU is an important trading in new skills may outweigh the benefits, partner for North Macedonia, the CBAM could causing an increase in early retirement that significantly affect the terms of trade unless could exacerbate the larger demographic 98  World Bank (2021b). 99  The Draft Law on Climate Action foresees the introduction of a carbon fee. 100  World Bank (2022c). 101  Garrote-Sanchez and Makovec (2021). NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 69 challenges facing North Macedonia.102 While the green transition is vital to avoid the worst climate-change scenarios, the government must adequately prepare workers to succeed in a changing labor market. 102  World Bank (2022c). 70 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE CHAPTER 4 PRIORITIES FOR FASTER, MORE INCLUSIVE, AND SUSTAINABLE GROWTH NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 71 The following section presents a set of policy Given the limited progress achieved in fulfilling priorities for reducing poverty and fostering the objectives outlined in the 2018 SCD, the shared prosperity in North Macedonia. This SCD identified priorities remain aligned with those Update has examined the numerous structural specified in this SCD update. Nevertheless, challenges facing North Macedonia, as well several changes have been introduced, as the adverse impact of Russia’s invasion of reflecting the country’s recent emerging Ukraine, escalating inflationary pressures, and challenges and opportunities. These changes the regional energy crisis. It also examined place greater emphasis on decarbonization the new opportunities related to the launch of and climate change adaptation. Firstly, in the the EU accession negotiations. Based on this 2018 SCD, decarbonization and adaptation analysis—as well as extensive consultations to climate change were treated as a single with the central and local governments, priority, whereas this SCD update presents civil society, academia, the private sector, them as three distinct priorities under a international partners, and guidance from separate HLO. Secondly, governance, fiscal the Country Management Unit—12 priorities prudence, and environmental sustainability, have been identified and organized into four which were previously grouped together High-Level Outcomes (HLOs). While the as one set of priorities in the first SCD, have HLOs and priority actions do not represent now been divided into two HLOs in this SCD an exhaustive list of worthwhile objectives, update. Moreover, the current prioritization they are intended to provide a focal point on process places increased importance on which the government can concentrate its mitigating the impact of political stability by constrained fiscal and institutional resources introducing an additional priority under the during this crucial period in the country’s third HLO focused on boosting productivity development. Moreover, HLOs are complex and facilitating the creation of well-paying and interconnected and, as a result, multiple jobs. priorities may be applicable to multiple HLOs. For instance, enhancing human capital Access to up-to-date and reliable statistics is formation (HLO 2) can simultaneously foster essential for achieving the proposed priorities. the generation of higher-paying employment Although the 2021 Census has successfully opportunities (HLO 3) and facilitate individuals addressed a significant knowledge gap in adapting to climate change (HLO 4).103 identified in the 2018 SCD—i.e., how many people are in North Macedonia—there are The prioritization process was conducted in still remaining knowledge gaps that need to two stages. First, the priorities of the 2018 SCD be filled—e.g., understanding the distribution were reviewed in the context of the updated of remittances in North Macedonia and analysis, and consultations were held with assessing the well-being of ethnic minorities. colleagues and experts within the World Bank Additionally, there are critical data gaps that Group to gather additional insights. Second, are crucial for informing evidence-based a series of in-person and online consultations policymaking. For example, obtaining more were organized in North Macedonia to recent household income data is necessary assess the relevance and importance of the to gain a better understanding of population prospective priorities and HLOs. Perspectives performance over time (Annex 1). and feedback were solicited from a variety of stakeholders, enriching the prioritization process. 103  World Bank (2022c). 72 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Table 1. HLO 1: More accountable service delivery to citizens Priorities Proposed specific measures Mitigate the impact of the political • Link strategic planning with budgeting. instability through establishment of • Improve public investment management medium- to long-term strategic and and align it with the national development spending priorities strategy. • Increase the accountability of the Secure rule of law and build professional judiciary and other public institutions. public institutions that are accountable to • Support the digital transformation of the citizens public sector to increase transparency. Ensure fiscal sustainability by reducing • Adopt medium-term fiscal consolidation fiscal risks, improving the efficiency measures. of spending, and enhancing revenue • Improve tax administration and mobilization modernize the Treasury system. HLO-I: MORE ACCOUNTABLE must link sectoral strategies with national SERVICE DELIVERY TO development goals and fiscal resources CITIZENS available to achieve them. A combination of skills development and systems improvement Weak governance and pervasive corruption will be necessary to enhance the strategic have long hindered North Macedonia’s planning and budgeting capacities of development. To sustain inclusive growth, the ministries, agencies, and municipalities. The government will need to strengthen the rule of integration of strategic plans into the budget- law, foster accountable public institutions, and preparation process should be coupled with ensure long-term fiscal sustainability. In this improvements in performance measurement. context, the first HLO focuses on improving Program budgeting therefore could be used the accountability of service delivery system to monitor progress if organized around for the citizens of North Macedonia (Table 1) substantive performance areas. highlighting three key priorities and proposing a range of policy actions. Strengthen public investment management and align with sectoral strategies and the Priority 1: Mitigate the impact of National Development Strategy. Currently, the political instability through there is no centralized body responsible for establishment of medium- to reviewing or approving all public infrastructure long-term strategic and spending projects regardless of their financing source. priorities As a result, the government tends to prioritize projects that have secured funding (i.e., from Link long-term strategic planning with donors) even if they are not the most urgent budgeting. Work on the National Development from a development perspective. Integrating Strategy is progressing and will provide a ICT planning and monitoring systems, foundation for the future allocation of EU grants operationalizing a central public investment to support long-term development and EU management unit, and linking development accession. To fully benefit from improvements plans and investment strategies would enable in the strategic planning process, policymakers more informed decision-making on public NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 73 investment priorities while also allowing Support the digital transformation of the for more effective project monitoring. In public sector to increase transparency. addition, public procurement should be Cross-government coordination and system used as a strategic tool to advance social, interoperability are necessary to enable environmental, and innovation objectives. the rollout of e-government systems. The Avoiding direct procurement and using the authorities should consider developing competitive practices can lead to important dedicated cloud infrastructure for the public budgetary savings while at the same time sector while also enhancing cybersecurity boosting level-playing field in accessing measures and recruiting and retaining government resources. the skilled ICT professionals required to implement such a strategy. Enabling the Priority 2: Secure rule of law and digital transformation of the public sector will build professional public institutions require improvements in data management, that are accountable to citizens the development of new online platforms and services, and updates to the relevant laws Strengthen the accountability of judiciary and regulations. Ensuring adequate access to and public institutions. To enhance the trust e-government services is also necessary for and accountability of the judiciary, the justice an inclusive digital transformation, and the system must make substantial progress in government should take steps to improve investigating, prosecuting, and adjudicating digital literacy among the public, with a corruption cases. Safeguarding the integrity particular focus on low-education and low- and independence of the judiciary will income groups, the elderly, and vulnerable require building the capacity of judges and households. prosecutors, and upgrading the automated court-case management information system Priority 3: Ensure fiscal sustainability to facilitate the automatic and random by reducing fiscal risks, improving distribution of cases. In parallel, expediting the the efficiency of spending, and passage of new laws on the organization and enhancing revenue mobilization operation of state administrative bodies, along with the revision of the Law on Administrative Adopt medium-term fiscal consolidation Servants and the Law on Public Service measures and reduce fiscal risks. To address Employees is a priority. These efforts should the fiscal deficit, the government has be accompanied by changes to the public committed in the Fiscal Strategy 2024-28 sector’s compensation system to ensure to implement a combination of revenue and merit-based recruitment, promotion, and expenditure reforms. The government has dismissal. Addressing instances of cronyism, adopted a Tax Reform Strategy to bolster the conflicts of interest, political influence, and revenue base by reducing tax exemptions, nepotism in public sector hiring practices increasing health-related excise taxes, and would help professionalize the civil service. expanding environmental taxation. On the Finally, ensuring the financial and institutional expenditure side, the authorities aim to lower independence of oversight institutions such operational costs while improving spending as the State Audit Office, the Fiscal Council, efficiency. However, the sustainability of the regulatory agencies, and the State Commission pension and healthcare systems must be for the Prevention of Corruption, will be reviewed in the context of demographic aging, essential to restore trust in public institutions and there is ample room to rationalize subsidies and the rule of law. and categorical social benefits. Revising 74 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE the subnational fiscal-transfer framework, business-process reengineering, integrated developing a market-based property valuation risk management, and systems modernization. system, and equipping local governments to Moreover, the mandatory use of electronic improve collection of property taxes are also invoices would increase VAT collection and key priorities. Finally, SOEs financial viability help combat tax evasion. On the Treasury would need to be assessed to adequately side, priorities include streamlining budget reduce fiscal exposures of the government. processes, implementing the new organic The fiscal consolidation strategy envisages a budget act, and developing a digitized very gradual consolidation, with the primary integrated financial management information balance reaching pre-pandemic levels only system (IFMIS). by 2027 and the public debt stock remaining above 60 percent of GDP. The measures would HLO 2. STRENGTHENED need to be frontloaded to create buffers and HUMAN CAPITAL FORMATION strengthen sustainability of public finances. AND CLOSING OPPORTUNITY To strengthen public financial management GAPS FOR ALL and ensure adherence to fiscal rules, fiscal prudence, and transparency, establishing an Human capital plays a vital role in the independent and professional Fiscal Council individual development of people and in the would be a priority. social and economic advancement of nations. Despite notable progress, North Macedonia’s Improve tax administration and modernize human capital remains underdeveloped. The the Treasury System. Corruption and political government must take steps to bolster the interference within tax administration are labor supply by providing inclusive, high- relatively minimal, and in the 2019 Enterprise quality education, protecting households Survey North Macedonia outperformed the against shocks, and addressing priority health averages both for the ECA and the rest of the challenges. The second HLO focuses on world on these indicators (with 3.7 percent of strengthening the formation of human capital firms expected to give gifts in meetings with and narrowing opportunity disparities for all tax officials compared with 6.5 percent in ECA (Table 2). and 11.8 globally). The Public Revenue Office and the Customs Administration continue to Priority 4: Endow people with quality improve online services for tax registration, and relevant skills throughout the life tax filing, and payments, reducing transaction cycle costs and mitigating the risk of discretionary treatment. Filing of customs declarations Increase the supply of integrated, affordable, electronically is mandatory and in 2020, high-quality early childhood education and 100 percent of customs declarations were care, especially among disadvantaged groups. filed electronically. Tax collection rates have Early childhood education and care is one of remained broadly stable, rising slightly from the highest-return investments in education, 27.1 percent of GDP in 2018 to 29.1 percent offering lifelong and intergenerational benefits in 2021. However, with informality high at 35 that can break the poverty cycle. By narrowing percent, further work efforts are needed to developmental gaps at a young age, early build the capacity of the large-taxpayer office, childhood education and care reduces learning enhance tax audits, improve the efficiency risks and makes consistent school attendance and effectiveness of revenue collection, more likely, increasing the chances of lifelong and strengthen tax administration through success in education. Active participation in NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 75 Table 2. HLO 2: Strengthened human capital formation and closing opportunity gaps for all Priorities Proposed specific measures Endow people with • Increase the supply of integrated, affordable, high-quality quality and relevant early childhood education and care, especially among skills throughout the life disadvantaged groups. cycle • Strengthen performance of the primary, secondary, and tertiary education sectors through financing reforms. Reduce disincentives • Develop a flexible vocational training system by aligning the and remove barriers curriculum with market needs. to labor market • Strengthen the activation programs for long-term participation, especially unemployed and social assistance beneficiaries.    for women and youth • Support digital skills development among all age groups. Improve efficiency and • Increase access to high-quality municipal infrastructure and access to quality public services. services for vulnerable • Provide adequate social assistance and social services to and in rural areas poor and vulnerable groups. • Improve efficiency of health spending, boost revenue, and expand the scope of primary healthcare level, the supply of outpatient healthcare, and the coverage of insurance. early childhood education programs is crucial and growing disparities. These challenges to enhance children’s readiness for primary are exacerbated by inadequate and non- school and improve their later academic transparent funding formulas across all performance. To prevent children falling educational levels, which worsen inefficiency behind, the government should prioritize and hinder attempts to restructure the efforts to raise pre-primary enrollment rates education system. While it is important to to the EU average. Specific attention should increase educational spending as a share of be devoted to initiatives that reach the most GDP, implementing measures to enhance vulnerable sections of society. The authorities spending efficiency is equally critical. Reform could also consider extending the education measures should focus on optimizing the allowance to cover enrollment in preschool primary and secondary education system and kindergarten. and reassessing financing formulas from pre- primary to higher education by incorporating Strengthen performance of the primary, performance criteria and ensuring alignment secondary, and tertiary education sectors with national priorities. Reallocating additional through financing reforms. Efficient fiscal resources to non-salary expenditures is educational investment can boost learning essential to improve educational outcomes. In outcomes and stimulate economic growth. a context of high emigration, the country may However, the school system is not aligned not fully reap the benefits of its investments in with demographic and enrollment trends, as human capital as better educated individuals a significant decrease in student numbers is may choose to leave the country in search of occurring simultaneously with an increase in better economic opportunities elsewhere. teachers and classes, leading to inefficiencies 76 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Priority 5: Reduce disincentives and a transparent monitoring and evaluation remove barriers to labor market framework, including a systematic graduate participation, especially for women tracing system, for all ALMPs. More funding and youth is needed, however, to increase the number of staff at ESA who engage with jobseekers Develop a flexible vocational training system and to update the available evidence on the that imparts relevant skills by aligning the effectiveness of the programs and adapt curriculum with market needs and improving accordingly. It is necessary to strengthen the quality of the training provided. To outreach and promotion of the ESA services build skills relevant to the job market, the and programs targeting lesser skilled government must encourage active employer unemployed, especially youths. The country involvement in the reform of vocational school could also consider expanding the ESA’s curriculums and general education, so-called client base to include the employed who are dual education. The quality of vocational at risk of redundancy or off-season workers. training can be enhanced by expanding the To overcome the obstacles that women face use of curriculum modules taught by industry when entering and re-entering the workforce, professionals and arranging visits from STEM it is essential to extend and enhance the education experts. Relaunching the STEP quality of early childcare and elderly-care survey and other skill-needs analyses could services accessible to families, particularly help the country better predict skills demand. in rural regions. Furthermore, it is crucial to Incentives for training provisions could assist women in transforming their caregiving motivate employers to provide more training. responsibilities into economic opportunities Efforts should also be made to streamline the by providing support and resources for tasks process for companies to engage with interns such as caring for the elderly, operating and work-based learners. The authorities daycare facilities for children, and undertaking should consider mandating internships for housekeeping duties. Effective labor market university students, expanding professional intermediation and employment programs orientation centers to all vocational schools, play a key role in fostering a more productive and establishing career service centers at workforce (including the self-employed), all universities. Implementing a systematic enhance employment outcomes, and fuel approach to tracking university graduates, faster and more inclusive growth. including collecting data on their job placements, working conditions, and wages, Support digital skills development among all would be an essential component of an age groups. The authorities should enhance effective professional development strategy. market competition in the ICT sector, enhance Sharing these data with prospective and the independence of regulatory bodies, and current students could provide crucial insights implement public-sector programs supporting and help inform their career decisions. broadband expansion in non-commercial areas. Bridging the supply-demand gap for Strengthen the activation programs for digital skills and closing the gender gap in ICT long-term unemployed and social assistance sector are also essential. Digital technology beneficiaries, and expand care services. can help build a more resilient and efficient With the current available resources education system, and investments in directed to ESA, the focus should be on infrastructure and human capital should be expanding effective employment services made in preparation for future crises. Key and programs, by, among others, introducing areas include expanding internet access NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 77 in schools, providing portable computers is limited, asset-management practices are to students, improving the digital skills of outdated and reliant on expert knowledge, teachers and students, and strengthening the financing is inadequate and used inefficiently, capacity of educational institutions to design resilience and safety considerations are not and implement digital pedagogy, both online adequately addressed, and urban mobility and in person. is rarely considered in a holistic manner. The institutional frameworks for disaster Priority 6: Improve efficiency and prevention, preparedness, and response are access to quality public services for inefficient both at the national and sub-national vulnerable and in rural areas levels, and there is an increasing financing gap associated with disaster response and Increase access to high-quality municipal recovery. As costs escalate and government infrastructure and services including explicit and implicit liabilities increase due to transportation, clean water and sanitation, the limited adoption of disaster insurance, and disaster-risk management. Addressing the addressing this challenge will become urban-rural divide and closing the infrastructure increasingly urgent. gap will require substantial investments in local infrastructure, holistic approaches, Provide adequate social assistance and well-synchronized spatial planning, and social services to poor and vulnerable guarantees that such investments are groups, including children, women, the financially, environmentally, and economically disabled, the elderly, and victims of violence. sustainable. These investments should A comprehensive assessment of the 2019 be anchored by improved fiscal planning reform effort is vital to further enhance the and management, a refined prioritization current social assistance system. Policymakers process, and sufficient managerial capacity should examine the possibility of broadening for operations and maintenance of acquired the Guaranteed Minimum Assistance assets. Investments in water infrastructure program to cover more individuals from must be accelerated, as wastewater treatment the bottom income quintile. To strengthen is currently accessible to only 13 percent of social services, the government should the population, and further improvements in continue to implement ongoing reforms to storm-water collection and water treatment service delivery, financing, licensing, and plants are necessary to ensure water security. monitoring and evaluation. Leveraging the Enhancing coordination between central case-management system will help facilitate agencies and local governments will be integrated needs assessment, and the new critical. New legislation that clarifies waste- integrated management information system management responsibilities and ownership can be used for seamless data exchange and rights would benefit the highly inefficient solid- referrals with other services and benefits. waste management system and encourage Capacity development at the local level should private-sector participation. The government be encouraged, and the availability of long- has initiated a comprehensive program for term care for the elderly should be expanded, rethinking the approach to reform local road possibly through increased private service management and public transportation, from provision. Finally, it is critical to evaluate the institutional and financial to technical and coverage both of contributory and social urban development perspective with the goal pensions and adopt policies to ensure fiscal to increase livability and improve access to sustainability and improve future pension jobs and services. However, local capacity adequacy and coverage. Potential strategies 78 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE might include raising the retirement age, HLO 3. INDUCED CREATION encouraging part-time work for retirees, OF BETTER PAID JOBS establishing sustainable indexation patterns, and increasing the contribution rates for Enhancing productivity is vital to stimulate pension schemes. growth and increase the supply of high- paying employment opportunities. However, Improve the efficiency of health spending, North Macedonia’s current productivity boost revenue, and expand the scope of indicators are weak and declining. To address primary healthcare level, the supply of this challenge, HLO 3 focuses on priorities outpatient healthcare, and the coverage for boosting productivity and spurring the of insurance. Out-of-pocket payments and creation of well-paying jobs (Table 3). informal fees represent a significant share of healthcare costs, indicating a need to increase Priority 7: Close the gaps in public healthcare funding. Implementing transport, energy, and other specific taxes on products with negative connectivity infrastructure for health effects, such as tobacco, alcohol, international and intranational and sugar-sweetened beverages, could connectivity supplement public health financing. Reducing the system’s reliance on out-of-pocket Increase investments in and efficiency of payments and addressing unmet healthcare transport infrastructure (including mobilizing needs could help reduce disparities across private financing when appropriate) at regions and income groups. Strengthening national and subnational levels. Given the multisectoral collaboration is critical to fiscal challenges faced by North Macedonia, effectively manage significant risk factors, a prudent approach to managing road assets particularly for NCDs. The government could and investments is vital to macroeconomic pass legislation to regulate exposure to stability. In the transportation sector, NCD risk factors and implement behavioral- the authorities must address the existing change policies to reduce the incidence of maintenance and rehabilitation backlog NCDs. To enhance access to equitable and both on the road and railway networks, cost-effective care, the delivery of health including networks within and beyond the services should be reoriented to be more TEN-T corridors. The most effective way patient-centered and less fragmented. The of bringing benefits to transport users is to authorities should modernize the hospital ensure competition in the supply of transport sector by developing a health-facility master services, thus incentivizing efficiency and plan that aligns with the population’s health quality among operators. To this end, public- needs, integrate primary healthcare services service operation contracts should incorporate more effectively, and ensure an equitable clearly defined and measurable performance distribution of healthcare professionals across indicators. The use of risk mitigations solutions regions. Improving the availability of health- for infrastructure financing to mobilize private sector data and analytical work will be vital to sector investments might be considered. support informed decision-making by enabling The efficient flow of goods and people can policymakers to monitor the health system’s be significantly improved through physical performance, identify areas for improvement, enhancements and upgrades to major and design interventions tailored to the needs systems and ICT infrastructure. However, of the population. improvements made to the road network to date have not yet resulted in equivalent NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 79 Table 3. HLO 3: Induced creation of better paid jobs Priorities Proposed specific measures Close the gaps in • Increase investments in and efficiency of transport transport, energy, and infrastructure (including mobilizing private financing when other connectivity appropriate). infrastructure • Invest in the transmission grid to connect renewable energy for international capacity and adapt energy system to work with generation and intranational variability. connectivity Increase financial • Strengthen financial intermediation and greening the intermediation and financial sector. inclusion • Improve financial inclusion for individuals and SMEs, and expanding government payments digitalization. Improve the • Improve the state aid policy, including in agriculture, towards competitive horizontal instruments. environment and foster • Streamline barriers for business entry and conduct. innovation • Further extend the coverage of free trade agreements and enable exports of services. efficiency gains at border points. Customs to grapple with air pollution, particularly in and border-management practices remain large urban areas like Skopje, primarily due burdensome, and the harmonization and to the use of solid fuels such as firewood digitalization of procedures have been slow. and coal for heating. Establishing a day- Implementing the National Single Window ahead electricity market is a key priority for over the next two years is expected to mitigate the energy sector. EU regulations designed these issues, and the government should to ensure the integrity and transparency of prioritize the establishment of additional the wholesale energy market have yet to be joint border-control posts to expedite cargo transposed to the domestic legal framework clearance, including goods destined for the and will require an amendment to the EU. These efforts should be integrated with Energy Law. Furthermore, the transposition the provision of more competitive logistics and implementation of the EU Acquis on services and improvements to logistical and renewable energy must be accelerated, connectivity-related infrastructure. along with the adoption of bylaws for implementing the Law on Energy Efficiency. Invest in the transmission grid to enable the Government efforts to enhance access to connecting renewable energy capacity and capital for renewable energy projects should adapt energy system to work with generation include support from developing lending variability. North Macedonia is poised for a facilities (to meet different scales and major energy transition, as its lignite reserves technological requirements). Concurrently, are projected to be depleted in the next 10-15 policies and standards for environmental years. Recognizing this, the government has protection must be strengthened to mitigate made a bold decision to replace lignite-based the environmental disruption associated with generating capacity with new gas-fired power new renewable energy production, including generation. However, the country continues small-scale hydropower, wind, and solar. 80 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Priority 8: Increase financial usage and leveraging the potential of digital intermediation and inclusion financial services. Key initiatives should focus on digitizing person-to-government (P2G) Strengthen financial intermediation through and government-to-person (G2P) payments; implementing cross-sectoral financial incentivize the shift away from cash; improving literacy actions and greening the financial rural payments infrastructure to encourage sector. Enhancing access to finance for electronic payment acceptance among MSMEs will require diversifying the available merchants; fostering the adoption of financial financial instruments and market players technology and broader sectoral innovation; while strengthening financial infrastructure. and identifying and addressing constraints to The Development Bank will play a key role in digital payments through the development alleviating these constraints. Encouraging the of a retail/digital payment strategy. The use of factoring, leasing, and other financial successful implementation of these measures instruments that are particularly beneficial could substantially reduce financial inclusion to MSMEs would be useful. A comprehensive gaps and promote economic growth. assessment of the legal, regulatory, tax, and market-infrastructure issues affecting the Priority 9: Improve the competitive development of the capital markets could environment and foster innovation serve to identify bottlenecks and areas for improvement. Capacity-building initiatives Improve the state aid policy, including in would benefit numerous stakeholders across agriculture, towards horizontal instruments capital markets. Public support instruments to support exports, technology adoption, such as credit guarantee programs for MSMEs technology transfers, digitalization, and or green-finance funds should be considered, green transition. To ensure a level-playing as these measures would aim to maximize the field, an inventory of State aid, including de efficiency of public resources, including those minimis aid, should be established under the allocated through the Development Bank, in authority of the Commission for the Protection addressing market failures. of Competition. This inventory would lay the groundwork for reorienting state aid towards Improve financial inclusion for individuals horizontal support measures. State aid policies and SMEs through diversifying financing should be designed to incentivize firms to instruments and expanding government digitize and go green, enhance their innovation payments digitalization.  Coordinated capabilities, and strengthen managerial skills, measures are crucial to address gaps in which are all crucial elements of the transition financial inclusion. These measures could towards Industry 4.0. Encouraging linkages include designating a lead institution for between foreign firms and local suppliers financial inclusion with a clear mandate, could spur corporate expansion, innovation, developing a comprehensive approach to and skills enhancement, particularly in sectors financial literacy for individuals and MSMEs, like ICT and automotive manufacturing, and deploying a coordinated strategy to which already boast a significant number of support capital-market development as part highly productive companies. In addition, of the sustainable finance agenda. Access augmenting financial support for research to finance for individuals can be increased and innovation could improve the quality of by promoting further account ownership innovative outputs. It is critical to improve the (currently 85 percent of adults have an predictability of support for the research and account, but only 53 percent owns a debit innovation sector and to bolster governance, card, and 22 percent owns a credit card) and coordination, and institutional capacity among NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 81 R&I policymakers and other stakeholders. private firms to compete on a level playing Assessing the functioning of the regulatory field, (ii) barriers to entry in network sectors, impact assessment system could identify and (iii) undue restrictions on regulated potential weaknesses in existing regulations professions. The government must synchronize and enforcement capacity while informing a its policy efforts to cultivate a competitive more robust public-private dialogue. Further, business environment and to encourage open to facilitate the green transition of the agri- markets. To expedite corporate restructuring, food sector agricultural policy support legislative amendments are necessary to should shift toward productivity-enhancing expedite distress management and improve innovations and promotion of sustainable the rules for out-of-court settlements. practices, which also decrease negative The government should also enhance the environmental impacts. Public support such institutional framework for insolvency as targeted investment aids, advisory services, practitioners, resolve their incompatibility with training, and agriculture infrastructure would other professions, and establish an efficient enhance the economic and environmental mechanism for licensing and monitoring sustainability. For example, innovations such of their performance. Finally, to mobilize as the development of precision farming private financing, enactment of Public-Private and broadband coverage would contribute Partnership Law, and an improvement of the to reduced pesticide and fertilizer use and concession law is needed. potentially reduce variable production costs. Cooperation among scientific and educational Further extend the coverage of free trade bodies, extension and training services, and agreements and enable exports of services. producers and processors should facilitate For North Macedonia to maximize the benefits a transfer of innovative and environmentally of deep RTAs, the government should: (i) friendly technology and farming methods, undertake a comprehensive review and which at the same time, would improve assessment of the impact of deep RTAs, (ii) economic performance and competitiveness expand existing RTAs and extending the of the agri-food sector. range of RTAs to facilitate new market access opportunities, (iii) implement horizontal Streamline barriers for entry and conduct in domestic support policies to enable firms of network services, trade, as well as professional varying sizes and sectors to expand exports services. Although there have been some of sophisticated, complex manufacturing improvements in allocative efficiency among exports, and to a lesser extent to services, and firms, greater emphasis must be placed on (iv) explore new trade opportunities in the facilitating the swift exit of insolvent firms, agricultural and services sectors. The ongoing simplifying market entry, and eliminating surge in global food prices spurred by Russia’s conduct barriers to foster increased market invasion of Ukraine is driving up demand for competition. Special attention should be agricultural products, including staple foods. given to the services sector, as it confronts North Macedonia has significant untapped unique challenges due to anti-competitive agricultural potential that could be harnessed distortions and burdensome administrative by boosting productivity in the sector and procedures that hinder the expansion of highly utilizing RTAs to access foreign markets. productive firms. The country’s OECD-WBG In the services sector, the ICT industry has Product Market Regulation (PMR) assessment especially significant growth potential and highlights several obstacles to competition, can create sustainable, well-paying jobs. ICT including: (i) the failure to enforce the principle has also proven highly resilient to global crises of competitive neutrality between SOEs and such as the COVID-19 pandemic. However, 82 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE the development of the services sector, in Priority 10: Accelerate particular ICT sector, also requires a skilled decarbonization and ensure energy labor force and should be supported by policy security reforms aimed at enhancing workforce skills. Accelerate the transition to renewable HLO 4. STRENGTHENED energy sources, support to decarbonize HOUSEHOLD RESILIENCE the transition to cleaner, more efficient TO CLIMATE CHANGE household economy, increase energy sources AND LOWERED CARBON to reduce air pollution,security and increase INTENSITY AND AIR affordability. North Macedonia possesses POLLUTION advantageous solar resources, substantial wind capacity, and a robust electricity Climate change adaptation will be essential in infrastructure. According to the International bolstering resilience to environmental shocks Renewable Energy Agency (IRENA), the and, as the world’s shift towards low-carbon country has the technical potential to generate growth intensifies, decarbonization will play over 8GW of renewable electricity, of which an increasingly pivotal role in maintaining roughly 2GW could be cost-competitive. international competitiveness. HLO 4 Renewable resources in North Macedonia are encompasses policy measures designed poised to play a significant role in offsetting to strengthen household-level resilience to the potential losses from the decommissioning climate change, promote the adoption of low- of existing power plants. The country’s carbon technologies, and reduce air pollution abundant hydroelectric resources, combined (Table 4). with increased natural gas access and the Table 4. HLO 4: Strengthened household resilience to climate change and lowered carbon intensity and air pollution Priorities Proposed specific measures Accelerate • Accelerate the transition to renewable energy sources, increase decarbonization energy security and energy affordability. and ensure energy • Support the transition to cleaner, more efficient household security energy sources. • Incentivize the shift to sustainable transportation. Scale up adaptation • Integrate disaster and climate resilience into sectoral legislation, to climate change strategies, and action plans. and improve • Accelerate investments in water infrastructure and create a new preparedness, mechanism to finance the water sector. response and recovery from natural disasters Improve public and • Develop an adaptive social protection system. private financial • Expand the availability of insurance and other risk-mitigation resilience to natural systems. disasters • Enhance the financial sector’s readiness to support climate- change adaptation and mitigation. NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 83 potential for battery storage, could facilitate to consider design and implementation the expansion of intermittent renewable modifications which will make the safety net power. The detrimental effects of air pollution and the energy safety net more adaptive with alone account for approximately 6.9 percent respect to their ability to identify energy poor of GDP and result in thousands of premature and vulnerable and respond to their needs. deaths annually (about 3,200 in 2015). This is An adaptive energy subsidy program has the primarily attributed to the use of solid fuels potential to foster resilience among energy- for heating purposes in large urban areas, as poor and vulnerable households, proactively well as the lignite’s dominance in the energy addressing their requirements in anticipation supply. One of the primary sources of air of energy price shocks. pollution in North Macedonia is the residential use of wood for heating. As a significant Promote circular economy and reduce air portion of wood is traded informally, non- pollution. The circular economy aims to fiscal measures are necessary to address air minimize waste generation and foster the pollution and help low-income households reuse, recycling, and recovery of materials. transition to superior heating alternatives. In line with the European Green Deal, the Addressing barriers beyond affordability European Commission introduced the new is crucial to ensure that support programs circular economy action plan in March 2020. are well-designed and implemented to drive As a candidate country, North Macedonia meaningful changes in behavior. Employing must align with and adhere to European insights from behavioral science can enhance standards. Given the waste sector’s increasing the uptake of support programs. For instance, contribution to emissions and its vital role the social recognition of early adopters, the in transitioning to a circular economy, it is dissemination of information through advisors crucial to explore additional measures for and installers, and the screening of videos that emission reduction. For instance, methane, summarize the experiences of early adopters the primary greenhouse gas emitted during can promote behavioral change and encourage waste decomposition, poses a significant participation in these programs. Evidence environmental concern. However, international shows that energy poverty and consumption experience demonstrates that capturing poverty do not always align. There is currently methane from wastewater treatment plants no official national definition of energy poverty. and landfills can be done at a low cost. Once The financial protection of vulnerable energy captured, methane can be utilized to generate consumers is regulated by two laws within the electricity, which offers the potential for social welfare legislative framework: the 2019 income while simultaneously providing a Law on Social Protection and the 2019 Law valuable domestic energy source. Embracing on Social Security of the Elderly. These laws these types of practices will enable North establish criteria for determining eligibility for Macedonia to make substantial progress the Guaranteed Minimum Assistance program towards circular economy goals. and social pension among poor households and households with elderly individuals Incentivize the shift to sustainable living in poverty, respectively. In addition, transportation. The variety of challenges these categories of households are eligible facing the transportation sector requires to receive subsidies for their energy bills. a comprehensive approach. One strategy However, the coverage of these programs the country should consider is encouraging is limited, and there is a pressing need for a the adoption of lower emission modes of more comprehensive official definition of transport to facilitate this shift and preparing energy poverty. Furthermore, it is essential the transition to e-mobility, such as the 84 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE introduction of low emission buses. Accurate information systems are underdeveloped and vehicle emissions testing, the establishment do not meet national needs, rated at maturity of standards reflecting true environmental level 2.4 out of a possible 5 based on a globally impact, and rigorous enforcement of these standardized assessment tool. Upgrades to standards are critical steps to curb vehicle early warning systems, shelters, community pollution. The authorities can improve the engagement and fire equipment are urgent emissions performance of the vehicle fleet given the increase in extreme heat and fires. through improved regulation of vehicles and Policymakers should increase the budget of fuels augmented by market mechanisms and the Hydrometeorological Service, strengthen adjustments to the tax code. These measures its autonomy, and expand its mandate. Gender would not only establish unambiguous market dynamics impact various aspects of resilience, signals to promote the adoption of eco-friendly including preparedness, coping mechanisms, vehicles, but also generate additional revenue and recovery access. By conducting thorough for investment in sustainable transportation impact evaluations and promoting female initiatives. Moreover, these actions would representation in disaster management hasten alignment with the EU Acquis, and agencies, women’s contributions to risk would lead to reduced air pollution. reduction and resilience can be acknowledged and supported effectively. Priority 11: Scale up adaptation to climate change and improve Accelerate investments in water infrastructure preparedness, response, and and create a new mechanism to finance recovery from natural disasters the water sector. Achieving comprehensive water security will require well-resourced Integrate disaster and climate resilience into and adequately staffed national and local sectoral legislation, strategies, and action institutions, as well as a clear policy and plans. Increasing the disaster- and climate- legislative framework. The water-related resilient building stock and investing in critical functions currently scattered across seven emergency-response infrastructure are urgent different ministries should be consolidated priorities. Land use and urbanization planning under unified agency, government must also integrate disaster and climate department, and ministry at the national level. resilience. Investments can be targeted Likewise, water-service provision must be to maximize cost-effectiveness, address rationalized, as North Macedonia currently has multiple hazards, and leverage co-benefits 77 public water utilities. The authorities must for sustainability, inclusivity, and public also reassess the adequacy of water tariffs wellbeing. In a context of more frequent and and prioritize investments in reducing non- intense disasters, adequate surge capacity revenue water (currently over 70 percent) is critical to save lives, preserve livelihoods, to minimize the water sector’s budgetary and protect economic assets. Supporting impact. Policymakers must identify, plan, key public institutions and the private sector design, finance, and implement priority water can improve contingency and emergency resource investments that advance national business-continuity planning, bolstering development objectives, particularly in water- preparedness against multiple risks. The dependent sectors, while ensuring long-term government must ensure that it possesses resilience. The government must develop a adequate surge capacity for emergency National Water Master Plan aligned with the response, healthcare, and social services. European Union Water Framework Directive. North Macedonia’s weather forecasting, water The Master Plan should encompass areas and climate monitoring, early warning, and such as food security, energy security, water NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 85 supply and sanitation, urban and rural flood coverage for natural disasters, helping protection, international transboundary countries mitigate the financial impact of issues, ecosystem services, and low-carbon catastrophic events. As one of the most growth. The plan should also account for vulnerable countries in ECA, North Macedonia land-use changes, urbanization, the effects of is particularly exposed to the adverse effects climate change, and demand for water in the of climate change, and its aging infrastructure agricultural sector. compounds disaster losses. In this context, the authorities should continue to deepen the Priority 12: Improve public and insurance market and expand the access of private financial resilience to natural homeowners, farmers, firms, and government disasters agencies to affordable insurance. Develop an adaptive social protection Enhance the financial sector’s readiness system. Transitioning the economy away from to support climate change adaptation and emissions-intensive industries and fostering mitigation. A clear funding gap is evident the growth of new, environmentally friendly in many disaster scenarios, highlighting the sectors will spur changes in the demand for importance of adopting a disaster-finance workforce skills. To mitigate adverse effects strategy based on predictable, rapid, and on sectors or regions that may have difficulty flexible financing instruments (e.g., contingent transitioning to a lower-carbon economy, a lines of credit or insurance). “Green finance” variety of policies can be contemplated. These instruments can promote climate-change include providing support for early retirement, mitigation and enhance climate resilience. The implementing retraining programs, and government can support the development of facilitating economic development initiatives. green finance instruments by: (i) enhancing Social assistance programs have proven to prudential measures to maintain the quality of be a vital component of the government’s financial-sector portfolios that may be subject response to the COVID-19 pandemic and, to direct or indirect climate shocks, and (ii) given the escalating frequency of climate enabling households, firms, and public agencies change-related shocks and other global to access financial instruments that support trends, social assistance programs will climate adaptation and mitigation. Increasing continue to play a crucial role in addressing awareness of climate and environmental risks crises. Integrating flexibility into the system is and managing these risks through (i) enhanced important to effectively respond to a diverse financial supervision, and (ii) the introduction range of shocks. Social protection is an of green taxonomy can play a key role in increasingly important policy for addressing changing financial behavior and mobilizing disaster vulnerability and can be carefully used capital to support the green transition. Finally, to mitigate gender-differentiated disaster there is the potential to crowd in local financial impacts. institutions and institutional investors (pension funds, insurance companies) to finance Expand the availability of insurance and other climate-resilient infrastructure and adaptation risk-mitigation systems. North Macedonia and projects with adequate risk identification and the wider region face significant vulnerability mitigation. Authorities could also consider to climate change and natural disasters. To local currency financing (Denar financing), address these risks, the Southeast Europe particularly from local institutions, to be Catastrophe Risk Insurance Facility (SEE mobilized to finance such investments. CRIF) was established to provide insurance 86 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE ANNEX 1: BOXES Box 1. Potential output before and after COVID-19 The COVID-19 global pandemic resulted in a decline of both the supply and the demand side of the economy. In 2020, measures to contain the spread of the virus prevented production factors to be fully utilized. Total factor productivity evidenced the steepest drop in more than two decades, while business bankruptcies lowered investment and employment, and school closures and rising healthcare needs eroded the country’s human capital. Even before the outbreak of the pandemic, potential output growth slowed and was already on a downward track, but estimates suggest that the pandemic pushed the level of potential output further down, scarring the economy for years to come (Figure 81). 81. Potential output trajectories before and after COVID-19 Figure 81 Figure 650000 600000 550000 500000 450000 400000 350000 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Pre-pandemic trajectory Post-pandemic trajectory Actual GDP Source: Authors’ calculations based on data from national authorities. NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 87 Box 2. Using satellite data to assess spatial economic activity In recent years, the proliferation of information-sensing devices such as mobile phones, remote sensing technology, software logs, cameras, microphones, RFID readers, and wireless sensor networks has generated a vast amount of new data, known as big data. This data provides an unprecedented level of detailed, real-time information, and governments are just beginning to tap into its potential. The World Bank is also using satellite or Earth observation data more frequently to measure spatial growth and economic activity. Satellite data, especially when combined with traditional survey data, can provide accurate, up-to-date, and cost-effective measurements to inform policy decisions. The SCD team in North Macedonia conducted an analysis using satellite data to examine patterns of urbanization, economic activity, and land use. The results demonstrate the feasibility of using satellite remote sensing data to estimate and track trends in the number of firms operating in the country and the level of economic activity. For instance, we found strong and positive correlations between the reported number of firms in North Macedonia between 2014-20 and the intensity of night-light measurements and urbanization patterns. The total number of firms increased from 59,162 in 2014 to 61,077 in 2020, with the Skopje region accounting for only 43 percent of that growth. During the same period, the sum of light indicators increased from 82,139 to 103,939, and the average light value per pixel increased from 0.61 per pixel to 0.78 per pixel, with the Skopje region accounting for 28 percent of that growth, which suggests a very modest correlation of new firm entry and the regional development. Figure 82. A modest correlation can be observed between firm-level and light information from satellite pictures (Number of firms 2014-20) (Sum of lights 2014-20) Source: Authors’ calculations based on VIIRS DNB satellite pictures and data from the Central Registry. 88 NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE Box 3. Data and knowledge gaps Poverty methodology: This report uses the World Bank’s international poverty rates, which employ the “dollar a day” methodology. This approach is designed to capture the minimum threshold of living standards as defined by the world’s poorest countries. It considers variations in price levels within and across countries, aiming to provide a consistent measure of poverty across different time periods and geographical locations. The international poverty rate represents the headcount of individuals living below this international threshold in a particular country. It is converted into local currencies and adjusted for temporal and spatial price differences. This rate differs from the national poverty line in North Macedonia, which is set at 60 percent of the equivalized median disposable income after social transfers. The national relative poverty rates are not necessarily indicative of absolute trends in welfare over time, as opposed to the international poverty lines. The poverty data presented in this report are expressed in 2017 Purchasing Power Parity (PPP) prices. The global poverty lines specified are $2.15, $3.65, and $6.85 per day, representing the typical national poverty lines of low-income, lower-middle-income, and upper-middle-income countries in 2017 (see pip.worldbank.org for further details). To measure poverty, this report uses the EU Survey of Income and Living Conditions (EU-SILC). In terms of data quality for monitoring welfare, the State Statistical Office (SSO) collects household surveys and generates reports with reasonable frequency. However, it is worth noting that the most recent poverty estimates provided in this report correspond to the calendar year 2020, which captures incomes from 2019. To obtain more up-to-date socioeconomic information, it is recommended that the SSO expedites its data collection processes. Additionally, concerns arise regarding the representativeness of the data due to the use of an outdated sampling frame based on the 2002 Population Census. To address this issue, the SSO has recently conducted a population census in 2021, and it is advisable for the SSO to update the sampling frame accordingly to accurately reflect changes in the population. Poverty maps, ethnic minorities, and remittances: The 2021 Population Census has been instrumental in filling a significant knowledge gap highlighted in the 2018 SCD: determining the population of North Macedonia. However, there are other knowledge gaps that remain unresolved in the present context. For instance, the well-being of ethnic minorities and the situation of remittances are areas where substantial information is still lacking. Resolving these data and knowledge gaps is key in facilitating evidence-based policymaking. Migration and the role of diaspora: As emphasized in the report the pull factors of emigration— higher wages in advanced European economies—are causing the demographic erosion that leads to a further decline in potential growth. While the discourse in the narrative highlights the negative aspects of emigration, the emigration also alleviates some pressures in the local labor market and overall society, and it may even create incentives for building skills that not only cater to foreign labor markets but also to local ones. Similarly, the agenda on harnessing the diaspora and return migrants can help present a more balanced picture, as North Macedonia seem to be underexploiting the potential of remittances and role of diaspora in technological progress and access to markets. Researching these areas might help designing different state aid and labor market programs. NORTH MACEDONIA SYSTEMATIC COUNTRY DIAGNOSTIC UPDATE 89 Box 3. continue Global value chain opportunities and diversification strategy: While the SCD update clearly identified the concentration of markets and products as a risk factor, ways to diversify and the strategies to move into higher levels of GVCs that entail more skill-intensive services and advanced manufacturing exports are not yet defined. For the diversification process, the education system needs to be revamped and the country state aid policy needs to move away from stimulating the low skilled-low paid job creation. The concrete diversification strategy presents a knowledge gap. Climate impact on natural assets: While noting the expected impacts of climate on infrastructure, the SCD does not elaborate on climate expected effects on natural assets and sectors such as forestry and agriculture. 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