BULGARIA

A c c elerating Bulgaria’s C o n v e r g e n c e : t h e Challenge of Raising P r o du c t i v i t y Volume II Main Report

Report No. 38570

BULGARIA
ACCELERATING BULGARIA’S CONVERGENCE: THE CHALLENGE OF RAISING PRODUCTIVITY
(In Two Volumes) Volume II: Main Report
July 2007

Poverty Reduction and Economic Management Unit Europe and Central Asia Region

Document of the World Bank

CURRENCY AND EQUIVALENT UNITS Currency Unit = Bulgarian Leva (BGN) EUR 1 = Leva 1.95583 US$1 = Leva 1.41 (On July 20, 2007) FISCAL YEAR January 1 – December 31 WEIGHTS AND MEASURES Metric System ACRONYMS AND ABBREVIATIONS
ALMP BAS BEEPS BGN CKOKO CEFTA CVT EFTA EIS EPA EPL EPO EU EUR FDI FE GDP ICT IT IUT KAM KEI KPI LFDI LFP LFS Active labor market programs Bulgarian Academy of Sciences Bank environment and enterprise performance survey Bulgarian Denominated Lev Center for Control and Assessment of the Quality of Education Central European Free Trade Agreement Continuing Vocational Training European Free Trade Association European Innovation Scoreboard Employment Promotion Act Employment Protection Legislation European Patent Office European Union Euro (Currency) Foreign Direct Investments Further Education Gross Domestic Product Information Communications Technology Information Technology Institutes Universitaire de Technologie Knowledge Assessment Methodology Knowledge Economy Index Key Performance Indicators Leadership and Faculty Development Institute Labor Force Participation Labor Force Survey NEA NCAS NCI NCSR NEAA NIS NSRF NRA NQA NQF NSF NSI NSSI NSRD OP OECD PAC PIRLS PISA RCI R&D SETC SME TIMSS UNESCO USPTO National Employment Agency National Center for Agrarian Studies National Council for Innovation National Council for Scientific Research National Evaluation & Accreditation Agency National Innovation Strategy National Strategic Reference Framework National Revenue Agency National Qualifications Authority National Qualification Framework National Science Fund National Statistical Institute National Social Security Institute National Strategy for Research and Development Operational Programs Organization for Economic Cooperation and Development Program Advisory Committees Progress in International Reading Literacy Study Program for International Student Assessment Relative Cost Indicator Research and Development Secondary Education Testing Center Small & Medium Scale Enterprise Trends International Mathematics and Science Study United Nations Educational, Scientific and Cultural Organization United States Patent and Trade Mark

MES MLSP MOF NAVET

Ministry of Education and Science Ministry of Labor and Social Policy Ministry of Finance National Agency for Vocational Education and Training

VET VETA VTC WTO

Office Vocational Education and Training Vocational Education and Training Act Vocational Training Centers World Trade Organization

Vice President: Country Director: Sector Director: Sector Manager: Task Team Leaders:

Shigeo Katsu, ECAVP Anand K. Seth, ECCU5 Cheryl Gray, ECSPE Bernard Funck, ECSPE Satu Kähkönen, ECSPE Peter Miovic

Table of Contents
1. THE CHALLENGE OF INCREASING PRODUCTIVITY........................................................... 2 I. II. III. IV. OBJECTIVE OF THE REPORT .......................................................................................................... 3 TACKLING THE CHALLENGE OF INCREASING PRODUCTIVITY...................................................... 4 IMPLICATIONS OF BULGARIA’S DEMOGRAPHIC TRENDS FOR SECTORAL REFORM ..................... 6 IMPLICATIONS OF THE INCREASING ROLE OF KNOWLEDGE AS A DRIVER OF GROWTH FOR SECTOR REFORM ........................................................................................................................... 8 V. THE ROADMAP FOR THE REST OF THE REPORT ......................................................................... 10 2. PRODUCTIVITY TRENDS IN BULGARIA ................................................................................ 13 I. PATTERNS OF OUTPUT GROWTH IN 2000-2005 .......................................................................... 13 II. GROWTH ACCOUNTING ............................................................................................................... 14 III. OUTPUT GROWTH AT THE SECTOR LEVEL DURING 2000-2005 ................................................. 15 A. Value-added and TFP Growth by Sectors............................................................................. 16 B. Decomposition of Productivity Growth................................................................................. 18 IV. CONCLUSIONS AND POLICY RECOMMENDATIONS ...................................................................... 21 3. IMPROVING PRODUCT MARKET REGULATION................................................................. 31 I. RATIONALE FOR IMPROVING PRODUCT MARKET REGULATION ................................................. 31 A. Product Market Regulation, Investment and Productivity .................................................... 31 B. Regulation of Product Markets and Innovation .................................................................... 33 C. Regulation of Product Markets and Labor Market Performance and Functioning.............. 34 II. REGULATION OF PRODUCT MARKETS IN BULGARIA .................................................................. 34 A. Overall Product Market Regulation...................................................................................... 35 B. Barriers to Trade and Investment ......................................................................................... 36 C. Barriers to entrepreneurship................................................................................................. 39 D. State Control ......................................................................................................................... 44 III. REGULATION AND QUALITY OF INSTITUTIONS .......................................................................... 46 IV. SUMMARY AND DIRECTIONS FOR REFORM ................................................................................ 47 4. IMPROVING THE FUNCTIONING OF LABOR MARKETS .................................................. 51 I. LABOR MARKET DYNAMICS ....................................................................................................... 51 A. Labor Force Participation and Employment Rates .............................................................. 52 B. Informal Employment and Self-employment ......................................................................... 53 C. Participation Rates by Gender and Education...................................................................... 54 D. Trends in Unemployment ...................................................................................................... 55 E. Youth Unemployment ............................................................................................................ 56 F. Regional Disparities.............................................................................................................. 57 G. Labor Potential of the Currently Inactive Population .......................................................... 58 II. LABOR COSTS, WAGE DYNAMICS, AND MINIMUM WAGES ....................................................... 58 III. EMPLOYMENT AND SOCIAL INSURANCE SYSTEM ...................................................................... 60 A. Unemployment Traps ............................................................................................................ 61 IV. LISBON AND STOCKHOLM EMPLOYMENT TARGETS ................................................................... 63 V. CHALLENGES FOR LABOR MARKET POLICIES ............................................................................ 64 A. Institutional Constraints........................................................................................................ 64 B. Improving Employment Services........................................................................................... 65 C. Employment Regulations....................................................................................................... 69 D. Adult Education and Training............................................................................................... 72 E. Improvements in Labor Market Statistics ............................................................................. 74

VI. CONCLUSIONS AND POLICY RECOMMENDATIONS ...................................................................... 74 5. GOVERNANCE AND FINANCE REFORMS IN PRIMARY AND SECONDARY EDUCATION .................................................................................................................................... 79 I. II. THE REFORM CHALLENGES......................................................................................................... 79 THE AGENDA FOR FINANCE AND GOVERNANCE REFORM ......................................................... 83 A. The Current Primary and General Secondary Education System: Input-oriented and Centralized ......................................................................................................................... 84 B. The New Primary and General Secondary Education System: Outcome-oriented with Selfmanaging Schools .............................................................................................................. 85 INCREASING EFFICIENCY IN PRIMARY AND GENERAL SECONDARY EDUCATION ...................... 87 WHAT HAS BEEN ACCOMPLISHED SO FAR? ............................................................................... 89 POSSIBLE FISCAL IMPACT OF THE REFORM ................................................................................ 91 POLICY RECOMMENDATIONS ...................................................................................................... 92

III. IV. V. VI. 6.

IMPROVING VOCATIONAL EDUCATION AND TRAINING................................................ 95 I. THE STRUCTURE AND ORGANIZATION OF THE VET SYSTEM ......................................................... 96 II. GOVERNANCE OF THE VET SYSTEM ......................................................................................... 100 III. CONTINUING VOCATIONAL EDUCATION AND TRAINING ......................................................... 101 IV. EXPENDITURES ON VOCATIONAL EDUCATION ......................................................................... 102 V. EMPLOYMENT OF GRADUATES ................................................................................................. 102 VI. THE LINK TO THE LABOR MARKET .......................................................................................... 103 VII. OCCUPATIONALLY-ORIENTED ALTERNATIVE SECTOR OF TERTIARY EDUCATION ................... 104 VIII. OPTIONS FOR REFORM OF VOCATIONAL SECONDARY EDUCATION ............................... 105

7.

STRENGTHENING TERTIARY (HIGHER) EDUCATION .................................................... 112 I. TYPOLOGY OF TERTIARY EDUCATION...................................................................................... 112 II. THE STRUCTURE AND ORGANIZATION OF TERTIARY EDUCATION IN BULGARIA ................... 114 III. ACCESS TO TERTIARY EDUCATION ........................................................................................... 115 IV. RELEVANCE OF THE ACADEMIC PROGRAM ORIENTATION TO THE NEEDS OF LABOR MARKETS118 V. THE BOLOGNA PROCESS ........................................................................................................... 119 VI. GOVERNANCE AND AUTONOMY ............................................................................................... 120 VII. FINANCING OF TERTIARY EDUCATION ..................................................................................... 121 VIII. FUNDING MECHANISMS ............................................................................................................ 122 IX. FACULTY ISSUES ....................................................................................................................... 123 X. QUALITY ASSURANCE ............................................................................................................... 124 XI. OPTIONS FOR REFORM OF TERTIARY EDUCATION ................................................................... 125

8.

TOWARDS RESEARCH AND DEVELOPMENT (R&D) STRUCTURES AND POLICIES SUPPORTING INNOVATION ..................................................................................................... 132
I.

BENCHMARKING OF BULGARIA IN R&D AND INNOVATION ..................................................... 133 A. European Innovation Scoreboard ....................................................................................... 133 B. Knowledge Assessment Methodology.................................................................................. 135 C. Innovation Environment in Bulgaria versus Finland.......................................................... 136 D. How to Catch Up?............................................................................................................... 138 II. INSTITUTIONAL FRAMEWORK FOR R&D AND INNOVATION .................................................... 138 A. National R&D and Innovation Strategies ........................................................................... 139 B. Coordination of R&D Policies............................................................................................ 140 C. Financing Instruments ........................................................................................................ 141 D. Key Actors ........................................................................................................................... 142 III. FUNDING AND TYPE OF R&D AND INNOVATION INVESTMENTS ............................................. 145

IV. V. VI. VII. 9. I.

A. Investment in R&D and Innovation..................................................................................... 145 B. Type of R&D Financed ....................................................................................................... 148 C. Enhancing Industry Engagement in R&D and Applied R&D ............................................. 148 D. Opportunities Provided by EU Research Programs and Grants ........................................ 151 HUMAN RESOURCES AND R&D AND INNOVATION .................................................................. 153 A. Availability of Researchers ................................................................................................. 153 B. Developing Links with the International Research Community.......................................... 154 INTELLECTUAL PROPERTY RIGHTS AND INNOVATION ............................................................. 154 A. Legislative Framework........................................................................................................ 154 B. Patents and Scientific Outputs ............................................................................................ 155 ROLE OF FDI IN PROMOTING R&D AND INNOVATION ............................................................... 156 CONCLUSION AND POLICY RECOMMENDATIONS ..................................................................... 157

BUDGET AND CAPACITY IMPLICATIONS ........................................................................... 160 COSTS AND BENEFITS OF THE PROPOSED REFORMS ................................................................ 160 A. Product Market Regulation................................................................................................. 160 B. Improving the Functioning of Labor Markets..................................................................... 160 C. Governance and Finance Reforms in Primary and General Secondary Education ........... 160 D. VET and Tertiary Education ............................................................................................... 161 E. R&D .................................................................................................................................... 168 II. CONSISTENCY OF THE PROPOSED REFORMS WITH THE OPERATIONAL PROGRAMS ............... 168 III. IMPLEMENTATION CAPACITY .................................................................................................... 169

REFERENCES........................................................................................................................................ 172

Tables
Table 1.1: Number of Student by Level Education, ISCED-97.................................................................... 8 Table 1.2: Net Enrolment Rates by Level of Education, ISCED-97............................................................. 8 Table 3.1: Indicators of Integration: Bulgaria and EU8 (percent of GDP) ................................................. 38 Table 3.2: Select Global Competitiveness Rankings .................................................................................. 47 Table 4.1: Labor Force Participation (LFP), Employment and Unemployment Rates (population age 15 years and over)............................................................................................................................................ 52 Table 4.2: GDP growth and labor force participation rates (population age 15-64 years), percent in 2006 .................................................................................................................................................................... 53 Table 4.3: Undeclared Work in select EU countries, latest available data ................................................. 54 Table 4.4: Labor market participation (population of 15-64 years of age), and employment by gender, professional status, and economic sectors, in percent in 2006 (employed population 2005) ..................... 54 Table 4.5: Number of Long-term Registered Unemployed (average per month) ....................................... 55 Table 4.6: Youth Unemployment, Employment and Labor Force Participation Rates, 2005 .................... 56 Table 4.7: Labor Market Participation Rates at Age 15-24 and 25-34 and the Level of Education in 2005, % ................................................................................................................................................................. 57 Table 4.8: Labor Market Indicators by Geographical Groupings (population aged 15 years and over), in 2005 ............................................................................................................................................................ 57 Table 4.9: Labor Cost Index (2000=100)*................................................................................................. 58 Table 4.10: Dynamics of average wages, minimum wages, and non-taxable monthly incomes, BGN ..... 60 Table 4.11: Employed and insured population, and the number of pensioners in 2000-2006 (million; average annual) ........................................................................................................................................... 61 Table 4.12: EU Employment Targets According to Lisbon Criteria, and New Jobs Needed to Reach them In Bulgaria .................................................................................................................................................. 63 Table 4.13: Expenditures in active and passive labor market measures, % of GDP in 2005 ............ 67

Table 4.14: Impacts of ALMPs based on experience of EU countries ....................................................... 68 Table 4.15: Rigidity of Employment Indexes in 2006................................................................................ 70 Table 4.16: Incidence and Composition of Part-time Employment, 20051 ................................................ 71 Table 4.17: Participation of Adult Population in Lifelong Learning, %*................................................... 73 Table 5.1: Net School Enrolment Rates Growing, but Still Low in Secondary.......................................... 81 Table 5.2: Student-Teacher Ratios in Primary and General Secondary...................................................... 82 Table 5.3: Large Variation in Student-Teacher Ratios Translating into Varying Per Student Costs.......... 88 Table 6.1: School Types in General Education (2005) ............................................................................... 96 Table 6.2: Types of Vocational Secondary Schools in Bulgaria (2006)....................................................... 97 Table 6.3: Distribution of Student Enrolment in Vocational Schools by Vocational Discipline and Level, percent (2006) ............................................................................................................................................. 99 Table 6.4: Enrolment Trends in Vocational Secondary Education, 2001-2006........................................ 100 Table 6.5: Expenditures on General (Upper) and Vocational Secondary Schools ................................... 102 Table 6.6: Unemployment Rates for Secondary (Vocational and Upper General) Graduates.................. 103 Table 6.7: Alternative Sector in Select Countries (2004)........................................................................... 104 Table 6.8: Characteristics of the two proposed models ............................................................................ 108 Table 7.1: The Tripartite System of Tertiary Education in Select Countries............................................ 113 Table 7.2: Tertiary Education Institutions in Bulgaria, 2006.................................................................... 114 Table 7.3: Types of Tertiary Education Institutions in Bulgaria, Romania, EU8, and EU15...................... 115 Table 7.4: Comparative Analysis of Participation in Secondary Education ............................................. 116 Table 7.5: Tertiary Education Participation Rates in Bulgaria, EU8 and EU15....................................... 116 Table 7.6: Total Enrolment in Tertiary Education in Bulgaria, Romania, EU 8 and EU15 ..................... 117 Table 7.7: Enrolment of New Entrants in Tertiary Education in Bulgaria, Romania, EU8 and EU15..... 117 Table 7.8: General Upper Secondary School Enrolment in Bulgaria ....................................................... 117 Table 7.9: Distribution of Students in Tertiary Education by Academic Discipline ................................ 118 Table 7.10: Bologna Scorecard for Selected Countries, 2005 .................................................................. 120 Table 7.11: Public Expenditures on Tertiary Education, percent of GDP ................................................ 122 Table 7.12: Funding Formula for Tertiary Education in Bulgaria ............................................................ 123 Table 8.1: Bulgaria’s performance relative to EU25 by indicator ............................................................ 135 Table 8.2: Investment in R&D in Bulgaria, percent of GDP ................................................................... 145 Table 8.3: Allocation of Government R&D Investment........................................................................... 148 Table 8.4: Allocation of R&D Funds by Type of Research, % of total investment ................................. 148 Table 8.5: Budget of the EU seventh Framework Program for Research, 2007-2013 ............................. 151 Table 9.1: Rough Estimated Costs (in 2007-2010) and Projected Annual Savings and Additional Operating Costs of the Proposed VET and Tertiary Education Reform Program .................................... 162 Table 9.2: Rough Estimated Investment Costs (2007-10) and Savings (starting in 2011) associated with the Rationalization of Vocational Secondary Schools .............................................................................. 163 Table 9.3: Rough Estimates of Investment Costs and Annual Operational Savings ................................ 165 Table 9.4: Rough Estimated Cost of Reform of the University Governance Structure ............................ 165 Table 9.5: Rough Estimated Costs and Revenues (Savings) from Increased Tuition Fees and the Student Loan Scheme............................................................................................................................................. 166 Table 9.6: Rough Estimated Costs and Savings from Introduction of Performance-based Funding........ 167 Table 9.7: Estimated Operating Cost Reductions from University Consolidation ................................... 167 Table 9.8: Rough Estimated Cost of Continued Teacher and Faculty Training ....................................... 168

Figures
Figure 1.1: Median Population Projections by Age Group, 2005-2050........................................................ 7 Figure 2.1: Contribution to Output Growth in Bulgaria 2000-2005, percentage points ............................. 14 Figure 2.2: Decomposition of Value-added Growth by year (%; contribution of L, K and TFP sum up to 100%).......................................................................................................................................................... 15

Figure 2.3: Decomposition of Value-added Growth and Growth of Its Components in Bulgaria by subperiod .......................................................................................................................................................... 15 Figure 2.4: Cumulative Value-added Growth by Sector in 2000-2005, % ................................................. 16 Figure 2.5: Structure of Value added by Sector in 2005, % ....................................................................... 16 Figure 2.6: Cumulative Employment Growth by Sector in 2000-2005, %................................................. 16 Figure 2.7: Structure of Employment by Sector in 2005, %....................................................................... 16 Figure 2.8: Cumulative Net Capital Real Growth by Sector in 2000-2005, %........................................... 17 Figure 2.9: Structure of Net Capital by Sector in 2005, % ......................................................................... 17 Figure 2.10: Cumulative TFP Growth by Sector in 2000-2005, %............................................................. 17 Figure 2.11: Growth Rates of Value added and Its Components, % (including remuneration of factors) . 17 Figure 2.12: Cumulated TFP Growth and Average FDI-to-Capital Stock Ratios in 2000-2005 and Share of Exports in Sales by Sector ...................................................................................................................... 18 Figure 2.13: Cumulative Labor Productivity Growth by Sector in 2000-2005, % ..................................... 19 Figure 2.14: Labor Productivity Levels by Sector in 2005 (economy-wide average =100%).................... 19 Figure 2.15: Shift-Share Analysis of Labor Productivity Growth for Bulgaria 2000-2005, % .................. 19 Figure 2.16: Shift-Share Analysis of Labor Productivity Growth for Poland 1996-2003, %..................... 20 Figure 2.17: Shift-Share Analysis of TFP Growth for Bulgaria 2000-2005, %.......................................... 20 Figure 2.18: Shift-Share Analysis of TFP Growth for Poland 1996-2003, % ............................................ 21 Figure 3.1: Product Market Regulation and Labor Productivity Acceleration ........................................... 32 Figure 3.2: Increase in Average Annual Business Sector Productivity Growth over 1995 to 2003 ........... 32 Figure 3.3: Product Market Regulation in 2003 ......................................................................................... 35 Figure 3.4: Product Market Regulation, Country Groups........................................................................... 36 Figure 3.5: Product Market Regulation in OECD Countries, 1998 and 2003 ............................................ 36 Figure 3.6: Barriers to Trade and Investment ............................................................................................. 37 Figure 3.7: Foreign Direct Investment Stock, million EUR ....................................................................... 38 Figure 3.8: Barriers to Trade and Investment by type ................................................................................ 39 Figure 3.9: Barriers to Entrepreneurship..................................................................................................... 40 Figure 3.10: Barriers to Entrepreneurship by Type .................................................................................... 41 Figure 3.11: Percent of firms indicating business licenses and permits as a problem for doing business .. 42 Figure 3.12: Administrative barriers to start-ups, 2003 and 2006 .............................................................. 43 Figure 3.13: State Control........................................................................................................................... 45 Figure 3.14: State Control by Type............................................................................................................. 45 Figure 3.15: Convergence to Best Performers in Product Market Regulation: Areas of Bulgaria’s Relative Strength ....................................................................................................................................................... 47 Figure 3.16: Distance from Best Performers in Product Market Regulation: Areas of Bulgaria’s Relative Weakness .................................................................................................................................................... 48 Figure 4.1: Labor Force Participation, Employment, and Unemployment Rates (population aged 15-64), % in 2006 Q2 .............................................................................................................................................. 55 Figure 4.2: “Tax” rate on Low Wage Earners: ........................................................................................... 61 Figure 4.3: Tax Rate on Low Wage Earners: Tax Wedge on Labor Costs in 2005.................................... 62 Figure 4.4: Doing Business, percent of Responding Firms Indicating a Problem in 2002 and 2005 ......... 65 Figure 4.5: International Comparison of Public Employment Service Staff (2002 and 2003; 2006 for Bulgaria) ..................................................................................................................................................... 66 Figure 4.6: Under employment due to Labor Regulations, % in 2002 and 2005........................................ 71 Figure 5.1: Mathematics Performance of Bulgarian Eighth Graders Fallen from Above to Below the EU8 Average ....................................................................................................................................................... 80 Figure 5.2: Years of schooling by ethnicity and poor/non-poor ................................................................. 81 Figure 5.3: Student-teacher ratios in 87 urban schools in Sofia.................................................................. 83 Figure 5.4: Student Numbers Falling Faster than Teacher Numbers, and Driving Fast Growth in Real Expenditure per Student.............................................................................................................................. 84 Figure 5.5: The three aspects of a finance and governance reform............................................................. 87

Figure 5.6: Student-Teacher Ratios and Drop-Out Rates (left chart) and Repetition Rates (right chart) by Schools, Bulgaria, 2004 .............................................................................................................................. 89 Figure 5.7: Groupings of municipalities, along with baseline amounts and adjustment coefficients for 2007 ............................................................................................................................................................ 90 Figure 5.8: Estimated Fiscal Impact of Introducing Per Student Finance to Primary and General Secondary Schools ...................................................................................................................................... 91 Figure 6.1: The Education System in Bulgaria ........................................................................................... 96 Figure 6.2: Distribution of Enrolment in VET Programs by Type and Level ............................................ 98 Figure 6.3: Enrolment Trends in Vocational Secondary Education ........................................................... 99 Figure 6.4: Percentage of Enteprises Providing Continuing VET, 2004 (Source: Eurostat, CVTS2) ...... 101 Figure 6.5: Percentage of Employees Participating in Continuing VET, 2004 (Source: Eurostat, CVTS2) .................................................................................................................................................................. 101 Figure 6.6: Per Student Public Spending on General and Vocational Education, BGN........................... 102 Figure 6.7: Distribution of Employees by Type of Education .................................................................. 103 Figure 7.1: Evolution of Tertiary Education: 1960 to 2005...................................................................... 113 Figure 7.2: Public Spending per Full-time Tertiary Student in 2005, percent of GDP per capita (source: Eurostat).................................................................................................................................................... 121 Figure 7.3: Proposed Governance Structure for Tertiary Education......................................................... 127 Figure 8.1: European Innovation Scoreboard 2005 and Bulgaria............................................................. 134 Figure 8.2: Relative strengths and weaknesses of the Bulgarian innovation system ................................ 136 Figure 8.3: Innovation environment in Finland and Bulgaria................................................................... 137 Figure 8.4: Institutional structure of the R&D and innovation system in Bulgaria .................................. 139 Figure 8.5: Total R&D Investment by Sector in 2005, % of GDP ........................................................... 145 Figure 8.6: Share of R&D Financed by Government in 2005, % of total R&D investment.................... 146 Figure 8.7: Share of R&D Financed by Industry in 2005, % of total R&D investment ........................... 146 Figure 8.8: R&D Investment by Sector, % of total investment (Source: National Statistical Institute)... 147 Figure 8.9: Allocation of Government R&D Investment in 2001-2005 ................................................... 147 Figure 8.10: Employment of Researchers by Sector, 2004....................................................................... 153 Figure 8.11: To what degree do you agree that the legal system will uphold contract and property rights? .................................................................................................................................................................. 155 Figure 8.12: Number of Scientific Publications per million Inhabitants, 2002 ........................................ 156 Figure 8.13: Inward FDI Stock ................................................................................................................. 157 Figure 9.1: Reforms Themes in Vocational and Tertiary Education ........................................................ 161

Boxes
Box 3.1: Reforms of Business Start-ups in Europe..................................................................................... 43 Box 3.2: Alternative Policy Instruments..................................................................................................... 45 Box 5.1: Equity in Education...................................................................................................................... 81 Box 8.1: Lisbon Strategy Targets/Objectives in R&D.............................................................................. 133 Box 8.2: Training of Policy makers on Economic Policy Management in Finland.................................. 141

ACKNOWLEDGEMENTS
This report was prepared under the general guidance of Bernard Funck, by a team co-led by Satu Kähkönen and Peter Miovic. Team members were Stella Ilieva (product market regulation, overall support); Arvo Kuddo (labor markets); Leszek Kasek (productivity analysis); Sam Mikhail (vocational and tertiary education); Christian Bodewig and Lars Sondergaard (primary and general secondary education); Jorma Routti, Kimmo Halme, and Tarmo Lemola (R&D and innovation); and Iglika Vassileva (data support). The team benefited from excellent support of the World Bank’s Sofia office, led by Florian Fichtl. Albena Samsonova provided invaluable logistical support to missions. Mismake Galatis was responsible for the production of the report, and provided excellent administrative support to the work. Peer Reviewers were Andrew Burns, Andreas Wörgötter and Simeon Djankov. The report was produced in close collaboration with the Bulgarian authorities. Mr. Lyubomir Datsov, Deputy Minister, Ministry of Finance was the immediate counterpart, and his support and comments were invaluable. However, he is not responsible for the recommendations offered. The cooperation with the rest of the Bulgarian Government was also excellent, and the team is grateful to officials at all levels, who took the time to meet with the team, and provided information in a competent and timely manner. Same applies to the private sector entities, NGOs, universities, schools, research centers, and employers’ associations visited. The report greatly benefited from these exchanges, and the team wants to thank them for their time and shared insights.

1.

THE CHALLENGE OF INCREASING PRODUCTIVITY

1.1 On January 1, 2007 Bulgaria and Romania became the newest members of the European Union (EU). In the run-up to this momentous event, the Bulgarian economy and institutions had gone through a major transformation. After an initial collapse in output and employment as the old supply-driven modes of production were largely destroyed, growth of output and employment has resumed, but now on a demand-driven basis and in an increasingly competitive environment. This is no minor achievement. Nevertheless, Bulgaria still has a long way to go to catch up with its fellow EU member countries. The country’s income per capita, at PPS in 2005, was 32 and 56 percent of the average level of EU25 and EU81, respectively. 1.2 Closing the income gap and facilitating convergence with other EU countries is, and has been for some years, an overriding priority for Bulgaria. However, the country is embarking on this road to convergence with two handicaps: the sheer distance that it hopes to traverse, and its rapidly declining working age population.2. For a time, the declining working age population can be offset by increasing the labor force participation rate, but this has a limit. Beyond that, output will inevitably decline, unless offset by productivity growth. 1.3 Hence, to close the income gap and converge, Bulgaria needs to raise not just its labor force participation rate, but above all its productivity. To give an idea of the magnitudes involved, Figure 1.1 presents scenarios of Bulgaria’s GDP per capita through 2040 under two sets of assumptions.3 Through the year 2015, both scenarios assume that: (i) employment will continue to grow at about 3 percent per year, as it has since 2002, with the employment rate rising to the Lisbon target of 70 percent, and (ii) labor productivity will continue to grow at its recent pace of two percent per year. During this period, Bulgaria’s GDP per capita converges from its current level of 34 percent of EU25 GDP per capita to 44 percent by 2015, assuming that EU25 GDP per capita continues growing at 2 percent per year, as it has on average in recent years (the uppermost trajectory in Figure 1.1). After 2015, the two scenarios diverge. At that point, there will be no more gains to be had from increased employment since the employable labor pool will have been more or less exhausted. From there on, productivity will be the sole driver of GDP growth. In the first scenario (the low trajectory), it is assumed that labor productivity will continue to grow at 2 percent per year. In the second scenario (the middle trajectory), growth in labor productivity accelerates to 5 percent per year and stays there for the duration. 1.4 Figure 1.1 shows that if the labor productivity growth remains at 2 percent, Bulgaria will never converge. Convergence to EU25 stops in 2015, and for the rest of the projection period Bulgaria’s GDP per capita remains at 44 percent of the EU25 GDP per capita. By contrast, if the rate of growth of labor productivity increases to 5 percent, Bulgaria’s GDP per capita converges to that of EU25 and achieves parity around year 2040. However, to achieve that, Bulgaria will have to push on with its reform program. Ensuring that the rate of growth of labor productivity picks up requires policies and bold

1

EU8 refers throughout the report to the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, the Slovak Republic, and Slovenia. Population is projected to decline at 0.7% per year. See discussion on demographic trends later in this chapter.

2 3

After the analysis for the report was completed, the Bulgarian authorities adjusted GDP figures for 2002-2005. These revisions are not taken into account in the report since they would not substantially alter the conclusions, but redoing all the analysis would take significant amount of time.

2

reforms, given the magnitude of the challenge. Marginal measures will not be enough to make the country converge.
Figure 1.1: Bulgaria's Convergence Challenge
G P/capita (in PPP term D s)
€ 50,000 € 40,000 € 30,000 € 20,000 € 10,000 €0

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EU25--average productivity growth (2% p.a.) Bulgaria--low productivity growth scenario (2% p.a.) Bulgaria--high productivity growth scenario (2% until 2015, 5% p.a. thereafter)

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I.

OBJECTIVE OF THE REPORT

1.5 This report aims to assist the Bulgarian authorities in analyzing and identifying an appropriate policy mix in the areas of product and labor markets, human resource development, and research and development (R&D) that would boost productivity and thereby competitiveness, economic growth, and achieve income convergence. The implications of these policies for the government’s budget are also briefly explored, including the utilization of EU grant funds. 1.6 The report largely focuses on the supply-side aspects of Bulgaria’s R&D and innovation system, its education delivery, and its labor and product markets, and identifies policy options for their improvement. A companion piece, the Investment Climate Assessment, which is being prepared in parallel, deals with the demand side and, using firm data, identifies the binding constraints to productivity growth from the firm perspective. While there is necessarily some overlap, the two reports together are designed to provide a more comprehensive view of the options to tackle the challenge of boosting productivity. 1.7 The areas selected for the study respond to the priorities identified by the Bulgarian authorities. In this context it is worth noting that this report builds on the analysis of two prior Bank reports on Bulgaria—the Country Economic Memorandum (CEM)4 of 2005 and the Public Finance Policy Review (PFPR) of 20065. This study is also closely linked with the World Bank study that benchmarked Bulgaria’s product market regulations using the OECD methodology.6 The benchmarking results have

World Bank (2005b), Bulgaria: The Road to Successful EU Integration—The Policy Agenda, Report No. 34233BG.
4

5

World Bank (2006) Bulgaria Public Finance Policy Review: Leveraging EU Funds for Productivity and Growth.

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been partly utilized in this report, along with some of the prior work carried out by the World Bank on education. In addition to the areas covered in this report, other factors, such as adequate infrastructure provision, are important for the quest to raise productivity. However, since they were already covered in earlier reports, they are not included in the current report. II. TACKLING THE CHALLENGE OF INCREASING PRODUCTIVITY

1.8 Since the onset of the new millennium, transition economies like Bulgaria have faced a significantly changed global environment. The dimensions of change include globalization, the emergence of knowledge as the driver of economic growth, and the “flattening” of the world through the high speed information and communication technology. In economies increasingly based on knowledge, wealth and economic development depend on citizens’ capacity to creatively use their knowledge and skills to develop products and services that meet the needs of discriminating globally-connected consumers. Public and private organizations develop their competitive capacity by providing their employees with life-long opportunities for learning, and retraining. The organizations and enterprises in knowledge economies become first and foremost “learning organizations”. Bulgaria will not escape the impact of these trends. To keep up, it must adapt, and in the process raise the rate of growth of productivity. 1.9 Innovation—defined as adoption of already existing or development of new technologies, products, and processes—lies at the heart of high productivity. It should, therefore, be the overriding objective for Bulgaria. For all countries, to build and maintain their productive sectors in the face of global competition, enterprises must be able to continuously improve their products and services and for that purpose successfully adopt new technologies and processes—that is, to innovate. However, there is no simple formula to promote innovation and thereby productivity growth. To increase productivity and move Bulgaria to a higher growth path, action would need to be taken on several fronts. Growth is a result of a number of factors, including an enabling institutional framework that provides appropriate incentives.7 The areas central to productivity growth and on which Bulgaria would need to focus on include the following: 1.10 Investment in R&D and Innovation Policies: Firms need incentives to innovate: to adopt existing or develop new technologies, products, and business processes that raise productivity. The most basic way to foster innovation is often considered to be investment in R&D. The available empirical evidence suggests that R&D investments have a positive impact on productivity growth.8 R&D enhances technology transfer by helping firms to learn about advances at the technology frontier. For example, a study on OECD countries9 shows that countries that are behind the world technology frontier can grow more quickly, if they invest in R&D and human capital to facilitate adoption of new technologies. Further, the closer a country or an industry is to the world technology frontier, the more important the R&D efforts become—which in this case means not just imitation of existing technologies but their improvement or replacement by entirely new technologies.

6

De Rosa, Fay, Ilieva (2006), “Product Market Regulation in Bulgaria: A Comparison with OECD Countries.” The World Bank.

For a review on current thinking on growth see for example, Rodrik, ed. (2005), In Search of Prosperity; and Aghion (2006), “A Primer on Innovation and Growth”, Bruegel Policy Brief, Issue 2006/06, October.
8

7

See for example Lederman and Maloney (2001), “R&D and Development.” Policy Research Working Paper No 3024, the World Bank.

9

Griffith, Redding, van Reenen (2000), “Mapping Two Faces of R&D: Productivity Growth in a Panel of OECD Industries.” Discussion Paper Series, No. 2457, Center for Economic Policy Research.

4

1.11 However, while R&D investments may be one of the factors affecting productivity, they alone are by no means enough to foster productivity growth. Above all, it is necessary to create micro and macroeconomic conditions that enable innovation and technological progress. These include promotion of: (i) competition and entry into product markets; (ii) flexible labor markets; and (iii) an educated labor force. 1.12 For Bulgaria, these other areas are the most pressing short-term priorities, and warrant most attention at the moment. As will be shown in Chapter 2, based on past productivity trends, improvements in these areas can be expected to have most impact on productivity growth in the short and medium run in Bulgaria. In Bulgaria, it is the adoption of existing technologies—that is, imitation—that primarily matters at the moment. In general, Bulgarian firms are not yet at the technology frontier, but should strive to move in that direction through acquisition of best technologies available. To move the country closer to the world technology frontier, Bulgaria would need to start paying increasing attention also to R&D. But that is more of a medium to long-term priority for the country. It is vital that the basic micro and macro-economic conditions are first met and that they are supportive of innovation. This includes above all promotion of competition. 1.13 Product Market Regulation: Unhindered entry, exit and turnover of firms are crucial for productivity growth. Firms have little incentive to adopt new technologies, if they are not stimulated by competition.10 Regulations limiting entry may hinder the adoption of existing and new technologies, as well as technology spillovers by reducing competitive pressures. Hence, policies that support competition and encourage outward orientation, flexible product market regulations, and attraction of new FDI inflows, play a key role in sustaining rapid productivity growth. This is particularly the case for Bulgaria, as will be discussed later in the report. 1.14 Flexible Labor Markets: Recent research indicates that product and labor market policies are complementary, and hence improving the functioning of both markets in parallel would be advisable to promote productivity growth. The evidence from OECD countries suggests that countries with restrictive product market policies also tend to have restrictive labor market policies, and vice versa.11 Effectively functioning and flexible labor markets are essential in the quest to raise productivity, since they are the critical link in ensuring that the skills and knowledge can be put to their most productive use. Rigidities in the labor market–such as those that discourage the shedding of redundant labor–hinder innovation and productivity growth, since they make it hard for a firm to move to a new activity and adopt a new technology. The analysis in Chapter 2 suggests that the reallocation of labor across sectors is still rather slow. Thus, further enhancement of labor market flexibility would need to be considered in Bulgaria to promote convergence. 1.15 Equipping Labor Force with Relevant Skills: Finally, having a highly skilled and technically savvy labor force is also essential for new technology adoption, and becomes increasingly important as a country moves closer to the technology frontier. Existing empirical evidence indicates that skill composition of the labor force matters for innovation—an increase in the stock of skilled labor is positively correlated with innovation efforts12, and a more educated labor force is quicker in adopting new
10

Recent economic research suggests that there is an inverted U type relationship between competition and innovation: while too little competition leads to no innovation, too much competition can discourage innovation since firms are not able to reap the benefits of their efforts. See Aghion, Bloom, Blundell, Griffith, and Howitt (2002).

11

Nicoleti and Scarpetta (2005), “Product Market Reforms and Employment in OECD Countries”, Economics Department Working Paper No. 472, OECD and the World Bank.

12

See for example Grossman and Helpman (1991), Innovation and Growth in the Global Economy, Cambridge, MA, MIT Press.

5

technologies.13 Recent research indicates that tertiary education investment increases a country’s ability to make leading-edge innovations, while primary and secondary education impact the country’s ability to implement existing technologies.14 The fact that in the age of globalization, knowledge is becoming an increasingly important driver of growth further emphasizes the importance of higher education. 1.16 Thus, it is secondary and tertiary education that are critical for productivity growth in Bulgaria. In addition to tertiary education, this report covers both general secondary and vocational education and training. However, since none of these education institutions would be effective without strong primary feeder institutions, the reform of primary education also matters. For that reason it is also covered in this report. 1.17 Changes in these various areas are likely to affect productivity differently. Increases in labor force participation and employment can increase aggregate productivity growth by improving resource utilization. Aggregate productivity growth can also increase if workers move from lower to higher productivity sectors, and thereby improve resource allocation. However, in addition to raising aggregate productivity, R&D and innovation, education, and liberalization of product markets have the potential to increase the rate of growth of productivity. This shift allows any given level of productivity to be achieved more rapidly. It is this that Bulgaria should be aiming for. 1.18 In analyzing the appropriate policy mix in the above-mentioned areas, it is important to reflect at the outset on the implications of two trends—Bulgaria’s population decline, and the increasing importance of knowledge for growth. In addition to influencing the speed of convergence, they also have implications for sectoral policies, in particular for education. III. IMPLICATIONS OF BULGARIA’S DEMOGRAPHIC TRENDS FOR SECTORAL REFORM

1.19 Demographic Trends: Of all EU member countries, Bulgaria’s population is declining fastest. In early 2004, Bulgaria had 7.8 million people.15 However, the population is projected to fall to 6.5 million by 2025, and further to 5.2 million by 2050. Projections carried out by the UN (2007) are similar, with the low/high scenarios of 6.2-6.9 million people in 2025, dropping to 4.2-6.0 million people by 2050. This represents a 0.7 percent decline in population per year. The demographic patterns are similar, but more moderate in all EU8 countries.16 By contrast, total population of EU15 is projected to stabilize, although the share of old people will rise, and that of children and working age population decline. 1.20 Consequently, the working age population (people of ages 15-64) will decrease in Bulgaria. According to projections, it will decrease about one percent per year after 2010. As a result, the working age population is set to go down from 5.4 million in 2004 to 4.2 million in 2025, and 3.1 million in 2050. By 2050, the working age population would represent only 60 percent of the entire population, down from 69 percent in 2004. This means that even if labor force participation rates increased to 70-75 percent, there would be 35-40,000 fewer workers available each year during 2010-2030, tapering off to an annual decline of 20-25,000 workers by 2040-2050. While this may quickly eliminate the current unemployment problem in Bulgaria, it also implies that the labor force will have to go through a major

13

Nelson and Phelps (1966), “Investment in Humans, Technological Diffusion and Economic Growth,” American Economic Review, 56(1/2), 69-75. See Aghion (2006), “A Primer on Innovation and Growth”, Bruegel Policy Brief, Issue 2006/06, October. Eurostat 2005 based on Bulgaria’s NSI data.

14 15 16

EU8 refers throughout the report to the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, the Slovak Republic, and Slovenia.

6

upgrading of its education and skill levels, accompanied by large capital investments, to raise its productivity and hence living standards to the average of those in other EU countries. 1.21 At the same time, the share of those aged 65 and above will rise from 17 percent in 2004 to 26 percent in 2050. Figure 1.2 presents these trends. Because the ratio of working age to older people (aged 65+) will be declining steadily, the working age group will need to raise its savings rates sharply over time to take care not only of the current old people, but eventually themselves. They will not be able to expect generations younger than themselves to take care of them, since younger generations will be declining in numbers, while expectations of the living standards once old, will be rising along with the general rise of living standards expected in the coming decades. 1.22 The number of babies born each year is projected to decline from its current range of 65-70,000 per year towards 50,000 per year. This would imply a birth rate of about 1.5 children per woman. This is slightly higher than the range of 1.1-1.3 births per woman that has prevailed in the last 15 years. Some argue that this reflects the unfavorable economic conditions of the transition, which are not expected to last. However, even if the birth rate were to recover to the population-stabilizing rate of 2.1 births per woman, which would make it the highest in Europe, it would imply only getting back to the current number of babies born each year. This “baby bust” will have implications above all for the school system, which would need to be kept in mind when contemplating reforms.

Figure 1.1: Median Population Projections by Age Group, 2005-2050
6000000

5000000

4000000 0 - 14 3000000 15 - 64 65 + 2000000

1000000

0 2005 2010 2020 2030 2040 2050

Source: Demographic Institute of BAS, Eurostat (2005) and UN (2007).

1.23 Implications for the Education Sector: The decline in the number of births in the past fifteen years is already showing up in the declining student cohorts at primary and lower secondary schools (see Table 1.1). The decline has been held back at the pre-primary and upper secondary school levels by a rise in net enrolment rates. However, the rise to net enrolment rates has a limit, and it is only a matter of time before the population decline will be reflected in the decline in absolute numbers at these levels. Only at

7

the tertiary level is there a likelihood that the absolute cohorts will actually grow in numbers, since net enrolment rates can still rise a fair amount (see Table 1.2). Table 1.1: Number of Student by Level Education, ISCED-97
Total Pre-primary Primary Lower secondary Upper secondary Post secondary non-tertiary Colleges Universities and equivalent higher schools Source: NSI 1999/ 2000 1569011 211,943 392,876 367,055 329,018 6,798 18,461 242,860 2000/ 2001 1522401 200,449 374,361 366,047 329,427 5,111 16,369 230,637 2001/ 2002 1474077 199,206 349,616 358,476 334,813 3,572 16,646 211,748 2002/ 2003 1475262 201,317 333,016 348,317 358,934 3,165 14,801 215,712 2003/ 2004 1451284 201,145 314,221 330,416 374,262 2,772 16,294 212,174 2004/ 2005 1419405 202,803 290,017 312,480 373,160 3,036 18,432 219,477

Table 1.2: Net Enrolment Rates by Level of Education, ISCED-97
Pre-primary Primary Lower secondary Upper secondary Post secondary non-tertiary Colleges Universities and equivalent higher schools Source: NSI 1999/ 2000 66.4 96.4 81.4 63.1 0.6 2.4 24 2000/ 2001 66.8 96.3 82.4 64.7 0.6 2.2 23 2001/ 2002 73.6 98.5 83.1 68.3 0.3 2.4 22.8 2002/ 2003 74.2 99.8 83.9 74.9 0.3 2.4 23.9 2003/ 2004 74.6 100.3 84.2 77.1 0.3 2.6 24.1 2004/ 2005 73.6 99.7 84.2 77.3 0.3 3.1 25.8

1.24 In terms of absolute numbers, average enrolment in schools at all grades from pre-school through upper secondary will have to adjust downwards to about 60,000 students per grade, which is 20-30 percent below current enrolments, depending on the grade. In tertiary education, where one can expect a rise in enrolment rates for some years to come, the absolute number of students may well stay in the 200250,000 range for a few decades. This suggests that when contemplating the reforms of the Bulgarian education system, gradual downsizing of the current primary and secondary school system should be planned for, together with the upgrading of the current tertiary education system. Chapters 5-7 have been written keeping these developments in mind. IV. IMPLICATIONS OF THE INCREASING ROLE OF KNOWLEDGE AS A DRIVER OF GROWTH FOR SECTOR REFORM

1.25 In addition to making R&D and innovation policies pertinent, the increasing role of knowledge as a driver of growth has implications for education and how it is delivered. Many of the OECD and EU countries have already faced this challenge. It is now Bulgaria’s turn. 1.26 Secondary Education: In response to increasing importance of knowledge, most countries have experienced less difficulty in developing and implementing policies for reform of primary and tertiary education than for secondary education, including vocational secondary education. This has been attributed to a number of distinctive dualities of secondary education, which is both terminal and preparatory, compulsory and post compulsory, uniform and diverse, serving both personal and societal

8

needs, and serving contradictory equity and selectivity purposes.17 These contradictory dualities have led many countries to experiment with more flexible pathways in upper secondary education and devise frameworks to allow students in the general secondary stream to acquire recognized labor market qualifications, and those in the vocational stream to acquire academic credits to allow them to gain access to tertiary education. A study conducted by OECD18 identified the following four elements in secondary education reforms: (i) reducing the number of vocational education programs by broadening the definitions of vocational areas and their qualifications; (ii) creating effective curricular linkages between general and vocational education; (iii) developing combination of school- and work-based learning, and (iv) building pathways between vocational secondary education and tertiary education. 1.27 The OECD study also suggested that the teacher-directed, rote learning that dominates secondary education needs to be replaced by a new student-centered paradigm, which emphasizes the analysis, application, and synthesis of knowledge in a collaborative learning environment. The continuous upgrading of teachers in the secondary general, and vocational schools is a real challenge in the knowledge economy because of the fast pace of change. A number of guiding principles have emerged and should be taken into consideration for the reform of the system in Bulgaria. These include: (i) upgrading and reform of teacher education and training has to be an integral part of any reform strategy; (ii) teacher training has to continue throughout the teacher’s career; (iii) teacher training should emphasize the importance of student-centered learning; and (iv) group learning complemented by selfstudy and self–learning should be incorporated in all teacher training programs. 1.28 Tertiary Education: Four features of the knowledge economy have far-ranging implications for the reform of tertiary education.19 First, knowledge is being developed and applied in new ways; the information revolution has expanded knowledge networks and expedited the innovation process. Second, product development cycles are shorter and the pressures for innovation greater. The product development cycle in the automotive industry, for example, dropped from six years in 1995 to less than two years by 2005. Third, the globalization of trade is increasing world wide, putting added pressures on transition economies to integrate their policies and practices and with potential trading partners. Fourth, SMEs in the manufacturing and service sectors have become significant players in economic growth and employment. 1.29 Over the past three decades, many countries have diversified their once publicly-dominated tertiary education systems in an attempt to respond to the challenge of the knowledge economy. This diversification includes many, or all of the following types: • Alternative Tertiary Institutions: Many countries have established, or substantially expanded, institutions that are clear alternatives to traditional universities. The new institutions are different in their mission, governance, and programs. They represent distinctive developments with some remarkable benefits compared to universities, including greater flexibility, increased access, equity, and responsiveness to identified employers’ needs, enhanced occupational orientation, and different approach to public service. Examples of these institutions include the community colleges in the USA and Canada, the Colleges for Further Education in the UK, the Institutes Universitaire de Technologie (IUTs) in France, and the Polytechnics in Finland.

17

. World Bank (2002), Expanding Opportunities and Building Competencies for Young People: A New Agenda for Secondary Education. OECD (2000) Knowledge and Skills for Life: First Results from the OECD Program for International Student Assessment (PISA). World Bank (2003b),, Life Long Learning in the Global Knowledge Economy.

18

19

9

Private Institutions: Private sector tertiary institutions have grown rapidly in developed and transition economies. Most EU8 countries have modified their tertiary education regulations to allow the establishment of private universities and institutions of tertiary education. Poland has 195 private institutions with enrolment of about 380,000 undergraduates. Private business schools have also mushroomed in the past decade: over 95 in Poland, 30 in the Czech Republic, 18 in Romania, and 4 in Bulgaria. Virtual Universities: The ICT revolution and the emergence of web-based services have changed the tertiary education landscape dramatically. An estimate made in 2000 indicated that there were over 3000 specialized institutions offering on-line education and training services in the U.S.20. National as well as regional virtual universities are being established in many countries, including the African Virtual University, the Virtual University of Monterrey, Mexico, the Arab Virtual University in Kuwait, and the Tun Abdul Razak University in Malaysia. Franchise Universities: Franchise universities have been setup in partnership with private or public local universities in a number of developing and transition economies by parent universities in North America, Europe, and Australia. They offer validated courses and programs from the parent university at the site of the local institution. The cost of these programs is usually 25-30 percent of the full cost of similar programs offered by the parent university. Corporate Universities: It is estimated that there are more than 1500 corporate universities worldwide today. Prominent among them are Motorola, Disney, and Toyota universities, to name but a few. Corporate universities may have their own network of physical campuses; operate as virtual universities, or through partnership with formal public or private institutions of tertiary education.

1.30 Life Long Learning: Another important paradigm that has been recognized by all developed and transition economies is the importance of life long learning in all stages of education. The speed of change in the knowledge economy means that skills depreciate much faster than they once did. Employers no longer rely solely on new graduates, or new labor market entrants as the primary source of skills and knowledge. They now increasingly seek out people, who have managed to retool, while already in the labor force. Schools and institutions of tertiary education thus need to prepare workers for life long learning that goes beyond the existing rigid system to include non-formal education and training in programs, such as apprenticeship, and internship programs, and structured on-the-job training, as well as informal education and training, which can take place in the home, community, or work place. V. THE ROADMAP FOR THE REST OF THE REPORT

1.31 In chapters that follow, this report examines a number of reforms that could help promote productivity and convergence in Bulgaria. The next chapter analyzes the productivity trends at sector/branch level in Bulgaria, after which the report turns to the sectoral reforms. Strong capacity to innovate and use the innovations effectively could lead to major gains in productivity in the right businesses environment. Chapter 3 covers some rigidities in the regulation of product markets which, if reduced, would raise efficiency and lower the costs of production. Reduction of rigidities would lead to a reallocation of resources to those sectors in which the regulations have been the most binding. The chapter lays out the main channels through which this might accomplished. 1.32 The labor market connects the demand for a whole range of skills with the supply of these skills. If labor productivity is to be raised, the labor market must be efficient in reallocating labor from lower to

20

Olsen, J (2000), Is Virtual Education for Real. TechKnowLogia. January-February.

10

higher productivity areas. It must achieve that in a constantly changing environment, so it must be flexible. Options to improve labor market functioning are covered in Chapter 4. 1.33 Chapters 5-7 deal with the accumulation of human capital in a number of ways. Chapter 5 covers the ongoing governance and finance reforms in primary and general secondary education. Chapters 6 and 7 examine the quality of vocational education and training as well as of tertiary education, with a particular focus on how well and efficiently the relevant institutions are preparing the students for the demands of today’s private businesses and public institutions. Reforms in these sectors could lead to major improvements in the use of public resources in creating the needed human capital. 1.34 Chapter 8 covers the Bulgarian R&D and innovation sector, both in terms of its size and its effectiveness. Finally, Chapter 9 links the proposed reforms with the budget. While the report concentrates on factors that lead to greater productivity from the supply side, their potential cannot be realized in a business environment that is not geared to facilitating the use of these factors, including matching them with the requisite capital. Therefore, the report touches on this aspect briefly in several chapters, based on the already existing research.

11

12

2.

PRODUCTIVITY TRENDS IN BULGARIA

2.1 Since 1997 Bulgaria has implemented important reforms, which have contributed to sustained output and employment growth. The size and scope of the public sector have been substantially reduced, the exposure to international trade and competition through trade and foreign direct investment has increased, and progress has been achieved in improving the regulatory environment for doing business. Supported by prudent macroeconomic management, output has expanded by close to 5 percent per year between 2000 and 2005, and is expected to have exceeded 6 percent in 2006. Solid macroeconomic performance supported by accelerated structural reforms has improved the environment for doing business in Bulgaria. Private sector’s share in the economy has increased substantially, and is now comparable to and even higher than in some EU8 countries. Investment surged to close to 30 percent of GDP in 2006, compared to below 10 percent in 1996-1997, while FDI stock accounted for close to 50 percent of GDP in 2005. Most of the non-infrastructure enterprises and banks have been privatized or liquidated, bank restructuring has been completed and banking supervision strengthened; trade and prices liberalized; reforms in the energy sector have been implemented in both district heating and electricity sectors; and major public sector and institutional reforms have been initiated. These actions can be expected to have affected productivity growth and/or increased employment. 2.2 This chapter presents a detailed sector-based examination of labor and total factor productivity trends in Bulgaria since 2000 as well as those in employment by sector, and identifies critical factors supporting their growth. The most striking message from this analysis is that almost none of the growth in labor and total factor productivity during the period 2000-2005 was due to the reallocation of labor and capital from one sector or another. The mobility of production factors, both labor and capital, was low. Instead, the productivity gains were achieved almost exclusively at the intra-sector level. Yet, for rapid sustainable growth in productivity and output in the longer run, it is the reallocation of resources across sectors that is critical. This problem warrants attention in Bulgaria. I. PATTERNS OF OUTPUT GROWTH IN 2000-2005

2.3 Services and manufacturing were the main sectors driving growth (average annual rate of 4.6 percent) in Bulgaria during the period 2000-2005 (see Figure 2.1, left panel). Both market services (including trade and transport) and non-market ones, constituting together about 60 percent of output, were important contributors to the expansion of the service sector. Unsurprisingly, agriculture was the most volatile sector: it recorded both strong downturns (in 2000 and 2005) and upswings (in 2002 and 2004). On the whole, the decreasing role of agriculture, and the rising role of services are bringing Bulgaria slowly closer to the economic structures prevailing in the rest of the EU. 2.4 Consumption and investment led growth on the demand side, while the contribution of net exports was mostly and increasingly negative (see Figure 2.1, right panel). Relatively strong contribution from the change in inventories, especially in 2005, resembles the experience of several EU8 countries.21 Bulgaria’s recent EU accession is expected to give a further boost to Bulgaria’s exports owing to improved market access, but also raise the risk of increased imports. That could further aggravate the external imbalances, unless a significant portion of the imports are investment goods that would help improve the competitiveness of firms operating in Bulgaria in the medium term.

21

For example, Poland had intensive accumulation of stocks in 2004, and massive de-stocking a year after EU accession, which had a large impact on GDP growth volatility.

13

Figure 2.1: Contribution to Output Growth in Bulgaria 2000-2005, percentage points Sector composition Demand-side composition
10 8 6 4
0

Agriculture and forestry Mining and quarrying Manufacturing Construction Elect., gas and water supply Services Value Added

15

10

Consumption Gross Investment Change in Inventories Net exports Statistical discrapency GDP

5

2 0 -2 2000 2001 2002 2003 2004 2005
-5

-10 2000 2001 2002 2003 2004 2005

Sources: NSI; and Bank staff calculations.

II.

GROWTH ACCOUNTING

2.5 As in other post-socialist transition countries, also in Bulgaria early gains in growth were driven solely by total factor productivity (TFP) improvements22, but since 2003 expansion in employment has significantly contributed to output growth (see Figure 2.2). TFP grew at almost 6 percent annually in the period 2000-2002, but decelerated sharply to 2.2 percent per annum during 2003-2005 (Figure 2.3).23 The growth accounting method was used to identify the contribution of different factors of production to overall growth.24 The results also indicate that capital contributed negatively in 2000-2002, but had a marginally positive impact on output growth in 2003-2005.25 This is in contrast to other transition countries, where capital contributed significantly to output growth. The example of Poland is depicted in Figure 2.2 (right panel).

22

Growth in TFP is usually attributed to factors such as improvements in human capital, research activity, foreign trade, reallocation of production factors, and “catching up”. See for example, Timmer and Szirmai (2000), and Miller (2003). Other variables that have been found to be important are demography, macroeconomic volatility, and structural changes such as deregulation or privatization. See for example, Hyeok and Townsend (2004), Escribano and Guasch (2005). In Bulgaria, casual observation of the correlations (at a sector level) between TFP growth and FDI concentration or share of export sales in revenues suggests that they are positive..

23

The TFP decline in 2003 is an anomaly. Since TFP is calculated as a residual, its drop in 2003 resulted from an increase of employment that was stronger than the increase in output. This sudden expansion in employment was largely supply-driven, since it was almost certainly due to the launch of the subsidized job-creation program “From Social Assistance to Employment”, introduced in late 2002 (see Chapter 4). After that, growth in employment was driven by demand, with the number of people in the employment program actually declining. Output growth (value-added) was decomposed into (i) the growth in the factors of production (capital and labor), and (ii) a “Solow” residual, termed Total Factor Productivity (TFP) growth. See Annex 1 for the methodology. This result holds even if one takes into account a possible underestimation of the real growth of the capital stock..

24

25

14

Figure 2.2: Decomposition of Value-added Growth by year (%; contribution of L, K and TFP sum up to 100%) Bulgaria 2000-2005 Poland 1996-2004
150 120 90 60 30 0 -30 -60 2000 2001 2002 2003 2004 2005 TFP Labor Capital

200 150 100 50 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 -50 -100 TFP L K

Source: Bank staff calculations.

Note: L-labor; K-capital.

Figure 2.3: Decomposition of Value-added Growth and Growth of Its Components in Bulgaria by sub-period Growth rates (including remuneration of factors) Decomposition of output growth
120 2.6 90 60 81.7 30 0 -30 2000-2005 44.2 -16.3 -5.1 2000-2002 2003-2005 15.7 121.4 Capital Labor TFP 9.9 45.8

35 32.3 2000-2005 30 25 20 15 10 5 0 -5 VA VA L K TFP 4.5 0.7 14.5 25.7

2000-2002

2003-2005

17.9 15.5

6.8 1.4 -0.7 VA L K K TFP

6.6

-2.2 L

Source: Bank staff calculations.

Note: VA–value added, L-labor; K-capital.

III.

OUTPUT GROWTH AT THE SECTOR LEVEL DURING 2000-2005

2.6 The analysis of output growth across 28 sectors reveals that growth in value added26 was most rapid in export-oriented manufacturing industries. TFP growth was the main contributor to value added growth in most sectors. Only a few relied on factor accumulation, and the reallocation of production factors across sectors played only a minor role. 2.7 This section first examines the trends, by sector, of value added, employment, investment, and productivity growth using the growth accounting framework. After that changes in productivity—both labor productivity and TFP—are decomposed into effects arising from reallocation of resources across sectors, and those due to within-sector productivity growth.

26

Owing to data availability, value added instead of output time series were used in the analysis.

15

TFP

A.

Value-added and TFP Growth by Sectors

2.8 Value added increased in real terms at an average rate of 5.4 percent during 2000-2005, with slightly faster average growth in 2003-2005. During the period 2002-2005 value added rose particularly fast in select manufacturing sectors, financial intermediation (+100 percent cumulatively), trade and repair (+69 percent), and other services (+69 percent). The cumulative 6-year output growth was most remarkable in manufacturing (+162 percent), textiles (+134 percent), non-metallic minerals (+134 percent), electrical and optical apparatus (+125 percent), and wood products (+113 percent)—see Figure 2.4 and Annex Table 1 for details. However, these rapidly growing sectors constituted a rather small share of the overall output (see Figure 2.5), so their overall impact is still small. Figure 2.4: Cumulative Value-added Growth by Sector in 2000-2005, %
180 150 120 90 60 30 0
ne r a gy co gric mat an ke ult . d s an ure oc d fu ia e pu ed l wo l bli c a re ucat rk dm al ion es ini str tate ati ele o cti cit che foon y, mi d ga ca s, w ls ba TO ater sic T me AL m ho min con achi tals tel in st ne tra s a g e ruc ry ns nd x. tio po rt res ene n an tau rgy dc ran om oth ts m er tra uni pape co mm tr ns cat r ad po io /so e rt e n cia and q u l/p ers repa . fin ru . S ir an bb e cia er lea rv. l in and th ter pl er oth me as er dia tic no tio n-m ele n eta ctric woo lic al e d ma mi qu nu ne . fac r tur tex als ing tile n.e s .c.

Figure 2.5: Structure of Value added by Sector in 2005, %
16 14 12 10 8 6 4 2 0
lea t he r r tra mi ubb nsp woo o nin er d an rt eq m a g of d p u. nu en l fac erg astic t ur y m oth ing at m er n. e . no inin . n-m g p c. eta ex. e aper lic ne mi rgy ele c t r ne r ica als oth c le er co hem qu. co ke i mm an cals d /so cia mac fuel l/p hin ho e e tel s a bas rs. S ry nd ic m ... res et he alt tau als ha ran nd so texti ts cia les lw ork e fin lect an icit edu foo d cia y, c l in gas atio ter , w n me at pu bli co dia er c a ns tru tion d tra tra mini ctio ns de str n po rt a an atio d n nd co agri repa mm cu ir un ltur e i rea catio le n sta te

-30

mi nin g

of e

Source: NSI, Bank staff calculations.

2.9 Employment growth (Figure 2.6) and structure (Figure 2.7) largely mirrored growth and structure of value added, with important exceptions of real estate and public administration. Also, in 2005 agriculture still employed almost a quarter of the entire labor force in Bulgaria, and the number of those working in the sector had hardly moved since 2000. Figure 2.6: Cumulative Employment Growth by Sector in 2000-2005, %
60 50 40 30 20 10 0 -10 -20 -30 -40 -50 -60
mi nin co g o ke f e an ne d f rg ue ym l a tra che ns mic t. po al s mi ba r nin sic t eq g e me u. x. t en als he ma erg alt y ch ha o nd ed iner tra ther so uca y ns no po n- ele cial tion m rt an eta ctric work d c lic al om mi eq mu ner u. nic als ele cti ati cit on y, ga fo s, od wa ag ric ter ult ur pa e p fin TO er an TA cia c l i on leat L oth ru nter stru her bb m c er er edi tion co an ati mm d p on /so las cia tic l/p ho ers wo tel . S od sa er nd tex v. r ma trad esta tile u pu nufa e an ran s bli ctu d r ts c a rin ep dm g air ini n.e str .c. rea atio n le sta te

he alt h

Figure 2.7: Structure of Employment by Sector in 2005, %
25 20 15 10 5 0
co k t e an d m ra mi inin nspo fue nin l r g g o ex . t eq u fe en . ne e rg y rg y rub ma be t. ra nd woo ot h pla d er s no lea tic n-m eta chem ther lic i ca mi ma ne ls nu r al fac pa s tu fin an ele ring per ci a ctr n.e ele l int ica .c. cti erm l eq cit y, edia u. ga tio ba s, w n ho sic ate tel r m sa oth ma eta nd er ls c co res hin er y mm tau /s r an pu ocia ts b he lic a l/per foo alt d m s. S d ha ini er v nd s so trat . io c co i al w n ns tru ork tra rea ctio ns le n po st rt a tex ate nd co edu tiles m c tra mun atio n de ic an atio d n ag r e p a ri c ir ult ure

Source: NSI, Bank staff calculations.

Source: NSI, Bank staff estimations.

2.10 Net investment was positive in over half of the sectors, with strongest increases in manufacturing of coke, refined petroleum product, nuclear fuel, hotels and restaurants, and trade and repair. The rate of increase in the overall capital stock was modest (2.3 percent cumulatively). Capital stock shrank significantly in non-market services (education, health and social work, public administration; compulsory 16

social security) and mining and quarrying of energy producing materials (Figures 2.8 and 2.9). However, since estimates of capital stock are rather uncertain, trends in net capital growth should be interpreted with caution. Figure 2.8: Cumulative Net Capital Real Growth by Sector in 2000-2005, %
40 30 20 10 0 -10 -20 -30 -40 -50 -60 -70 -80
he alt pu h an ed d b mi lic a soc ucat nin dm ia ion g o in l wo f e istr rk ne ati rg o ch y m n e a rea mica t. tra l e ls mi ns sta po elec ning te rt an ticity ex. pape d c , g en r om as erg fin mu , w y an n ate cia l in ma icati r ter ch on ele med iner ct ia y ba rical tion sic eq m e u. ma t oth lea als nu er fac t co tur TO her mm ing TA /so n.e L oth cia .c er l/p no ers foo . n-m ag . Se d eta ri rv. lic cul mi ture ru ne bb ra er a te l s tra nd xtile ns pla s co port stic ns eq tru u. ho ct tel trad s a e a w ion nd nd oo res re d co tau pair ke ra an nts df ue l

Figure 2.9: Structure of Net Capital by Sector in 2005, %
25 20 15 10 5 0
ed ma uc nu ati f ru actu lea on bb rin th er g n er a he alt tra nd p .e.c. h a ns la nd po stic so rt e co cial qu. k w ele e an ork ctr d f mi ica uel ni n le go qu . mi f en nin er woo g e gy d x. ma t e ma ner . gy c ch hine em ry oth fin ica a er co ncia pa ls mm l in p /so ter text er cia me iles l/p dia tio e ba rs. S n sic er oth v er ag met . no ric als n pu -met rea ultur l b ho lic alic esta e tel adm min te sa nd inis erals res trat tau ion ran ele ts tra cti con ns cit str food po y, uc rt an trad gas, tion d c e a wa om nd te m u re p r nic air ati on

Source: NSI, Bank staff calculations.

2.11 During 2000-2005, TFP grew most rapidly in several export-oriented manufacturing sectors and, surprisingly, in education. This is likely due to data problems in the education sector: it is not clear how to properly measure value-added in education, and there may have been an overestimate in the decline of the capital stock in education. Overall, TFP growth accounted for the bulk of the real output increase in Bulgaria (81.7 percent), while labor accounted for 15.7 percent, and capital accumulation for less than 3 percent. If education is treated as an outlier, TFP increased more in manufacturing branches than in services (see Figure 2.10 and Annex Table 1 for details). Among the five sectors with the fastest TFP growth were the modern industrial sectors, such as manufacturing of electrical and optical equipment (+146 percent cumulative growth), and manufacturing of transport equipment (+87 percent). TFP growth was particularly rapid during the early years, reflecting labor shedding and weak investment. Notably, TFP decreased in sectors that are hardly exposed to foreign competition. These were real estate, renting, business activities, agriculture, hunting, forestry, and fishing. These sectors recorded TFP declines of 1316 percent over the period (Figure 2.10). Figure 2.11: Growth Rates of Value added and Its Components, % (including remuneration of factors)
8 6 4.5 4 2 0 -0.6 -2 2000 -4 VA L K TFP VA L K TFP VA L K TFP VA L K TFP VA L K TFP VA L K TFP 2001 2002 2003 2004 2005 4.6 3.8 3.3 7.9

Figure 2.10: Cumulative TFP Growth by Sector in 2000-2005, %
160 140 120 100 80 60 40 20 0 -20
rea ho le tel s s a mi and gric tate nin res ultu go f e taura re ne rg nts ym at. tra de an foo dr d ele ep air he ctici alt T t h a y, ga OTA nd s L so , wa oth cia ter er pub l co lic cons wor mm ad k t /so min ructi cia ist on l/p rat ers ion .S erv . lea ru the bb r er an pap tra d p er ns po ma lasti rt a c nd cok chin e co e a mm nd ry un fue ica l tio mi bas n nin ic g e met a x. en ls erg fin y an cia w l in che ood ter mi me cal s dia tio n ma tra t nu nsp extil fac ort es oth tur eq er ing u no n. . n-m eta edu e.c. lic cat mi ion ele ne r ctr ica als le qu .

Source: NSI, Bank staff calculations.

17

2.12 Growth in productivity was in part due to exposure to foreign competition through FDI and growing integration with EU. Evidence of the importance of openness is that FDI and exports were both positively and significantly correlated with TFP growth at the sector level (Figure 2.12). Owing to data constraints it was not possible to compute the correlation between TFP growth and innovation. Figure 2.12: Cumulated TFP Growth and Average FDI-to-Capital Stock Ratios in 2000-2005 and Share of Exports in Sales by Sector TFP growth and FDI-to-capital stock ratio, % TFP growth and export-to-total sales ratio, %
160 140 120 100 TFP growth 80 60 40 20 0 -20 0
agriculture real estate manufacturing n.e.c. financial transport equ. textiles wood intermediation transport and mining basic metals coke and fuel machinery rubber and plastic communication paper leather other comm/social/pers. Serv. construction electicity, gas, water trade and repair hotels and restaurants chemicals electrical equ. other non-metalic minerals

160 140 120 TFP growth 100 80 60 40
food

electrical equ. other non-metalic minerals manufacturing n.e.c. transport equ. textiles mining ofwood chemicals nonbasic metals energy machinery rubber and plastic leather

paper

20 0
100

electicity, gas, water food

20 40 60 80 FDI/capital stock, average from 2000-2005, %

0

20 40 60 Share of exports in total sales, Jan-Sep 2006

80

B.

Decomposition of Productivity Growth

2.13 Productivity growth can be decomposed into effects arising from reallocation of production factors across sectors, and those coming from within the sector. The purpose of such decomposition is to distinguish the impact of “structural changes” in the economy from the impact of “intrinsic” productivity growth. In the case of aggregate labor productivity, one can distinguish three separate effects: (i) a static shift effect--the effect of reallocation of labor towards sectors with above-average initial level of labor productivity; (ii) a dynamic shift effect--the effect of reallocation of labor towards sectors with higher growth in labor productivity; and (iii) a within-sector growth effect--gains in labor productivity achieved through means other than reallocation of labor, including increases in the capital-labor ratio within the same sector. Along the same lines, aggregate TFP growth can be decomposed into two effects: (i) an intra-sector effect--assuming constant factor-shares; and (ii) a total reallocation effect (TRE)--resulting from shifts of labor and capital between sectors. TRE is measured as the difference between aggregate TFP growth and output-weighted TFP growth at the sector level (see Annex 3 for “shift-share” methodology). Labor Productivity and “Shift-Share” Analysis 2.14 By 2005, the highest levels of labor productivity were recorded in manufacturing of coke, refined petroleum products, and nuclear fuel, and financial intermediation, real estate, renting and business activities. Growth in labor productivity in various sectors during 2002-2005 and the resulting levels of labor productivity in 2005 are presented in Figures 2.13 and 2.14, respectively (details in Annex Table 2). In most cases, strong labor productivity growth resulted in above average labor productivity levels. Unsurprisingly, the lowest productivity levels remained in agriculture, forestry, fishing, leather industry and textiles. During 2000-2005, labor productivity decreased only in three sectors: (i) real estate, renting and business activities; (ii) public administration and compulsory social security; and (iii) agriculture, hunting and forestry and fishing.

18

Figure 2.13: Cumulative Labor Productivity Growth by Sector in 2000-2005, %
175 150 125 100 75 50 25 0
pu bli c a re dm al e ho ini sta tel st te he s a alt nd agri ratio h a re cu n nd sta ltur tra soc uran e de ial t a n wo s d r rk ep ele air cti foo cit oth y, er ga TOTAd co s mm ed , wat L mi /soc cons ucat er nin ial tr ion g o /pe uct f e rs. ion n e Se rg y rv . t ra ns m po ru b pa at. rt a be pe nd r co and leath r mm p er fin an un last cia ica ic l in ter tex tion me til e ma diati s ma ch on nu in fac tur w ery o i mi ba ng n od nin sic .e g e me .c. x. tal c en s co hem ergy ke oth ica tra an er n s d ls no n-m elec port fuel eta tric equ lic al e . mi qu ne . ral s

Figure 2.14: Labor Productivity Levels by Sector in 2005 (economy-wide average =100%)
1000% 900% 800% 700% 600% 500%
168% 175% 254% 391% 965% 59% 38% 39% 48% 59% 60% 64% 65% 67% 74%

-25

100% 0%

Source: NSI, Bank staff calculations.

Source: NSI, Bank staff estimations.

2.15 Reallocation of labor towards more productive sectors played only a small role in shaping overall labor productivity growth, compared to the “intrinsic growth” effects (Figure 2.15). This is similar to the pattern observed in Poland during 1996-2003 (see Figure 2.16). In Bulgaria, the static effect was positive in 4 of the 6 years covered by the analysis, which means that employment shares grew in sectors with high initial productivity levels. Over the 6-year period this effect accounted for 27 percent of the total labor productivity growth of 24 percent. By contrast, the dynamic effect was negative throughout the period. This reflects the “structural burden” of the transition economy, in which sectors with rapidly growing productivity were actually shedding labor. The static and dynamic effects were usually acting in opposite directions, with the former slightly stronger. The within growth effect was robust, positive, and dominated the other two, with the exception of the unusual 2003, in which all three of them were negative (see earlier analysis). This may reflect not only labor productivity gains (for example, improvements in labor utilization), but also the flow of capital towards more productive sectors.27 Figure 2.15: Shift-Share Analysis of Labor Productivity Growth for Bulgaria 2000-2005, %
10 8.3 8 6 4.3 4 2 0 -2 2000 2001 2002 2003 2004 2005 4.6 3.5 3.5 I. Static shift effect [LP(base)* d(S)] II. Dynamic shift effect [d(LP) * d(S)] III. Within growth effect [d(LP) * S(base)] Labor productivity growth

ot he rc

30 24.1 24 18 12 6 0 -5.6 -6 2000-2005 23.6 6.4

Note: The effects I-III may not sum up to the overall labor productivity growth because of rounding. LP–labor productivity; base–base year; S–labor share; and d (…) – change between base and final year. Source: Bank staff calculations.

27

However, lack of change of the alpha-coefficient value (standing for remuneration of labor), which stayed steady at 0.69 between 1999 and 2005 (see Annex Table 2), and the results from the TFP decomposition exercise, suggest that the impact from the change of the capital-labor ratio in sectors was limited.

19

ag ric ul tu m le re /s at oc he ia tra l/p text r de ers ile he an . S s al d erv th re an pa d so w ir m ci oo al d ho anu te fa ed wo ls ct uc rk an uri a ru d r ng tion bb es n. er ta e.c an ura . d nt pl s as ti m fo c ac o hi d ne TO r y T el ec p AL tra tric ape ns al r ot eq he p ba or u. rn si t e on c q m -m con me u. in et s ta in a tr l pu g o lic uct s tra bl f e min ion ic n e ns ad erg ra po m y ls rt in m an is at d co ch trat . m mm em ion el inin u ic ec g ni al tic e ca s ity x. tio fin , g en n an as er ci al re , w gy in a at te l e er rm st co ed at ke ia e an tion d fu el om

I. Static shift effect [LP(base)* d(S)] II. Dynamic shift effect [d(LP) * d(S)] III. Within growth effect [d(LP) * S(base)] Labor productivity growth 18.2 3.8

87%

88%

94%

200%

100%

105%

116%

15.9

119%

120%

124%

128%

132%

300%

5.0

216%

223%

400%

1.2 5.2 -1.0

-1.6

2000-2002

2003-2005

303%

Figure 2.16: Shift-Share Analysis of Labor Productivity Growth for Poland 1996-2003, %
9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 -1.0 1996 1997 1998 1999 2000 2001 2002 2003

50.0

Within growth effect [d(LP) * S(base)] Dynamic shift effect [d(LP) * d(S)] Static shift effect [LP(base)* d(S)]
30.0
37.6

Within growth effect [d(LP) * S(base)]
40.0

Dynamic shift effect [d(LP) * d(S)] Static shift effect [LP(base)* d(S)]

20.0
19.9

10.0
7.2

13.9

0.0
-6.2

3.4 -1.1

1.5 -2.0

-10.0 1996-2003 1996-1999 1999-2003

Source: Bank staff calculations.

TFP and “Shift-Share” Analysis 2.16 During 2000-2005, TFP growth in Bulgaria was predominantly driven by intra-sector productivity improvements. Reallocation of resources across sectors (TRE) contributed virtually nothing. By contrast, in Poland the reallocation of resources played an important role, particularly in the second half of the 1990s (Figures 2.17 and 2.18). Figure 2.17: Shift-Share Analysis of TFP Growth for Bulgaria 2000-2005, %
9 8 7 6 5 4 3 2 1 0 -1 -2 2000 2001 2002 -0.6 2003 2004 2005 4.5 4.6 3.8 3.3 7.9
TRE (total reallocation effect) Intra-branch effect TFP growth at aggregate level

30 25.7 25 20 15 10 5 0 -5 2000-2005 -0.3 26.0

TRE (total reallocation effect) Intra-branch effect TFP growth at aggregate level

17.9

1.0

16.9

6.6 7.8 -1.2

2000-2002

2003-2005

Note: Intra-branch effect - TFP increases are weighted with value added-shares in constant prices; Reallocation effect (TRE) – the difference between total TFP growth and the intra-branch effect (the sum of TRE and intra-branch effects sum up to total TFP growth--all in logarithms). Both effects may not sum up to the overall TFP growth because of rounding. Source: Bank staff calculations.

20

Figure 2.18: Shift-Share Analysis of TFP Growth for Poland 1996-2003, %
6.0
5.3

35.0

TRE (total reallocation effect)
30.0
29.4

5.0 4.0

4.8 3.9 3.1 2.9 4.1

Intra-branch effect TFP growth at aggregate level
11.6

25.0 20.0
1.5

3.0 2.0 1.0 0.0

15.0 10.0 5.0 0.0

15.5 ` 12.1 8.2 17.8 2.2

0.8

TRE (total reallocation effect)
-1.0 -2.0

Intra-branch effect TFP growth at aggregate level
1996 1997 1998 1999 2000 2001 2002 2003

7.3

9.8

1996-2003

1996-1999

2000-2003

Source: Bank staff calculations.

2.17 These decomposition results suggest that inter-sectoral mobility of production factors (both capital and labor) is still low. This contrasts with Poland’s experience, where at least capital proved to be relatively mobile across sectors. This also raises concerns about the medium to long term growth potential of the Bulgarian enterprise sector. In the most dynamic economies growth takes place through the Schumpeterian process of “creative destruction”, in which firms either actively invest in new technologies and/or organizational change, or achieve labor productivity gains through capital-labor substitution, in the process challenging their competitors to do the same or face decline.28 The “creative destruction” process includes the firm entry and exit of firms (“churning”). To gain a better understanding of and confirm these patterns, firm level analysis is needed. The forthcoming Investment Climate Assessment, a companion piece to this report, is expected to provide that information. 2.18 Although it is encouraging that employment has been expanding and that intrinsic productivity growth at the sector level has been robust, there remains much potential for achieving productivity gains from reallocation of resources towards more productive uses. This is especially true of agriculture and the largely publicly-funded “non-market” services, such as other community, social and personal service activities, health, social work, and education. IV. CONCLUSIONS AND POLICY RECOMMENDATIONS

2.19 Bulgaria has witnessed rather robust output growth during 2000-2005. Services have been the main driver of output growth, followed by industry. On the demand side, growth came from increases in consumption and investment. Exports, while growing, were overshadowed by imports, with net exports exerting an increasingly strong drag on growth in GDP. However, to the extent that imports reflect a rise in the imports of investment goods due to strong growth in FDI, they are likely to eventually show up in rising productivity and exports, and thus contribute to a sustained expansion of GDP. 2.20 TFP growth was the driver of output growth in most sectors, especially in export-oriented manufacturing with high concentration of FDI. TFP, in turn, was driven almost entirely by intra-sector “intrinsic growth” factors, such as organizational or managerial improvements in the utilization of labor. Almost none of the TFP improvements came from the reallocation of human and capital resources across sectors.29 This suggests that there is a lot of untapped potential, which would need to be exploited. In
28 29

See for example, Aghion and Howitt (2005).

While this report will cover some of the reasons for labor immobility—such as overregulated product markets, inflexible labor markets and skills mismatches owing to weaknesses in the education system—there are likely to be

21

particular, since in the long run it is the reallocation of resources across sectors that will be key to sustained and rapid growth in TFP, and hence GDP. 2.21 There is a potentially worrisome trend in both TFP and labor productivity (and they are related). The growth rate of both declined between 2000-2002 and 2003-2005. In the case of the rate of growth in labor productivity, its decline was a mirror image of the rapid rise in employment (the sum of the two adds up to the rate of growth of GDP). This can continue for some years, given Bulgaria’s low employment rate and the still substantial pool of unemployed (see Chapter 4). But at some point these reserves of labor will run out, and further rapid growth in GDP will depend on the rate of growth of productivity and, as was shown in Chapter 1, with productivity growth remaining at 2 percent beyond that point, Bulgaria’s convergence might come to a halt. 2.22 The results suggest that policies that support competition and encourage outward orientation, including further deregulation and reduction of the role of the state in the economy, and attraction of new FDI inflows, will play a key role in sustaining rapid productivity growth in Bulgaria. This could have a particularly large pay-off in various services and agriculture, since these sectors are traditionally less exposed to competitive pressures than the manufacturing sector. Such policies should go hand in hand with efforts to further improve the investment climate, and increase labor market flexibility. Flexibility in labor markets is crucial in aiding the process of creative destruction by shifting labor from firms in decline to those on the rise. Rather than protecting existing jobs, policies should aim at equipping workers through education to be better prepared for the changes in the demand for labor and assisting their search for new employment possibilities through active labor market policies. As Michael Spence the 2001 Nobel laureate in economics, said “institutions and policies that retard the movement of people and resources will also retard growth, and generally it is better to protect people and incomes rather than jobs and firms.” (Spence 2007) 2.23 Finally, the demographics of Bulgaria put an extra premium on raising labor productivity. As the dependence burden of the working age population rises, it will become increasingly difficult for those employed to improve their standard of living while at the same time supporting proportionate rises in the standard of living of those living on pensions. 2.24 The remaining chapters in this report address the problem of how to shift the drivers of TFP growth increasingly from intra-sector productivity improvements to gains that can be had from intersectoral allocations of factors of production, and especially labor. The next two chapters address the question of how to increase competition in the product markets and how to increase the flexibility of labor markets. They also discuss the inter-linkage of the two. Subsequent chapters address the questions of equipping the labor force with more and better education and acquisition of skills. The penultimate chapter grapples with the problem of R&D and innovation. R&D will not be the main driver of Bulgaria’s growth in the immediate future, but will become ever more important as Bulgaria approaches the technological frontiers in various sectors of the economy. As will be argued, R&D and innovation do best in a system that has a good business environment, flexible labor markets and an excellent education system that is sensitive to the requirements of business.

other reasons as well not covered by this report (such as weaknesses in transport infrastructure and housing markets). Further in-depth analysis would be warranted on this issue.

22

Annex 1:
Growth Accounting Methodology: The approach used is the standard growth accounting framework based on an aggregate production function (expressed in growth rates). This approach focuses on the supply-side of the economy (that is, the accumulation of labor and capital, as well as technical progress, as the drivers of any increase in output over time). In line with common practice, Cobb-Douglas production functions with constant returns to scale were used and factor markets were assumed to be competitive. The key parameter, the income share of labor (capital) α (1-α) was calculated from national income accounts. Because of data constrains the analysis covered the period 1999-2005, while the growth rates were available from 2000 and the 2005 data were preliminary estimates. Y = f (L, M, K) P Yt = (LL(t)α(L) MM(t)α(M) KK(t)α(K)) P (1) (2),

where Y–output; L–labor; M–intermediate materials; K–capital services; and P–productivity of inputs. Reflecting data availability, value-added instead of output time series were used. Therefore, intermediate materials were removed from the right hand side of the equation. Moreover, the assumption of constant returns to scale implies that α (L) = 1 - α(K) and P=TFP (Total Factor Productivity). VA = (LL(t)α(L) * KK(t) 1- α(L)) TFP ln(VA) = α ln(L) + (1- α) ln(K) + ln(TFP) in logarithms. In terms of growth rates (indicated by lower-case letters): ln(va) = α ln(l) + (1- α) ln(k) + ln(tfp) Thus, TFP growth is calculated as a residual (the “Solow” residual) using the equation: ln(tfp) = ln(va) - α ln(l) - (1- α) ln(k) (6) (5) (3) (4)

23

Annex 2:
Data and Methodology Data: The growth accounting exercise for Bulgaria in 2000-2005 was based on data available from the Bulgarian National Statistical Institute (NSI) in January 2007. The analysis was made at a level of desegregation corresponding to the A-31 breakdown of the Statistical Classification of Economic Activities in the European Community30. Gross fixed capital formation. A breakdown of investment by classification A-31 (29 economic sectors) is obtained using the structure provided in the NSI annual statistical survey on the expenditure on acquisition of tangible fixed assets. As for 2005 only data by 17 sectors was available (A-17), additional allocations and extrapolations were made to arrive at estimates of the fixed capital formation by the 29 sectors. Capital. The NSI does not provide estimates for gross capital and net capital (K(t)) either in current or constant prices. However, based on the information from NSI, investments in fixed assets (I(t)) and value of amortization by sector31 were estimated. The initial capital stock in constant prices was taken from Ganev, K. (2005), "Measuring Total Factor Productivity: Growth Accounting for Bulgaria", Bulgarian National Bank discussion paper DP/48/2005 (available only in Bulgarian). Since the real growth rates of capital were not available, an assumption about the capital deflator was made, connecting it with the value added deflator. As the baseline scenario, it was assumed that capital deflators were half of the value added deflators. Alternative scenarios assumed that the capital deflator increased at the same pace as the VA deflators (bottom scenario), and that capital deflator was equal to zero (capital prices are constant – cap scenario). Based on these simulations, it was concluded that under the baseline scenario the average difference between the economy-wide capital deflators and investments deflators over the period 2000-2005 was minimal. Wage bill and operating surplus of the self-employed. The share of labor costs in value added determines the key coefficient α in the Cobb-Douglas production function. The labor input in the calculations was computed as a sum of the compensation of employees and the operating surplus (OS) of the selfemployed. Doing this it was implicitly assumed that the OS is highly labor-intensive. Data on the operating surplus was available from the generation-of-income account of the NSI national accounts. It was calculated as the difference between the gross value added, and the sum of the compensation of employees and net other taxes on production. Methodology: Estimation of depreciation rates As a check, branch-level depreciation rates (d(t)) were calculated using the following formula:

30

In fact, the analysis was made on 28 sectors. This was because for many economic variables the data on the sector AA (agriculture, hunting and forestry) and BB (fishing) were available as a single aggregate. Additionally there was no data available for the sectors PP (activities of households) and QQ (extra-territorial organizations and bodies).

31

Due to the fact that as of January 2007 there were no data available on fixed capital consumption for 2005, the figures for this year are estimates based on extrapolation of the data for 1999-2004.

24

Knet(t) = Knet(t-1)* (1-d(t)) + I(t) Where K(t) denotes net capital and I(t) investment in fixed assets (all data in current prices). Annex Table 1: Capital Depreciation Rates, % 1999 2000 2001 3.2% 3.3% 3.7% Depreciation rate Source: Bank staff calculations. Estimation of income shares (α)

(7)

2002 4.4%

2003 4.9%

2004 5.3%

2005 5.8%

There are two methods of estimating α (labor share in total income) at the aggregate level: (1) econometric regression of the production function; and (2) the Solow method (based on the income-share of labor in value added). The income share of labor is the total wage bill of employees plus the operating surplus as a proxy for compensation of self-employed. α was estimated for each individual branch using the second method (because of short time-series that did not allow for econometric regression). The value of α at the aggregate level was in the range of 0.69-0.72 during 1999-2005. This is broadly in line with values normally found in the literature. The estimated value of α varies significantly across the analyzed 28 branches.

25

Annex 3
Shift-share analysis of labor productivity and TFP Shift-share analysis of labor productivity The “shift-share” analysis of labor productivity is based on the following equation: ln(va) - ln(l) = ά ln(l) + (1- ά) ln(k) + ln(tfp) - ln(l) ln(va/l) = (1- ά) ln(k/l) + ln(tfp) (8),

where VA - output, L – labor, and K – capital (small letters indicate growth rates of the variables). Growth in labor productivity contains two effects: changes in the capital/labor intensity [k/l] and increases in total factor productivity. The aggregate growth of labor productivity is decomposed into three separate effects (Peneder, 2002): Equation (9) Static shift-effect Dynamic shift effect Within growth effect
n n n ∑ LPi, by ( S i, fy − S i, by ) + ∑ ( LPi, fy − LPi, by )( S i, fy − S i, by ) + ∑ ( LPi, fy − LPi, by ) S i, by LP − LP T , fy T , by i = 1 i =1 i =1 growth ( LP ) = = T LP LP T , by T , by

where LP=labor productivity; d(LPT) = growth of LP in time T, by = base year, fy=final year; T=sum over sectors i; Si = share of sector i in total employment. Shift-share analysis of TFP In order to measure the impact of changes in both labor and capital shares in the various sectors of the economy on aggregate total factor productivity growth, the shift-share analysis of TFP was conducted. For a given sector i: ln(vai) = άi ln(li) + (1- άi) ln(ki) + ln(tfpi) The production function at the aggregate level can be rewritten as: ln(va) = ∑(VAi/VA) * ln(vai) = ∑(VAi/VA)* άiln(li) + ∑(VAi/VA)* (1- άi)ln(ki) + ∑(VAi/VA)* ln(tfpi) (11) At the same time at the aggregate level: ln(va) = ά ln(l) + (1- ά) ln(k) + ln(tfp) (12) (10)

Using equations (8) and (11) the difference between aggregate TFP growth, ln(tfp), can be calculated and value added-weighted TFP growth in branches, ∑(VAi/VA)* ln(tfpi), which is referred to as the Total Reallocation Effect (TRE).

TRE = ln(tfp ) − ∑

VA VA l VA k i ln(tfp ) = ∑ i α ln( i ) + ∑ i (1 − α ) ln( i ) i i VA VA i l VA k

(13)

26

Where: tfp = TFP at aggregate level, tfpi=TFP in sector i, aggregate value added, VA =

∑Y ,
i

l=

∑l

i

k=

∑k .
i

VA i = the share of value added in sector i in VA

TRE results from shifts of labor and capital from one sector to another: the last term on the right hand side of equation (12) indicates the effects of changes in capital shares on aggregate TFP, while the previous term indicates the effects of changes in labor shares. Links between shift-share analysis of labor productivity and TFP growth Both static and dynamic shift effects, as defined above in Equation (8), describe reallocation of labor to sectors with above-average labor productivity level or growth rates, respectively. They are included in the first term on the right hand side of Equation (12). These two effects turned out to usually act in opposite directions so they did not explain TRE. Nevertheless, the third within growth effect in Equation (8) includes labor productivity gains, which can be attributed to both the contribution of capital as a production factor, and to gains from capital reallocations from sectors with below-average to sectors with above-average TFP growth. The stronger the labor productivity growth resulting from more efficient capital utilization in the economy as a whole (measured as the sum of output-weighted TFP), the higher the last term on the right-hand side of Equation (12) and the higher the TRE.

27

Annex Table 1: Bulgaria: value-added growth in 2000-2005 and its decomposition by sector, %
Structure of VA Value Added growth and its components
VA 2000 100.0 13.9 0.9 0.7 3.6 2.2 0.2 0.2 0.7 2.1 1.8 0.4 0.7 2.2 1.8 0.9 0.4 0.4 5.1 4.6 8.2 2.1 11.5 3.0 16.9 6.9 4.2 2.5 1.6 2005 100.0 9.3 0.6 0.9 3.1 2.8 0.3 0.4 0.9 1.7 1.4 0.6 1.1 2.2 2.0 1.2 0.5 0.7 4.5 5.6 8.2 2.5 13.7 4.7 15.5 6.8 3.9 2.9 2.1 32.3 -11.5 -29.4 52.2 20.7 134.3 69.1 112.9 56.9 -2.3 24.8 91.6 133.6 46.7 48.7 124.5 65.1 162.2 25.2 49.0 68.8 55.2 59.2 100.0 16.6 18.6 9.2 1.7 68.9 L 2000-2005 4.5 1.2 -32.5 -11.0 -1.1 20.2 5.5 7.1 3.0 -44.2 -23.2 7.4 -3.5 -15.5 -9.9 -7.6 -16.3 27.4 0.1 7.2 22.9 24.4 -5.2 9.6 42.2 10.3 -9.9 -9.5 11.1 0.7 0.3 -11.3 -3.3 2.6 5.5 1.0 8.6 -5.6 3.6 -11.5 7.0 7.2 0.4 -1.7 -1.1 5.5 1.5 -2.0 5.0 10.1 9.3 -1.3 -1.0 -2.7 -23.6 -41.9 -12.6 4.3 25.7 -12.8 17.9 76.8 19.0 84.8 58.6 83.0 61.4 69.1 83.6 66.7 125.8 73.0 67.8 145.8 86.9 102.8 27.6 32.4 24.8 14.1 70.2 84.4 -15.8 40.7 108.6 28.5 45.7 14.5 -5.0 -21.7 8.8 2.7 78.3 48.9 29.6 26.5 5.0 3.8 18.3 25.1 18.2 13.0 93.6 15.3 34.5 37.1 8.8 24.7 11.7 35.4 35.7 8.3 9.8 4.9 7.3 10.2 K TFP VA L 2000-2002 -2.2 -2.6 -25.2 -9.1 -6.7 11.8 1.2 -3.1 1.7 -17.2 -17.4 -4.9 -12.9 -20.4 -7.7 -9.4 -19.7 -1.4 1.1 -7.7 8.6 4.3 -2.5 -2.9 18.8 1.7 -8.6 -7.7 -6.0 -0.7 -1.2 -5.9 -1.5 -0.3 4.3 1.9 10.6 -3.3 -2.2 -4.0 0.2 2.8 4.7 -1.8 -1.1 -0.1 -2.5 -3.7 1.9 4.4 3.9 -2.7 -1.1 -4.0 -14.7 -19.7 -7.9 -0.8 17.9 -1.3 11.3 21.6 10.4 53.0 44.4 21.0 28.7 29.8 30.9 24.2 39.6 41.8 24.6 116.1 43.8 39.9 40.8 15.7 10.1 3.1 42.8 41.3 -5.0 26.5 42.8 26.2 18.2 15.5 -6.8 -9.8 39.8 17.6 31.4 13.6 64.3 24.0 -7.0 20.2 62.0 86.8 24.1 31.6 16.0 43.1 95.0 -8.7 37.0 35.4 38.9 17.6 47.4 7.7 8.0 4.1 -5.2 53.3 K TFP VA L 2003-2005 6.8 3.9 -9.7 -2.0 6.0 7.6 4.3 10.6 1.3 -32.6 -7.0 13.0 10.8 6.1 -2.4 2.0 4.2 29.2 -1.0 16.2 13.2 19.3 -2.8 12.9 19.8 8.4 -1.4 -1.9 18.2 1.4 1.5 -5.7 -1.8 2.9 1.1 -0.8 -1.8 -2.4 6.0 -7.9 6.8 4.3 -4.1 0.1 0.0 5.7 4.1 1.8 3.1 5.5 5.2 1.5 0.1 1.4 -10.4 -27.7 -5.1 5.2 6.6 -11.7 5.9 45.4 7.8 20.8 9.8 51.3 25.4 30.3 40.3 34.3 61.7 22.1 34.7 13.7 30.0 45.0 -9.4 14.5 13.4 10.7 19.2 30.5 -11.3 11.2 46.0 1.8 23.3 32.3 -11.5 -29.4 52.2 20.7 134.3 69.1 112.9 56.9 -2.3 24.8 91.6 133.6 46.7 48.7 124.5 65.1 162.2 25.2 49.0 68.8 55.2 59.2 100.0 16.6 18.6 9.2 1.7 68.9 K TFP

Value Added growth and its decomposition (L, K and TFP sum up to 100%)*
VA L 2000-2005 15.7 -9.7 113.0 -27.7 -6.0 21.6 10.2 9.1 6.6 2553.7 -119.3 11.0 -4.2 -44.1 -26.2 -9.8 -35.5 25.1 0.3 17.4 39.4 49.7 -11.5 13.2 228.9 57.4 -117.9 -597.1 20.1 2.6 -2.3 34.5 -8.0 13.6 6.3 2.0 10.9 -12.9 81.7 112.0 -47.4 135.7 92.4 72.1 87.8 80.0 106.3 14.5 -5.0 -21.7 8.8 2.7 78.3 48.9 29.6 26.5 5.0 3.8 18.3 25.1 18.2 13.0 93.6 15.3 34.5 37.1 8.8 24.7 11.7 35.4 35.7 8.3 9.8 4.9 7.3 10.2 K TFP VA L 2000-2002 -16.3 51.7 118.9 -113.3 -260.9 19.2 3.0 -12.2 7.0 -384.4 -512.0 -30.1 -61.6 -136.6 -65.8 -15.0 -153.8 -4.8 3.4 -95.9 37.2 38.3 -8.4 -9.6 216.6 17.9 -188.4 -115.0 -64.2 -5.1 23.0 25.1 -17.8 -13.1 7.3 4.7 38.8 -14.3 -46.0 -107.9 1.0 12.2 27.5 -14.5 -1.6 -0.8 -8.6 -11.8 22.1 19.3 34.2 -9.2 -3.7 -51.4 -169.1 -460.2 -117.4 -8.5 121.4 25.3 -44.0 231.1 374.0 73.5 92.4 73.5 107.3 530.4 720.0 129.2 149.3 209.1 180.3 116.6 254.6 113.5 108.5 173.8 43.4 27.5 117.5 113.3 -65.2 251.2 748.7 332.4 172.8 15.5 -6.8 -9.8 39.8 17.6 31.4 13.6 64.3 24.0 -7.0 20.2 62.0 86.8 24.1 31.6 16.0 43.1 95.0 -8.7 37.0 35.4 38.9 17.6 47.4 7.7 8.0 4.1 -5.2 53.3 K TFP VA L 2003-2005 45.8 -54.3 98.9 -6.1 35.8 26.8 32.8 20.2 6.2 547.9 -39.4 25.3 16.3 27.3 -8.7 13.4 11.6 38.4 11.0 47.6 40.9 53.6 -17.5 31.2 242.0 105.7 -34.9 36.1 39.2 9.9 -20.7 56.5 -5.5 18.0 4.1 -6.4 -3.6 -11.4 -80.9 -44.8 13.6 6.8 -19.6 0.2 -0.2 15.4 6.0 -19.1 9.6 17.7 15.5 9.0 0.2 18.7 -143.9 -801.2 97.5 11.9 44.2 175.0 -55.4 111.7 46.3 69.1 73.6 83.4 105.2 -367.1 184.2 61.1 76.9 92.3 108.4 86.8 73.1 55.6 108.1 42.9 41.4 31.0 108.4 68.6 -160.7 138.2 936.1 -33.6 49.0 K TFP

In percent
TOTAL 1 AA Agriculture/Forestry/Fishing 2 CA Mining and quarrying (energy) 3 CB Mining and quarrying (non-energy) 4 DA Food, beverages and tobacco 5 DB Textiles 6 DC Leather and leather products 7 DD Wood and wood products 8 DE Pulp and paper; publishing 9 DF Coke, petroleum and nuclear fuel 10 DG Chemicals 11 DH Rubber and plastic products 12 DI Other non-metallic mineral products

-156.0 -2297.7 -55.5 10.4 8.2 0.9 -4.3 -1.3 10.8 1.5 -8.9 12.2 18.4 20.2 -2.8 -1.5 -17.5 -157.8 -616.8 -803.3 8.1 274.7 78.6 96.0 143.2 130.5 111.2 124.7 73.4 108.6 70.4 42.3 30.1 114.4 88.3 -111.4 200.4 834.7 1500.3 71.8

13 DJ Basic metals 14 DK Machinery and equipment n.e.c. 15 DL Electrical and optical equipment 16 DM Transport equipment 17 DN Manufacturing n.e.c. 18 EE Electricity, gas and water supply 19 FF Construction 20 GG Trade, repair 21 HH Hotels and restaurants 22 II Transport, storage and comm.

23 JJ Financial intermediation 24 KK Real estate activities 25 LL Public administration; social security 26 MM Education 27 NN Health and social work 28 OO Other activities

Note: *) If the change of value added and its components was of the same sign (either positive or both negative) the positive values in the last 12 columns inform about the same direction of change of the value added and its components (L, K or TFP). The negative values in the last 12 columns inform that the change of the value added and its respective component went in opposite directions. Sources: Bulgarian NSI, Bank staff calculations.

28

Annex Table 2: Bulgaria: working population, labor productivity and α coefficient estimates
Employment
In percent (unless otherwise indicated) TOTAL 1 AA Agriculture/Forestry/Fishing 2 CA Mining and quarrying (energy) 3 CB Mining and quarrying (non-energy) 4 DA Food, beverages and tobacco 5 DB Textiles 6 DC Leather and leather products 7 DD Wood and wood products 8 DE Pulp and paper; publishing 9 DF Coke, petroleum and nuclear fuel 10 DG Chemicals 11 DH Rubber and plastic products 12 DI Other non-metallic mineral products 13 DJ Basic metals 14 DK Machinery and equipment n.e.c. 15 DL Electrical and optical equipment 16 DM Transport equipment 17 DN Manufacturing n.e.c. 18 EE Electricity, gas and water supply 19 FF Construction 20 GG Trade, repair 21 HH Hotels and restaurants 22 II Transport, storage and comm. Structure 2000 2005 2000-2005 100,0 26,2 0,8 0,5 3,7 4,9 0,7 0,6 0,8 0,4 1,1 0,6 0,9 2,0 2,6 1,2 0,5 0,8 2,0 4,3 11,8 2,9 7,4 1,1 4,1 3,1 7,3 5,0 2,9 100,0 24,5 0,5 0,4 3,6 5,8 0,7 0,6 0,8 0,2 0,8 0,7 0,8 1,9 2,1 1,1 0,4 1,0 1,8 4,5 13,9 3,4 6,3 1,2 5,1 4,1 6,0 4,5 3,6 6,6 1,0 -50,3 -19,5 -1,8 32,2 8,6 14,0 6,4 -50,8 -36,9 12,3 -11,0 -22,4 -16,7 -12,2 -25,8 39,7 -1,0 10,2 38,4 37,5 -8,1 12,3 51,7 46,0 -15,4 -14,0 23,2 Growth 2000-2002 -3,1 -3,1 -37,3 -15,1 -10,8 18,9 2,1 -5,5 3,8 -21,0 -28,9 -8,9 -25,2 -30,0 -12,9 -14,7 -30,2 -2,2 1,3 -10,5 13,7 5,9 -3,9 -4,1 22,2 8,3 -13,5 -12,4 -7,2 2003-2005 10,0 4,3 -20,8 -5,1 10,1 11,2 6,4 20,6 2,5 -37,6 -11,3 23,4 19,0 10,8 -4,3 2,9 6,3 42,8 -2,2 23,1 21,7 29,8 -4,3 17,1 24,1 34,8 -2,2 -1,8 32,7

Labor productivity
Tho cons. BGN per worker 1999 2005 2000-2005 6,9 4,4 7,9 9,0 6,7 2,7 2,7 3,7 5,6 29,7 7,5 4,5 5,8 5,2 5,3 4,4 5,9 3,5 15,6 7,9 5,1 6,1 9,4 17,3 34,3 15,7 3,6 3,3 3,3 8,6 3,8 11,2 17,0 8,2 4,9 4,1 6,9 8,2 58,9 14,9 7,7 15,2 9,8 9,5 11,4 13,0 6,6 19,7 10,7 6,2 6,9 16,2 30,8 26,4 12,7 4,6 3,9 4,6 24,1 -12,4 42,2 88,9 22,9 77,3 55,7 86,7 47,4 98,5 97,7 70,5 162,5 88,9 78,5 155,7 122,4 87,7 26,4 35,3 21,9 12,8 73,2 78,1 -23,1 -18,8 29,1 18,2 37,1 Growth 2000-2002 18,2 -2,0 25,0 28,2 15,1 49,9 45,8 37,1 21,8 33,0 46,0 29,8 67,2 68,7 29,7 126,9 65,2 37,4 35,4 21,5 9,6 5,4 40,9 41,5 -11,4 1,4 21,2 22,5 18,7 2003-2005 5,0 -10,7 13,8 47,4 6,8 18,2 6,8 36,2 21,0 49,2 35,4 31,4 57,0 12,0 37,6 12,7 34,6 36,6 -6,6 11,3 11,2 7,0 22,9 25,9 -13,2 -19,9 6,5 -3,5 15,5

α coefficient
1999 0,69 0,83 0,77 0,90 0,59 0,57 0,57 0,57 0,48 0,68 0,42 0,51 0,50 0,70 0,60 0,54 0,56 0,64 0,78 0,74 0,65 0,74 0,59 0,69 0,86 0,18 0,61 0,58 0,72 2005 0,69 0,91 0,40 0,65 0,61 0,65 0,72 0,57 0,49 0,87 0,31 0,57 0,59 0,49 0,66 0,73 0,71 0,78 0,35 0,76 0,60 0,71 0,64 0,79 0,82 0,30 0,62 0,98 0,60

23 JJ Financial intermediation 24 KK Real estate activities 25 LL Public administration; social security 26 MM Education 27 NN Health and social work 28 OO Other activities

Sources: Bulgarian NSI, Bank staff calculations.

29

30

3.

IMPROVING PRODUCT MARKET REGULATION32

3.1. Competition in product markets provides incentives to firms to reallocate resources to more productive activities, increase innovation and technological diffusion. In the process it raises productivity. In addition, less restrictive regulations may affect positively employment by reducing the rents that some firms extract from overregulation and force firms to expand their activities.33 Unhindered entry, exit, and turnover of firms are crucial for productivity growth. As was shown in the previous chapter, in Bulgaria productivity growth has indeed been fastest in sectors most exposed to competition. 3.2. This chapter presents the rationale for improved product market regulation, and explores the links between regulation, investment, productivity, and innovation. It also looks at the effect of regulation on labor market performance and functioning, and presents analysis of the current state of product market regulation in Bulgaria in comparison with OECD countries. 3.3. The analysis shows that Bulgaria has come a long way in improving its product market regulations. In some areas it performs even better than the OECD average However, distance from the best performers in OECD and EU8 remains still large in some areas, suggesting that further efforts are needed, if Bulgaria is to achieve meaningful gains in productivity and investment. The methodology for benchmarking product market policies used in this analysis does not allow comparison of another important complement of regulatory quality—the functioning of institutions, including the judiciary. Nevertheless, a number of international comparative studies suggest that Bulgaria will need to further improve the functioning of its institutions to ensure that institutions have adequate capacity to enforce better regulations. I. A. RATIONALE FOR IMPROVING PRODUCT MARKET REGULATION Product Market Regulation, Investment and Productivity

3.4. Policies that encourage competition in product markets have been found to exert positive pressure on productivity growth, especially in countries like Bulgaria, which are far from the EU and world productivity leaders. A number of studies34 point to substantial improvements in productivity as a result of reducing product market regulations. The gains from product market reforms are found, as expected, to be larger in countries with relatively restrictive product markets, which generally tend to have lower productivity levels. The more profound the product market reforms are in low productivity countries, the faster will be the pace of convergence towards the productivity levels of the high productivity countries. Figure 3.1 plots the increase in productivity in OECD countries between two periods—1996-2003, and 1985-1995—and the restrictiveness of regulation in seven non-manufacturing sectors. As shown in the Figure 3.1, countries that regulate less tend to have higher productivity growth.

32

This chapter is in part based on the diagnostic and analytical work conducted under the leadership of the ECA Chief Economist Office. The work involved benchmarking Bulgaria and Romania’s product market policies and institutions using the OECD methodology and data for OECD countries. The results of this benchmarking exercise for Bulgaria and a detailed description of all indicators can be found in Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay, and Ilieva, The World Bank (2006). Conway, Janod, and Nicolletti (2005). Conway, de Rosa, Nicoletti and Steiner (2006), and Nicoletti and Scarpetta (2005a).

33 34

31

Figure 3.1: Product Market Regulation and Labor Productivity Acceleration

3.5. The potential impact of regulatory reforms in OECD countries is estimated by Conway et al. (2006) to range between 0.2 to 1.8 percentage points increase in labor productivity per year, depending on the size of the productivity gap and regulation gaps, provided that all countries converged to the most liberal regulatory policies (Figure 3.2). Potential gains in productivity are smallest in countries such as Figure 3.2: Increase in Average Annual Business Sector Productivity Growth over 1995 to 2003 (given a move to sectoral regulations that are least restrictive to competition in 19951)

Source: Conway, de Rosa, Nicoletti and Steiner (2006)

32

the UK and the US with high productivity levels and among the most liberal product markets. By contrast, Greece and Portugal would have increased their labor productivity by 1.8 and 1.4 percentage points per annum, respectively, between 1995 and 2003, if they had aligned their product markets to the best practice in OECD. 3.6. While data limitations do not allow the inclusion of Bulgaria in this analysis, the state of product market regulation in Bulgaria, and the level of productivity suggest that gains in labor productivity similar to those available to but unexploited by Greece or even higher could be expected, if Bulgaria embarked on profound regulatory reforms. The potential pay-off to these reforms for Bulgaria is therefore very large. 3.7. Regulation of the economy affects productivity levels and growth through several channels. Overregulation in the economy could reduce incentives for firms to increase investment and innovative practices in production of goods and services. A study by Alesina et al. (2005) looks at the effects of regulation on investment in a number of sectors—transport, communication, and utilities. The study finds that reducing barriers to entry and the extent of public ownership, has affected positively capital accumulation in these sectors. Moreover, the impact on investment was much larger where substantial improvements in regulation were implemented, whereas small steps in removing barriers to entry have not had any discernable impact in relatively restrictive economies. Empirical estimates suggest that product market reforms could lead to an increase in the investment rate on the order of 2 percentage points of GDP in the long run. This analysis provides further arguments for the need to lessen barriers to investment and entrepreneurship in Bulgaria, where investment picked up only recently and the upgrading of capital stock is still at an early stage35. While barriers to trade and investment have been reduced substantially in Bulgaria, and are comparable to the OECD average, their further relaxation together with solid improvements in domestic regulatory policy could bring substantial benefits in terms of the quantity and quality of investment, including importantly FDI inflows. 3.8. As will be shown, Bulgaria fares well on barriers to trade and investment, when compared its immediate peers—Czech Republic, Hungary, Poland, and Slovakia (hereinafter EU4) and middle-income countries (MICs) such as Brazil, Mexico, and Turkey—but needs to deepen reforms to ease barriers to entrepreneurship, if it is to achieve the average levels of OECD and EU15 countries. Barriers to entrepreneurship could constrain trade integration and divert FDI flows from Bulgaria, which would further limit the opportunities to catch up with world productivity leaders. Trade integration and FDI penetration have been found to be powerful sources of transfer of best practices and technologies. Nicoletti and Scarpetta (2003) find that easing barriers to trade and investment as well as some other domestic regulations could improve significantly FDI inward positions of OECD countries. It is estimated that on average inward FDI stocks could grow by more than 10 percent from their initial level in OECD countries. In countries with relatively restrictive product market policies--such as Greece, Italy, and France—this growth could be between 60 and 80 percent. The same would apply to Bulgaria. B. Regulation of Product Markets and Innovation

3.9. Restrictive product market policies have been found to affect negatively investments in ICT, and hence the speed of transfer of knowledge and skills to low level productivity countries. Conway et al. (2006) estimate that 12 percent of cross-country differences in ICT investment in OECD countries could be attributed to differences in product market regulation. Countries with more liberal product markets tend to have the highest share of ICT investment in total investment, while more restrictive countries are at the lower end of innovation. ICT investment in Bulgaria remains one of the lowest among the EU

35

World Bank (2005b) Bulgaria: the Road to Successful EU Integration—The Policy Agenda.

33

countries. Therefore, policies that would encourage the use of ICT could be especially beneficial for Bulgaria’s growth agenda. Higher ICT adoption, however, would require a well-educated labor force with adequate skills to produce and use ICT. Discussion on the quality of the human capital in Bulgaria follows in Chapters 5-7. 3.10. Similar analysis on the impact of product market reforms on innovation has been conducted for EU countries.36 This impact is expressed in increased incentives for firms to innovate when profits and rents of firms are squeezed by enhanced competition. Product market reforms, such as lowering domestic non-tariff barriers to trade and other barriers to the free movement of factors of production across borders, have been found to exert pressure on average profitability of firms, which has a positive impact on R&D intensity, and hence total factor productivity growth. Therefore, reforms that improve significantly product market regulation could support the increase in R&D investment in Bulgaria to levels close to the target under the Lisbon Agenda (3 percent of GDP, of which two-thirds are expected to come from the private sector). A discussion of other policies that may have a bearing on R&D in Bulgaria will be covered in Chapter 8. C. Regulation of Product Markets and Labor Market Performance and Functioning

3.11. The analysis of Nicoletti and Scarpetta (2005b) reveals that the impact of product market policies on employment (in non-manufacturing sectors) is even larger than that of labor market policies per se. High state control and barriers to entry have had a negative impact on employment rates in OECD countries. It is estimated that lessening these barriers to those in place in product markets in the best performing OECD countries, could increase employment rates between 2.5 and 5 percentage points. It should be noted however, that product and labor market reforms could explain only partially the variation in employment rates among countries. There are likely to be other factors at play that have not been included in the above analysis. II. REGULATION OF PRODUCT MARKETS IN BULGARIA

3.12. Bulgaria has gone a long way in reforming its product market polices and institutions. However, comparison with best performers in product market regulation suggests that there is no room for complacency. Reforms aimed at enhancing competition need to continue to ensure firms operate in an environment with less state involvement, lower barriers to entrepreneurship, including barriers to entry, and relying more on incentive-based regulation. Comparing Bulgaria’s performance with high and middle income countries that are members of OECD provides an idea of where the focus of reforms should be. 3.13. Product market regulation in Bulgaria has been assessed using the OECD methodology37 that provides comparative estimates on economy-wide, and industry specific regulatory provisions. The assessment of product market regulation is based on a survey of existing policies rather than on the actual enforcement, or outcomes of these policies, and covers a wide range of product market policies—public ownership, market access and competition issues, regulatory and administrative policies and processes concerning public administration, and sector specific policies in road freight, railways, passenger air travel, and retail distribution. In addition, information from World Bank’s Doing Business database was used to benchmark administrative burdens on start-up of companies.

36 37

Griffith, Harrison, and Simpson (2006).

Conway, Janod and Nicoletti (2005). For more information on the results for Bulgaria see Product Market Regulation in Bulgaria: A Comparison with OECD countries, de Rosa, Fay, and Ilieva, World Bank (2006).

34

A.

Overall Product Market Regulation

3.14. The overall indicator of product market regulation, country by country, shows that Bulgaria has still some way to go to catch up with the best performers in OECD and EU15 in terms of changing policies that restrict competition (see Figure 3.3).38 Benchmarking Bulgaria to OECD countries provides useful insights on how Bulgaria compares with the high and middle income countries. The survey for OECD countries was conducted in 2003, while all data for Bulgaria refer to 2006. This provides an opportunity to compare Bulgaria with four EU8 countries—the Czech Republic, Hungary, Poland, and Slovakia (hereafter EU4)—prior to their joining EU. Country group comparison (Figure 3.4) reveals that Bulgaria’s performance in 2006 was comparable to the EU4 average before their accession, as well as to other middle income countries (MICs) such as Brazil, Mexico, and Turkey (Figure 3.3). Figure 3.3: Product Market Regulation in 2003
3 2.5 2 1.5 1 0.5 0 Norway Italy Switzerland New Zealand Czech Rep. Germany Australia Hungary Sweden Iceland Bulgaria Greece Mexico Ireland U.S. Austria France Korea Spain Canada Luxembourg Finland Netherlands Slovak Rep. Denmark Portugal Belgium Poland Japan Turkey UK

OECD

Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay and Ilieva, World Bank, 2006. Note: the values are for 2006 for Bulgaria and for 2003 for all other countries. The indicator ranges from 0—least restrictive, to 6—most restrictive.

3.15. However, the gap between Bulgaria and other countries may be larger now, if these countries have further reformed their product markets since 2003, and have kept up the trend observed since 1998. Between 1998 and 200339, OECD countries implemented a number of reforms, which led to improvements in the overall product market indicator by close to 30 percent on average (Figure 3.5). These reforms focused on price liberalization, removing barriers to trade and investment, easing the licensing and permits systems, and reducing direct control of state over business enterprises. Countries with more restrictive policies—including the Czech Republic, France, Greece, Hungary, Italy, Korea, Mexico, Poland and Turkey—made substantial progress in deregulating their economies. Bulgaria’s most immediate peers—such as the Czech Republic and Poland40--focused on reducing economic regulation by limiting state control over businesses, while progress in easing administrative regulation was more limited. All countries substantially reduced barriers to trade and investment.
38

The indicators were calculated on the basis of the qualitative and quantitative information obtained from survey answers, which were coded and normalized over a scale of zero to six, with 0 reflecting least restrictive and 6 most restrictive regulations. Two surveys have been conducted so far with data for 1998 and 2003. Benchmarking product market regulation has proved to be a useful tool for monitoring performance of policies and institutions in OECD countries, for identifying gaps, and thus exerting peer pressure on member states. There are no data for Slovakia for 1998.

39

40

35

Figure 3.4: Product Market Regulation, Country Groups
3.0 2.5 2.0 1.4 1.5 1.0 0.5 0.0 Slovak Rep. EU15 Czech Rep. Bulgaria EU4 Hungary Poland 2.8

OECD
1.4

2.0 1.7 1.8

2.0

Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay and Ilieva, World Bank, 2006. Note: the values are for 2006 for Bulgaria and for 2003 for all other countries. The indicator ranges from 0—least restrictive, to 6—most restrictive.

Figure 3.5: Product Market Regulation in OECD Countries, 1998 and 2003
4.5 4 3.5 3 2.5 2 1.5 1 0.5 0 New Zealand Luxembourg Slovak Rep. Germany Australia Hungary Norway Finland Austria Turkey Italy Sweden Iceland Switzerland Canada Netherlands Denmark Portugal Belgium Czech Rep. Greece Mexico Poland Ireland Japan Korea Spain UK France U.S. 1998 2003 1998 OECD average 2003 OECD average

Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay and Ilieva, World Bank, 2006. Note: The indicator ranges from 0—least restrictive, to 6---most restrictive.

3.16. To better understand the divergence of performance among countries the overall indicator of product market regulation is decomposed into three broad indicators: (i) barriers to trade and investment; (ii) barriers to entrepreneurship; and (iii) state control. In the next sections, a comparison of Bulgaria’s performance with other countries is made both using these broad indicators as well as some of their subcomponents. B. Barriers to Trade and Investment

3.17. Bulgaria has succeeded in reducing most of the barriers to trade and investment faster and further than its peers— other MICs and EU4 prior to their accession to the EU. The indicator measures barriers

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to foreign trade and investment in the form of tariffs or other regulatory barriers to trade, legal restrictions on foreign ownership, and discriminatory procedures against foreign investors. In this area Bulgaria is close to the average OECD level, and performs even better than the other MICs and EU4 (Figure 3.6). Figure 3.6: Barriers to Trade and Investment
2.5 2.0 2.0 1.6 1.5 1.0 0.5 0.0 EU15 Czech Rep. OECD Bulgaria Hungary EU4 Slovak Republic MICs Poland 0.9 0.7 1.0 1.3 1.4 1.6 2.4

Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay and Ilieva, World Bank, 2006. Note: the values are for 2006 for Bulgaria and for 2003 for all other countries. The indicator ranges from 0—least restrictive, to 6—most restrictive.

3.18. Easing barriers to trade and investment has translated into improved integration of Bulgaria with global economy. Bulgaria’s trade of goods and service has grown rapidly over the last five years to reach the levels of the most integrated EU8 (Table 3.1). In 2005, Bulgaria’s total foreign trade accounted for close to 140 percent of GDP. Integration in goods has been expanding on the back of rapidly expanding imports, while the growth of merchandise exports has been more gradual. Trade integration in services has been advancing more rapidly than in goods, and is the second highest after Estonia among the new EU member states. Services have also attracted the largest share of foreign direct investments (FDI) in the country—about 80 percent of the total stock—mainly in ICT - using and producing sectors, such as financial intermediation and telecommunications. The total stock of FDI in Bulgaria more than tripled in euro terms between 2000 and 2005 (see Figure 3.7), and in 2005 stood at close to EUR10 billion or 45 percent of GDP. More than 10,000 FDI enterprises operate on the territory of Bulgaria, and employ more than 255,000 employees, which accounts for close to 12 percent of the total number of employees under labor contract. 3.19. Looking forward, strong FDI inflows will be instrumental in ensuring continued macroeconomic stability, and sustained productivity growth. FDI inflows have provided ample coverage of the rapidly growing external current account deficits in Bulgaria, and so far supported the strong increase in private investment. To continue the trend in an environment in which few enterprises remain to be privatized will take further improvements in the business climate. Attracting FDI with further cuts in corporate income taxation has been exhausted, as Bulgaria levies one of the lowest corporate tax rates in EU since 2007. In addition, Bulgarian legislation is more or less aligned with the acquis. Therefore, competition for increased FDI inflows would be increasingly based on the regulatory quality, and its effective enforcement.

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Table 3.1: Indicators of Integration: Bulgaria and EU8 (percent of GDP)
Trade integration, 2000-2005 Goods Services Total Bulgaria Czech Republic Estonia Hungary Latvia Lithuania Poland Romania Slovakia Slovenia Average, excluding Bulgaria 92 116 125 116 75 92 56 66 130 99 97 29 19 42 22 22 17 10 10 19 18 20 120 134 167 139 97 109 67 76 149 118 117 Trade integration goods & services, 2005 138 144 174 137 110 124 74 77 150 130 124 FDI stock 2005 45 44 82 49 30 29 27 26 33 10 37

Source: Eurostat, IMF, BNB, and World Bank staff estimates

Figure 3.7: Foreign Direct Investment Stock, million EUR Error! Objects cannot be created from editing field codes.
Source: Bulgarian National Bank and World Bank staff estimates

3.20. Bulgaria represents best practice in eliminating all discriminatory and other regulatory barriers to trade and investment, and fares better than OECD and EU15 on average in this area (see Figure3.8, left panel). This means that Bulgaria does not discriminate between foreign and domestic firms, both of which have equal rights to appeal and redress through competition agencies, regulatory bodies, trade policy bodies, or private rights of action. The Law on Encouraging Investment adopted in 2003 provides explicitly for equal treatment of investors. Easing other regulatory barriers includes the use of internationally certified standards and certification procedures, and engagement in mutual recognition agreements with other countries. Bulgaria has signed mutual recognition agreements with a number of countries outside EU, and was a member of CEFTA prior to EU accession, and signed free trade agreement with EFTA countries. However, further progress in aligning with international standards and certification procedures might be warranted.

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Figure 3.8: Barriers to Trade and Investment by type
1.2 EU4 Other MICs EU15 OECD Bulgaria
5 4.5 EU4 Other MICs EU15 OECD Bulgaria

1.0

4 3.5 3

0.8

0.6

2.5 2

0.4

1.5 1 0.5

0.2

0.0

0

discriminatory procedures

regulatory barriers

ownership barriers

tariffs

Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD countries, de Rosa, Fay, and Ilieva, World Bank, 2006. Note: the values are for 2006 for Bulgaria and for 2003 for all other countries. The indicator ranges from 0—least restrictive, to 6—most restrictive.

3.21. Tariff levels in Bulgaria were higher than the EU15 average, but lower than in some EU4. Only the Czech Republic and Slovakia had reduced their tariff levels prior to EU accession, while Hungary and Poland entered EU with higher tariff levels than Bulgaria had a year before accession. Bulgaria acceded to EU in 2007 with tariff levels already matching those of EU. However, Bulgaria still ranks low in terms of some aspects of trading across borders, 104th out of 175 economies according to Doing Business 2007 (World Bank (2006b)). It takes 6 to 8 days more to export in Bulgaria than in EU4 or other middle income countries, and the cost to export per container is 2/3 higher than in the Czech Republic. 3.22. Also, some foreign ownership barriers still remain in Bulgaria. They are predominantly related to restrictions on privatization of selected state-owned enterprises (SOEs) in some sectors like electricity generation, gas, and water. These restrictions apply to the sale of these enterprises both to domestic and foreign investors and take the form of statutory or legal limits to the number or proportion of shares that can be acquired by foreign investors in SOEs as well as the use of special voting rights that the state has in firms to restrict the acquisition of equity by foreigners. In Bulgaria, as in other EU countries, there is a ceiling of 49 percent of foreign ownership in the airline sector. C. Barriers to entrepreneurship

3.23. Bulgaria had comparatively lower barriers to entrepreneurship41 in 2006 than its peers in 2003. (Figure 3.9). The “barriers to entrepreneurship” indicator covers policies related to licensing and permits systems, communication and simplification of rules and procedures, general and sector specific administrative burdens, as well as legal barriers to competition, and anti-trust exemptions. Relieving these restrictions has proved to be less pronounced in OECD countries between 1998 and 2003, with progress achieved mainly in easing the administrative procedures for start-ups. The modest progress can

This aggregate indicator should be treated with caution as some of the lower level indicators have been constructed based on a methodology that is not directly comparable to the one used for OECD countries. Such indicators include administrative burdens on start-ups and to a lesser extent the sector specific administrative burdens.

41

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be explained by the fact that domestic policies are subject to a large degree of domestic discretion42 in contrast to policies governing foreign trade and investments, which are subject to international agreements including the membership of EU and WTO. Figure 3.9: Barriers to Entrepreneurship
2.5 2.0 1.5 1.1 1.0 0.5 0.0 Bulgaria Slovak Republic EU15 Hungary EU4 Czech Rep. MICs Poland 2.3 2.0

OECD
1.2

1.9 1.3 1.4 1.7

Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay and Ilieva, World Bank, 2006. Note: the values are for 2006 for Bulgaria and for 2003 for all other countries. The indicator ranges from 0—least restrictive, to 6—most restrictive.

3.24. Although ahead of its immediate peers (EU4 and other middle income countries) and of the OECD average (Figure 3.9), Bulgaria needs to deepen reforms to ease barriers to entrepreneurship, if it is to enhance further competition on the domestic market and thus maintain high productivity rates required for accelerated convergence. Bulgaria performs better than OECD and EU4 countries in eliminating antitrust exemptions to publicly-controlled firms, legal barriers to entry, and administrative burdens for corporations43. The only divergence in policies appears to be in sector specific administrative burdens (Figure 3.11). Removing barriers to competition in Bulgaria has been the result of aligning the competition legislation with the acquis communautaire. Legal barriers in the form of restrictions imposed on the number of competitors exist only in electricity generation, gas import, collection and purification of water, and the air transport infrastructure. The rest of the utility sub-sectors have been fully liberalized, with a large number of the companies in these sub-sectors already privatized, including by foreign investors. 3.25. It should be noted, however, that the product market indicators do not take into account the enforcement of competition legislation and the quality of institutions, which may differ substantially in the benchmarking countries. Moreover, comparison of Doing Business indicators on administrative barriers to start-ups suggests that while Bulgaria has achieved progress in this area, the country is still behind most of the OECD countries (Fig. 3.12) that have succeeded in reducing by half the duration of registration procedures and the cost to register a company between 2003 and 2006. Progress in Bulgaria has been more modest.

42 43

De Rosa, Fay and Ilieva (2006).

This indicator is constructed using Doing Business data which are not comparable to the data for OECD countries and therefore comparisons based on this indicator should be treated with caution.

40

Figure 3.10: Barriers to Entrepreneurship by Type
3.0 2.5 2.0 1.5 1.0 0.5 0.0 Antitrust exemptions Legal barriers License & Communication & simplif. of permits system rules & procedures Sector specific administrative burdens Administrative burdens for corporations* EU4 OECD Bulgaria

Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay and Ilieva, World Bank, 2006. Note: the values are for 2006 for Bulgaria and for 2003 for all other countries. The indicator ranges from 0—least restrictive, to 6—most restrictive.

3.26. Bulgaria has achieved progress in improving the communication of new rules and regulations but there is room for further improvements to ensure that these rules are actually being adhered to. The indicator on communication and simplification of rules and procedures refers to the existence of systemic procedures for making regulations known to affected parties, procedures in place to allow appeal against adverse enforcement decisions, programs for simplification of administrative burdens, and programs for reducing the number of licenses and regulatory regimes imposed by the national government. In Bulgaria, an amendment to the Law on Normative Acts in 2003 requires that all new regulations be communicated to affected parties through mass media or representative associations prior to their approval by Parliament. Affected parties have the right to submit comments to the body drafting the regulation within at least one month. Consultations on new legislation are organized with business associations and some of the new regulations are discussed at the sessions of the Council for Economic Growth44. In addition, the Law on Administrative Regulation and Administrative Control on Economic Activities was enacted in 2003. The Law regulates the issuance of new regulations, which can be passed only by Parliamentary approval and requires that new regulations be accompanied by an assessment of compliance costs. Specific guidelines were issued to central and municipal bodies on the design of proposed new regulatory regimes, including the identification and measurement of costs and benefits, and the establishment of a process by which new regimes evolve appropriately from concept to implementation. However, to ensure that the intended impact of these regulation is achieved, uniform application and compliance of the above mentioned legislation is warranted both in terms of the consultation mechanism with affected parties, and in terms of effective parliamentary control over the issuance of administrative regulations by different levels of government. 3.27. To align its communication and simplification policies with those of the best performers in OECD, Bulgaria would need to design and implement a program for the optimization of administrative burden imposed on firms and individuals. This program should be developed in consultation with the private sector, and aim at eliminating unnecessary or overlapping regulations, and improving the quality of existing or new regulation. It should be implemented at all levels of government, including in
44

A consultative body established in 2002 under the Council of Ministers and consists of representatives of businesses, and ministers of economy and energy, finance, transport, regional development, and labor and social policy.

41

municipalities, and should outline performance indicators with clearly defined lines of accountability. The regulatory impact assessment would provide important information about the costs and benefits of regulations and their impact on competition. The OECD Guiding Principles for Regulatory Quality and Performance45 could be incorporated in the development of this program. 3.28. Initial steps in developing a Better Regulation program have already been taken. In June 2006 the Council for Economic Growth approved an action plan for introducing best regulatory practices and assigned responsibilities among affected ministries and institutions. A working group has been established to study best practices in simplification and modernization of regulatory practices. 3.29. The achievements in the simplification of licenses and permits requirements are visible in the levels of regulatory and administrative transparency, where Bulgaria compares well with benchmark groups, ranking as well as or better than EU15 or OECD (Figure 3.10). Bulgaria has implemented a number of important reforms to bring down the number of licenses and permits at central level, although progress at local level has been limited. A special program for optimization of the centrally mandated licenses and permits has been in place since 2002. As a result of this program, 85 percent of the regulatory regimes slated for optimization have been simplified or eliminated. Moreover, these achievements have been acknowledged by businesses in Bulgaria, who saw licenses and permits as less of a problem in 2005 compared to 2002 (Figure3.11). Figure 3.11: Percent of firms indicating business licenses and permits as a problem for doing business Error! Objects cannot be created from editing field codes.
Source: EBRD-WB BEEPS, 2005.

3.30. Nevertheless, streamlining of regulatory regimes needs to continue, if Bulgaria is to align with best performers in the world. Further optimization of licensing and permits may be needed, since about a quarter of businesses indicate this still as a problem for doing business. Review of the implementation of the reform program that started in 2002 and evaluation of its outcomes is needed to assess if the program has actually led to overall reduction of licenses and permits issued by central government, and hence reduced the burden of compliance. The streamlining needs to be expanded to include also municipalities and be accompanied by training to ensure that all issuing and enforcement bodies have adequate capacity to estimate the compliance cost and propose further improvement. The enforcement of licensing and permits regimes could be further strengthened both at central government, and especially at local level. The introduction of the “silence is consent” rule for automatic licensing could also help in this regard. Further improvements in licensing regimes would reduce the compliance costs of businesses, and also bring savings from lower administrative costs at central and local government levels. Monitoring of progress in eliminating licensing, and increased reliance on consultation with private sector would be key for successful streamlining of licensing and permits. 3.31 Reducing administrative barriers to companies needs to continue to allow easier access of new entrants to the market. As mentioned in the previous section, enhanced competition would force companies to reallocate resources to more productive activities and provide incentives to firms to innovate. According to Doing Business 2007 indicators, Bulgaria has made progress in easing the startup of corporations, although it still ranks quite low on that compared to many other countries (Figure 3.12). The indicator measuring “administrative burden for corporations” is based on the Doing Business data on number of procedures and days needed to start a company, and the cost of opening a company. Bulgaria had improved on this indicator by 6 ranks between 2005 and 2006, as a result of eliminating two

45

OECD (2005).

42

out of eleven procedures needed to start a business, but still ranks quite low, scoring 85th out of 175 countries. Figure 3.12: Administrative barriers to start-ups, 2003 and 2006
Number of procedures required to register a firm
12 10 8 6 4 2 0 Bulgaria OECD EU4 2003 2006
60 50 40 30 20 10 0 Bulgaria OECD EU4

Number of days to register a firm
2003 2006

25 20 15 10 5 0

Official cost of registering a firm (% of GNI per capiata)
2003 2006

Bulgaria

OECD

EU4

3.32 To ease the administrative burden on firms, a number of reforms have been initiated. In the beginning of 2006, the National Revenue Agency (NRA) integrated the collection of taxes and social contributions, with a view of reducing the taxpayer compliance burden. There is an initiative to simplify and ease reporting requirements to taxpayers, and especially for start-ups. The new Tax and Social Insurance Procedural Code provides for reduced reporting requirements for companies and individuals— most of the information required before from tax payers is now received electronically from other institutions, which eliminated the need for separate tax and social security registration. With the launch of the NRA integrated information system in early 2007, benefits to businesses are expected to increase. In 2006, a Law on Commercial Registry was enacted, which transferred the responsibility for business registration from courts to a special enlistment agency, thus transforming business registration into an administrative process. The start-up of the new agency was delayed by more than a year, and is expected to become operational in early 2008. 3.33 Despite progress in reducing administrative burden to corporations, Bulgaria needs to further the reforms to catch up with the Box 3.1: Reforms of Business Start-ups in Europe best performing countries in terms of starting a business— Portugal is singled out as a top performer in business entry in 2005/06. The Canada, Australia, New reform took 5 months. The country managed to reduce the number of days Zealand, United States, and to register a company from 54 to 8 days within a year. This success was Ireland, where it takes 2 to 5 achieved by introducing a new fast-track registration service, which provides days to set up a business, and a choice of pre-approved names at the registry’s website. The registry deals involves fewer than 5 with tax, social security, and labor registration and publishes the procedures. The pay-off from incorporation notice website of the Ministry of Justice. Standard articles of such reforms is likely to be a association make the application fast and error-free—with no need for a substantial increase in the notary. Within a year, the number of companies using the new service rose from 12 to 75 per day. number of new businesses, improved competition not least Other countries in Europe have also focused on cutting costs or simplifying through innovation, lower registration—eliminating stamp duties in Switzerland for the first opportunities for extracting EUR1,000,000 of start-up capital; abolishing the registration fee and piloted bribes, and reduced online registration in Belgium; reducing minimum capital requirements by administrative costs to the 90 percent in Georgia; and creating a virtual one stop-shop for new business government. As mentioned in start-ups in Lithuania. previous section, the gains of
Source: World Bank (2006b) Doing Business 2007: How to Reform

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such reforms would be higher if improvements in regulation were substantial. Small steps in removing barriers to entry have not had any discernable impact in relatively restrictive economies. An example of how starting a business is being improved in other countries is presented in Box 3.1. 3.34 Entry into sectors such as road freight and retail appears to be highly regulated in Bulgaria and needs to be reviewed and eased where necessary. These regulations refer to the need to register, notify and wait for approval or license for establishing and operating national road freight business, or engaging in selling clothing or food. D. State Control

3.35 Bulgaria is far advanced in reducing state control of the economy, although benchmarking with OECD countries suggests that the reform agenda is still unfinished. The state control indicator refers to the state involvement in business operations of enterprises either through various forms of state ownership, price controls, or the use of coercive rather than incentive-based regulation both in specific sectors and in general. In Bulgaria, privatization of the financial sector has been completed, and most state-owned non-financial enterprises have been privatized, including in telecommunications and some of the utility sectors. Thus, in 2005 state-owned enterprises in the non-financial sector generated only about seven percent of GDP and employment46. Prices have been liberalized and most price controls eliminated, with the exception of controls over some staples, tobacco47, and pharmaceuticals. Despite these important reforms, Bulgaria lags behind some EU4 countries, and is far behind the EU15 and OECD averages (Figure 3.13). The largest gaps in performance (Figure 3.14) appear to be due to the state’s direct control over business, and the use of command and control regulation instead of incentive based regulation. The size of the public non-financial sector in Bulgaria remains comparatively large.

46 47

Refers to employment in state-owned enterprises only. Price controls on tobacco and tobacco products have been eliminated since January 2007.

44

Figure 3.13: State Control Error! Objects cannot be created from editing field codes.
Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay and Ilieva, World Bank, 2006. Note: the values are for 2006 for Bulgaria and for 2003 for all other countries. The indicator ranges from 0—least restrictive, to 6—most restrictive.

Figure 3.14: State Control by Type
5 4.5 4 3.5 3 2.5 2 1.5 1 0.5 0

State Control
EU4 OECD Bulgaria

Price controls

Direct control over business enterprise

Size of public enterprise sector

Scope of public enterprise sector

Use of command & control regulation

Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay and Ilieva, World Bank, 2006. Note: the values are for 2006 for Bulgaria and for 2003 for all other countries. The indicator ranges from 0—least restrictive, to 6—most restrictive.

3.36 When it comes to direct state control over enterprises, Bulgaria is on par with EU4, although the Czech Republic and Poland have eliminated any constraints to the sale of equity in state-owned enterprises. Comparison with OECD countries reveals even bigger divergence of Bulgaria from best practice in this area. The direct control over business enterprises indicator measures the existence of constraints on the sale of equity in state-owned enterprises; government’s special voting rights in privately-owned firms, and the extent to which these special voting rights are being exercised to control strategic choices of firms. The economic rationale for preserving such constraints needs to be reviewed and appropriate action taken. 3.37 The indicator that measures the extent of the use of coercive regulation rather than incentivebased regulation shows that Bulgaria is still far from best reformers in this area. The indicator measures both general and sector specific regulations in a number of sectors. The divergence of Bulgaria from best practice is due to the fact that alternative forms of regulation have not yet been considered. Alternative forms of regulations are increasingly being used in OECD countries—out of the 30 member countries, only in seven countries regulators are not required to assess alternative policy instruments before adopting a new regulation. Examples of alternative forms of regulation are shown in Box 3.2. On a more encouraging note, and in contrast to some of the OECD countries, Bulgaria does not regulate shop opening hours in retail trade, restrict road freight on backhauling, contractual carriage, and inter-modal operation, or insist on transport only for own account. Box 3.2: Alternative Policy Instruments
Performance-Based Regulations—specify required outcomes or objectives rather than the means by which they must be achieved. Thus firms and individuals can choose processes that are more efficient and less costly, which promotes the use of new technology on a broader scale. Such type of regulation is increasingly used in health, safety, consumer protection, and environmental regulation1. Drawbacks include measurement problems related to

45

desired outcomes, higher administrative and monitoring costs, and greater responsibilities for small companies to develop appropriate compliance strategies. Most countries have resorted to the use of guidelines or “safe harbors” in conjunction with performance-based regulation. Guidelines provide information on appropriate compliance strategies, while safe harbors allow the benefits of certainty of compliance associated with prescriptive regulation to be attained, while also allowing more innovative firms to take advantage of the benefits of such regulation. Process Based Regulations—require businesses to develop processes that systematically control and minimize production risks. These processes are used in businesses with multiple and complex sources of risk, where ex post testing of the product is either ineffective or expensive. Process based regulation is predominantly used in health, food safety, and environmental regulation. Co-regulation—businesses take the lead in regulation through endorsement and adherence to codes of practice. This type of regulation is highly cost effective for the government. Drawbacks include the possibility for encouraging anti-competitive activities by business or professional organizations. Economic Instruments—taxes, subsidies, tradable permits, vouchers and the like. Economic instruments allow businesses to achieve regulatory goals in the least costly manner and provide market incentives which reward the use of innovation and technical change. Information and Education—most widely used approach to regulation in OECD member states; empower consumers to adopt actions or make informed choices to change their behavior. Examples include campaigns aimed at reducing speeding when driving, anti-litter behaviors; reducing the use of drinking water; and eco-labeling of products. Guidelines—issued by regulatory authorities, setting out processes or providing interpretations to aid understanding of government objectives by businesses and citizens. Guidelines may accompany existing regulations, but also are increasingly used as stand-alone documents. Guidelines, for example, are widely used in the area of consumer protection in Denmark. Voluntary Approaches—initiated by industries, sometimes formally sanctioned or endorsed by government. They include voluntary initiatives, voluntary codes, voluntary agreements, and self-regulation. An example of a voluntary arrangement is the chemical industry’s Responsible Care Program, used in 40 countries, which promotes the adoption of rules for sound environmental management practice. Source: OECD (2002a), Regulatory Policies in OECD Countries: From Interventionism to Regulatory Governance 1 Product market regulation indicators do not include environmental regulations.

III.

REGULATION AND QUALITY OF INSTITUTIONS

3.38 While the quality of written rules and regulations matters for helping countries move closer to productivity levels of the best performers, the quality of institutions that enforce these regulations is equally important. Even if best practice rules and regulations exist in a country, divergence in implementation may favor one company or individual to another, and thus increase anti-competitive pressures in the economy. Good regulations may exist only on paper, if there is little effort in monitoring the enforcement of these regulations. Differences in implementation may exist also between different levels of government, or between different central government agencies, depending on the degree of their administrative capacity, or propensity to extract rents from enforcing regulations. The adequate functioning of the judiciary system can also encourage or discourage such variation in regulation implementation. Private sector pressure groups could exert pressure on institutions to be more effective, or tolerate the status quo, if benefiting from low institutional quality. 3.39 As shown in the previous section, Bulgaria is behind the best OECD performers and its EU peers in terms of product market regulations, which is measured exclusively by looking at the quality of written rules and regulations. A number of international comparisons point to the conclusion that Bulgaria does

46

not score well in terms of quality of institutions either. The most recent Global Competitiveness Index48 released suggests that Bulgaria is far behind all OECD and EU8 countries. Moreover, at 72nd place in 2006/07, Bulgaria has even worsened its ranking compared to 2006/05 by 11 places, which is the third largest deterioration in country rankings. On market efficiency, Bulgaria ranks 90th, much behind countries with similar per capita income levels. The indicator of market efficiency measures the degree of distortions in the economy (agricultural policies costs; efficiency of legal framework; extent and effect of taxation; and ease of starting a business), competition policy (extent of barriers to foreign trade and investment, intensity and effects of competition on the domestic market), and indicators of trade integration. In terms of quality of institutions, the performance of Bulgaria is even poorer—the country ranks at 109th out of 125 countries included in the comparison. Indicator of institutions measures the quality of public institutions (property rights, ethics and corruption, judicial independence, government efficiency, and security—reliability of police and costs to business of crime) as well as private ones (corporate ethics and accountability). Table 3.3 summarizes the results. Table 3.2: Select Global Competitiveness Rankings
Bulgaria Cyprus Czech Estonia Hungary Latvia Lithuania Malta Poland Romania Slovak Slovenia (1) 72 46 29 25 41 36 39 39 48 68 37 33 (2) 109 35 60 30 46 50 59 31 73 87 53 43 (3) 65 34 33 30 48 39 44 37 57 77 47 32 (4) 35 72 42 16 98 34 41 76 70 97 68 29 (5) 39 22 58 43 66 79 70 32 26 69 74 19 Indicator (6) 62 41 27 23 30 28 29 47 33 50 38 26 (7) 90 55 41 25 37 40 45 46 64 76 34 63 (8) 68 38 26 16 35 43 42 22 51 49 30 29 (9) 84 50 29 35 49 54 41 51 63 73 45 36 (10) 87 55 28 30 31 66 50 62 44 68 42 34

Source: World Economic Forum (2006), The Global Competitiveness Report 2006-2007 Notes: (1) global; (2) institutions; (3) infrastructure; (4) macro economy; (5) health and primary education; (6) higher education; (7) market efficiency; (8) technological readiness; (9) business sophistication; (10) innovation.

IV.

SUMMARY AND DIRECTIONS FOR REFORM

3.40 Over the last years Bulgaria has improved the regulatory environment for doing business. In some areas of product market regulation Bulgaria performs even better than the OECD average. Areas in which Bulgaria outperforms the OECD average (see Figure 3.15) are: antitrust exemptions, procedures that discriminate against foreign investment; legal barriers to entry; other regulatory barriers to trade and investment, and licenses and permits systems. Areas, in which Bulgaria is comparable to the OECD average, or at least not seriously lagging, include: price controls; the scope of the public enterprise sector, and tariffs. In all other areas Bulgaria significantly lags the OECD average (see Figure 3.16). And if one looks at Bulgaria’s performance vis-a-vis OECD’s best performers, Bulgaria lags significantly even in some areas in which it outperforms the OECD average such as licensing and permits and legal barriers. Figure 3.15: Convergence to Best Performers in Product Market Regulation: Areas of Bulgaria’s Relative Strength

48

For more information on the coverage of indicators, rankings and score, see World Economic Forum (2006) The Global Competitiveness Report 2006-2007.

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3.5 3 2.5 2 1.5 1 0.5 0 -0.5 -1

Distance from OECD average Distance from OECD best performer Distance from EU4 best performer

Antitrust exemptions

Discrim. procedures

Commun.& simplif.

Legal barriers

Regulatory Licence and barriers permits

Price controls

Scope of public sector

Tariffs

Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay and Ilieva, World Bank, 2006. Note: The values are for 2006 for Bulgaria and for 2003 for all other countries. Distances are calculated as the difference between Bulgaria’s scores and those of the comparator group. Negative values show better performance of Bulgaria, while positive values show worse performance relative to the comparator groups.

Figure 3.16: Distance from Best Performers in Product Market Regulation: Areas of Bulgaria’s Relative Weakness
4 .0 3 .5 3 .0 2 .5 2 .0 1.5 1.0 0 .5 0 .0 S ize o f public secto r O wne rs hip ba rrie rs D ire c t c o nt ro l o v e r bus ine s s Us e o f c o m m a nd & c o nt ro l re gula t io n S e c t o r s pe c if ic a dm in. burde ns D is t a nc e f ro m O E C D a v e ra ge D is t a nc e f ro m E U8 be s t pe rf o rm e r D is t a nc e f ro m O E C D be s t pe rf o rm e r

Source: OECD and Product Market Regulation in Bulgaria: A Comparison with OECD Countries, de Rosa, Fay and Ilieva, World Bank, 2006. Note: The values are for 2006 for Bulgaria and for 2003 for all other countries. Distances are calculated as the difference between Bulgaria’s scores and those of the comparator group. Positive values show worse performance relative to the comparator groups.

3.41 To align Bulgaria’s product market policies with the best performers in OECD, a well defined, government-wide reform program, enjoying high-level political commitment and developed in close consultation with the private sector, would be needed. Sizeable gaps with best performers exist in all but 4 of the 15 benchmarked policy domains (see Figures 3.15 and 3.16). To address them, both short and medium-term measures would be warranted. 3.42 In the short term, the program should aim at, in the order of priority:

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Minimize administrative burden on business, including barriers to entry of firms: To promote competition and thereby productivity growth, it would be critical to make the starting and closing a business administratively easy and inexpensive. While Bulgaria has made significant progress in reducing the legal barriers to entry, starting and closing a business is still administratively cumbersome and costly, compared to the OECD average. For starting a business, nine procedures are required in Bulgaria compared to the OECD average of six. Opening a business in Bulgaria still takes on average 32 days, while the OECD average is 16 days, and the minimum capital required in Bulgaria is about 91 percent of the GNI per capita while it is 36 percent on average in OECD countries. Bulgaria should aim to reduce these requirements at least to the average OECD levels, but preferably below. Experience shows that the impact of taking a substantial step in this area is much more significant than that of a series of small steps. The fast-track business registration service introduced in Portugal would be worth considering also in Bulgaria. Continue privatization and abolish state’s special voting rights in privatized companies: To further lessen state’s control over enterprises, the government should consider removing the remaining ownership barriers such as the sale of equity in state-owned firms, and the use of special voting rights to control strategic choices of firms. In addition, continuing with the privatization program would help increase the efficiency in the economy, and improve labor productivity. Such reforms would contribute also to the reduction of the size and scope of the public enterprise sector, as well as to the creation of a leaner and more efficient public administration. Simplify further the licensing and permit system: Even though Bulgaria’s licensing and permit system is broadly comparable to the OECD average, it still lags behind the best performers. Also, despite significant improvements, in a 2005 survey 27% of business still considered licensing and permit procedures to be cumbersome. The Bulgarian authorities may want to consider introducing the “silence is consent” rule for automatic licensing to simplify the system further and thereby facilitate business. This area of action could also include further progress in the simplification and communication of rules and regulations.

3.43 In the medium-term, the following steps could be taken to improve the investment climate in Bulgaria: • Rely more on the use of incentive-based regulation through the use of alternative instruments. Following the example of OECD countries, the government may consider requiring the regulators to assess alternative policy instruments before adopting a new regulation. The authorities could also consider implementing a “regulatory guillotine” to eliminate unnecessary regulations, which impose administrative burden on business. Improve the enforcement of regulations: The quality of written norms and regulations is important for achieving government goals and objectives, and for encouraging competition and competitiveness of businesses. Little can be achieved, however, if it is not matched by adequate quality of the institutions enforcing these regulations, including the functioning of the judiciary system in the country. Even if some regulations, or reduced forms of regulations exist on books, their actual implementation depends on the enforcing institutions, which may further increase the costs of regulation, if processes and procedures are cumbersome, or if leading to corrupt practice and anti-competitive pressures on selected firms and individuals.

49

Bulgaria does not fare well in international comparisons in the quality of its governance framework. It ranks low in terms of the quality of institutions in the Global Competitiveness Index, Transparency Index, and BEEPS indicators. Therefore, improving regulation of product markets in Bulgaria and reaping the benefits from this, would hinge upon reforms aimed at upgrading the quality of institutions. Furthering reforms in public administration and judiciary would maximize the gains from better regulation of product markets in terms of higher productivity, innovation and technological upgrade of the economy, which are key for achieving the goals of the Lisbon Agenda. 3.44 Finally, being behind on the productivity ladder and behind best performers in product market regulation, implies that Bulgaria could reap high returns from reforms aimed at liberalizing the business environment both in terms of quality of regulations and quality of regulatory authorities. These returns to the society could be even higher, if combined with reforms that increase the flexibility of the labor market that allow firms and individuals to allocate resources to their most productive uses.

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4.

IMPROVING THE FUNCTIONING OF LABOR MARKETS

4.1. Recent cross-country empirical analysis for OECD countries finds that restrictive product market policies tend to go hand in hand with restrictions in labor market policies.49 Correlation between product and labor market reforms implies that these policies are complementary, and profound reforms in one policy domain might facilitate reforms in the other, or amplify the effects of the latter. This means that Bulgaria should proceed with reforms in product and labor markets in parallel in order to facilitate productivity growth and convergence. The previous chapter examined some of the constraints in Bulgaria’s product markets. This chapter covers the issues in the labor market, taking into account the findings on productivity trends in Chapter 2. 4.2. The analysis in Chapter 2 suggests that while labor productivity and employment have been increasing strongly during 2000-2002 and 2002-2005, respectively, inter-sector mobility of labor is still low. Lack of labor mobility suggests that sectors with high levels and/or high growth of labor productivity have not been growing sufficiently rapidly--whether through the expansion of existing firms or the entry of new ones--to demand new workers. Strong growth in employment in the past fours years was instead mostly in less productive lower paying sectors. Even there, the relatively high minimum wage may have dampened the labor demand of the small vulnerable enterprises. At the same time some of the sectors are reporting shortages of relatively high skilled workers, which would suggest a supply side problem. Also, on the supply side there may exist an unemployment trap, wherein relatively high social benefits, when compared to the likely after-tax wage, discourage some workers from seeking employment. Constraints thus exist on both product and labor market sides, and they need to be tackled in parallel. I. LABOR MARKET DYNAMICS

4.3. Labor markets in Bulgaria have gone through a profound and painful transition since the start of political, economic, and social reforms in the early 1990s. As a result, employment which stood at about 4.1 million on the eve of the reforms in 1990, declined to just under 3 million in 2000.50 This job loss reflects closure of many enterprises, and “defensive restructuring” by others—a process in which redundant labor is shed in order to increase productivity. This period of “job loss” growth was followed by a period of “jobless” growth. 4.4. Bulgaria’s GDP began to grow again in 1998, but it was not until 2002 that the number of employed persons also began to rise. The employment increase since then has been substantial: about 400,000 new jobs were created during 2002-2006. Excluding the roughly 50,000 participants in the

49

See Nicoletti and Scarpetta (2005). In this paper, a summary indicator of labor market policies was estimated for OECD countries, which includes tax wedges, gross replacement rates, and employment protection legislation. The indicator of product market regulation includes barriers to entry, public ownership, market structure, vertical integration, and price controls in seven industries—gas, electricity, post, telecoms, air transport, and railways.

Based on the NSI establishment surveys and administrative records/register-based statistics. Comparable labor force survey data are available only since the beginning of 2003, at which point NSI aligned LFS to Eurostat methodologies. Data from previous years is not comparable. Subsidized employment refers primarily to the program “From Social Assistance to Employment.” Other subsidized employment programs include, inter alia, “Beautiful Bulgaria”, “JOBS”, and “Social Assistant”.

50

51

subsidized employment program (“From Social Assistance to Employment”), the net gain in jobs was about 350,000, or 12 percent of the labor force (see Table 4.1).51 4.5. Almost two-thirds of the increase in employment, however, has been concentrated in low wage, low productivity industries, such as agriculture, forestry, sub-sectors of manufacturing, construction, and trade. Employment in higher wage sectors, such as mining, electricity supply, transport, communications, and financial intermediation remained relatively stagnant. In the public sector, employment in public administration has increased by 36,600 employees, but declined slightly in education, health and social work during 2002-2006. By sectors, the share of jobs in the service sector rose from 43 percent in 1998 to 48 percent in 2005, while the share of industry fell from 31.6 percent to 27.5 percent, and that of agriculture stagnated at about 25 percent of total employment.52 These numbers probably overstate the number of people actually working in agriculture as it probably includes many who own some land and live in a rural area, but do not actually make a living from working in agriculture (for comparison, see Table 4.4 that uses the Labor Force Survey (LFS) estimates). Even discounting for that the proportion is rather high even by EU8 standards. Also, private sector employment has risen significantly from 61 percent of total employment in 1998 to 79 percent in 2005.53 Table 4.1: Labor Force Participation (LFP), Employment and Unemployment Rates (population age 15 years and over)
Labor force (1000) Employe d (1000) Unemploye d (1000) LFP Rate (%) Empl. Rate (%) Unempl. Rate (%) Employe d (1000) Incl. Subsidized Empl. (1000) Registered Unemployed (1000)

2002 Na na na na 2003 3283.1 2834.0 449.1 49.2 2004 3322.0 2922.2 399.8 49.7 2005 3314.2 2980.0 334.2 49.7 2006 3415.7 3110.0 305.7 51.3 Source: Labor Force Survey (LFS), except employment 2005, NSI 2006c), and data of registered unemployment Agency (MLSP/NEA 2006a). .* administrative data.

na Na 2979.0 42.4 13.7 3166.5 79.4 551.6 43.7 12.0 3226.3 93.6 469.2 44.7 10.1 3253.5 59.1 424.4 46.7 9.0 3349.2 47.6 356.1 data from the National Statistical Institute (NSI yearbook 2003and subsidized employment data from the National Employment

A.

Labor Force Participation and Employment Rates

4.6. Limited job opportunities during the 1990s led to a massive withdrawal from the labor force, especially among younger and older cohorts and women. According to the 2006 LFS data, the labor force participation (LFP) rate of the population aged 15–64 was only 64.5 percent, while the employment rate was 58.6 percent (51.3 percent and 46.7 percent, respectively, when measured as a proportion of all people age 15 and above).54 This is still low by any standard, but is a considerable achievement when compared to the situation in the year 2000. Comparative statistics for Bulgaria, select EU8 countries, and the EU15 average are presented in Table 4.2.

51

Almost equal employment growth is recorded by the administrative data and the Labor Force Survey (LFS), which do not distinguish between formal and informal sectors, and thus the growth is not a statistical effect of shifting employment from the informal to the formal sector.

Based on data from establishment surveys and administrative records. According to the LFS data, only 8.9 percent of the employed worked in agriculture, hunting, forestry, and fishing.
53 54

52

NSI (2000) and (2006c).

The labor force participation rate refers here to the rate among the population aged 15-64, while Table 4.1 refers to the rate in a broader population group covering 15 and above.

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B.

Informal Employment and Self-employment

4.7. The informal sector is still sizeable in Bulgaria. There are different estimates of the size of the informal sector. Data from the National Social Security Institute (NSSI) indicate that in 2006 social contributions were paid for about 2.75 million people. In the same year, there were on average 3.35 million people employed, according to establishment surveys, and 3.11 million according to the LFS data. This suggests that about one-fifth to one-fourth of employment is informal, that is, working but not making social contributions. While informal employment provides a cushion for workers who cannot find a job in the formal sector, it also leads to a loss in budget revenues. These features of the Bulgarian labor market point to various bureaucratic and regulatory rigidities, which hinder labor market adjustment, and job creation. Even in the formal sector, according to the 2005 BEEPS survey, about six percent of the workforce, and 14 percent of the wage bill was not registered with tax authorities. Table 4.2: GDP growth and labor force participation rates (population age 15-64 years), percent in 2006
Bulgaria Romania Estonia Czech Republic Hungary Poland Slovak Republic EU15

GDP, average annual growth in 2000-2006 Per capita GDP (dollars), at PPP, 2005 LFP rate Employment rate: Male Female Youth (15-24) Older workers (55-64) Hours worked per week of full-time employment** Average exit age from the labor force (years), 2005

5.6 9223 64.5 58.6 62.8 54.6 23.2 39.6 41.4

5.5 8785 63.6 58.8 64.6 53.0 24.0 41.7 41.3

9.1 16414 72.4 68.1 71.0 65.3 31.6 58.5 41.5

4.0 18341 70.3 65.3 73.7 56.8 27.7 45.2 42.7

4.8 16825 62.0 57.3 63.8 51.1 21.7 33.6 41.0

3.6 12994 63.4 54.5 60.9 48.2 24.0 28.1 42.9

4.6 16041 68.6 59.4 67.0 51.9 25.9 33.1 41.6

1.8 29332 * 71.6 66.0 73.5 58.4 40.1 45.3 41.9

60.2

63.0

61.7

60.6

59.8

59.5

59.2

61.1 (e)

Harmonized 9.0 7.7 5.9 7.1 7.5 unemployment rate*** Male 8.6 6.5 6.2 5.8 7.2 Female 9.3 9.0 5.6 8.8 7.8 Youth (15-24) 19.5 16.3 12.0 17.5 19.1 Long-term 5.0 4.3 2.8 3.9 3.4 unemployment rate**** Notes: (e) – estimate;* unweighted average for EU15 countries; ** spring 2006;*** aged unemployed 12 months and over as a percentage of the total active population Source: Eurostat online database; IMF online database; OECD 2006.

13.8 13.0 14.9 29.8 7.8

13.4 12.3 14.7 26.6 10.2

7.4 6.5 8.4 16.1 3.1

15-74; **** population 15 +

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4.8. Among the EU countries, Table 4.3: Undeclared Work in select EU countries, latest Bulgaria has the highest ratio of available data55 undeclared work (see Table 4.3). EU EU8, Bulgaria, % of GDP Select EU15 % of GDP uses the concept of “undeclared Romania work,” referring to “any paid Bulgaria 22-30 Austria 1.5 activities that are lawful as regards Czech 9-10 Belgium 3 their nature, but not declared to the Estonia 8-9 Denmark 5.5 public authorities” (EC 2004). This Hungary 18 Finland 4.2 18 France 6.5 definition excludes criminal activities, Latvia 15-19 Germany 6 and work that does not have to be Lithuania Poland 14 Greece 20+ declared. The main attraction of the 21 Italy 17 undeclared economy is financial. Romania Slovak 13-15 Netherlands 2 This type of activity allows Slovenia 17 Portugal 5 employers, paid employees, and the Sweden 3 self-employed to increase their UK 2 earnings or reduce their costs by Source: EC (2004) evading taxation and social contributions. This shifts the tax burden to registered workers, which therefore is much higher than would otherwise be the case in Bulgaria. C. Participation Rates by Gender and Education

4.9. Labor force participation of males is higher than that of females in Bulgaria. According to the LFS 2006 data, the labor force participation rate of females aged 15-64 is 60.2 percent compared to 68.8 percent for males. Employment rate for females is 54.6 percent, and 62.8 percent for males (see Table 4.4). While the unemployment rate for females is slightly below that for males, women tend to be more active than men in their search for a job through the National Employment Agency (NEA). In 2006, there were 204,600 females on the roster of NEA, and “only” 151,500 males.56 Table 4.4: Labor market participation (population of 15-64 years of age), and employment by gender, professional status, and economic sectors, in percent in 2006 (employed population 2005)
Labor force participation rate Employment rate Unemployment rate Employed population*: Total employees Employees in private enterprises Employers Self-employed Unpaid family workers Agriculture and forestry Industry Services Total 64.5 58.6 9.0 100.0 85.8 56.7 3.8 8.6 1.5 8.9 34.2 56.8 Males 68.8 62.8 8.6 100.0 83.1 57.8 5.2 10.5 0.9 10.7 38.9 50.3 Females 60.2 54.6 9.3 100.0 88.8 55.5 2.3 6.5 2.2 6.8 28.9 64.2

Notes: * employed population 15 years of age and over; 0.3 % of the total unknown. Source: Eurostat online, NSI 2006 c.

55 56

NSI estimates the proportion of undeclared work at 22 percent of GDP. MLSP/NEA 2006a.

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4.10. As expected, better- Figure 4.1: Labor Force Participation, Employment, and educated workers have much Unemployment Rates (population aged 15-64), % in 2006 Q2 more favorable employment Figure 8.1: Labor Force Participation, Employment, and outcomes. In the second quarter Unemployment Rates (population aged 15-64), % in 2006 Q2 of 2006, able-bodied population with higher education had 100 Labor force participation rate employment rate of 83 percent Employment rate 80 compared with 69 percent for Unemployment rate 60 those with upper secondary schooling, and 33 percent with 40 lower secondary education (see 20 Figure 4.1). The difference in 0 unemployment rates by the level T otal Higher Upper secondary Lower secondary Primary or lower of education is also significant. In 2006, the unemployment rate was only 3.8 percent for those with higher education, but rose to 18 percent for individuals with lower secondary education, and to over 30 percent for those with primary or lower education. The gap in employment and unemployment rates by education is significant for all age groups. D. Trends in Unemployment

4.11. Bulgaria’s labor market still has a fairly large gap between supply of and demand for labor, despite the notable improvements in the past four years. According to LFS data, the rate of unemployment was 8.4 percent in the fourth quarter of 2006. 4.12. The bulk of the unemployed are long-term unemployed, less educated, and young (see Table 4.5). In 2005, 60 percent of all unemployed Table 4.5: Number of Long-term Registered Unemployed workers had been without work for at (average per month) least one year, and 34 percent for longer 2002 Januarythan three years. Out of total September 2006 unemployed with higher education, 47 Total number (1000) 332.5 209.5 percent were out of work for more than Of which (%): 12 months. Among job seekers with Females 52.8 57.1 secondary vocational education, the Males 47.2 42.9 10.9 9.0 ratio was 49 percent, while 60 percent Youth up to 24 22.1 33.6 of job seekers with lower secondary or Persons over 50 lower education had been jobless for By professional qualification: 19.3 16.4 more than a year (II quarter of 2006). With worker specialty Specialists 10.7 10.0 Forty-four percent of the long-term Without qualification 70.0 73.6 unemployed had lower secondary, primary or lower education.57 There are By education: 3.3 3.3 indications that most of these numbers Higher Secondary vocational 22.4 19.5 have improved a little in the last few Secondary general 5.8 5.5 months.
Primary and lower 68.5 71.7

4.13.

Unemployment is high among

Source: MoLSP/NEA 2006b.

57

NSI (2006a).

55

certain ethnic groups, particularly the Roma. The Roma have the lowest employment rate at 29 percent, and the highest unemployment rate at about 70 percent.58 The Roma interviewed in the context of the JOBS (2003) program, which supports integration of Roma into the labor markets in ten municipalities, revealed that 45 percent of them had never worked, and 16 percent participated in work activities for the first time in their life through the program “From Social Assistance to Employment”.59 E. Youth Unemployment

4.14. As in other transition countries, the negative effect of high unemployment rates is especially serious and damaging for youth. On average, youth unemployment rates in Bulgaria are twice as high as overall unemployment rates (see Table 4.6), which is similar to other EU countries. Young uneducated people are in the worst situation in the labor market. This group, with no vocational education and experience, is so uncompetitive that even a considerable improvement in labor market conditions and employment growth may not improve their situation. Table 4.6: Youth Unemployment, Employment and Labor Force Participation Rates, 2005
Youth unemployment rate, % 16.5 22.3 19.3 19.4 37.8 29.9 Youth/adult unemployment ratio 2.0 2.2 2.4 2.7 2.1 1.8 Youth employment rate, % 39.7 21.6 27.3 21.8 20.9 25.6 Youth labor force participation rate, % 47.6 27.5 33.9 27.1 33.5 36.5

EU15 Bulgaria Czech R. Hungary Poland Slovakia

Source: OECD (2006), LFS 2005 for Bulgaria

4.15. In addition to high youth unemployment rates, Bulgaria has low youth labor force participation rates. At 27.5 percent, Bulgaria’s youth participation rate is fully 20 percentage points lower than the EU15 average. A significant portion of Bulgarian youth are neither working nor in school. In the age group 15-24, the rate of joblessness (the proportion of the population neither working nor in school) was 21 percent in 2004, and the rate of idleness (the proportion of the population neither in the labor force nor in school) was 14 percent. Compared to many EU8 countries, the share of early school leavers of 18 percent is quite high in Bulgaria. There are two main reasons for this. First, about 35 percent of the dropouts cited family reasons associated with economic instability, unemployment, and poverty (inability of the family to provide students with textbooks, clothes, or the need to help earn the living) as the cause for dropping out. The second most important reason, cited by 29 percent of the drop-outs was unwillingness to study.60 Bulgarian youth are not alone in their plight. The World Bank’s World Development Report 2007 on Youth noted that an increasing share of young people is facing difficulties in transitioning from education to the labor market. Primary reasons for this are poverty, poor educational background, barriers to entry in the labor market, and getting stuck in low productivity jobs.61 As the LFS data reveal (see Table 4.7), labor force participation, employment and unemployment rates among young people strongly correlate with the level of education.

58 59 60 61

World Bank (2003). MLSP (2006). MLSP (2006). World Bank (2006b).

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Table 4.7: Labor Market Participation Rates at Age 15-24 and 25-34 and the Level of Education in 2005, %
Level of education Higher Upper secondary Secondary vocational Secondary general Lower secondary Primary or lower
Source: LFS 2005 for Bulgaria.

Activity rate 15-24 25-34 71.1 88.0 48.7 80.8 61.0 84.1 36.8 74.2 9.4 63.9 18.2 40.0

Employment rate 15-24 25-34 60.5 83.3 40.2 73.8 51.4 76.8 29.0 67.6 6.0 51.6 9.1 24.9

Unemployment rate 15-24 25-34 14.9 5.4 17.4 8.7 15.8 8.6 20.0 8.9 35.7 19.2 49.9 37.7

4.16. In the rapidly changing market economies of the transition countries, an individual’s occupational future is uncertain, and the risk of a mismatch between the skills of an individual and those required by the available jobs is high. Therefore, the World Development Report 2007 recommends that these countries provide young labor market entrants with general academic skills, which will make them mobile across industries/sector and easier to employ. This is consistent with the proposed reform recommendations for the education sector in Chapters 6-7. The young are a particularly important group in Bulgaria, since they have a potentially long working life ahead of them, and the burden of financing the pensions of the rapidly ageing population will to a great extent fall on their shoulders. F. Regional Disparities

4.17. There is significant regional variation in participation, employment, and unemployment rates in Bulgaria. Table 4.8 shows labor market indicators by the urban, rural, and major regional groupings. Unemployment rates in urban areas are almost five percentage points lower, and participation and employment rates considerably higher than those in rural areas, suggesting that recent growth has been concentrated in urban areas as might be expected. The situation in the North-West region is the most difficult, although the rate of unemployment is almost as bad in the North-East region. Table 4.8: Labor Market Indicators by Geographical Groupings (population aged 15 years and over), in 2005
Total 49.7 44.7 10.1 Urban 54.2 49.3 9.0 Rural 39.2 33.8 13.7 NorthWest 40.7 35.2 13.6 North Central 46.3 41.4 10.7 Planning regions NorthSouthEast East 51.1 48.8 44.3 44.1 13.3 9.6 South Central 48.5 43.7 10.0 SouthWest 54.1 50.0 7.6

LFP Rate Employment Rate Unemployment Rate

Source: MLSP/NEA 2006a

4.18 Finer geographical disaggregation at district level show even more disparity. Variation in unemployment rates is between 2.2 percent in Blagoevgrad district (South-West), 3.3 percent in Gabrovo (North Central) and 5.4 percent in Stara Zagora (South Central), as the districts with the lowest unemployment levels, to 22.5 percent in Vidin (North-West) and 17.7 percent in Pazardzhik (South Central) as the districts with the highest unemployment levels. Although the capital city Sofia has one of the highest employment rates of 51.8 percent (second highest following Blagoevgrad district), the unemployment rate in Sofia is relatively high–7.6 percent (NSI 2006).

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4.19 Wage levels seem to respond to the demand for labor. The correlation between regional average wages, as reported to the NSSI, and unemployment rates is negative (-0.3744) and significant at the five percent level. (2005 data). Regions with low unemployment (higher demand for labor) tend to have higher wage levels. The finding is also consistent with often heard statement that wages in the private sector are rising rapidly in Sofia (south-west region) due to shortages of labor. However, there are no data available to confirm that. G. Labor Potential of the Currently Inactive Population

4.20 Bulgaria has just over 3.2 million people aged 15 years and above that are not in the labor force. Labor potential of this currently inactive population should not be ignored. Although a vast majority (85 percent) of this economically inactive population does not want to work, cannot work, or is unable to work (students, retirees, disabled, household members taking care of children or other dependants) according to the 2006 LFS, about 15 percent of the inactive population (268,000 individuals) could be considered to be discouraged workers. They would like to work and would be ready to start working, but for various reasons are not actively looking for a job. In most cases such respondents report that they have lost any hope of finding work, or do not know where or how to search. II. LABOR COSTS, WAGE DYNAMICS, AND MINIMUM WAGES

4.21 Relatively cheap and well qualified workforce continues to be one of Bulgaria’s main competitive advantages. Labor costs in Bulgaria are the lowest among EU countries, and are about one-tenth of the average hourly labor costs in EU27 countries (Table 4.9). They have also grown slowly compared to other EU countries. According to Eurostat data, Bulgaria is the only new EU member state where real labor costs decreased in 2006 compared to 2000 (see Table 4.9). Combining the low rate of growth in labor costs with the improvements in labor productivity in the last 5-6 years (see Chapter 2), unit costs of labor have grown much less in Bulgaria than among its comparators. This has helped preserve Bulgaria’s competitive edge, improved profitability and future prospects of many of Bulgaria’s enterprises, and contributed to keeping down the rate of inflation. 4.22 There is a concern, however, that Bulgaria’s competitiveness relies too heavily on low labor costs, and that Bulgaria may be locking-in into unskilled labor-intensive activities, and low productivity patterns of specialization. Low unit costs of labor are also a temporary and volatile advantage. As the labor markets in Bulgaria tighten, pressure to raise wages will mount. This could, in the future, create inflationary pressures, unless labor productivity rises at least as rapidly as wages.
Table 4.9: Labor Cost Index (2000=100)*

2005 2006 Nominal value EU27 Czech Republic Estonia Latvia Lithuania Hungary Poland Slovenia Slovakia Bulgaria Romania 119.9 141.8 163.9 163.4 127.5 161.2 136.8 143.5 157.6 132.7 281.8 123.4 150.5 191.1 201.5 151.0 175.4 144.2 152.5 170.4 139.0 339.0

2005 Deflated 106.1 128.3 137.7 133.7 121.7 121.4 119.5 109.6 118.6 101.3 121.5

2006 106.7 133.5 153.7 154.7 138.9 126.8 124.4 113.5 123.0 98.8 137.1

Hourly labor costs. EUR, 2005 … 6.56 4.71 2.91 3.62 6.57 5.78 11.49 4.59 1.61 2.38

Notes: * Labor costs include gross wages and salaries, employers social contributions, and taxes net of subsidies connected to employment;** 2003

58

Source: Eurostat online

4.23 Since 1997 real (reported) wages have increased at about the same pace as real GDP. Private sector wages are reported at 72 percent of the public sector wage level; although this is open to doubt. There are indications that actual (rather than reported) wages in the private sector are considerably higher.62 Nevertheless, the public sector seems to have become an attractive option for many, which perhaps explains the growth in employment in public administration. Whatever the case, getting better data on wages, productivity gains, and unit labor costs should be a high priority. 4.24 In Bulgaria, as in many other Central and Eastern European countries, minimum wages are set at a relatively high level, amounting to about 47 percent of the average reported wages in 2005, while for example in the United States they are at 27 percent (Table 4.10). According to the latest Eurostat data from early 2007, in relative terms Bulgaria, together with Malta, Luxembourg and Ireland, has the minimum wage above 49 percent of average gross monthly earnings. In absolute terms, however, Bulgaria has the lowest level of monthly minimum wage in EU at EUR92, and second lowest when applying Purchasing Power Parities to households’ final consumption expenditure. Nevertheless, in some low-wage sectors of the economy, such as in agriculture and forestry, minimum wage is about 65 percent of the average wage. In trade, the ratio is 60 percent.63 Such high ratios are typically more damaging for SMEs because these enterprises tend to be more labor intensive, and financially weaker. This likely contributes to keeping many SMEs smaller than they might otherwise be. It also gives them an incentive to stay in the informal sector. So, a well-intentioned policy (a high minimum wage) may well have the perverse effect of reducing the tax base, and possibly the overall level of employment.64 The reason for high minimum wages in Bulgaria seems to be that, according to the Labor Code, their level is established administratively by a Decree of the Council of Ministers--it is set centrally and at a uniform rate.65 This decision is likely to be influenced most by insiders that is those who already have a job. It is also unlikely to reflect the varying conditions faced by enterprises in different sectors and regions, or be sensitive to the preferences of certain groups of job-seekers. The process of setting the minimum wage should therefore be revisited.

62

This differential may reflect as well larger share of underreporting in the private sector than in the public sector. According to the wage survey conducted in 2006, actual average monthly wages were BGN840 in Sofia, BGN700 in Burgas, BGN600 in Plovdiv, and BGN590 in Varna (Industry Watch 2006).

63

The draft 2007 budget law envisages a minimum monthly wage of BGN170, but the threshold might be raised to BGN180 during the discussions in the Parliament. World Bank (2005b). However, according to MLSP, the social partners are consulted within the framework of the Commission on incomes and living standards under the National Commission for Tripartite Cooperation but an Agreement on Economic and Social Development in the Republic of Bulgaria until 2009 (a national tripartite agreement) does not indicate the levels of the minimum wages. Article 10.12 of the Agreement only suggests that the minimum wage should be determined after negotiations with the social partners taking into consideration the official poverty line and the average wage for the country.

64 65

59

Table 4.10: Dynamics of average wages, minimum wages, and non-taxable monthly incomes, BGN
Minimum monthly wages* 2002 2003 2004 2005 2006 100 110 120 150 160 Average monthly wages ** 258 273 292 320 343**** Average monthly wages ** 267 263 295 313 336**** Ratio of minimum wages to average wages 0.338 0.403 0.411 0.469 0.466**** Non-taxable monthly incomes*** 100 110 120 130 180

Notes: * the minimum wage is set by the decree of the Council of Ministers; ** employees under labor contract; ** according to the Personal Income Tax Act; **** January-September Source: NSSI

4.25 High minimum wages have been found to have negative effects on employment. These effects may be small in the aggregate, but significant among workers in jobs that have low productivity, since even a “minimum” wage may be higher than a particular worker’s productivity, making it unprofitable to employ him/her.66 This is particularly true of many jobs held by young people. For more experienced workers the evidence is more mixed.67 4.26 Bulgarian authorities are reportedly thinking of linking the minimum wage to the poverty line. This is generally not advisable. OECD data indicate that the relatively weak link between low pay and poverty is a rule rather than an exception.68 The main reason for this is that poverty is predominantly associated with non-employment (including unemployment), rather than with low wages. Many poor families have no one working and many minimum wage workers live in households with above average incomes. Therefore, and given that high minimum wages have negative effects on employment, linking the minimum wage to the poverty line may only exacerbate poverty and distort the labor markets. Rather than using minimum wages as an instrument to reduce poverty, it should be the social assistance system that helps those below the poverty line. III. EMPLOYMENT AND SOCIAL INSURANCE SYSTEM

4.27 Mandatory registration of labor contracts with the National Social Security Institute (NSSI) as of 2003 has led to rapid growth in the number of registered new labor contracts, and thus in revenues to the social security system (see Table 4.11). Initially, most of the increase was due to the registration of people employed in the informal sector. Later, most of the increase came from the creation of new jobs. As discussed in Chapter 1, Bulgaria is facing the challenge of a rapidly declining and aging population. This will eventually lead to an absolute decline in working age population, although for a decade or two the inevitable fall may be staved off by higher labor force participation and employment rates and, if the right measures are taken, by a diminished number of people working in the informal sector. Thus, the ratio of pensioners to insured people, which is now falling, will eventually reverse course and the burden of dependency will rise.

66 67

World Bank (2005a).

See Kertesi and Köllö (2002) for Hungary, and Gottvald et al (2002) and Eriksson and Pytlikova (2002) for the Czech Republic and Slovakia. OECD (1998).

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Table 4.11: Employed and insured population, and the number of pensioners in 2000-2006 (million; average annual)
Population 2000 2001 2002 2003 2004 2005 2006 8.170 7.913 7.869 7.824 7.781 7.740 7.699 Employed 2.980 2.968 2.979 3.166 3.226 3.276 3.349 Pensioners 2.379 2.371 2.351 2.337 2.328 2.314 2.285 Insured* 2.306 2.311 2.170 2.394 2.492 2.597 2.747 Ratio of pensioners to insured persons* 103.3 102.6 108.3 97.6 93.4 89.1 83.2

Source: NSSI; Notes: * Insured in the Mandatory Social Insurance System

A.

Unemployment Traps

4.28 High levels of unemployment and other social benefits coupled with high taxes can create unemployment traps.69 These are situations where unemployed people have financial disincentive to seek employment since the level of social benefits as unemployed are higher than net earnings as employed after withdrawal of those benefits. They are “trapped” in unemployment due to perverse effects of the system of incentives. Low-wage traps may also occur, that is, situations where a relatively large part of the increase in earned income is taxed Figure 4.2: “Tax” rate on Low Wage Earners: away through higher income taxes, Unemployment Trap, % in 2005 contributions and reduced benefits, Figure 8.2: "Tax" rate on Low Wage Earners: thus making higher skill work Unemployment Trap, % in 2005 (source: Eurostat) unprofitable.
Slovakia 43 55 65 66 68 69 74 75 75 76 76 80 81 87 93 0 20 40 60 80 100

4.29 Comparative data from EU countries suggest that Bulgaria may suffer from an unemployment trap. When unemployed workers in Bulgaria go back to work, they lose unemployment benefit, all or some of the social assistance (Guaranteed Minimum Income; energy benefit, income-based child allowance) and other benefits paid to the family of the unemployed, while having to pay social security contributions and income taxes. On average, the net effect of all this amounts to an implicit “tax” totaling 76 percent of earnings for a prospective low-wage workers (see Figure 4.2).

Hungary Estonia Czech R. United Kingdom Romania Ireland Germany EU25 EU15 Bulgaria Lithuania Poland Latvia Slovenia

Source: Eurostat

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The unemployment trap measures the percentage of gross earnings, which is "taxed away" through higher tax and social security contributions and the withdrawal of unemployment and other benefits when an unemployed person returns to employment. This structural indicator covers single persons without children earning, when in work, 67 percent of the average earnings. See the data and methodology in: http://epp.eurostat.ec.europa.eu/portal/page?_pageid=1073,46870091&_dad=portal&_schema=PORTAL&p_produc t_code=EM042

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4.30 Bulgaria ranks in the middle of the scale in terms of generosity of unemployment benefit entitlements, but is well above Slovakia and Hungary which are the leading reformers in this area. According to the Law on Social Insurance, the duration of benefit payments is from four months for beneficiaries with at least three years of insurance records, to twelve months for those with over 25 years of insurance records. Bulgaria is the only transition country that increased the maximum duration of unemployment insurance payments from 6 to 12 months between the beginning and the end of the 1990s.70 The size of the benefit is 60 percent of the average monthly insurance income of the beneficiary, and the minimum and maximum benefit levels are determined annually in the budget law.\71 For comparison, many EU countries are moving in the direction of shortened maximum duration of receiving a benefit. Others are decreasing the benefit with the length of unemployment spell or, as is the case in Denmark, even canceling it at some point. However, it should be noted that due to dominance of longterm unemployment, relatively few registered job seekers--about one fifth–receive the benefit. Because of the mandated minimum level of the unemployment benefit (over 50 percent of the maximum level); the current benefit formula creates adverse incentives for job search among the unemployed who were being paid low wages before losing their jobs. 4.31 In recent years, the Government has taken steps to reduce the dependency of unemployed as well as able-bodied but inactive population on social benefits. An increase in the level of guaranteed minimum income and other social benefits has been delayed, and eligibility rules made more stringent.72 Moreover, ablebodied beneficiaries of social assistance are asked to participate in “From Social Assistance to Employment” program to retain their access to income support. But more could be done. 4.32 What about the low-wage 73 trap? The tax rate on low wage earners at 35 percent in Bulgaria is below the EU average of 39 percent. This is largely due to a relatively high level of non-taxable income (Table 4.9). Therefore, once the worker enters the labor market, the
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Figure 4.3: Tax Rate on Low Wage Earners: Tax Wedge on Labor Costs in 2005
Figure 8.3: Tax Rate on Low Wage Earners: Tax Wedge on Labor Costs in 2005
Ireland United Kingdom Bulgaria Slovakia Estonia EU25 EU15 Slovenia Lithuania Romania Latvia Czech R. Poland Hungary Germany 0.0 10.0 20.0 30.0 40.0 19.9 29.9 35.2 35.3 38.9 39.4 39.4 39.8 40.9 41.0 41.0 42.1 42.4 42.9 46.7 50.0

World Bank (2005b). This was driven by the accelerating privatization and enterprise restructuring, which is now largely over.

Relatively high unemployment benefit tends to be associated with longer spells in unemployment, inter alia, because of the decline in the intensity of job search, although it may also potentially improve the quality and duration of job matches.
72

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In particular, the maximum duration of the guaranteed minimum income benefit for able-bodied people who are not holding disability certificate was limited to 18 months. This will be in effect as of January 1, 2008. The tax wedge on labor cost measures the relative tax burden for an employed person with low earnings.

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tax burden on labor is below the average in EU25. Thus, from the point of view of taxes, the Bulgarian labor market has built-in incentives for unemployed people to enter the labor market, although there are instruments such as tax credits for low-wage workers that could help make the incentives for initial (re)entry into the labor force stronger, but that could be reduced as wages rose. Also, once the unemployed have re-entered the labor market, it would be important for the system to encourage them to develop their skills and thus earning potential. IV. LISBON AND STOCKHOLM EMPLOYMENT TARGETS

4.33 Even assuming that strong growth in GDP and employment will continue for some years, the EU Lisbon targets are beyond reach for Bulgaria by 2010. These targets call for the overall employment rate to rise to 70 percent, the employment rate for women to reach 60 percent, and the employment rate for older workers (55-64) to be at 50 percent by 2010 (see Table 4.12). However, the national target of reaching an employment rate of 61 percent by 2010 is achievable, provided the GDP continues to grow at about five percent per year. Achieving it would imply adding just over 40,000 new jobs in each year of the four year period 2007-10; a pace considerably slower than that observed since 2002. If one were to assume an employment elasticity with respect to GDP of 0.3—roughly the rate observed globally in the last 15 years74--and project Bulgaria’s GDP growth at 5-6 percent per year, employment would continue to grow at 1.5-2.0 percent per year. This would translate into about 50,000 additional jobs per year, leading to the Lisbon target goals being achieved around 2015. Under this projection, Bulgaria’s employment will have grown by 450,000 people between 2006 and 2015. By 2015, total employment would be in the range of 3.55-3.7 million (depending on the data source), and the employment rate would be 69-72 percent. The labor force in such a scenario would by then have absorbed all but the hardest core of unemployed, most of the quarter million discouraged workers, and would have started tapping into those underemployed in the rural areas, or those employed in low-wage occupations but looking for better opportunities. By 2015, the inter-sector reallocation of labor, which is currently almost non-existent (see Chapter 2) could be well underway, if the various constraints in the product and labor markets were reduced or removed. Beyond 2015, with the age group of 15-64 year olds declining at almost one percent per year and open unemployment virtually gone, the labor market would tighten considerably, and most of the further growth in GDP would have to come from rising total factor productivity. Under that scenario, provided the rate of growth of labor productivity increased to well above its recent pace of 2 percent per year, Bulgaria would continue to converge towards the average income level of EU25. Of course, this relatively rosy picture depends a great deal on the policies pursued between now and then and to some extent on the developments beyond Bulgaria’s borders. Table 4.12: EU Employment Targets According to Lisbon Criteria, and New Jobs Needed to Reach them In Bulgaria
EU Lisbon targets 2005 67 57 2010 70 60 50 Bulgaria Estimated number of new jobs needed to reach EU targets in 2010 (1000) 635 165 178 Estimated number of new jobs needed to reach national targets in 2010* (1000) 170 -

Overall employment rate Employment rate for women Employment rate for older workers (55-64)

2005 55.8 51.7 34.7

Notes: * employment rate at age group 16-64 at 61 percent level; Pact on social and economic development of Bulgaria until 2009 signed by representative social partners and the Government. Source: Staff calculations.

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World Economic Forum (2006)

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V.

CHALLENGES FOR LABOR MARKET POLICIES A. Institutional Constraints

4.34 Bulgaria has undertaken significant institutional reforms in the field of labor market policies in the last couple of years. The Labor Code was harmonized with EU Directives. The Law on Economic and Social Council adopted in March 2003 regulates the establishment of an Economic and Social Council, a consultative body on economic and social issues involving both social partners and civil society. A National Institute for Arbitration and Conciliation was established to focus on resolution of collective labor disputes. The Employment Promotion Act was amended to allow the provision of active job brokering services by the private sector,75 and an agreement on Economic and Social Development in the Republic of Bulgaria until 2009 was signed among the employers’ associations, trade unions, and the government in 2006. 4.35 Surveys of local employers suggest that the demand for labor is constrained primarily by the business environment, which is perceived as not particularly conducive to investment and job creation, although the situation has clearly improved since 2002 (Figure 4.4).76 In the 2005 survey, the most frequently heard complaints by local businessmen were related to factors such as uncertainty about regulatory policies; anti-competitive practices of their competitors; cost of financing; and tax rates. Issues such as macroeconomic instability and access to financing that were important in 2002 had receded by 2005.

75

By early 2006, there were 432 private job brokerage agencies licensed in Bulgaria, of which 142 agencies were recruiting locally for work abroad (MLSP 2006).

76

Based on the results of the EBRD-World Bank environment and enterprise performance survey (BEEPS) of 2002 and 2005.

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Figure 4.4: Doing Business, percent of Responding Firms Indicating a Problem in 2002 and 2005

Figure 8.4: Doing Business, percent of responding firms indicating a problem in 2002 and 2005
Access to land Title or leasing of land Customs and trade regulations Labour regulations Business licensing and permits Skills and education of workers Tax administration Contract violations Access to financing Functioning of the judiciary Corruption M acroeconomic instability Tax rates Cost of financing Anti-competitive practices of others Uncertainty about regulatory policies 0 10 20 30 40 50 60 70 80 90 2002 2005

4.36 The surveyed businesses perceive skills and education of workers to have worsened between 2002 and 2005, and consider it as an increasingly binding constraint on job creation. It is the only indicator to have worsened since 2002. In 2005, almost 30 percent of managers indicated skills as an issue, including one-tenth as a major obstacle to expanding business. This constraint is likely to gain further prominence in the future, as the labor markets continue to tighten, and the competitive advantage of firms becomes increasingly based on innovation in products and processes. There are already some signs of this. Employers report difficulties in hiring certain types of high skilled workers, such as construction or IT specialists. Moreover, employers’ current unwillingness to spend much on upgrading of their labor force—through continuing vocational training, distance education, and other formal and informal methods—may have a negative impact on labor productivity, and the ability of labor to move from low-productivity to high-productivity jobs. Chapters 5-7 will cover different education sub-sectors and reforms needed in those areas. B. Improving Employment Services

4.37 The National Employment Agency (NEA), which is implementing government’s labor market policies, is well resourced. Its activities are based on the National Employment Action Plan prepared by MLSP jointly with other ministries and social partners. The Action Plan serves as the operational tool for concrete actions and measures to attain the objectives laid down in the Bulgaria’s Employment Strategy 2004-2010. For example, the 2006 action plan listed 63 different programs, measures, or projects. Many of these measures, however, covered only a small number of beneficiaries. NEA is relatively well staffed 65

compared to similar agencies in other transition countries. In 2006, NEA had 2,825 staff, of whom 2,136 were front line counselors, who worked directly with job seekers. Thus, the staff caseload—the ratio of clients to employment counseling staff–was 130 job seekers per one job counselor (see Figure 8.5).77 Figure 4.5: International Comparison of Public Employment Service Staff (2002 and 2003; 2006 for Bulgaria)

Figure 8.5: International Comparison of Public Employment Service Staff(2002 and 2003; 2006 for Bulgaria)
Serbia Latvia Germany Slovakia Lithuania Estonia Bulgaria Denmark Switzerland Austria Netherlands 0
67 58 71 72 57 49 256 86 108 195 187 170 376 337 1637 486

Registered unemployed per PES staff dealing directly with job seekers and employers Registered unemployed per PES total staff

167 130 74 114 96

172

200

400

600

800

1000

1200

1400

1600

1800

4.38 Public spending on employment programs in Bulgaria also compares favorably with EU8 and even EU15 countries. In 2005, Bulgaria spent about 0.44 percent of GDP on active labor market programs (ALMP), compared to the EU15 average of 0.55 percent of GDP (see Table 4.13). However, what makes Bulgaria an outlier is that more than 70 percent of this amount was spent on direct job creation (through the program “From Social Assistance to Employment”). Since 2005, the ALMP policy has been changing. An increasing share of funds has been spent on training and assistance to disabled individuals.78

77 78

ILO online database, and NEA.

In January-September 2006, expenditures on ALMPs were BGN135.7 million, of which 52 percent was spent on direct job creation, 18 percent on assistance to disabled people, and 12 percent on training.

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Table 4.13: Expenditures in active and passive labor market measures, % of GDP in 2005
Bulgaria Czech R. Hungary Romania Active measures, % of GDP* 0.440 0.122 0.197 0.097 Active measures total 100 100 100 100 Of which in %: Training 15.2 10.7 19.8 11.3 Job rotation and sharing Employment incentives 9..3 34.4 50.8 51.5 Integration of disabled 2.0 28.7 Direct job creation 71.8 30.0 29.4 36.2 Start-up incentives 1.7 3.2 0.0 0.0 Passive measures, % of GDP 0.218 0.242 0.391 0.357 Passive measures total 100 100 100 100 Of which in %: Out-of-work income support 100 100 98.0 100 Early retirement 2.0 Notes: * excluding labor market services provided by the staff of PES Source: Eurostat online Slovakia 0.170 100 14.0 16.4 5.3 35.7 28.6 0.269 100 64.7 35.3 Denmark 1.433 100 35.5 31.1 33.4 0.0 2.514 100 72.9 26.1 EU15 0.545 100 38.9 0.6 23.9 16.6 13.9 6.1 1.413 100 94.4 5.6

4.39 However, ALMPs cannot substitute for structural labor market reforms, which aim to improve the functioning and efficiency of the labor market.79 While ALMPs are an important component of labor market policy, they mainly help disadvantaged groups, and often do not have a significant impact on unemployment or employment in general. Bulgaria would need to identify the programs that can improve future employment and earnings prospects in a cost-effective manner. Currently the funds are scattered across a multitude of programs and projects, the outcomes of which have not been assessed in recent years. Based on international experience, there is a general consensus that even under best circumstances, payoffs from ALMPs are modest, and it is difficult to address large scale unemployment through these programs. They may work for specific groups in specific circumstances, and therefore need to be carefully targeted. Table 4.14 summarizes the EU country experience with different types of ALMP (see also Betcherman et al 2004). 4.40 The lessons learned from other countries, as summarized in Table 4.14, suggest that NEA should focus on helping individuals to find jobs themselves through the provision of job information services and job search assistance, including job search skills training, job search clubs, or job fairs. Workers often lack information and confidence about how to look for a job. Also counseling can help job seekers obtain information about education, training, and alternative job opportunities, make other employment services increasingly demand-oriented, and thereby improve expenditure targeting. Employment and professional orientation programs for youth and adults are still limited in Bulgaria. Such services provide assistance to the unemployed individuals, students, and other groups in determining appropriate work fields and employment opportunities.80

79

There is an extensive literature on the impact of ALMPs on labor market outcomes. For example, see European Commission (2006a), Employment in Europe 2006, Brussels. In 2005, through the system of Professional Information Centers, 131,700 individuals received relevant counseling (MLSP/NEA 2006b).

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Table 4.14: Impacts of ALMPs based on experience of EU countries
Intervention Job-search assistance (job brokerage and counseling) (Re)training unemployed for Summary of overall impact Significant positive impact on the transition from welfare to work Effective for some target groups (adult women), but not for others (adult men and youth) Disappointing results Comments Improved outcomes when: (i) combined with monitoring and enforcement of criteria, on which the receipt of unemployment benefits is conditioned; and (ii) job search activities linked with participation in other programs, such as training. Following features enhance programs effectiveness: (i) small scale; (ii) targeted at disadvantaged groups; (iii) close partnership with local employers; (iv) training certified, and certificates recognized and valued by the market. Interventions such as pre-school facilities, measures to reduce early school-leaving, and improve basic skills and the relevance of competencies provided by the education system seem to pay better dividends. Cost effective to target employment subsidies at specific groups (young men with high levels of education), and combined with counseling services. Should be short duration and targeted at the most disadvantaged groups, if used.

Youth measures

Employment subsidies

Positive effects on the probability of future unsubsidized employment Positive results rare

Direct job creation Source: EC (2006a).

4.41 The Operational Program on Human Resources Development 2007-2013 calls for additional investments in early professional orientation in schools, and the creation of career development centers in all universities. Providing information to young people on labor market opportunities, and pay-offs to different levels and modalities of schooling would allow them to make educated guesses about their future returns, producing efficiency gains. Other programs for the unemployed youth could include the provision of employability and training plans, job and career counseling services, aptitude and vocational assessment tests, and assistance in developing profiling methods to identify profiles that are most susceptible to long-term unemployment. 4.42 NEA is already downsizing “From Social Assistance to Employment” program. Its primary objective has been to reintegrate the unemployed people on social assistance into the labor market, restore their work habits and motivation, and reduce their dependency on the social safety net. The program covers the most disadvantaged and hardest-to-place groups—that is, those with a low level of education, the Roma, the long-term unemployed, and the social assistance recipients. The attractiveness of the program may be partly attributed to the fact it also covers pension and health insurance (including maternity benefits). It has provided employment for a group of unemployed that would otherwise have remained unemployed much longer and positively impacted their work discipline, habits, and qualifications.81 However, the results of the program’s impact analysis (the only impact assessment carried out of the ALMPs) indicate that only eight percent of program participants have found employment at the end of the program, while in the control group this proportion was 16 percent. If getting a job was their only goal, the participants would have done better looking for work themselves. 4.43 As noted earlier, sizeable long-term unemployment is a serious issue in Bulgaria. Most of these jobless have no qualifications, and/or a low level of education. They may have multiple employment barriers, including cognitive and health-related barriers, and difficult home lives (for example, lack of transportation, many children, child care problems, domestic violence), which makes their employability
81

Participants can enroll in a literacy course combined with part-time employment (five hours), and a daily fourhour study session. However, 67 percent of the employers involved in the program stated that they did not train their workers either before or during the project (de Koning et al (2005)).

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a problem.82 Assistance to the long-term unemployed should resort to a combination of temporary employment, on-the-job training, and job-placement assistance (Egger 2003). Early interventions could include profiling of job seekers to identify which one of the individuals or groups of unemployed are susceptible to long-term unemployment. The programs typically include the provision of employability and training plans, job and career counseling services, various aptitude tests, and vocational assessment tests. To reduce the probability of long-term unemployment among young workers, they should be provided with effective job search assistance, or active labor market measures within the first 6 months of unemployment. 4.44 Given that many of the registered unemployed may not be genuinely unemployed, NEA should refocus all its efforts on activation policies.83 Good activation policies involve: (i) improving personal, social, and vocational skills and competencies, and facilitating social integration; (ii) individually tailored ways to participate in ALMPs, taking into account such factors are the person’s age, experience, needs and priorities; (iii) taking advantage of the resources and strengths of the beneficiary; (iv) networking with labor market services, social services, health services, housing sector, and communities; and (v) cooperation and interaction between the beneficiary and the agency in the planning, design, and implementation of individual action plans. 4.45 Based on international experience, other measures might include: (a) frequent contacts with the responsible labor or social office (most OECD countries), and contract-based obligations (UK “New Deal”); (b) profiling of job searchers based on the amount of help needed to find a job (UK, Denmark); (c) matching available programs with different categories of job seekers (the Netherlands); and (d) intensive interviews to adjust/redesign the individual action plan at a certain stage of unemployment. These measures should be supported by incentives that push people to re-enter the labor force, for example, by reducing the level of benefits after a (shorter) time period and/or insisting that, after a period, the unemployed take jobs that they may not have considered “suitable” early in their search. 4.46 Finally, the positive impact of labor market policies cannot be taken for granted. There should be continuous monitoring and evaluation of their outcomes. NEA should also establish a system for the evaluation of gross and net effects of programs and measures. C. Employment Regulations

4.47 On paper (de jure) Bulgarian labor market regulations may not seem particularly rigid, but in practice (de facto) they are considered to be a problem. Almost one-fifth of Bulgaria’s firms indicate that rigid labor market regulations are a problem for doing business (see Figure 4.4), and about eight percent of employers consider them a major obstacle. 4.48 Also, the rigidity of employment index suggests that Bulgaria’s employment regulations are still rather inflexible (see Table 4.15).84 The main problems seem to lie in the difficulty of hiring, rigidity of working hours, and the level of hiring costs. Flexibility in such parameters is especially important for small businesses, which tend to be labor intensive, and are therefore an important means of creating new
82 83

For example, in 2005 about five out of 100 registered unemployed had disabilities (MLSP (2006a)).

Activation policies encourage certain unemployed individuals to step up their job search after an initial spell of unemployment, with a later obligation to participate in various programs. Eventually, the activation principle makes the receipt of benefits conditional on participation in programs, in the process shifting the balance between the rights and obligations of the unemployed. See EC 2006. Rigidity-of-Employment index varies between 0 and 100, with higher values indicating more rigid regulation. See http://www.doingbusiness.org for the methodology.

84

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jobs. Also, flexible labor markets will become increasingly important to the quest of raising productivity by allowing movement of labor from low to high productivity areas. As highlighted in Chapter 2, the immobility of factors of production is an issue in Bulgaria. This suggests that the implementation and administration of the labor laws and regulations merits attention. Table 4.15: Rigidity of Employment Indexes in 2006
Rank Difficulty of Hiring Index Rigidity of Hours Index 50.7 80 20 20 80 60 80 60 45.2 0 0 20 0 Difficulty of Firing Index 37.1 10 30 0 10 40 40 40 27.4 10 10 10 0 Rigidity of Employment Index 40.8 47 28 7 34 33 51 39 33.3 3 7 14 0 Hiring Costs (% of salary) 26.7 30.1 35.0 20.0 35.2 21.4 33.3 35.2 21.4 21.3 1.0 11.0 8.5 Firing Costs (weeks of wages) 26.2 8.7 21.7 4.3 34.5 13.0 3.0 13.0 31.3 4.0 0 22.1 0

… 34.2 Europe and Central Asia Bulgaria 100 50 Czech R. 45 33 Georgia 6 0 Hungary 90 11 Poland 49 0 Romania 101 33 Slovakia 72 17 … 27.0 OECD Australia 9 0 New 10 11 Zealand United 17 11 Kingdom USA 1 0 Source: World Bank 2006b.

4.49 There are many indications that current labor regulations hinder flexible forms of employment contracting. Only about two percent of the employed work fewer than 30 hours a week (that is, part-time) compared to about 18 percent on average in EU15 countries, while six percent of the employed hold temporary jobs (fixed term rather than open-ended contracts), as shown in Table 4.16. LFS indicates that the main reason for working part-time is lack of work, or the unavailability of full time jobs. While it may be true that employees cannot afford to work part-time because of Bulgaria’s low wages, the main reason for employment on a fixed-term basis is that respondents cannot find a permanent job (or they have a contract for the probationary period). Inflexible working hours and working time arrangements are also a problem, with almost all workers working 40-49 hours per week. 85 Overtime is restricted, and only about six percent of employees work 50 or more hours per week.86 Seniority bonus paid to workers and employees depending on their job tenure creates disincentives to labor mobility across firms, jobs, and regions.87

Recently the maximum length of the working hours under an employment contract was increased from 40 to 48 hours per week. The employer can increase the working hours per week in excess of 48 hours for a period of six months in case of a written consent of the employee. The Labor Code provides additional opportunities for the employers to introduce flexible arrangements for the working hours, for example owing to production considerations, but the employer is obliged to inform in advance the Labor Inspectorate.
86

85

Within the EU, some 12 million full-time employees or nine percent, usually work more than 48 hours a week, which is the statutory maximum number of working hours per week in most EU Member States (EC (2006a)). The seniority bonus is established minimum 0.6 percent of the base wage due for each year of service with any employer, but could be more, depending on the enterprise level Collective Agreement.

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Table 4.16: Incidence and Composition of Part-time Employment, 20051
Total 2.0 3.3 3.2 11.7 9.7 2.6 18.1 Part-Time employment as share of employment Men 1.6 1.6 1.8 7.1 9.3 1.4 7.0 Women’s share in parttime employment Women 2.4 5.5 5.0 17.4 10.2 4.1 32.3 56.7 72.8 70.5 66.5 … 69.2 78.3

Bulgaria Czech Republic Hungary Poland Romania Slovakia EU15

Notes: 1 Part-Timers are those individuals, who work less than 30 hours a week in their main job (not only wage earners) Source: OECD (2006), LFS (2005) for Bulgaria and ILO (KILM 4th edition) for Romania

4.50 The impact of labor Figure 4.6: Under employment due to Labor Regulations, % in regulations on employment can 2002 and 2005 be measured through an indicator measuring underemployment due to labor regulations. The 2005 BEEPS survey of local Hungary 2005 employers indicates that 2002 Slovenia employment in the formal sector Estonia could be increased by almost Czech R. eight percent, if labor regulations were eased, a notable increase Bulgaria from three percent in 2002 (see South Eastern Europe Figure 4.6). Despite some EU8 improvements in the Labor Code Europe and Central Asia in recent years, most complaints Slovakia of employers are related to rigid Poland arrangements for fixed-term Romania contracts, seniority bonuses, 0 2 4 6 8 10 12 14 16 overtime provisions, and burdensome administrative arrangements for dismissals.88 Source: BEEPS The worsening between 2002 and 2005 may also indicate that the constraints emanating from the Labor Code are becoming more binding as competition in Bulgaria’s product markets intensifies. 4.51 Bulgaria’s employment protection legislation (EPL) does not only discourage hiring and firing, but may also slow down adjustment to shocks and impede the reallocation of labor. The effects of employment protection legislation (EPL) on labor market performance remain controversial.89 Typically, EPL makes it harder for certain groups, including youth, women and displaced older workers, to enter or re-enter the labor market, at least on an open-ended contract; increases long-term unemployment, and seems likely to strengthen labor market “insiders”. Regression analysis on pooled data from OECD, and Central and South Eastern European countries for the second half of the 1990s finds that the strictness of temporary EPL provisions is positively correlated with higher youth and female unemployment. Stricter EPL increases the risk of long-term unemployment; and stricter temporary EPL discourages labor
88 89

For more detailed discussions of labor legislation, see World Bank (2005b). See, for example, OECD (2004c) and (2006); EC (2006a); Young. (2003).

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supply.90 On the other hand, countries with stringent EPL may have more durable or stable jobs. Recent studies also indicate that greater flexibility in the host country’s labor market relative to that in the investor’s home country is associated with larger foreign direct investment flows. This may be of relevance to Bulgaria, given the importance of sustained high FDI inflows for the economy (see Chapter 3).91 4.52 Drafting and implementing a new set of labor regulations in Bulgaria may thus be called for. Bulgaria’s current Labor Code dates back to 1985. It had major revisions in 1992, and, as noted earlier, the Code has been harmonized with EU Directives in the past few years. Nevertheless, there are good reasons, based on the evidence presented above, for recommending the revision of labor legislation. First, in the last decade the nature of jobs has changed, and the incidence of temporary and casual informal sector jobs has increased. Second, there has been a shift from less skilled, blue-collar manufacturing jobs towards more skilled, white-collar service sector jobs. Third, the share of employment in micro and small enterprises is rapidly increasing, and especially for this sector, promotion of more diversified employment relationships would increase incentives to hire workers. Fourth, in general, bargaining on terms and conditions of employment should become more market driven in order to overcome rigidities of the current labor market. In terms of enhancing competitiveness of the country’s business and investment climate it is beneficial to have less rigid labor relations, especially in comparison with other countries in the region. 4.53 Enhancing flexibility of labor markets—in parallel with reducing barriers in product markets—is also important from the macroeconomic point of view. Given the Currency Board Arrangement, the adverse consequences of a macroeconomic shock on growth and employment can only be minimized through labor and product market flexibility and adaptability. On the labor market side, measures to promote flexibility would need to be coupled with measures promoting workforce adaptability through skills upgrading and increasing labor market participation. Similarly, reducing regulatory complexity and improving the quality of the institutional framework to facilitate competition in the domestic markets would be needed to improve the adaptability of product markets. Moreover, faster responses in labor and product markets to the changing external environment would facilitate greater diversification of the economy and would reduce output volatility. D. Adult Education and Training

4.54 Upgrading of the labor force, or vertical mobility, is a precondition for rapid structural and technological change in all countries, for competitiveness in the world market, and for raising the share of high-value-added products and services in the markets. The world is moving towards a “lifelong learning” system, which means not just improving basic skills of adults, but enabling them to continue to develop a range of skills, and to enhance their employability throughout their lives. 4.55 As the Employment Strategy 2004-2010 of Bulgaria states, there is a deficit in training of workers in the modern basic and key skills. There are skill gaps in the new types of professions, especially in the area of advanced and new technologies in production and services, modern technologies in agriculture, and management and marketing. As will be discussed in Chapters 6 and 7, opportunities to upgrade skills through adult education and training and active labor market programs are limited. As stated in the European Commission’s report “Employment in Europe 2003”, an adaptable skilled workforce, with access to training, career development, job mobility, flexible work organization, and with a sense of job

90 91

World Bank (2005a). See Javorcik and Spatareanu (2004).

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security is the key to increasing productivity within Europe, and encouraging job creation and higher employment rates. Table 4.17: Participation of Adult Population in Lifelong Learning, %* 4.56 Adult education and training is 2000 2005 uncommon in Bulgaria. One of the EU25 7.5 (e) 10.1 Lisbon employment targets deals with EU15 8.0 (e) 11.1 lifelong learning and calls for the EU Czech Republic … 5.6 average level of participation in lifelong Estonia 6.5 6.5 … 6.9 (e) learning to be at least 12.5 percent of the Latvia 2.8 4.9 (e) adult working age population (25-64 year Lithuania 2.9 3.8 age group) by 2010. According to the Hungary Poland … 4.7 latest Eurostat labor force survey, … 15.0 Bulgaria has the weakest performance on Slovenia Slovakia … 4.3 this front among EU countries: only 1.3 Bulgaria … 1.3 percent of surveyed workers stated that Romania 0.9 1.3 they had received education or training in Denmark 19.4 29.2 the four weeks preceding the survey (see Sweden 21.6 32.1 (2005) Table 4.17). United Kingdom 20.5 26.6 (e)
Notes: * Life-long learning refers to persons aged 25 to 64 who stated

4.57 Only a small percentage of that they received education or training in the four weeks preceding the of the same age group. enterprises provide continuing vocational survey out collectedtotal population of the or training whether or The information relates to all education not training (CVT) to their employees (see relevant to the respondent's current or possible future job. also Chapter 6) The most comprehensive e-estimate data on continuing vocational training Source: EU Labor Force Survey. (CVT) in Bulgaria can be obtained from the latest 2004 survey of about 53,000 enterprises, of which 28 percent were in the public sector and 72 percent in the private sector (NSI 2006d). Stylized facts from the survey are as follows: • Only 8.6 percent of enterprises introduced technologically new or improved products or services in 2004. This would require, as a rule, an upgrading of skills of at least some parts of workforce. However, only 25 percent of firms indicated that in 2000-2004 they had the need to obtain new skills for their workers. Only a fraction of enterprises, 6.6 percent, had a specific training plan; 4.6 percent of firms had a specific training budget, and 1.3 percent of enterprises had their own training center. Only around 30 percent of enterprises provided training courses in 2004. In 2004, 15 percent of employees in surveyed enterprises participated in vocational training courses, and in total 0.1 percent paid working time hours were spent on it. Most courses were of short duration: on average 17.2 hours were spent per participant in CVT courses in 2004. In only 30 percent of enterprises providing CVT courses a formal procedure for evaluation was applied. Only 3.6 percent of enterprises provided initial vocational training, of which 69.2 percent was for pupils from professional schools and students; 17.1 percent for apprentices and newly employed with training contract; and 24.6 percent for unemployed persons sent by the employment agency to undergo vocational training and qualification.

• • •

• •

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Training costs per participant equaled BGN291, which is slightly below the average reported monthly wage in the country.

4.58 Co-financing schemes, under which employers, employees and governments jointly finance training, are considered to lie at the heart of a comprehensive strategy to foster CVT. The shift towards this policy approach is based on three general principles: • • • in most societies, because of budget constraints, public authorities alone cannot provide the necessary financial resources for lifelong learning; as lifelong learning generates considerable private returns, employers and employees should finance most of its costs; and greater reliance on market forces could strengthen the incentives both for learners to seek more efficient learning options and for providers to achieve higher levels of efficiency.

4.59 Recently, the Government has taken some steps to improve the situation. Issues associated with lifelong learning stand high in the Operational Program on Human Resources Development 2007-2013. The program emphasizes the following main activities: (i) creation of a system for professional orientation and career development; (ii) development of vocational education; (iii) giving opportunities for a “second chance” for education and training; (iv) giving opportunities for making adults literate; and (v) development of distance education. E. Improvements in Labor Market Statistics

4.60 Although Bulgaria has been carrying out Labor Force Surveys according to the Eurostat methodology since 2003, and a census of all establishments is conducted regularly, the lack of comprehensive labor statistics hampers the assessment of developments in employment and wages, especially in the private sector. The main shortcomings include: (i) the under-reporting of private sector wages; (ii) the reporting of only average gross earnings, not wages for time worked nor wages by occupation; and (iii) the lack of coverage of the self-employed, and employment in small firms. At present, NSSI administrative data are used to estimate wages by occupation and the number of selfemployed and employment in small firms, which is inadequate for many analytical purposes. Another shortcoming is the lack of a nation-wide system for assessing the current or likely future demand of employers for labor and various kinds of skills. VI. CONCLUSIONS AND POLICY RECOMMENDATIONS

4.61 On the surface, Bulgaria’s labor markets are doing well. Employment has increased significantly in Bulgaria since 2002. Some 300,000 jobs were added during the period 2002-2005, bringing the number of employed to the three million range. Although this number includes the workers covered by the subsidized employment program “From Social Assistance to Employment”, the number of these workers has been cut in half since 2004. It now stands at about 50,000, and is expected to be reduced further during 2007. Preliminary data suggest that, the number of employed may have grown another 100,000 during 2006. As a result, employment rates have continued to rise not only for overall labor force, but also for women, youth, older workers and even long-term unemployed. 4.62 Nevertheless, major challenges lie ahead. Employment and participation rates remain among the lowest in EU, and are still far from the Lisbon goals. Bulgaria also still has a substantial reserve of unused labor, both in terms of registered unemployed and those who, for a variety of reasons, choose not to participate in the labor force. Unemployment remains high, in particular among youth and people with few skills and a low level of education. Regional disparities in employment situation are significant.

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4.63 But increasing employment is only one of the objectives of the reforms, although perhaps the most important one in the short run. The other objective is to increase the mobility of labor across sectors. Research reported in Chapter 2 points to a problem in this area. If it is not addressed, it will make it harder to increase the rate of growth of labor productivity which, in the longer term, also means slower GDP growth. It is for this reason that this chapter has taken a close look at policies and structural rigidities that contribute to the inflexibility of Bulgaria’s labor market, and laid the basis for the recommendations that follow. Also in light of Bulgaria’s Currency Board Arrangement promoting labor market flexibility would be critical. 4.64 The 2006 EU Joint Employment Report highlights that a good balance between flexibility and security in the labor market, also referred to as “flexicurity”, can be achieved by the interaction of four key elements: (i) sufficiently flexible contractual arrangements; (ii) effective active labor market policies; (iii) a credible lifelong learning system; and (iv) modern social security systems. Bulgaria faces challenges in all of these areas. EU guidelines for the employment policies suggest that member states should: (i) encourage job creation by supporting entrepreneurship and a favorable business environment for enterprises; (ii) simplify and reduce the bureaucracy, regulations and administration governing starting business, hiring staff, and accessing start-up capital; (iii) improve access to training and re-training by employees; (iv) reform overly restrictive employment legislation that affects labor market dynamics; (v) promote flexible and diverse forms of labor agreements and working arrangements; and (vi) remove disincentives to work (for example, simplify regulations, provide incentives), and develop actions to eliminate undeclared employment. 4.65 Actions (i) and (ii) suggested above by the EU guidelines for employment policy are arguably the most important in terms of creating a strong demand for labor. They belong more to the overall business climate, and some aspects of them were discussed in the previous chapter. Actions covered by (iii) will be discussed in more detail in the chapters on vocational and tertiary education (Chapters 6-7), although this chapter did look at the current situation with respect to lifelong learning. But the main focus of this chapter has been on the analysis which underpins potential actions in areas (iv)-(vi). The proposed reforms that the government may wish to consider in these areas are listed below roughly in the order of priority and grouped into short and medium term actions. 4.66 In the short term, the authorities may want to consider the following actions: • Develop and encourage lifelong learning: Employers report that workers with the right skills are increasingly difficult to find, despite the fact the Bulgarian labor force is relatively well educated. This problem is likely to only get worse, if the Bulgarian economy keeps expanding. Therefore, the culture of lifelong learning needs to be further developed, and education delivery systems modernized. As will be discussed in Chapter 6, this includes expanding the network of adult training centers, VET schools and private providers, and other alternative training opportunities. Also, their curricula need to be adjusted so that the certificates obtained by their graduates at the end of their training are recognized and valued by the employers. Many countries have established tax incentives to encourage adult education. In Lithuania, the Law on Income Tax of Individuals envisions the possibility of receiving partial compensation of the cost of studies. In Hungary, employers pay a vocational training contribution equivalent to 1.5 percent of the wage. Employers that spend the same amount on apprenticeships, the training of their own employees, or on the development of a vocational training school are exempted from this contribution. In-company training, training related to investments creating new jobs, and training aimed at improving the 75

competitiveness of SMEs, and the development of entrepreneurial skills are supported by grant schemes.92 Although it may have budgetary implications, Bulgaria may also consider introduction of tax incentives to stimulate lifelong learning. Meeting the training needs of employed individuals may require them to stop working for a period of time, which can be costly to both employers and employees. For this reason, Bulgaria may consider following the example of many OECD countries, which have introduced statutory or contractual training leave schemes that guarantee employees the right to return to their jobs after completing the training course, as well as institutional arrangements facilitating access to training and education on a part-time basis. Reinstatement rights help to reduce the risk element of human capital investment borne by the workers and imply some cost-sharing with employers (who need to either replace the workers undertaking the training or make do without them on a temporary basis). • Revise labor legislation and regulations, while complying with EU requirements: Drafting a new Labor Code and revising labor regulations further is one of the actions that need to be taken. Although the Labor Code has been amended a number of times, it remains in some important ways too prescriptive for today’s realities. Social partners—the employers and representatives of the employees—need to be given a greater role in determining employment relations. They are best positioned to assess the situation in their enterprises and industries and, through collective bargaining, develop rules that determine such important matters as wages, benefits, seniority bonus, and overtime and part-time work arrangements, without sacrificing an appropriate level of social protection. This would enable workers to benefit from de facto rather than just de jure employment protection because, by being partners in a negotiated settlement, their employers would have less incentive for non-compliance, and enforcement would be easier. At the same time, employers would have a chance to renegotiate regulations that are particularly costly to them, but of less value to workers. Shift the emphasis of active labor market programs (ALMP) to support job search and strengthen their monitoring and evaluation: NEA should retune the structure and content of ALMPs, and increasingly shift resources from the job creation program to other ALMPs deemed to be more cost effective. These include, first of all, activation policies, such as jobsearch assistance, counseling, job brokerage, and career guidance. Job seekers should have stronger incentives to look for new jobs, even in other occupations and in other regions of the country. This would require a more intensive follow-up of the individual cases by the frontline social workers than at present. A large-scale direct job creation program is justified at times of economic downturns, when aggregate demand is depressed and there are few vacancies. This is no longer the case in Bulgaria. On a limited scale it might be used as means of helping the most disadvantaged groups of unemployed to regain contact with the labor market. It should be possible, over the next couple of years, to carry out this reshuffling of resources from direct job creation programs to other, more cost effective, programs in a budget neutral way, since the direct job creation program still consumes a good chunk of ALMP resources. There should be a special focus on young workers so that they do not turn into long-run unemployed. However, there is a need to modernize and strengthen the administrative capacity of NEA for this shift to succeed. Also, ALMPs need to be accompanied by monitoring and impact evaluation, in order to fine-tune those of most relevance to the labor market situation in
92

See: (http://europa.eu.int/comm/employment_social/employment_strategy/04_national_en.htm).

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Bulgaria. The net impact of most ALMPs has not been assessed since 199993 A net impact assessment is a rather expensive undertaking, and can be repeated say only once every five years, but there are less costly alternatives to evaluation of programs developed in other countries in the region, such as Performance Information and Management Systems (PIMS). In the meantime, NEA can begin to shift emphasis to programs, which experience has shown in other countries to be the most effective in reducing unemployment. • Revisit the mechanism for establishment of the minimum wage and its level: Current levels of minimum wages are high in Bulgaria compared to other transition economies. This may be especially harmful in poorly paid industries, and in micro and small enterprises. Hence it would be important to make sure that the relatively high ratio of the minimum wage to the average wage is reduced over time. Currently, the minimum wages are set by the Council of Ministers. It may make better sense for the government to secure close involvement of social partners (employer and labor representatives) in the process, and have minimum wages determined sector by sector, in the context of collective bargaining agreements and in line with the ever-changing situation in each sector.94 Close involvement of social partners in fixing the level of minimum wages is consistent with the ILO Convention 130 on minimum wages, which suggests that social partners should be consulted (not just informed), as well as the Pact on Economic and Social Development until 2009. Also, while evidence is mixed on the impact of minimum wages on employment, it is fairly clear in the case of young workers. Creating sub-minimum wages for young workers or in economically depressed regions, as is done in many EU countries, would promote job creation for less productive workers, who are also the ones typically hardest hit by unemployment. For example, Poland recently introduced a youth sub-minimum wage (at 80 percent of the regular minimum wages) in an attempt to alleviate youth unemployment. Revisit the current eligibility and entitlement rules of the unemployment benefit: Bulgaria’s unemployment benefit eligibility and entitlement rules do not per se currently create major labor supply disincentives. However, taken together with other schemes, they may give rise to an “unemployment trap”, especially in lagging regions, where benefits account for a high proportion of the prevailing market wage of low skilled labor, or for job seekers who had low wages before losing a job thus giving less incentive to the beneficiaries to go out and find a job. The current unemployment benefit entitlement rules, and mechanisms attached to their delivery, should therefore be revisited. The policies may include setting more efficient activation strategies, which better coordinate the level of unemployment benefits with ALMPs. In particular, NEA could monitor more closely the job search efforts of an unemployed person using individual action plans prepared for particular job seekers and, if their efforts are found wanting, impose sanctions ranging from partial to total withdrawal of the benefits. Although same performance criteria—such as “availability for work”, or evidence of “active job search”—are used to decide who will be allowed to the register as unemployed, unemployment benefits of regressive scale and of limited duration, relatively strict job search requirements, monitoring of job search intensity efforts, and the quality job of brokerage services may help speed up transitions out of unemployment.

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The net impact of most ALMPs in Bulgaria has been evaluated only once. In 1999 the Netherlands Economic Institute (NEI) implemented the project “Evaluation of the Net Impact of the Active Labor Market Policies”. At that time all analyzed programs had positive net impact—participation in them improved the chances that the unemployed have on the primary labor market.

94

Currently the thresholds for minimum social security contributions are negotiated between social partners and the government by most branches and main professional groups.

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4.67 In the medium term, the key actions to consider for increasing labor productivity and employment would be as follows: • Reduce labor taxes further in a fiscally sustainable manner: According to the 2005 BEEPS survey, about six percent of the formal enterprise workforce and 13 percent of the wage bill is not reported. This combined with the still sizeable informal sector, means that the tax base is not as wide as it could be, and that taxes on those who pay them are higher than they otherwise might be. The Government is obviously aware of this since it, for example, lowered the social contribution levy by six percentage points in 2006. It may, however, following a careful assessment of the impact of recent tax cuts, wish to consider further reductions of disincentives to work embedded in the tax and benefit systems, including further reductions of the tax burden on wages. This would need to be done in a budget neutral manner. While lowering the tax wedge might partly finance itself through higher employment and output, additional revenue measures or preferably expenditure cuts would likely be required. Engage employers’ associations: Involvement of employers’ organizations is an important instrument for minimizing the emerging skills mismatch in the labor market. Occupational standards, or employment specifications, must be defined by employers using procedures agreed upon by all stakeholders, as will also be highlighted in Chapter 6 on vocational education and training. These standards can then be used to develop more relevant criteria for the curricula of training institutions. This process is in train but should be evaluated and adjusted in line with the outcome of the evaluation. Strengthen labor market statistics: Bulgaria’s labor market information system, especially wage statistics, needs further improvement. In addition, the government should consider developing other statistical instruments. Employer-based surveys of current and projected labor market conditions, for example, could focus on actual and planned job creation and job destruction, and on key determinants of hiring and firing. The objective of such surveys would be to determine the degree of labor market flexibility, and to prepare projections of likely changes in employment and unemployment.95 A tracer survey of displaced workers would trace changes in labor market status (earnings, employment compared to unemployment, career developments), depending on the educational status of workers or unemployed individuals. It would be useful to keep track of graduates some years after graduation, as part of labor market monitoring. All these suggestions are in line with the Operational Program for Human Resources Development 2007-2013, which urges the promotion of cooperation between the education system, the vocational education and training system, the national economy, and EU through the development of systems for monitoring, analysis, and projections of labor demand and supply.

95

Recently NEA launched an employer survey to determine labor demand by professions and qualification levels.

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5.

GOVERNANCE AND FINANCE REFORMS IN PRIMARY AND SECONDARY EDUCATION

5.1. An important step in promoting labor productivity will be the development of a skilled, technically savvy, and adaptable labor force, which has knowledge and skills that match the demands of the labor market. As mentioned in the previous chapters, rather than protecting existing jobs, policies should aim at equipping workers through education, on the job training, and lifelong learning for inevitable changes in the demand for labor, and thereby promote their adaptability and mobility across industries and sectors. While Bulgaria has a highly educated population for its level of income, that education does often not translate to marketable skills. To raise labor productivity and mobility, Bulgaria would need to further upgrade its human capital by modernizing its education system. The next three Chapters of this report (Chapters 5-7) analyze the performance primary and general secondary education; vocational education and training; and tertiary education, and identify options for further strengthening of education delivery. 5.2. Bulgaria has recently embarked on an ambitious program to reform its primary and general secondary school system with the aim of increasing the quality and relevance of skills, raising participation rates and optimizing resource use.96 While there seems to be broad recognition and agreement on the challenges facing the Bulgarian school system, there is no consensus on their magnitude and even less on the policies needed to tackle them. 5.3. This chapter discusses the available evidence and presents reform options for finance and governance of primary and general secondary education.97 Vocational secondary and higher education will be covered in the chapters to follow. This chapter argues that decentralizing the school network and introducing reforms to the finance and governance system can improve the way schools are managed, and help promote efficiency savings that can be redirected to improving the quality of education, and raising participation rates. The underlying premise is that the current spending pattern is inefficient, and a lot more could be done within the existing budgetary framework. I. THE REFORM CHALLENGES

5.4. Increasing the quality of education: Bulgaria does not have a national system of external testing of student achievement. This makes it difficult to substantiate the widespread claim that quality of education is unacceptably low, and that it has been declining over the last decade. However, several indicators suggest that the problem is severe. For instance, in the OECD Program of International Student Assessment (PISA) 2000 survey, assessing proficiency in foundation skills for the knowledge society (reading, mathematics and scientific literacy), 40 percent of Bulgarian 15-year olds performed at or below the lowest level of proficiency in reading literacy. This was twice the EU average and 2.6 times

96

The reform agenda is laid out in the “National Program for the Development of School Education 2006-2015”. For an in depth analysis of the challenges facing Bulgaria’s primary and general secondary education system see Ministry of Finance (2005) “Public Expenditure Review–Education–Condition, Problems and Opportunities”, and World Bank (2005c)“Bulgaria–Education and Skills for the Knowledge Economy”, Policy Note.

This chapter is based on prior analysis and work by the World Bank’s Bulgaria education team comprising of Christian Bodewig, Lars Sondergaard, Steven Bakker, Boryana Gotcheva, Rebekka Grun, Anna Khachatryan, Rosalind Levačić, Nickolay Mladenov, Juan Manuel Moreno and Reema Nayar. The authors express their gratitude to Stoyan Baev from the National Statistical Institute for preparing extensive datasets with school-level data.

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the Lisbon benchmark98. Equally, in the area of mathematics, Bulgarian eight-graders participated in three rounds of an international assessment Trends in International Mathematics and Sciences Study (TIMSS) in 1995, 1999, and 2003. Worrisomely, of all the countries participating in the study, Bulgarian students had the steepest declines in mathematics and science achievement between 1995 and 2003 (see Figure 5.1). Clearly, international tests such as TIMSS and PISA scores alone are not sufficient evidence of the poor (and declining) quality of education, but they are the only external assessment of schools available for now. Figure 5.1: Mathematics Performance of Bulgarian Eighth Graders Fallen from Above to Below the EU8 Average
Mathematics performance of eight graders in TIMSS, 1995-2003 1995 560 540 520 500 480 460 440 Lithuania Hungary Slovenia 420 Bulgaria Netherlands Latvia United States Sweden Czech Slovak
NMS (1995), 510 NMS (2003), 508

2003

NMS (1995)

NMS (2003)

Selected EU8 countries

.

5.5. Raising participation rates: Participation rates among the school age population have increased over the last decade (see Table 5.1). Net enrollment rates at pre-primary, basic, and upper secondary levels are all higher today than they were 10 years ago. Nevertheless, the net enrollment rate in lower secondary education—at 84 percent—is too low for a country where lower secondary education is compulsory.99 The sharp fall in net enrollment rates from primary to lower secondary, which is a part of compulsory basic education, is of concern. Upper secondary shows impressive increases, although to some extent this reflects the recent increase in the duration of some programs.100 Low participation rates affect mostly the poor and vulnerable, many of whom fail to complete compulsory education.

World Bank (2005c). Bulgarian students are doing better at the lower level: in the 2001 Progress in International Reading Literacy Study (PIRLS) test of reading literacy of fourth graders Bulgaria ranked 4th among 35 countries. However, this advantage appears to disappear at the higher level.
99

98

Age enrolments, defined as participation of the relevant age group independently of the educational level, are higher, and close to universal levels, suggesting that a significant fraction of the lower secondary age group may still be in primary education, while others may have progressed to upper secondary.

The duration of several (but not all) upper secondary programs was increased by one year to five years in 2002/03, while the denominator refers to a four year age cohort. Nevertheless, absolute enrolments also increased by about 14 percent between 2000/01 and 2003/04, despite the fall in the population age cohort.

100

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Table 5.1: Net School Enrolment Rates Growing, but Still Low in Secondary
Pre-primary (ICSED-0) Primary (grades 1-4, ICSED-1) Lower Secondary (grades 58, ICSED-2A) Upper Secondary (grades 912, ICSED 3A,3C) 1994/95 59.7 92.8 79.0 61.4 2000/01 66.8 96.3 82.4 64.7 2001/02 73.6 98.5 83.1 68.3 2002/03 74.2 99.8 84.0 74.9 2003/04 74.6 100.3 84.2 77.1 2004/05 73.6 99.7 84.2 77.3 2005/06 73.7 99.5 84.9 78.0

Source: National Statistical Institute (2006) Education in the Republic of Bulgaria 2006. Note: Upper secondary includes students enrolled in general (ISCED 3A) and vocational upper secondary schools (ISCED 3C).

Box 5.1: Equity in Education
Equity in education remains an issue, evident by low participation and achievement rates among children from poor and minority backgrounds. Regarding participation, Figure 5.2 shows that a large share of the poor and vulnerable groups fails to complete compulsory education. It is not possible to document the achievement of children from poor and vulnerable backgrounds, given the lack of external assessment of student achievement, and the fact that no administrative data record the ethnic or socio-economic background of students. However, recent external pilot evaluations of fourth graders conducted by the Open Society Institute Bulgaria (OSIB 2006), which has been pioneering external assessment of students in the country, provide some concrete evidence of what is widely assumed in Bulgaria: there are large gaps in student scores between many of the schools predominantly attended by Roma minority students and majority schools. These evaluations also show that in the schools sampled, the average student in the “Roma schools” had not mastered half of the curricula taught, and that student performance fell well short of the performance in “non-Roma” schools. While no hard data exist, anecdotal evidence suggests that children from ethnic minorities, in particular Roma, are disproportionately represented in schools for children with special learning needs, perhaps driven by insufficient preparation (as evident in an insufficient command of the Bulgarian language).. Also, the current segregated and selective system of secondary education is another source of inequality for the poor, vulnerable, and minority students.

Figure 5.2: Years of schooling by ethnicity and poor/non-poor
Years of education completed by poor (20-28 yr olds) 100 90 80 70 60 50 40 30 20 10 0 1 2 3 4 5 6 7 8

Non Poor

Poor

9 10 11 12 13 14

Ye ars of e ducation comple te d by e thnicity (20-28 yr olds) 100 90 Bulgarian 80 Roma 70 60 T urkish 50 40 30 20 10 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Years of completed schooling

(%)

Years of completed schooling

Source: Staff calculations from Multi-Topic Household Survey (NSI, 2003).

5.6. Increasing efficiency of resource use: At first glance, the efficiency of resource use looks reasonable when looking at readily available aggregate statistics. For example, overall spending on education as a share of GDP is in line with other countries at similar level of income (4.3 percent of GDP

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(%)

in 2005), and aggregate student-teacher ratios—the most commonly used summary measure in international comparisons of efficiency—are lower than OECD averages in primary and general secondary, but not necessarily excessively so (see Table 5.2). Table 5.2: Student-Teacher Ratios in Primary and General Secondary
Primary OECD Average EU15 ** EU8 ** Bulgaria * Czech Republic Estonia (01/02) Hungary Latvia Lithuania Poland Slovenia Slovak Republic United Kingdom Finland France Germany Sweden United States 16.5 14.9 15.1 16.7 18.3 .. 10.6 .. .. 11.9 .. 19.4 20.0 16.6 19.4 18.7 12.3 15.5 Lower Secondary 14.3 12.1 12.2 12.8 14.3 11.2 10.6 13.5 8.5 12.6 13 13.9 17.4 9.8 13.7 15.6 12.1 15.5 Upper Secondary 13.0 11.6 12.3 12.1 12.6 10.3 13.2 12.7 8.3 13.5 13.7 14 12.6 15.9 10.6 13.7 14.1 15.6 Public spending, % GDP 5.2 4.3 4.3 5.5 5.8 4.3 5.1 6.0 5.8 4.4 6.5 5.4

Notes: *Bulgaria refers only to public education. The number of teachers based on NSI data (full-time equivalent public teachers). The number of students in primary, lower and upper general secondary based on NSI school level data base. **Not weighted by population size (that is, the average of the countries’ student-teacher ratios) Source: OECD, education at a glance 2005; and National Statistical Institute, expenditure data from 2003, Bulgaria 2005.

5.7. However, public spending per student has been increasing rapidly since 1997, mostly because student cohorts have declined faster than the number of teachers (resulting in lower S/T ratios) and because of rising teacher salaries. But aggregate figures conceal substantial variation in student-teacher ratios across schools: a large number of schools (31 percent of the municipal schools)—both in rural and urban areas—have exceptionally low student-teacher ratios (less than or equal to 11). Bulgaria’s problem of small schools with low student-teacher ratios is partly a result of having a large number of municipalities located in rural, mountainous areas with scattered settlements. However, there is also a large number of schools with low student-teacher ratios located in urban areas (see Table 5.3), where optimization of the school network should be considerably easier, given the short distances between schools. This problem is particularly visible in Sofia’s 87 “urban” schools teaching only grades 1-8.101 The student-teacher ratio in these schools at 13.2 is lower than the national average of 13.9 for similar type schools located in urban areas. There are a number of schools with low student teacher ratios and very few schools which are operating with reasonably high ratios (that is, above 16) (see Figure 5.3). In addition, schools in Bulgaria have a large non-teaching staff: for every 100 teachers in the system, there is 43 non-teaching staff.102

Even large municipalities have schools classified as “rural”. These schools are located in the periphery of the municipality. In Sofia, some of these schools are located in the surrounding mountains, which make school consolidation more difficult. Therefore, in the discussion of Sofia above, focus is only on the “urban” schools.
102

101

Annual Census of Schools, the National Statistical Institute.

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Figure 5.3: Student-teacher ratios in 87 urban schools in Sofia (grades 1-8)
25 Number of schools 20 15 10 5 0 5 10 Student-teacher ratio 15 20

Source: School level expenditure data base, NSI/MOF/MES/WB

II.

THE AGENDA FOR FINANCE AND GOVERNANCE REFORM

5.8. In mid-2006, the Bulgarian National Assembly approved an ambitious 10-year reform agenda for its general school system in the National Program for the Development of School Education 2006-2015. The strategy, which covers primary and general secondary education, has six broad objectives: a) Orienting school education towards the stimulation of thinking, independence, formation of practical skills, and personality building; b) Establishing an efficient internal assessment system through the wide-scale use of tests, and an introduction of a national standardized external assessment system; c) Decreasing the number of drop-outs and increasing enrollment rates of children in the compulsory schooling age; d) Strengthening the authority and improving the social status of the teacher; e) Decentralizing the school network through the gradual introduction of delegated budgets for all schools, and providing increased flexibility to municipalities to appoint school directors; and f) Optimizing the school network by introducing a single standard (per capita) financing formula, and putting in place a system of financial incentives for the closure of ineffective schools. 5.9. While the Government is pursuing reforms across all six priorities, the decentralization, finance, and governance agenda is essential for promoting access and quality, and freeing up resources to be reinvested in the pursuit of the overall reform agenda. The objectives of the finance and governance reforms, as set out in the National Program, are as follows: (i) improved efficiency: better educational outcomes per BGN spent; (ii) equity: a fair educational system, which gives the right incentives and equal access to educational opportunities for all children, in particular marginal students; (iii) greater participation in decision making by local governments, school directors, school staff, parents, and the local community; and (iv) higher quality of education for all students. The first three objectives will assist in the achievement of the most important objective: higher quality education for all. Greater efficiency would allow higher quality to be achieved with a given amount of expenditure on education. Equity would help to achieve equal access by all students to the available educational opportunities.

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Greater participation would allow education decisions to be taken by those who have relevant knowledge of local educational needs and conditions. A. The Current Primary and General Secondary Education System: Input-oriented and Centralized

5.10. The National Program describes the education system as excessively centralized, and the legal framework as complex and inconsistent. Also, the current system of financing municipalities for the costs of managing schools does not provide incentives for efficient school management. Detailed norms about teaching hours and class sizes determine the number of teachers, and hence teacher salary costs, for which municipalities are then compensated. There is, therefore, little incentive or possibilities for municipalities to reduce costs by closing and consolidating small schools or by organizing larger classes, since both would result in reduced municipal revenues from the state. Until now, the bulk of education related resources a municipality receives from the state has gone to pay staff, and these funds have been only loosely tied to the number of students in the municipality. Specifically, a municipality can only hire a teacher if—according to official class size standards—there is an appropriate number of students to justify it. However, this relationship is weak, since there are upper and lower bounds for class sizes. Thus, a municipality could wait years before having to dismiss a teacher, as class sizes drop below the minimum. Moreover, the closing of a school can be postponed for years, as municipal councils can simply choose to overrule the minimum class size requirements, and provide the gap in funding from their own sources or postpone repair work. In this way, the system has left in place more schools than needed, sometimes in poor state, all suffering slow decline, with staff compensation consuming a rising share of total expenditures, and the resources available for teaching materials declining.103 5.11. As a consequence, the decline in student numbers has not been followed by the expected proportionate decline in the number of teachers. This, along with rising teacher salaries, has helped push up real costs per students (see Figure 5.4). Figure 5.4: Student Numbers Falling Faster than Teacher Numbers, and Driving Fast Growth in Real Expenditure per Student
Student and teacher numbers, index 1992-2005
105 100 95
(1992=100)
Students (index, 1992=100) T eachers (index, 1992=100)

Real expenditure per student, index 1997-2006
190 170 150 130 110 90 70

90 85 80 75 70 1992 1994 1996 1998 2000 2002 2004

(1997=100)

1992

1994

1996

1998

2000

2002

2004

Source: National Statistical Institute and Ministry of Finance; Note: includes teachers and students from preprimary to non-tertiary post-secondary level, including vocational (ISCED0-4C).

Inability to explain the observed variation in student-teacher ratios across municipalities with typical factors is consistent with this story: a crucial determinant in explaining student-teacher ratios is unobserved, namely, the mayor’s and municipal council’s willingness to consolidate schools.

103

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2006

B.

The New Primary and General Secondary Education System: Outcome-oriented with Selfmanaging Schools

5.12. The reformed general education system that is envisaged by the National Program is one of selfmanaging schools.104 In the new education system, the Ministry of Education and Science (MES) would focus on the results of the education system rather than on detailed management of the inputs, and defining the curriculum in terms of content and student hours. This would require setting goals for student learning outcomes, and monitoring the achievement of those goals at national, municipal, and school level. Further, school management and resources would be decentralized to the municipal and school levels. This would require strengthening of regulatory and monitoring capacity of MES, for example, through information systems to monitor the implementation of school policy. The transition towards self-managed schools is planned to be done in three related steps: (i) by introducing a unified standard per student; (ii) by expanding the use of delegated budgets,105 and (iii) by relaxing MES regulations and establishing school-based management. Box 5.2 defines these terms. Among other EU countries, Sweden and the UK have been introducing similar reforms to enhance school-based management to various degrees over the past decade. 5.13. Introducing a unified per capita financing changes the incentive framework to promote efficient school management, and access to education. First, the unified standard provides incentives for school consolidation by tying all the funds a municipality receives for education directly to the number of students. Second, it gives municipalities and schools a clear incentive to attract and keep students. Thus, the unified standard is likely to help raise enrollment rates, and lower the drop out rates. In parallel, the Ministry of Education and Science will need to step up oversight efforts through regional inspectorates to prevent municipalities and schools from reporting ghost students.

A well known definition of this system by Caldwell (2002: p. 35) is: “A self-managing school is a school in a system of education to which there has been delegated a significant amount of authority to make decisions related to the allocation of resources [resources defined broadly to include knowledge, technology, power, material, people, time, assessment, information, and finance] within a centrally determined framework of goals, policies, standards and accountabilities.” The term “delegated budget” has generated some confusion in Bulgaria, because the municipalities that have experimented with delegated budgets have introduced them in different ways. Similarly, given that there has already been some element of per student financing in Bulgaria for several years (for non-staff cost), it is often not understood that the unified standard per student is meant to cover all education expenditures. Bulgaria begun introducing delegated school budgets and school based management in the late 1990s (with EC support). By 2006, about 40 municipalities out of 264 had some form of delegated school budgets. Since each municipality developed its own system, there are substantial differences between them. However, a common feature is that budget delegation is limited in practice, and the school director has discretion only over all or parts of the non-staff budget. In the few instances where salaries are said to be delegated, it only means that the school manages the payment of salaries, not the determination of the number of staff or their salaries as these are determined by MES regulations. The shift to a delegated non-staff budget has been successful: municipalities and school directors consider their spending on the non-staff part of the budget more efficient than before. For further details on the evaluation of delegated school budgets in Bulgaria, see Club Ekonomika (2005), Local Government Initiative (2005), Secondary Education Information Resource and Financial Management Center (2003), and European Commission (1998).
105

104

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Box 5.2: School Finance and Governance Reforms: Understanding the Terms
Unified standard per student: The unified standard per student is unified because it includes funding for both staff salaries and non-staff expenditures. Since 2002, the Ministry of Finance has been allocating to municipalities a per student amount for non-staff expenses. To provide incentives to municipalities increase efficiency, salaries should be funded on a per student basis as well. For example, if the unified standard applied to Municipality A is BGN800 per student per year and it has 20,000 students, it would receive a grant of BGN16 million per year from which to meet all the recurrent costs (that is, excluding capital costs) of education for grades 1 to 13. Municipalities could top up the BGN800 from its own revenues. However, the presumption is that the BGN800 per student would be sufficient to cover all recurrent costs associated with educating a child, and that a municipality would not receive any additional funds to cover education costs. That is, all current schemes of funding—such as, heating allowances, scholarships, traveling costs, clothes allowances—would be abandoned, and the municipalities would have to cover all costs from the per student unified standard. However, the unified standard is not uniform. That is, it will not be the same amount for all municipalities, but will vary depending on the type and municipality and structural factors that influence cost per student. The structural factors are beyond the control of the municipality, such as mountainous terrain, low population density, or higher than average percentages of socially deprived students, which cause the cost per student to be high. Municipalities would not be given additional funds owing to small sizes of schools, since this would provide perverse incentives and defeat the purpose the reform. Delegated school budgets: Under the unified standard per student, the school receives a single lump sum, with no indication of allocation between salaries and other expenses. This decision is left to school authorities. The school budget is determined by a formula, which applies to all schools in the municipality. The main factor in the formula, which determines the size of the school budget, is the number of students. The amount per student may be different for different grades, if the cost per student varies by grade due to differences in class sizes, teaching hours, or teacher pay rates. Examples of other factors included in the formula could be additional supplements for students with special learning needs, which may be due to their socio-economic background, lack of fluency in the language of instruction, or to disabilities. Some structural cost factors, such as an isolated location or having staff with higher salaries, could also be taken into account (for further details, see Ross and Levačić 1999). The main purpose of delegating budgets to schools (and accompanying it with school based management) is to delegate more decisions about education to those who have knowledge about local educational needs and conditions. This, in turn, is likely to lead to more efficient use of resources and higher quality of education. School based management has different forms, but its main features are: (i) the school director manages the school budget, including determining the number of teachers and other staff, and selecting and appointing teaching and non-teaching staff; (ii) the school director is accountable for the honest and efficient management of the school budget and resources to a school council, which usually consists of representatives of parents, staff, and the local community (the council may have the power to appoint the school director and the ultimate authority to approve the budget decisions); and (iii) the school director can also be held accountable by the education authority (that is, the municipality). The school director and school council have to operate within the MES framework of education goals and standards—such as salary levels and working conditions for teachers and other staff. School-based management has been introduced in some OECD countries.

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5.14. For a coherent and well functioning system of self-managing schools, all three key elements— unified standard, delegated school budgets, and Figure 5.5: The three aspects of a finance and school based management—need to be implemented governance reform (Figure 5.5). In Bulgaria, the reform process started on January 1, 2007 with the introduction of the School based unified per student financing standard, and Delegated management Budgets decentralization to municipalities. While this is an essential and important first step, the other two elements should also be implemented in due course to achieve the full effects of greater autonomy and accountability. Problems might arise if only partial reform was pursued. Rigid central class size and Unified standard teaching hour norms in turn would prevent schools to flexibly adjust to per student financing. Without further delegated budgets, municipalities might reallocate funds to schools on an uneven basis. Also, only further delegation of budgets to school will unleash the full incentive effect from per student financing for attracting and retaining students. III. INCREASING EFFICIENCY IN PRIMARY AND GENERAL SECONDARY EDUCATION

5.15. Optimization of the primary and general secondary school network, and introduction of a per capita formula financing system for primary and general secondary education could save substantial resources for reinvestments in education quality. This is true even if the consolidation were limited to only large municipalities, where distances between schools are small. For example, there are 667 municipal schools located in urban areas within large municipalities (that is, with a population greater or equal to 60,000).106 Out of these schools, only 320 operate with student-teacher ratios greater than or equal to 14, and a consolidation of these schools into schools with student-teacher ratios greater than 14 would yield savings. There are even larger savings to be generated, if policy makers were willing to tackle the problem of many small village schools. As reflected in Table 5.3, the vast majority of the 794 schools operating with student-teacher ratios less than or equal to 11 are located in villages.107 Consolidating school in these areas would, however, be more challenging and require more planning and thorough analysis of its impact on access to education. 5.16. There are also large possible savings resulting from the decline in Bulgaria’s student-age population. As discussed in Chapter 1, the average enrolment in school at all grades from pre-school through upper secondary will have to adjust downwards to about 60,000 students per cohort over time, which is 20-30 percent below current enrolments, depending on the grade. With fewer students to educate, the school network can be further consolidated, freeing up resources for the schools that remain in the system. 5.17. International evidence suggests that per capita formula financing and school network optimization can lead to substantial savings without negatively affecting the quality of education. Neither would it negatively affect access to education, if mitigating measures are in place. It is well-established that marginal reductions in class size (especially below 30) have at best only a small, if any, impact on

106 107

There are 29 municipalities (out of 264) which have a population greater than 60,000. The term village can refer to a small settlement in the periphery of a larger municipality.

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student attainment. However, it has been argued that large reductions can have an impact on children in the early years of schooling, and on those from socially deprived backgrounds.108 Table 5.3: Large Variation in Student-Teacher Ratios Translating into Varying Per Student Costs
Location % of student in municipal schools % of municipal school expenditure109 4.8 10.6 15.4 68.5 16.1 84.6 73.3 26.7 100.0 36.1 5.6 41.8 Average studentteacher ratio 9.3 8.9 9.0 14.4 14.3 14.3 13.9 11.8 12.7 15.8 17.7 16.4 Average expenditure per student 1,092 1,176 1,166 711 838 766 745 999 889 665 766 700 Number of schools

Student-teacher ratio≤11 City 3.9 Village 7.1 Total 11.0 Student-teacher ratio>11 City 73.9 Village 15.1 Total 89.0 All municipal schools City 77.8 Village 22.2 Total 100.0 Of which: schools with student-teacher ratio≥14 City 41.4 Village 5.9 Total 47.3

99 695 794 1,014 769 1,783 1,113 1,464 2,577 529 278 807

Source: School level expenditure data base, NSI/Ministry of Finance/Ministry of Education and Science, and the World Bank.

5.18. Consistent with international experience, recent evidence from Bulgaria suggests that schools with lower student-teacher ratios do not automatically achieve better education outcomes (such as reduced drop out or repetition rates) than schools with higher ones.110 To obtain a measure of education outcomes, school-level information on drop-out and repetition rates is added to the school-level database. Figure 5.6 presents scatter plots showing the relationship between drop out, repetition, and studentteacher ratios.111 The data reveal that schools with few students per teacher do not achieve better quality outcomes as measured by drop-out and repetition rates. The graphs reveal that there is neither a discernable relationship between the drop-out rate and the number of teachers per student, nor the repetition rate and student-teacher ratios. Figure 5.6 also shows that there are a worrisomely large number of schools with very high drop-out and/or repetition rates. Interestingly, schools with high dropout rates do not necessarily also have high repetition rates, ruling out the possibility that poor outcomes observed on aggregate can be attributed to a core of schools, which fail in all dimensions. It goes beyond

108 109 110

For example, Wößmann, (2003); OECD (2005b), and Hanushek (1999). Municipal school expenditures accounted for about a third of total public expenditure on education in 2005.

OECD (2004d) analyzed PISA 2003 results in OECD countries, and found no statistically significant relationship between the student-teacher ratio and student performance.
111

There is data on both drop-out and repetition rates for 2,983 schools in 2005, suggesting that a large share of about 3,300 schools do not report one or the other. There are 58 schools performing poorly on either or both accounts–or have data of questionable quality. These schools have repetition rates or drop-out rates above 22.4 percent (the cut-off point for the top one percent drop-out rates), or 26.4 percent repetition rates (the cut-off point for the top one percent repetition rate). The analysis in this chapter excludes these 58 schools because of their data quality.

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the scope of this chapter to analyze the drivers of drop-out and repetition by school, but it is a key area for future analysis. Figure 5.6: Student-Teacher Ratios and Drop-Out Rates (left chart) and Repetition Rates (right chart) by Schools, Bulgaria, 2004
20
25

5

drop-out rate in school (%) 10 15

0

0 0

5

repetition rate in school (%) 10 15 20

0

10

20 student-teacher ratio

30

40

10

20 student-teacher ratio

30

40

Source: Staff calculations from school-level database and NSI data

IV. •

WHAT HAS BEEN ACCOMPLISHED SO FAR?

The new financing system effective from January 1, 2007 sets four different financing standards for four different types of municipalities. Figure 5.7 presents the groups and per student standards. The first group consists of the municipalities which have over (or equal to) 70,000 people in the municipal center. The remaining municipalities (which all have fewer than 70,000 inhabitants living in their municipal centers) are divided into three groups: (i) municipalities with the population density greater than (or equal to) 65 per square kilometer; (ii) municipalities with the population density less than 65 per square kilometer; and (iii) small mountainous municipalities (a subgroup of (i) and (ii)) with more than three settlements, and less than 10,000 inhabitants in their municipal center. Under the new financing system, there are 88 losing municipalities—that is, municipalities which will receive less (in nominal terms) under the per capita scheme than in 2006. In 2007, they are entitled to receiving a compensation equivalent to the difference between the allocation based on the new per student amount and their allocation in 2006.112 However, these municipalities have to present a school consolidation plan to MES and the Ministry of Finance (MOF) by March 31, 2007 in order to receive the compensation. Current plans envisage that the compensation is limited to 2007 only, and that the per student financing rule will be fully implemented from January 1, 2008 onwards, implying school consolidation needs to proceed in 2007. Losing municipalities will thus have multiple incentives to initiate school consolidation. With wages increasing by about 5-10 percent per year nominal terms, the only way for those municipalities to be financially viable under the per capita scheme is to consolidate their school network (assuming that non-wage costs are not cut instead, which is a risk that should be taken into account in the plans).

The implementation plans do not specify any ceiling on winning municipalities. Thus, the municipalities which have well-optimized school systems will experience increases in their education budgets.

112

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Figure 5.7: Groupings of municipalities, along with baseline amounts and adjustment coefficients for 2007
Large municipalities: population ≥ 70,000 in the municipal center 40 municipalities: baseline amount x 1.07, or BGN 849 70 municipalities: baseline amount x 1.2, or BGN 958 Underpopulated municipalities: population < 70,000 in the municipal center and a population density ≥ 65 persons per square meter

15 municipalities: baseline amount BGN 796

139 municipalities: baseline amount x 1.12, or BGN 894

Other municipalities: population < 70,000 in the municipal center and population density < 65 persons per square meter

Small mountainous municipalities: population < 10,000 in the municipal center and ≥ 3 separate settlements

5.19. The Government has created mechanisms to support adjustment by municipalities to the new funding system and school consolidation. The challenge of introducing the unified standard per student is that the municipalities which have failed to fully optimize their school network are likely to run into short-run financial difficulties (or have driven down their maintenance and material spending). While this should provide municipalities incentives to move ahead decisively, there may be transition problems. Therefore, MES has introduced support measures for school consolidation. This includes hands-on advice on managing the process of school consolidation, and a budgetary facility to finance mitigating measures, such as parent outreach work, transport, and physical adjustments to school buildings to accommodate students from closed schools. 5.20. The introduction of finance and governance reforms will necessarily span over a number of years, with municipalities consolidating the network and adjusting to the new financing parameters and delegated budgets being gradually rolled out.113 It is essential for the Ministry of Education and Science to monitor this process carefully, in particular through the regional inspectorates and external student assessments, to detect unduly negative effects on quality and access. Equally, under the new system it is important to monitor school budgets to prevent municipalities from financing municipal schools on an unequal basis. Under the intermediate system of decentralized financing to municipalities, and not to schools through delegated budgets, there is a risk that municipalities provide beneficial financing to some schools at the expense of others. This may lead to a worsening of short-term outcomes in underfinanced

In England, the introduction of school-based management and delegated budgets took seven years from the announcement of the reform in 1988 to its full roll-out in 1994. Sweden followed a similar multi-year process.

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schools. To offset this, the introduction of delegated budgets to schools should be accelerated, while carefully monitoring individual school budgets at the municipal level to ensure equity. V. POSSIBLE FISCAL IMPACT OF THE REFORM

5.21. The introduction of a unified standard, provided it leads to school consolidation, is set to yield substantial efficiency savings. These can be reinvested into the overall education system. Figure 5.8 provides preliminary estimates of the possible costs and potential savings of shifting to a per capita financing scheme in municipal schools. The graph on the left hand side of Figure 5.8 illustrates the additional costs and savings from the reform compared to current situation. The graph on the right-hand side traces the paths of education expenditures for two different reform scenarios. The underlying assumptions are explained below. Total savings and costs arising from the reform include (from left to right in Figure 5.8): (i) an efficiency gain (estimated by MoF when setting the initial funding rates); (ii) the “demographic dividend” (the saving associated with the fact that the student population is declining); and (iii) expenditures on mitigating measures. Figure 5.8: Estimated Fiscal Impact of Introducing Per Student Finance to Primary and General Secondary Schools
Total spending on municipal schools with and without the funding reform Estimates for 2009 in ‘000 Leva
850,981 99,132 60,426 35,000 726,423
4.4 4.3 4.2 (share of GDP) 4.1 4.0 3.9 3.8

Education spending in % of GDP

Difference: program-based spending

Baseline case

MOF proposal

Total spending w/o funding reform

Efficiency gain estimated by MOF

Demographic dividend (cumulative)

Transport, refurbishing and other mitigation

Total spending with funding reform

3.7 2005 2006 2007 2008 2009 2010

Source: Ministry of Finance, the World Bank school level expenditure data base for Bulgaria and World Bank education team simulations

5.22. School consolidation and adjustments to the number of non-teaching staff can achieve substantial savings. First, school level data shows that 794 schools in Bulgaria (that is about 30 percent) operate at student-teacher ratios below 11. Measures to consolidate these schools, and to reduce the overall number to 400 schools operating at ratios just above 11, could yield savings of over BGN80 million per year over the next three years. Second, a parallel reduction of non-teaching staff by 30 percent (about 7,000 people) could yield additional savings of about BGN20 million. The total amount of possible and acceptable savings is a matter of judgment. The figure of about BGN100 million shown in the graph contains the combined consolidation and non-teaching staff reduction savings. This scenario assumes that municipalities will respond to the incentives and support measures provided by the central level to consolidate schools. 5.23. There are also large possible savings resulting from the continued decline in the student-age population. The “demographic dividend” encompasses the savings that are made to the central government budget, since the new funding accrues per student and therefore accounts for declining student numbers. According to the UN population projections, the student age population (that is, age 619) will decline by about 40,000 during 2005-2010, and by another 20,000 by 2050. Assuming that Bulgaria manages to offset some of this decline by raising participation rates, the decline in students may be only about 27,000 in 2005-2010. The dividend arises from comparing the funding amount (under the

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new per capita regime) without student decline with the funding amount with student decline. The demographic dividend grows each year, in line with the shrinking school-age population, and is estimated at BGN60 million by 2009. 5.24. Mitigating and support measures in school consolidation are in place to assist municipalities adjusting the school network. Figure 5.8 also factors in any mitigating and support measures during the transition period. These would include a program to cover material improvement of school buildings, a bus transportation scheme, parent-involvement strategies, and municipal capacity support. The annual expenditure for this is estimated to be BGN35 million. 5.25. The medium-term budget framework for 2007-2009 projects a freeze in total education spending as a share of GDP at the 2006 current level.114 The fiscal projections on the right hand side of Figure 5.8 integrate all elements of the reform agreed so far by different ministries. The baseline scenario assumes that spending grows at the rate of growth of GDP in 2007-2009. The line below the baseline scenario indicates expenditure under per-student financing as percentage of GDP, if there is full transition to the new per capita funding rates, and losing schools are compensated for two years. The savings generated (illustrated by the vertical arrow) will be reallocated to the education system. The reduction in allocations to municipalities based on per student formula would be compensated with increased program spending (by part of the savings). In 2007, program spending is planned to be allocated to policies aimed at mitigating the impact of school consolidation, investments in strengthening staff qualification, modernization of the school base, education quality enhancements, and external student assessment. VI. POLICY RECOMMENDATIONS

5.26. The initiation of the school governance and finance reform in primary and general secondary education opens an opportunity for the government to promote long-term reforms improving access and the quality of education. First, the reform agenda, if sustained, would lead to a more efficiently managed school system with greater focus on quality than before, in particular if coupled with the introduction of internal and external assessments of learning outcomes to promote achievement of national education standards. Second, efficiency savings would open the possibility to finance in a sustainable manner measures aimed at achieving improved education outcomes, and needs in other parts of the education system. 5.27. While the government has already shifted to per student financing on January 1, 2007 for primary and general secondary schools, further policy steps on governance and finance sides would still need to be taken. The remaining short and medium-term policy steps and recommendations can be grouped as follows. 5.28. The four key short-run policy steps and recommendations would be: • Establish a clear and credible timeline for reform implementation to facilitate school consolidation: The efficiency savings will only materialize, if the per student financing formula leads to a further consolidation of the school network. Therefore, ensuring that school consolidation happens is critical. The government would need to announce a credible timeline for the roll-out of the reforms (and their sequencing) across all municipalities, covering 2007 and subsequent years. At the same time, the government should continue supporting the consolidation process through targeted advice and financial assistance to

114

Ministry of Finance (2006) Report on the Three-Year Budgetary Forecast for the Period 2007-2009.

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those municipalities which proceed with the consolidation of their school systems. In addition, hands-on advice to municipalities on how to manage consolidation would be helpful. Several municipalities have gained experience on school consolidation over the past years, and MES could promote peer learning activities among municipal authorities jointly with the National Association of Municipalities. This support and advice would need to be available throughout the reform period. • Monitor the impact of reforms, and introduce external evaluation of learning outcomes: It is essential that the roll out of the reforms and their impacts are closely monitored and, based on the results, plans are adjusted as needed. The first stock taking in municipalities and schools would need to be conducted early on to detect any problems and allow early course correction. In addition, it would be important to monitor that municipalities treat all schools equally and fairly in their funding allocations, in particular prior to the roll-out of delegated budgets to schools. In parallel, the Ministry of Education and Science’s (MES’s) capacity to monitor education outcomes would need to be strengthened through the introduction of nationwide external testing to determine learning outcomes, and through its management information system. MES has already conducted pilot student assessments and is scheduled to phase in systematic external testing over the coming years. Relax central regulations on teaching hours and class sizes: The per student formula funding, and rigid top-down regulations regarding teacher working hours or class sizes are mutually inconsistent and could lead to a fiscal crisis in municipalities (or for schools, once the formula reaches them through delegated budgets). With the shift to per student funding, schools would need considerable flexibility in determining how they allocate students to classes and how many classes they establish. Therefore, it is recommended that MES leaves the class sizes for municipalities to decide, and relaxes regulations on teaching hours. Implement school-based management and delegated budgets: Per student financing enhances efficiency and quality only if it is accompanied by an expansion of school-based management and further delegation of budgets to schools. Hence, it is important that the school-based management is rolled out in the next few years, as the school consolidation proceeds, which requires preparation now. In the context of the shift to school-based management, capacity building for school directors and municipal education department staff will be needed, including on budgetary issues and determination of the delegated budget formula. MES has recently established an Institute of School Directors for this purpose, and a number of school principals have already been trained. In the meantime, however, MES should not hold off delegating responsibilities to directors, as the most important learning will happen on the job. When shifting to school–based management, introducing performancerelated pay schemes to teachers might also be contemplated: school principals, who are accountable for quality, would need means to evaluate teacher and influence teaching quality. MES is also promoting the establishment of school councils comprised of parents and local stakeholders, such as community associations and private businesses. While the experience with such councils is mixed in OECD countries, they may enhance parent and stakeholder involvement in the school, and thereby help hold schools and municipalities accountable for school performance and budgeting, provided they are empowered and given full information.

5.29.

The key medium-term policy step would be: • Reinvest savings in measures aimed at promoting quality of education and access: The introduction of per student formula financing, if it leads to the consolidation of the school network, can yield substantial savings. Since consolidated spending on education as a share 93

of GDP is projected to remain constant in the 2007-2009 medium-term fiscal framework, this implies that a growing share of the education budget can be reinvested in other education system needs, including policies to enhance education access and quality. In addition to the needs on the vocational and tertiary education side, this could include teacher training, external assessments of schools to promote school and teacher accountability115, and preprimary education to promote school readiness and reduce subsequent drop outs116.

115

The Center for Control and Assessment of the Quality of Education (CKOKO) has been tasked with the institutionalization of the goals for an outcome-oriented education system. Similar agencies exist in every EU country, and they have emerged as one of the key players in the education sector. The government is planning to strengthen CKOKO’s technical capacity to implement testing programs, which include: (i) a new placement test at the end of 7th grade, which has the potential to radically overhaul current patterns of student access to upper secondary school; (ii) designing and piloting a new Matura, that is, secondary school-leaving examination; (iii) new tests (sample or census-based) to be used strictly as system-wide evaluation of education quality; and (iv) managing Bulgaria's participation in international achievement tests. This includes international tests such as TIMSS, PISA, and PIRLS. Bulgaria has already participated in some international assessment studies but without sustained interest and funding from MES, which prevents it from taking full advantage of the benefits associated with these international endeavors. For example, Bulgaria has not participated in PISA since 2002.

Household survey data suggest that children from poor and marginalized communities are under-represented in pre-primary education, and are particularly likely to drop out from primary school. Adopting measures to promote access to pre-primary education for children from vulnerable groups—for example, through waiving the kindergarten fees for low income families, and facilitating establishment of community child care providers—might be a cost-effective way to promote school readiness and reduce drop-out rates. Years later, such measures may have an important pay-off in terms of lowering youth unemployment (see Chapter 4).

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6.

IMPROVING VOCATIONAL EDUCATION AND TRAINING

6.1 The major economic and social changes that have taken place in Bulgaria since 1989 have had an impact on the role of the vocational education and training (VET) system and its institutions, especially the public vocational secondary schools. These schools were established to serve the needs of centrally planned economic sectors of production, such as mining, ore processing, chemical and oil products, and heavy machinery—that is, sectors that have suffered major downturns in their share of production in the past fifteen years. The old VET system was also designed to serve the needs of large state-owned enterprises, with their training centers providing avenue for vocational training for students in the VET systems, as was also the case in current EU8 countries. These centers are now closed down, and opportunities for practical training have become limited. Vocational secondary schools still focus on programs designed to serve the old economic sectors, such as forestry, wood processing, and chemical, metallurgical, and machine technology. However, the new emerging economy is dominated by private small and medium enterprises (SMEs) in light industries and service sectors, and the needs of these enterprises are quite different from those that prevailed in the old one. 6.2 During the transition period, the labor market has experienced disequilibrium, and there is general consensus among officials and representatives of employers associations117 that the knowledge and skills of the graduates of vocational secondary schools do not match the skill set required for the emerging job vacancies, despite the relatively low unemployment rates among its recent graduates (Table 4.7). The situation is further aggravated by negative population growth rate and emigration. 6.3 With this in mind, the Council of Ministers approved in 2001 the Employment Promotion Act (EPA 2001), which introduced incentives for employers to train their employees and maintain and improve their qualifications.118 The Vocational Education and Training Act (VETA 1999) in turn defined the regulatory mechanisms for initial and continuing vocational education and training. Its major goal is to “match the quality of the vocational education and training provided for the needs of the labor market, and in accord with the trends in the European Union”.119. Since then a National Agency for Vocational Education and Training (NAVET) has been established, which is in charge of licensing VET providers and the classification of occupations. Amendments to the VET Act were introduced in 2003 and 2005 to approve a new list of professions and framework programs regulating the acquisition of vocational qualifications. The Bulgarian approach in defining qualification levels and professional competencies is consistent with the approach developed by the European Qualification Framework and based on knowledge, skills and personal qualities required for the profession. In 2005, consistent with European directives, progress was made in the mutual recognition of vocational qualifications. These developments notwithstanding, there is still significant room for improvement in the system as a whole. 6.4 This chapter provides first an overview of the VET structure and its governance in Bulgaria, highlighting the enrolment trends. This is followed by a look at continuing VET and how it compares with the EU8 countries. Finally, the chapter explores the cost-effectiveness of VET, as well as its links to the labor markets. The chapter ends with a presentation of some options for reform.
Such as the Bulgarian Chamber of Commerce and Industries, the Bulgarian Industrial Association, and the Bulgarian Small and Medium Enterprises Agency.
118 117

EPA regulates the types of continuing VET organized by the National Employment Agency, and the conditions of its delivery. Council of Ministers (2005) “National Strategy for Continuing Vocational Training, 2005-2010”.

119

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I. THE STRUCTURE AND ORGANIZATION OF THE VET SYSTEM 6.5 The structure of the Bulgarian VET system is complex and includes several different types of schools. The typology and organization of the Bulgarian education system as a whole and vocational schools in particular is shown in Figure 6.1. Further, to put into perspective the size of the VET network, the types and the number of schools providing general education are summarized in Table 6.1. The Figure and the Table together indicate that in terms of number of schools the VET system is about a sixth of the size of the secondary education system. Figure 6.1: The Education System in Bulgaria

7 6

Bachelor
3 Specialist 2 1 4 3 2 1

Age 20 19 General Secondary 18 Schools 17 16 15 14 VIII VIII 13 VII VII VI VI 12 V V 11 B 10 IV IV 9 III III 8 II II I 7 I A C
Legend

5 4 3 2 1

Doctorate

Tertiary (Higher) Education

Masters
XIV XIII L Secondary Education

XII XI X IX D

XII XI X IX VIII VII VI V E1

XII XI X IX VIII VII VI V IV III II I E2

Vocational Secondary Schools

IX VIII VII F

IX VIII G

IX H

XII XI X IX I

XIII XII XI X IX J

XIII XII XI X IX VIII K

Basic Education

A: Elementary School, B: Lower Secondary School, C: Primary School, D: Upper Secondary School E1 & E2: Comprehensive School, F, G&H: Vocational Training School, I,J&H: Vocational Secondary School, L: Vocational College

Table 6.1: School Types in General Education (2005)
School Primary (Grades I-IV) Lower Secondary (Grades V-VIII) Basic ( Grades I-VIII) Upper Secondary (V-XII) Comprehensive Schools (V-XII) and (I-XII) Total
Source: National Statistical Institute (2006e).

Type A B C D E1,E2 Urban 118 10 516 166 350 1,160

Number of School Rural Private 155 4 10 3 1,244 22 2 26 60 4 1,471 59

Total 277 23 1,782 194 414 2,690

6.6 Vocational education is provided in three categories and seven types of vocational schools and colleges. The numbers of schools, teachers, enrollment, and student-teacher ratios by categories and types of school are summarized in Table 6.2. The categories are as follows:

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Vocational Training Schools: These schools provide avenues for students, who wish to pursue vocational studies as early as Grade VII (Type F), Grade VIII (Type G), or Grade IX (Type H). That is, students can shift to a vocational school prior to the completion of compulsory education. Successful completion of VET programs in these schools provides for semi-skilled occupations (level 1 qualification), with competencies in the targeted trades emphasizing routine activities, and repetitive tasks. Vocational Secondary Schools: These schools provide specialized vocational courses in selected occupations, and academic courses similar to those offered in general secondary education. Some of them (type I, J, K) provide for manual skills and occupations (level 2 qualifications), with competencies in the targeted trades involving the execution of complex activities. Others (type J and K) provide for skilled occupations (level 3 qualification), with competencies in the targeted trades involving the execution of complex activities, including responsibilities for the work of other people. Vocational Colleges: These colleges established under Article 18 of the Vocational Education and Training Act (VETA) provide the highest VET award sanctioned (level 4). They prepare for skilled occupations with middle-management supervisory responsibilities, with competencies in the targeted trades involving the execution of complex activities, including responsibilities for the work of other people, and for the allocation of resources as required.

Table 6.2: Types of Vocational Secondary Schools in Bulgaria (2006)
School Category Vocational Training Schools Vocational Secondary Schools Vocational Colleges Total VET Award Level 1 F/G/H Level 2 Level 3 Level 4 I J/K L 2-3 4 5-6 2 na 85 397 23 505 2627 38429 149665 3984 194,705 72 2120 16178 405 18,775 36.5 18.1 9.3 9.8 10.4 School Type Duration of Studies in Years Number of Schools Enrolment Number of Teachers StudentTeacher Ratio

Sources: 1. National Statistical Institute (2006e) 2. National Agency for Vocational Education and Training (NAVET)

6.7 The Ministry of Education and Science (MES), with support from NAVET, has defined a list of approximately 275-300 occupations for which VET is provided. The characteristics of the qualifications for the existing VET scheme in Bulgaria are summarized in Annex 1. The scheme defines the duration and form of training, the admission requirements, the graduation procedures, and certification secured upon graduation as well as the continued education opportunities for graduates. 6.8 The quality and labor market relevance varies substantially across the vocational schools. Some of them are among the elite schools in the country, while others are of much lower caliber academically and in terms of the quality of their facilities. 6.9 The VET system in Bulgaria streams students before the end of the compulsory education (as early as grade VII) into vocational schools and designated occupational areas. The experience of other countries120 indicates that students streamed narrowly early in their education are harder to reorient than their contemporaries in general secondary education when they become unemployed, because of their
120

World Bank (2006), “Fiscal Efficiency and Vocational Education in the EU8 Countries.”

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weak educational background. They also often have difficulty accessing Figure 6.2: Distribution of Enrolment in VET Programs by tertiary education, and lifelong Type and Level learning opportunities. In other EU and OECD countries, the streaming 80 into VET typically takes place only at the end of compulsory general 60 education, roughly at age 16. Many per cen 40 OECD countries have been also t exploring the development of flexible 20 educational pathways in upper secondary education, which allows the 0 integration of relevant generic Level 1 Level 2 Level 3 Level 4 vocational skills in all secondary schools to respond to the needs of a Art Business & IT Technology Services diverse student population, and changes in the nature of work. This is what the EU Bologna process is also aiming for (see more of the Bologna process in Chapter 7 on tertiary education).121 To achieve that typically requires reducing the number of vocational education programs by broadening the definition of vocational areas; creating linkages between general and vocational secondary schools; developing a combination of school and work-based learning; and building bridges between vocational secondary education and tertiary education.122 6.10 Over 60 percent of vocational students are enrolled in technology programs at levels 1, 2 and 3, as shown in Figure 6.2 and Table 6.3. This still largely reflects an old style VET mandated to prepare workers for construction and heavy industries.

EU launched in 1999 the Bologna process, which supports a series of reforms to make European Higher Education more compatible, comparable, competitive, and attractive for EU citizens and citizens and scholars from other continents. The aim of the European Higher Education Area, which EU hopes to establish by 2010, is to provide citizens with choices from a wide and transparent range of courses, and benefit from smooth recognition procedures. OECD (1994), Vocational Education and Training for the 21st Century: Opening Pathways and Strengthening Professionalism.
122

121

98

Table 6.3: Distribution of Student Enrolment in Vocational Schools by Vocational Discipline and Level, percent (2006)
Vocational Area Arts and Humanities: Arts Humanities Business & IT: Business & Administration Computing Technology: Technics Manufacturing and Processing Technology Architecture & Building Construction Agriculture, Forestry and Fishery Veterinary Science/Technology Services: Social Services Personal Services Transportation Other Services Total Level 1 0 0 0 0 13.4 59.7 2.4 7.4 0 0 17.1 0 0 100 Level 2 0 0 8.1 0 38.6 18.4 6.4 9.7 0 0.3 17.8 0.2 0.1 100 Level 3 3.6 0.4 18.7 2.7 36.0 12.7 6.4 7.5 1.6 0.0 8.2 1.1 0.9 100 Level 4 4.7 1.6 68.5 0 6.2 0.1 4.8 1.8 0 0 8.5 0.4 3.5 100

Sources: 1. National Statistical Institute (2006e) 2. National Agency for Vocational Education and Training (NAVET)

6.11 New enrolment in vocational secondary Figure 6.3: Enrolment Trends in Vocational Secondary Education education has been in decline 140000 in the past few years. 120000 Enrolment trends in VET 100000 programs offered in the vocational secondary schools 80000 are summarized in Figure 6.3 60000 and Table 6.4. The data show 40000 that total enrolment increased 20000 from 2001, peaked at 2003 and declined by 7 percent 0 2001 2002 2003 2004 2005 from that peak by 2006. However, there has been a Total M ale Total Female New Entrants steady decline in the new entrants by 21 percent in the five year period from 2001 to 2006. Also, unlike enrolment in general secondary education where female enrolment exceeds male enrolment, the pattern in vocational secondary schools is the opposite: female enrolment is less than 40 percent of total enrolment. The declining VET enrolment is consistent with the experience of EU8 countries. Since 1990, the share of vocational secondary in total secondary enrolment has fallen significantly in all EU8 countries, except the Czech Republic, as students have opted for the general secondary education.123

123

World Bank (2006e), “Fiscal Efficiency and Vocational Education in the EU8 Countries”.

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Table 6.4: Enrolment Trends in Vocational Secondary Education, 2001-2006
Year Male 2001 2002 2003 2004 2005 2006 116420 123710 130538 128456 123791 120147 Enrolment Female 74908 78802 80848 78939 77154 74558 Total 191328 202512 211386 207395 200945 194705 New Entrants Male Female Total 33876 31591 31763 30602 28041 26453 21141 19693 18948 18340 18078 17067 55017 51284 50711 48942 46119 43520 Number of Teachers 18129 18809 19362 19352 19064 18775 StudentTeacher Ratio 10.6 10.8 10.9 10.7 10.5 10.4

Source: NSI (2006e).

II.

GOVERNANCE OF THE VET SYSTEM

6.12 Several government and private sector bodies are involved in the governance of the VET system. These are the following: • The Ministry of Education and Science (MES): MES manages and controls the implementation of national VET policies. It regulates and controls the provision of VET programs through a system of public and private VET secondary schools, art schools, and vocational colleges. The Minister approves national occupational standards, the list of approved VET occupations, and programs for preparation of VET graduates in the MES affiliated schools. The Ministry of Labor and Social Policy (MLSP): MLSP develops, and coordinates the national policies for the professional qualifications of the workforce. It is also responsible for the development of the annual national plan for employment, and the determination of the needs for vocational training based on labor market analysis. Further, MLSP is responsible for the maintenance of the National Classification of Occupations and Positions. The National Employment Agency (NEA): NEA is an agency of MLSP, which implements the national policy for employment promotion and labor market protection, and organizes professional information and counseling, vocational and motivational training for both the employed and unemployed, and mediatory employment-related services. The National Agency for Vocational Education and Training (NAVET): NAVET, established in 1999, is a specialized body under the Council of Ministers mandated to license VET activities and coordinate the institutions involved in VET. It develops the national VET education requirements, the list of VET-related occupations, and oversees and regulates the provision of VET in the licensed VET centers. Government Ministries and Municipalities: The Ministry of Culture implements the VET policies in the Art Schools, and participates in the development and coordination of VET programs in these schools, and in securing certification in the related occupations. The Ministry of Health determines the list of chronic disease and physical injury that are incompatible with VET programs and related occupations Employers Associations: Various employers associations participate in the development, coordination, and maintenance of the national VET educational requirements for the acquisition of occupational qualifications. They have representatives in the NAVET Board of Management and expert commissions, and participate in the examination process to certify candidates for occupations relevant to them.

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Labor Unions: Labor unions designate representatives to the NAVET Board of Management and participate in the development, coordination, and maintenance of the list of occupations. III. CONTINUING VOCATIONAL EDUCATION AND TRAINING

6.13 Continuing vocational training in Bulgaria is delivered by formal education, training, and VET institutions, and by a variety of non-formal institutions. The formal institutions are the various types of vocational secondary schools and colleges discussed earlier, and Vocational Training Centers (VTC). In 2005, there were 490 such institutions, including 440 state, 15 municipal, and 35 private schools. Continuing education was provided by 182 of these schools. NAVET licenses the VTCs and monitors their operations. All VTCs licensed since 2002 offer VET Figure 6.4: Percentage of Enterprises Providing Continuing VET, programs for the first, second, 2004 (Source: Eurostat, CVTS2) and third levels of vocational 76 80 71 70 qualifications. Currently there 70 59 are 146 licensed VTCs, and 169 55 55 60 49 affiliates. Most universities and 45 44 50 43 higher education institutions 40 32 also provide continuing 30 education certificates and 13 20 diplomas, many of them in 10 vocational subjects in 0 continuing education divisions and units. Some enterprises offer informal continuing VET courses, on-line courses, on-thejob training, seminars, and workshops.
percent
R. Es to ni a La tv ia Li th ua ni a H un ga ry Po lan d Sl ov en ia Sl ov ak R.

percent

6.14 The support of Bulgarian enterprises for continuing VET (CVT) lags behind most EU8 countries, and is significantly below the EU15 average. Figures 6.4 Figure 6.5: Percentage of Employees Participating in Continuing and 6.5 show the levels of VET, 2004 (Source: Eurostat, CVTS2) continuing VET in Bulgarian 50 45 43 enterprises in comparison 41 45 40 with the EU8 countries, 35 35 Romania, and the EU15 30 25 average. 25 6.15 According to 10 NAVET,124 the key challenges for CVT are lack of adequate learning a a a d 8 ia ia ry ria R. R. 15 ni ni ni tv resources; inadequate training an lan ga ga EU EU to ak ve ch ua La ul Po un lo om ze Es ov i th B S R H C L Sl of teachers in adult education and training methodology; and insufficient dialogue with and support from employers, who have so far not shown meaningful support for CVT activities. The participating schools also consider the centralized financial management of revenues generated from continuing education activities to be a problem.
20 15 10 5 0
17 17 16 18 14 15

124

Council of Ministers (2005), National Strategy for Continuing Vocational Training 2005-2010.

Cz ec h

101

15 Bu lg ar ia Ro m an ia

EU

8

EU

IV.

EXPENDITURES ON VOCATIONAL EDUCATION

6.16 Early introduction of VET at the secondary school level is costly, as Table 6.5 shows. Comparison of public spending per student in general and vocational secondary schools indicates that the average per student expenditures in vocational secondary education were 20 percent higher than the corresponding expenditures in general secondary during 2001-2005 (see Figure 6.6). This is true also in all EU8 countries. There are two reasons for this: (i) student-teacher ratios tend to be lower in vocational schools; and (ii) the cost of Figure 6.6: Per Student Public Spending on General and Vocational equipping, upgrading, and Education, BGN maintaining workshops in a 1800 large number of relatively run-down vocational schools 1500 is costly. These additional 1200 costs might be justified, if the VET graduates were more 900 employable than the graduates 600 of general secondary 300 education: that is, posses skills that are in high demand 0 2001 2002 2003 2004 2005 in the market. Whether that is the case, will be explored General Secondary Vocational Secondary next. Table 6.5: Expenditures on General (Upper) and Vocational Secondary Schools
Students in general upper education Expenditures on general upper secondary 96,585 123,639 education (thousands of BGN) Expenditures per student in general upper 650 769 secondary school (BGN) Vocational Secondary Schools Students in vocational secondary schools 181,595 192,759 Expenditures on vocational secondary 152,136 178,983 education (thousands of BGN) Expenditures per student in vocational 838 929 secondary education (BGN)
Source: Ministry of Finance.

2001 2002 General Upper Secondary Schools secondary 148,581 160,871

2003 166,995 152,759 915

2004 170,482 195,716 1,148

2005 170,462 245,346 1,439

202,274 205,339 1,015

197,818 263,919 1,334

191,649 340,456 1,776

V.

EMPLOYMENT OF GRADUATES

6.17 Graduates of secondary vocational schools have unemployment rates that have been consistently 1-2 percentage points lower than those of their general secondary school counterparts (see Table 6.6). So, they seem to be more employable. However, one has to weigh that against a number of considerations. The education of each of the vocational graduates is 23 percent more expensive. They also are about 50 percent more likely to be among the long-term unemployed, which suggests that, in the longer run, general secondary education might have served them better. Furthermore, studies on returns to investment in education in OECD countries show substantial wage premia for graduates of alternative occupational tertiary institutions over secondary school graduates of either type. Those skills are 102

increasingly in demand in advanced economies. But to get there, the students are best served by a broadbased general education at the secondary level. On balance, the evidence points in favor of general secondary schools, accompanied by a broadening of curricula in the remaining vocational schools at the secondary level. Table 6.6: Unemployment Rates for Secondary (Vocational and Upper General) Graduates
Number of unemployed: upper general secondary Number of unemployed: vocational secondary Unemployment rate of upper general secondary graduates Unemployment rate of vocational secondary graduates 2001 112, 800 228,000 19.4 17.5 2002 98, 800 223,300 17.3 17.1 2003 72,500 157,700 13.5 12.1 2004 62,800 144,900 11.4 11.0 2005 52,300 117,400 10.2 8.6 2006 47,100 103,400 8.2 7.5

Source: National Statistical Institute, Bulgaria.

VI.

THE LINK TO THE LABOR MARKET

6.18 An earlier World Bank study presented evidence that there was a mismatch between the skills of graduates and the needs of employers.125 To get further information on this issue, a small survey of the Bulgarian enterprises was carried out for this study by the Bulgarian Chamber of Commerce and Industry. The aim was to gauge employers’ satisfaction with skills of their employees. The survey covered 300 enterprises employing a total of Figure 6.7: Distribution of Employees by Type of Education 34,424 employees. The enterprises were of four sizes 43.9 50 ranging from micro to large.126 41.2 38.5 38.2 39.6 In the surveyed enterprises, 40 30.2 27.2 irrespective of their size, the 23.9 30 24.9 20.7 17.3 18.3 largest category of employees 20 11.5 was the graduates of vocational 6.8 8.1 4.5 schools (Figure 6.7). 10
percent

6.19 Employees with tertiary M icro Small M edium Large education received the highest Tertiary Vocational Secondary General Secondary Other combined score for the satisfaction categories (very satisfied, or satisfied), and the lowest combined score for dissatisfaction categories (unsatisfied or very unsatisfied), when the surveyed enterprises were asked to indicate their level of satisfaction with their employees in relation to their educational attainment. Employees with tertiary education were followed
125 126

0

. World Bank (2005b).

The surveyed enterprises were from the following sectors: agriculture, forestry, and mining—6.4 percent; energy and process industries—45.7 percent; construction and related business—24.6 percent; services—19.3 percent; and others—4 percent. Of the surveyed enterprises, 24 percent were micro (up to 10 employees; 35 percent small (11-50 employees); 30 percent of medium size (51-250 employees); and 33 percent large (over 250 employees).. While the sample size is too small for the results to be statistically valid, the results still provide a snapshot of views of employers.

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by graduates of vocational secondary schools, the graduates of general secondary schools, and the others. The implied preference of employers for tertiary education graduates is consistent with results of similar surveys in OECD countries. It is also not surprising that the employers prefer people with vocational skills to those with more general (secondary level) backgrounds. But as discussed earlier, the provision of such skills at the secondary level is costlier than the provision of general education. It also increases the risk that if the skills are not needed at some point in time, the lack of a broader general education will make it harder for such individuals to adjust to the demands of the labor market. A number of countries have come to the conclusion that the way forward is some sort of a hybrid–a general secondary education for (nearly) all, followed by a variety of non-university skill-building options at the tertiary level. 6.20 Overall, the link of the VET institutions to labor market is weak. The challenges facing VET in Bulgaria as identified by NAVET127 include: (i) improving market intelligence and information availability to potential clients and stakeholders; (ii) developing effective communication and information dissemination framework; (iii) continuously updating the occupational standards in line with the needs of employers; (iv) devising effective continuing VET programs to close the competency gap with EU; (v) creating incentive mechanisms to motivate the employers and workers to appreciate the need for and effectively participate in continuing VET; and (vi) mobilize and coordinate the efforts of all social partners, local authorities, NGOs and other to actively participate in the process. VII. OCCUPATIONALLY-ORIENTED ALTERNATIVE SECTOR OF TERTIARY EDUCATION 6.21 Bulgaria has a fairly small and ineffective alternative sector of tertiary education, which may partly explain the low overall tertiary enrolments in Bulgaria compared to other EU countries. The sector consists of two public and nine private colleges, which enrolled fewer than 7,000 students of the total of 221,400 students—or 3.1 percent—in 2005. In addition, Bulgaria has a large number of post-compulsory, specialized and costly vocational Table 6.7: Alternative Sector in Select Countries (2004) colleges.
Country

6.22 This is in stark contrast with other EU and OECD Australia countries, most of which have Canada Finland significant and strong France alternative sectors of tertiary Ireland education, with enrolments Norway ranging from a minimum of Spain 16.4 percent of total tertiary Bulgaria enrolment in Finland to about Source: OECD Statistics 2004. Tables C6.1 and A3.0 40 percent in Australia, Canada, Ireland, and Norway (see Table 6.8). All EU8 countries and Romania, have alternative tertiary institutions and colleges with larger relative enrolments than Bulgaria.128 6.23 Academic programs offered by these institutions are typically vocationally and occupationally oriented, which differentiates them from universities. For this reason they are covered under the VET
NAVET has no jurisdiction over the more than 490 vocational secondary schools and colleges that constitute the VET system. While it is mandated to coordinate the VET system by developing the framework and the occupational standards governing the four levels of certification, and also mandated to ensure the integrity of the certification examination system and the participation of employers in it, NAVET does not have any say in the development and delivery of the VET curricula at the four levels, or in the training required for teachers, especially in emerging technologies.
128 127

Gross Enrolment Rate 46.4 49.2 64.6 40.0 42.2 40.7 31.1 25.7

Percentage of Enrolment in: University Sector Alternative Sector 59.9 40.1 60.5 39.5 82.6 16.4 72.0 28.0 62.7 37.3 78.1 21.9 56.9 43.1 96.9 3.1

A summary of the organization of tertiary education and its institutions in the EU8 countries is provided in Annex 2.

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chapter. The alternative sector institutions can also provide innovative degree-level programs, such as the Foundation Degrees in the UK, the Engineering Technology Degrees in the United States, and the Applied Degrees in Canada. Examples of the well established generic areas of studies in such institutions include business management129, information and communication technology (ICT)130, applied science131, technology132, agriculture and natural resources133, trades134, applied arts and design135, health studies136, and social services.137 VIII. OPTIONS FOR REFORM OF VOCATIONAL SECONDARY EDUCATION

6.24 As mentioned earlier, high quality vocational education is needed to promote adoption of existing technologies and promotion of labor productivity. However, this chapter has shown that the skills provided do not sufficiently match the current and evolving labor market needs. In addition, the system does not seem to be particularly cost-effective. To move the Bulgarian VET system closer to the best practice examples in EU and OECD countries, and ensure that vocational education students have an appropriate basis for lifelong learning to promote their adaptability and mobility across sectors and industries, the government may want consider five short and medium-run reform options. 6.25 In the short run, the government would be advised to pursue the following financing reform to promote the efficiency of VET: • Introduce per student financing to VET: To provide incentives for improvements in relevance and for cost control, the ongoing governance and finance reforms at the primary and general secondary levels could be extended to vocational secondary schools. This would include the shift to per student financing and delegated budgets to schools. The process of the reform extension, and revisions that might be required compared to primary and general secondary schools would need to be worked out and require further analysis.

Including business management, office and organizational management, retail operations, accounting, marketing, human resources, e-business, supply chain operations, banking and financial services transportation operations, and hospitality and tourism studies. Computer systems software systems, computer networks, computer games, animation, multimedia design, Website design, and Internet services. For example, biotechnology, pharmaceutical studies, environmental studies, nutrition studies, veterinary science, natural resources, industrial chemistry and laboratory studies Such as, mechanical systems, manufacturing technology, automation, transportation and heavy machinery, electrical distribution, electronics, energy systems, computers and ICT, telecomm, construction and building technology, architecture, and surveying For example, field crops and processing, agribusiness, agriculture technology, dairy animals, milk production, and horticulture, forestry, and forest management.
134 135 136 133 132 131 130

129

For example, construction trades, automotive and transportation trades, heavy machinery, and industrial trades. For example, interior design, graphic design, fashion design, multi media, journalism studies, and theatre design.

Nursing, paramedical studies, spa therapy, medical laboratory studies, dental hygiene, optometry, biomedical technology, assistive devices technology, medical rehabilitation studies, geriatric care studies. New programs are also being developed in fields such as avionics, digital media, financial services, small business enterprises, marketing, disability studies, early childhood education, leisure studies, animal husbandry, and optometry.
137

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6.26 To promote labor adaptability and mobility in response to market needs, it is critical that all students are equipped with basic general education, and the education system provides options for continued lifelong learning. To shift the Bulgarian VET system into that direction calls for broader structural reforms in the medium term. The four key medium-term reform options the authorities may want to consider are the following: • Start vocational secondary education only after the completion of compulsory education: Following the example of other EU countries, Bulgaria would be well advised to delay the streaming of students into VET until the completion of compulsory education. Students streamed early in education are hard to reorient when they become unemployed, because of their weak general education. If this reform is implemented, the vocational schools presently offering the early programs would need to be closed and the students directed to schools offering lower general secondary education. In parallel, develop curricula for the remaining vocational secondary schools that balance vocational and general studies. The curricula would need to emphasize occupationallyoriented skills and competencies as well as strengthening the core of natural and social science, mathematics, foreign language, and the applied dimensions of this knowledge. This would imply increased integration of the curricula of the vocational138 and general secondary schools. The aim would be to ensure strong general education of vocational students, which would enhance their adaptability and readiness for continued learning. Establish Occupationally-Oriented Regional Colleges: In today’s world, increasingly sophisticated skills are required even in many vocational occupations. As Bulgaria climbs up the technology ladder, the demand for people with occupational skills and education beyond the vocational secondary can be expected to rise. To strengthen the existing alternative education sector so that it can respond to this demand, the government may want to consider initially clustering/merging and upgrading select existing vocational secondary schools (types J and K in Figure 6.1) as well vocational colleges (type L) into occupationally-oriented regional colleges. The selection criteria for clustering and upgrading would include the reputation of the institution, quality of its human and physical resources, and relevance of its programs to the needs of the local economy. The curricula offered by each college should be tailored to match the demand in the region (for example, programs geared towards tourism in regions close to the Black Sea). These new comprehensive occupationally-oriented colleges would be similar to those in other EU and OECD countries, and would satisfy the demand for access to tertiary education by a more diverse student population. This would include students with acceptable level of academic preparation, students from vocational secondary schools with possibly lower academic preparation, students seeking tertiary education qualifications, and students from disadvantaged groups. Therefore, the establishment of these colleges can be expected to increase tertiary education enrolment in Bulgaria. The new sector would establish important bridges between vocational secondary education and tertiary education on the one hand, and between the two sectors of tertiary education on the other. Students from both upper general and vocational secondary schools with, and in some cases without, the matura exam will be eligible to enter the new colleges. Graduates of these institutions can, after a period of employment, or immediately after completing their sub-degree studies, continue their studies towards a university degree. Figures 6.9 and 6.10 show two alternative models for the new institutions with the earlier mentioned bridges, and Table 6.11 summarizes the characteristics of each. Figure 6.11 shows in turn an example of the

138

Vocational school types J and K in Figure 5.2.

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relationship among the various occupations in the construction sector in terms of the type and duration of studies at the secondary and the tertiary levels, and the corresponding occupational categories. Error! Objects cannot be created from editing field codes. Error! Objects cannot be created from editing field codes. Error! Objects cannot be created from editing field codes. • Establish a National Qualification Framework and Authority to Strengthen Life Long Learning: If the proposed vocationally-oriented tertiary colleges and institutions were established, it would be important that a National Qualification Framework (NQF) also be developed. NQF would allow recognition of qualifications earned at various levels and stages of education and training to ensure that mobility, access, and life long learning opportunities are available. In addition, it would be worthwhile to consider establishment of a National Qualifications Authority (NQA), based on other similar existing successful agencies, such as NQA of Ireland. NQA would have three tasks: (i) the establishment and maintenance of NQF for all educational awards in Bulgaria; (ii) the establishment, promotion, and maintenance of the standards for education and training awards in all institutions (secondary, alternative tertiary, universities); (iii) the promotion and facilitation of access, transfer, and progression through the education and training system. It should be mentioned here that substantial consultations have taken place in Bulgaria since 2005 concerning the establishment of such a framework that adopts the guiding principles of the European Qualification Framework.

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Table 6.8: Characteristics of the two proposed models
Aspect
International Example Bridges to Secondary Education Bridges to Universities Program Level

Model 1

Model 2

The Colleges for Further Education in the UK, and The Institut Universitaire de Technologie IUT, the Technical Institutes in Ireland France Both models provide bridges to vocational secondary education allowing students in vocational schools to continue their studies towards higher occupational awards without obtaining their end of secondary education certificates. Program-specific articulation because the colleges are separate from universities. Post compulsory and tertiary programs offered in the same institution. At the tertiary level short cycle and three-year innovative degree level programs are offered. • Open access for post compulsory programs Matura for tertiary programs • • • • Certificates and advanced certificate of VET qualifications 2-year diplomas 3-year new applied degrees The new institutions can be easily, quickly and cost-effectively established from selected existing vocational gymnasia and colleges that meet certain criteria for capacity and quality. The new institutions can be vehicles for regional economic development. The new 3-year applied degree can allow Bulgaria to meet the Bologna objective of a 3year Bachelor degree. The new “applied” degrees would have to be formally recognized by MES and the National Qualification Agency, and included in the Higher Education Act. The innovation would meet resistance from the academically conservative established universities, and thus would require political will and leadership. • • • Certificates of VET qualifications 2-year diplomas The institutions can be linked to existing public and private universities, and benefit from their management and academic capacity. The link to university implies the development of systemic articulation between the short cycle programs and their university counter part, and mobility for students The short cycle two- year program has to be fully recognized and transferable to university programs through a reasonably accessible and short bridging program. The stronger link to university can also be a disadvantage stifling the spirit of innovation in the new institution and creating a “poor cousin” syndrome. Systemic articulation. The institutes are university-based institutions. Mostly tertiary short-cycle programs. Postcompulsory programs can be offered.

Admission Requirements Academic Awards

Strengths

• •

Weaknesses

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Annex 1: Typology of VET Qualification in Bulgaria
Aspect of VET Skills and Occupational Levels Level 1 Predominantly basic semi-skilled occupations Level 2 Predominantly manual skills and occupations Level 3 Skilled occupational categories Level 4 Skilled occupational categories with middlemanagement supervisory responsibilities 5 or 6 years after basic education in vocational secondary school or in a vocational college

Duration of Studies

1 or 2 years after basic education in technical schools

2 or 3 years after basic education in technical schools

4 years after basic education in vocational secondary schools

Type of Studies Admission requirement Graduation Procedures Certification

Formal in institutional setting as well as in vocational centers and on-line training Completion of Grade VI or VII Qualification Examination

Formal in institutional setting Basic Education Certificate + Admission Exam

Basic Education Certificate

State Examination + Qualification Examination Vocational Qualification Certification + Secondary School Diploma Vocational College or University University

Vocational Qualification Certification + Documentation of Completion of Specific Grade Secondary Schools

Access to Continuing Education

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Annex 2: Higher Education System - Tertiary Institutional Types Bulgaria
Institution Institution Type ISCED Level 5B 5A, 6 ISCED Level 5B 5A, 6 ISCED Level 4 5B 5A, 5B, 6 ISCED Level 5B 5A,6 ISCED Level 4,5B 5A,6 ISCED Level 5B 5A,6 ISCED Level Length years 2, 3, 5 3, 4, 5, 6 Length years 2, 3, 5 3, 4, 5, 6 Length varies 3,4,5 3, 4, 5, 6 Length 2, 3, 4 3, 4, 5, 6 Length 2, 3, 4 3, 4, 5, 6 Length 2, 3, 4 3, 4, 5, 6 Length Non-university higher education institutions (kollegi) Non University Universities and specialized higher schools (academies and institutes) University

Czech Republic
Institution Tertiary Professional School (Vyssi odborna skola) Higher Education Institution (vysoka skola) Institution Type Non University University Institution Type (Kutsekeskharidus Post-Secondary higher education Non Universty University Institution Type Non University University

Estonia
Institution Vocational Post Secondary keskhariduse baasil)* Institutions of professional (rakenduskorgharidus) Universities

Hungary
Institution Colleges (Foiskolak) Universities (egyetemek)

Latvia Institution Institution Type Non University Type institutions (Koledza) (first and and second level professional higher education programs) Non University University, Academia (universitate, akademija) University Institution Type Non University University

Lithuania
Institution Non University Type institutions (Kolegija) Universities Type (Universities and Academies)

Poland
Institution Institution Type Universities, Technical Universities, Agricultural Academies, Schools of Economics, Teacher Education Schools, Medical Academies, Maritime Schools, Academies of Physical Education, Artistic Schools, Theological Schools, Military Schools and Internal Affairs Schools; Higher Vocational Schools (just undergrad) University

5A,6 ISCED Level 5B 5A,6

3, 4, 5, 6 Length 2, 3, 4 4, 5, 6

Romania
Institution University Colleges (colegii universitare) Universities, Institutes or Academies Institution Type Non University University

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Slovakia
Institution Stredna odborna skola (vyssie odborne studium) Univerzita, Vyosoka skola, Akademia Institution Type Non University University ISCED Level 5B 5A,6 Length 2, 3, 4 3, 4, 5, 6 Length 2 2, 3, 4 3, 4, 5, 6

Slovenia
Institution Higher Technical Colleges (visje strokovne sole) Professional colleges Universities Type (Universities and Academies) Institution Type ISCED Level Post Secondary (Subdegree level) Non University 5B University 5A,6

Source: European Commission, (2006)National Summary Sheets on Education Systems in Europe and Ongoing Reforms, Eurydice http://www.eurydice.org/portal/page/portal/Eurydice/ShowPresentationND?pubid=047EN&country=null&countryreg=null

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7.

STRENGTHENING TERTIARY (HIGHER) EDUCATION

7.1 Tertiary education institutions are facing the challenge of adapting themselves to the multiple demands from stakeholders: students for the high quality education, employers for the relevance of education to their needs, and the government for accountability of the public resources allocated to the tertiary institutions. Higher education usually refers to the system of universities, or university-type institutions, which offer undergraduate and graduate studies leading to Bachelor, Master, and Ph.D. degrees. By contrast, tertiary education is a more comprehensive designation that includes most forms and levels of post-secondary educational provision in both the conventional university sector, and in non-university institutions forming an alternative sector. 7.2 Institutions of tertiary education are no longer seen as remote places where students acquire academic knowledge and professional qualifications, but instead as a major force in the ongoing economic development, and the advancement of knowledge. Tertiary education is an important determinant of individuals’ earning capacity and employment prospects, and therefore plays an important role in determining the level and distribution of income in society. In most developed and transition economies, the wage premium earned by the graduates of tertiary education compared to the graduates of upper secondary education are substantial and increasing with work experience. The graduates of tertiary education also face a lower risk of unemployment than those without tertiary education. I. TYPOLOGY OF TERTIARY EDUCATION

7.3 To put the Bulgarian tertiary education system in context and to highlight the link with the discussion of VET in the previous chapter, the evolution of tertiary education systems in select other countries is first briefly summarized. The development of a typology of modern tertiary education faces two challenges: (i) defining the identity, role, and an appropriate place for the new alternative sector institutions (that is, the type of occupationally-oriented colleges proposed in the previous Chapter 6) in systems dominated by the universities; and (ii) branding or labeling of the institutions that do not belong to the traditional university sector. The early work of the OECD, and the European Association for the Study of Higher Education called them tertiary short-cycle institutions. However, some of these institutions provide degrees requiring 3-4 years of study, which could not be considered to be short cycle. The 1991 OECD report called them alternatives to universities, and some authors referred to them as the non-university sector of tertiary education. 7.4 A better approach is to define the tertiary education system as a tripartite system composed of three tiers of institutions.139 Tier I consisting of the elite research and comprehensive universities; Tier II of lower level universities, and some degree granting tertiary colleges and institutes; and Tier III of institutions offering mostly short-cycle programs/occupationally-oriented programs. Figure 7.1 outlines the evolution of tertiary education in OECD countries during 1960-2005. The hierarchy of institutions in Tiers I and II is established by the nature of the degrees offered, by the selectivity of their admission criteria, and by the resources allocated per student, which are almost universally greater in Tier I universities than in Tier II or III institutions. For example, in the UK Tier I cover Oxford, Cambridge, and the rest of the so-called Russell group of high-status universities; Tier II consists of universities of lower status, research orientation, and selectivity, including the former polytechnics; and on Tier III are the Further Education (FE) colleges, which are occupationally-oriented colleges. In the United States,
139

Grubb, W.N (2003). The Roles of Tertiary Colleges and Institutes: Trade-offs in Restructuring Postsecondary Education, OECD Publications.

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Tier I is composed of the ivy league and other research universities; Tier II consists of less-selective universities, which offer a wide array of occupational programs; and Tier III has the community colleges, and technical institutes. France also has a tri-partite system, in which the Grandes Ecoles form Tier I with selective admission and high spending per student; the universities form Tier II; and the Institut Universitaire de Technologie (IUTs), and the Sections de Technicians Superieurs (which award the Brevet de Technicien Superieur) operated by secondary schools constitute Tier III. See Table 7.1 for further examples. 7.5 The boundaries between the Figure 7.1: Evolution of Tertiary Education: 1960 to 2005 The University Sector of three tiers are fuzzy, and typically The Alternative Sector of Tertiary Education Tertiary Education hotly disputed by many of the institutions in the lower tiers. In the The Binary System Two Sectors; the University U.K., there are institutions that Alternative and the Alternative Sectors of Universities Institutions provide higher education degrees and Tertiary Education (1960 – 1985) further education courses, and are therefore hybrid institutions. Canada The University Sector of The Alternative Sector of has university colleges that cooperate Tertiary Education Tertiary Education with local universities in providing Bachelor’s degrees. Australia has Tier I Tier II Tier III The Tri-Partite System Elite Universities & Tertiary Short Hybrid Tier II Institutions and the dual-tier institutions that include Research Degree Granting Cycle (TSC) Shift in The Boundaries Between Universities Institutions Institutions Sectors (1985 – 2005) universities, and Technical and Further Education colleges co-located with shared infrastructure, and some U.S. universities are allowed to grant 2-year associate degrees commonly offered by community colleges. However, these complications and fuzzy boundaries should not obscure the conclusion that the tripartite model reflects the reality of tertiary education in most OECD countries in 2006. The alternative sector of tertiary education includes all the institutions of Tier III, and some of the institutions in Tier II, which are not considered, within a national context, to be part of the university sector. Table 7.1: The Tripartite System of Tertiary Education in Select Countries
Country
Australia Canada Finland France Germany Ireland Norway Spain

Tier I
8 research universities 30 research and comprehensive universities 20 universities 37 Grandes Ecoles 78 technical and comprehensive universities

Tier II
32 universities and some TAFE colleges 56 universities, university colleges, polytechnics, ITALs* 31 polytechnics 86 universities 182 Fachhochschulen FHS 43 Berufsakademien 13 technical institutes 26 state colleges Facultades y Escuelas Universitarias

Tier III
68 TAFE Colleges 145 community colleges and technical institutes Short cycle programs in polytechnics 123 IUTs** Dual training institutes

8 universities training centers 4 universities adult education institutes Escuelas Técnicas Superiores y Formación Profesional de Facultades Universitarias Grado Superior (FPGS) UK 20 Oxbridge and the “Russel” 53 newer and polytechnic universities 340 further education (FE) universities colleges USA 690 Ivy League and public and 1760 polytechnics, colleges, and 1075 community colleges and private research universities smaller state universities institutes of technology Bulgaria 2 comprehensive universities 40 medium and small universities 11 small vocational colleges with meaningful research capacity Notes: * Institutes of Technology and Applied Learning in Ontario; ** Institut Universitaire de Technologie

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II.

THE STRUCTURE AND ORGANIZATION OF TERTIARY EDUCATION IN BULGARIA

7.6 Tertiary education was established in Bulgaria after the country’s liberation at the end of the 19th century, with the establishment of the University of Sofia. The evolution of tertiary education in the 1920s and 1930s was influenced by the Humboldtian ideal of the university. The nature and structure of tertiary education changed drastically after the Second World War. In 1947, the first law on higher education was adopted, and it emphasized the role of universities and institutions of higher education as agents for the transformation of the Bulgarian economy into an industrial economy. The mission of the universities was seen as to primarily prepare graduates with the knowledge and skills to facilitate such transformation. The structure of the system, which still prevails today, is specialized and characterized by single-discipline institutions serving a particular sector. Examples include the universities of forestry, chemical technology, and metallurgy. 7.7 After the collapse of communism, and the transformation of the Bulgarian economy and society into a market economy, a number of changes have taken place in the tertiary education system, including renaming of some institutions to reflect the paradigm shift in the philosophy and values of society. An important development has been the emergence of private universities, and the establishment of colleges of tertiary education, mostly in the private sector. Tertiary education in Bulgaria today consists of three categories of institutions: (i) comprehensive and technical universities; (ii) specialized institutions of higher education; and (iii) colleges. These three categories of institutions are both in the public and private sector (see Table 7.2). A complete list of tertiary education institutions in Bulgaria is in Annex 1. Table 7.2: Tertiary Education Institutions in Bulgaria, 2006
Institutional Category Public Universities Private Universities Public Specialized Institutions Private Specialized Institutions Public (Short-Cycle) Colleges Private (Short-Cycle) Colleges Total Number of Institutions 10 4 26 2 2 9 53 Enrolment 78,500 37,424 118,820 2,250 1,000 5,470 243,464 Average Size 7,850 9,356 9,850 1,125 500 608 4,594 Number of Faculty 7,784 1,977 13,648 161 102 453 24,125 StudentFaculty Ratio 10.1 18.9 8.7 14.0 9.8 12.1 10.1

Source: Bulgarian Higher Education System- Human Resource Development Centre Bulgaria

7.8 Table 7.2 shows that there is a large number of small specialized institutions, and only a small number of comprehensive universities (only seven universities have more than 10,000 students). This is a concern from the quality, fiscal, and effectiveness of R&D points of view. Small narrowly specialized institutions, such as the University of Transportation (1,000 students), or the University of Mining and Geology (2,600 students) carry a relatively high overhead cost. As a result, they are likely to have fewer resources to spend on research, and student support, thus raising quality concerns. Also, proliferation of small universities reduces the benefits to be gained from scale and scope, and hinders the increase in student-faculty ratios from the current low levels. Further, as will be discussed later in Chapter 8, it hinders R&D in universities, since a critical mass of scientists and researchers is usually needed for that. At the same time, the alternative sector of tertiary education—the colleges—is small compared to EU8 and EU15 countries, as was discussed in the previous chapter in the context of VET reform. 7.9 Further, the overall student-faculty ratio in the system is below 11, and in the specialized institutions it is below 9, which is significantly lower than the norm of 16 in OECD countries. If private universities, which employ many of the faculty of public universities (see paragraphs 7.32-7.34 for discussion of faculty issues), are excluded, the ratio is even lower. This is a concern, since it highlights that resources are not efficiently allocated. These characteristics suggest that there are opportunities for reform

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of the system, consolidation of institutions achieving more cost-effective use of resources, and improving the quality of learning and student services. 7.10 Private provision of tertiary education is uneven in Bulgaria. Of the six private universities and eight private colleges, three are among the top ten of all institutions by size. All the others, except one, are small with less than 1,000 students. The demand for private universities in Bulgaria—as in EU8 countries—is high, and still growing, while the demand for public universities is leveling off. The advantages of private universities include: (i) they act as a catalyst for reform in tertiary education, increasing private investment, and providing competition and innovation; (ii) they provide an avenue to respond to some of the unsatisfied demand by the public sector for tertiary education; and (ii) owing to their flexible management and staffing arrangements, they are able to respond flexibly and efficiently to market and student demand. 7.11 However, the private universities also raise concerns, Table 7.3: Types of Tertiary Education Institutions in Bulgaria, mostly related to the quality of Romania, EU8, and EU15 University Non University Public Private education provided and indirect Country access to public finance. There Czech Republic 28 36 26 38 is concern that owing to the Estonia 11 29 20 20 small size of most of these Hungary 24 47 31 40 institutions, they are unlikely to Poland 209 218 126 301 be able to provide broad and Latvia 36 20 36 20 comprehensive curricula. Many Lithuania 19 51 48 22 of the small institutions focus Slovakia 22 2 20 4 on business management, social Slovenia 48 31 62 17 studies, and other disciplines, Average EU 8 50 54 46 58 which do not require large Average EU 15 59 82 98 31 investment in capital equipment Bulgaria 42 9 37 14 or infrastructure. However, this Romania 122 55 67 concern applies as well to Source: Eurydice-Eurybase--UNESCO-CEPES--Bologna-Bergen 2005. public universities, which are also predominantly small. There is also a widespread concern that private universities admit students who do not have the required qualifications for higher education. In addition, there is a strong belief that by hiring part time faculty, who are moonlighting professors from public institutions, private universities are indirectly subsidized by the taxpayer, and give little in return. 7.12 Compared to most EU8 countries, Bulgaria has (i) a relatively large number of small specialized universities; (ii) small share of privately run tertiary institutions; and (iii) a small number of alternative tertiary institutions. These are weaknesses that would merit attention. The comparative analysis of the types of tertiary education institutions in Bulgaria, Romania, EU8, and EU15 countries is shown in Table 7.3. Of the EU8 countries, the comparison with Czech Republic and Hungary is most relevant, since they they have comparable population and demographics; both countries have smaller number of universities and much larger alternative sector of tertiary education. III. ACCESS TO TERTIARY EDUCATION

7.13 A modern knowledge-based economy needs an adequate supply of skilled educated workers, and the majority of these workers are expected to have tertiary education. Table 7.4 shows that Bulgaria compares unfavorably with EU8 countries in two important factors influencing participation in tertiary education: (i) the percentage of 18 years old still in the education system; and (ii) the percentage of 22 years old that have completed upper secondary education. Bulgaria scores lower than all EU8 countries

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in these two important predictors of potential participation in tertiary education. A recent study140 suggests that this is both a challenge and an opportunity. The challenge is that participation rates in tertiary education depend on high-school graduation, and without improvements in performance at the secondary school level, student numbers in tertiary education are unlikely to increase. The opportunity in turn is that if school performance improves to the level of the EU8 countries, appropriate supply side policies could translate this latent demand into actual demand for tertiary education. Table 7.4: Comparative Analysis of Participation in Secondary Education
Country Participation rate of 18-year old in education (ISCED 1-6) 90.8 80.5 83.3 88.9 76.4 86.9 87.2 82.1 73.6 58.3 84.5 76.3 Percentage of 20-24-year old with at least upper secondary education completed 91.4 80.3 79.5 85.0 83.5 90.9 90.5 91.7 76.1 75.3 86.6 74.2 Percentage of 22-year old with upper secondary education completed 90.5 83.9 75.6 78.4 85.5 91.2 90.2 93.0 74.8 Na 86.0 Na

Czech Republic Estonia Latvia Lithuania Hungary Poland Slovenia Slovakia Bulgaria Romania Average EU8 Average EU15
Source: Eurostat Data (2004)

7.14 The participation rate in tertiary education in Bulgaria is lagging behind the EU8 countries, and the EU15 average. As can be seen Table 7.5: Tertiary Education Participation Rates in from Table 7.5, the participation rate Bulgaria, EU8 and EU15 in tertiary education is not only Country 2000 2001 2002 2003 2004 2005 substantially and consistently lower in Czech Republic 30.2 30.5 34.3 34.8 35.2 35.6 Bulgaria than in EU8 and EU15 Estonia 60.8 60.5 66.2 66.7 67.1 67.4 countries, but the gap has also Hungary 40.1 40.7 49.9 52.2 54.1 54.6 64.1 63.8 71.9 72.2 73.9 74.1 widened during 2000-2005. Table 7.6 Latvia 59.9 59.9 67.8 68 68.4 68.9 shows a troubling trend in the Lithuania 54.1 56.7 59.9 60.7 61.5 61.8 enrolment in tertiary education in Poland Slovakia 29.8 30.5 32.3 33.1 33.9 34.2 Bulgaria: during 2000-2004, Bulgaria 60.8 61.2 67.9 68.4 69.6 69.9 was the only country among EU8 and Slovenia Average EU 8 50.0 50.5 56.3 57.0 58.0 58.3 EU15 that had a decline of about 13 Average EU 15 52.6 53.6 53.9 57.6 57.8 58.0 percent in tertiary education Bulgaria 24.3 25.7 25.9 26.4 26.8 26.9 enrolment. During the same period, Source: UNESCO Institute of Statistics all the other countries had robust growth in tertiary enrolment ranging from 14 percent in the Czech Republic to 51.5 percent in Romania. Table 7.7 shows that this same troubling trend was for a while happening in the enrolment of new entrants to the system. However, preliminary data for 2005 and 2006 suggests a reversal of this decline along with a strong pick-up in net enrolment rates.

Bekhradnia, B. (2004). Higher Education in Bulgaria: A Review for the Ministry of Education and Science, Higher Education Policy Institute.

140

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Table 7.6: Total Enrolment in Tertiary Education in Bulgaria, Romania, EU 8 and EU15
Country 2000 Czech Republic Estonia Latvia Lithuania Hungary Poland Slovenia Slovakia Bulgaria Romania Average EU8 Average EU15 253.7 53.6 91.2 121.9 307.1 1579.6 83.8 135.9 261.3 452.6 2626.8 12563.3 Enrolment in Thousands 2001 260.0 57.8 102.8 135.9 330.5 1775.0 91.5 143.9 247.0 533.2 2897.4 12820.3 2002 284.5 60.6 110.5 148.8 354.4 1906.3 99.2 152.2 228.4 582.2 3116.5 13191.0 2003 287.0 63.6 118.9 167.6 390.5 1983.4 101.5 158.1 230.5 643.9 3270.6 13589.6 2004 318.9 65.7 127.7 182.7 422.2 2044.3 104.4 164.7 228.5 685.7 3430.6 13859.7 % Change 26% 23% 40% 50% 37% 29% 25% 21% -13% 52% 31% 10%

Source: UNESCO Institute of Statistics

Table 7.7: Enrolment of New Entrants in Tertiary Education in Bulgaria, Romania, EU8 and EU15
Country 2000 2001 Czech Republic 51.845 56.81 Estonia 13.055 14.749 Hungary 99.152 88.001 Latvia 34.788 33.295 Lithuania 34.154 37.464 Poland 419.308 435.648 Slovenia 15.363 20.927 Slovakia 36.037 38.72 Total EU8 703.702 725.614 Total EU15 1922.25 2518.08 Total OECD 6052.14 6184.42 Bulgaria 49.767 41.901 Romania 129.237 170.974 Source: UNESCO Institute of Statistics Enrolment in Thousands 2002 2003 2004 56.261 61.026 71.957 14.01 18.162 18.855 94.343 106.645 110.524 36.986 40.659 43.037 39.94 40.332 42.145 458.339 458.108 465.674 23.27 23.353 23.782 41.6 38.725 46.054 764.749 787.01 822.028 2587.837 2739.958 2297.933 7302.342 7336.492 7258.515 42.434 43.564 46.101 158.094 147.537 195.408 % Change 39% 44% 11% 24% 23% 11% 55% 28% 17% 20% 20% -7% 51%

7.15 The imbalance that exists at present between male and female enrolment in secondary education, a phenomenon that is common in EU countries, suggests that the demand for tertiary education could be increased. In Bulgaria, female participation in general upper secondary education is over 50 percent higher than male participation, as shown in Table 7.8 (this ratio is almost reverse in VET schools). While this situation is potentially serious owing to the shorter participation of females in the labor market, it also means that policies to encourage male participation in secondary

Table 7.8: General Upper Secondary School Enrolment in Bulgaria
Year 2001/2002 2002/2003 2003/2004 2004/2005 2005/2006 Males 55,920 61,502 65,149 67,891 68,745 Females 92,661 99,369 101,846 102,591 101,727 Total 148,581 160,871 166,995 170,482 170,472

Source: National Statistical Institute, Bulgaria (2006)

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education, rather than being siphoned off into the VET sector, could lead to increased participation in tertiary education. The establishment of occupationally-oriented colleges, as proposed in the previous chapter, could help to address this. 7.16 Inequities in access to education have limited school participation rates in Bulgaria. At present the highest birth rates are among the poorest and least well educated segments of society—the Roma and Turkish minorities—whose children are least likely to continue their education. However, with the EU accession, and growth of the economy, the demand for tertiary education among disadvantaged groups should grow as it has in the EU8 countries. The limited institutional diversity of tertiary education in Bulgaria is likely limiting the participation of disadvantaged minorities. Most of the institutions are traditional institutions belonging to the university sector, and there are few colleges offering occupationally-oriented programs. The occupationally-oriented colleges discussed and proposed in the previous chapter would often be better suited to the academic qualifications, needs, and aspirations of disadvantaged groups as well, and more responsive to the needs of the labor market. 7.17 The present disjointed admission process involving university, or institution-based examination is seen as an obstacle to improved access to higher education. Currently, each university sets up its own standards, entrance examinations, and criteria for admission. Experience suggests that for a country the size of Bulgaria, a nation-wide system of the end-of-secondary school examination would be the best approach to ensure fairness and transparency, and simplify the entrance examination process. IV. RELEVANCE OF THE ACADEMIC PROGRAM ORIENTATION TO THE NEEDS OF LABOR MARKETS

7.18 The distribution of students across academic subjects in Bulgaria differs significantly from the rest of EU countries, and may not match the needs of the modern economy. Table 7.9 shows some discrepancies between the pattern in Bulgaria and the rest of EU: (i) a high proportion of students (47 percent) studying social sciences, compared to 26 percent in the rest of the EU; (ii) a small percentage (six percent) enrolled in service-related programs compared to 17 percent on average in the EU; and (iii) only four percent compared to 12 percent in the rest of EU study mathematics, science, and information and communication technology, subjects essential to achieve competitiveness in the knowledge economy environment. Table 7.9: Distribution of Students in Tertiary Education by Academic Discipline
Academic Discipline Social Science, Business and Law Services Health Sciences and Related Studies Engineering Humanities and Liberal Arts Science Math and ICT Education Agriculture and Veterinary Science Total
Source: Bekhradnia,B. (2004)

Percentage of Total Students Enrolled EU Average Bulgaria 26 47 17 6 12 9 14 12 10 9 12 4 8 10 1 3 100 100

7.19 In an attempt to encourage universities to offer programs that are relevant to the needs of the market, MES has responded with mostly supply-side measures involving the allocation of approved enrolment numbers, and associated grants to each university on the basis of the perceived needs of the market. This approach does not take into account the willingness, or the ability of universities to provide instruction in the targeted areas, nor the readiness of the students to enroll in those programs. An

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alternative, demand-side approach that has been discussed, but not yet implemented is one in which MES provides incentives in the form of subsidies to institutions, and scholarships to students in the disciplines it considers a priority. However, this approach, while attractive, has a number of implementation problems. First, MES would need to identify the subjects which it wished to encourage, and would need to establish appropriate networks of public and private sector stakeholders to provide input about the market needs. Second, MES would need to ensure that the universities and other tertiary institutions have the capacity and resources to offer the approved programs. Third, MES would need to monitor the outcome of the initiative closely to ensure that the supply of incoming students and the demand for graduates in those targeted areas indeed meets. Finally, MES would have to establish a strong alternative sector of tertiary education offering occupationally-oriented programs strongly tied to identified needs of the labor market. V. THE BOLOGNA PROCESS

7.20 Prior to 1991, the degree structure in Bulgarian universities followed the traditional European two-stage model with the Masters degree over total of five years of study, followed by the Doctorate stage over three additional years. Bulgaria has since taken the necessary steps to adopt the Bologna three-cycle (Bachelor/Master/Doctorate) structure. However, the change was more in form than in practice: the Bachelors degree qualification is not regarded as a valid qualification by the majority of students and their families. Two thirds of the graduates with the Bachelors degree go on immediately to a Masters program, and study for five years consecutively before seeking employment. Such a high proportion is contrary to the goal of the Bologna process, which aims to promote employability of Bachelor degree holders, and also represents a burden on public finances, even if many of the students in the Masters phase are selffinanced and not subsidized by the state. It may also involve opportunity costs in terms of the students staying out of the labor force longer than necessary. 7.21 Countries that have joined the Bologna process have restructured their higher education degree system according to the 3+2 and less frequently to the 4+1 model of the first two cycles.141 Bulgaria, has adopted the 4+1 model in its universities. The Bologna process intended the Bachelors degree to be a viable qualification for entry into the workforce. One advantage of a 3-year Bachelors degree is that, if it is accepted by the labor market and society at large, the financial resources that could be released for use elsewhere in the tertiary education system would be substantial. 7.22 The current "specialist in" qualification, which is readily awarded in a small number of colleges and in branches and departments of universities, does not fit the Bologna framework, because it is neither a college award nor an accepted Bachelors degree. As such, it is somewhat of an anomaly in the Bulgarian tertiary education. It is intended to provide access to tertiary education for students who do not have the appropriate academic qualifications from secondary school to enter a Bachelors degree, but despite the implications of “specialist” in its title, it does not appear to be particularly valued in the job market. Therefore, the majority of students with the “specialist in” qualification seek advanced-standing admission to Bachelor degree programs; some in the second and others in the third year of the program, taking in total 5-6 years to complete the degree. As such, these programs provide the “university transfer” function that community colleges in the United States and Canada, and the Institut Universitaire de Technologie in France provide. 7.23 The results of the latest stocktaking on progress show that Bulgaria still faces a number of challenges with regard to the implementation of the Bologna action lines (see Table 7.10). Every two years, prior to a ministerial conference, a major stocktaking exercise is undertaken in each country to
England, Wales, and Northern Ireland are exceptions and follow a model where a three year Bachelor is followed by a one year Master. Some institutions in the Netherlands also offer this possibility.
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assess the progress of reform along the so called Bologna action lines. The last stocktaking was done in 2005 for the Bergen Ministerial Meeting (the results of 2007 exercise are expected to be available in May 2007). The results suggest that Bulgaria is doing relatively well when it comes to the implementation of the two cycle structure, although, as stated above, the employability of Bachelor degree holders has not been fully realized and there remain issues to be resolved with regard to the access to the second cycle. Bulgarian universities have implemented the European Credit Transfer and Accumulation System and the Diploma Supplement, but some obstacles still hamper mobility. A major challenge remains on the quality assurance front. Bulgaria is ranked in the lowest category for participation of students in the quality assurance process, and also scores low on international participation in the quality assessment procedures. Table 7.10: Bologna Scorecard for Selected Countries, 2005
Quality Assurance Albania Croatia Macedonia Montenegro Serbia Bulgaria Romania Slovenia *** *** **** ** ** ** *** *** 2-cycle ** *** ** *** ** **** ** ***** Recognition **** **** **** ***** *** **** ***** ***** Total score *** *** *** *** ** *** *** ****

Notes: (1) The maximum score is 5 stars--the scorecard is expressed in ‘traffic light’ colors (from red to dark green) but stars have been assigned here for clarity. (2) Since the 2005 conference, the Bologna Process has moved to a 3-cycle system (i.e., BA, MA, and PhD) Source: Bologna Scorecard 2005.

VI.

GOVERNANCE AND AUTONOMY

7.24 Several reviews of higher education have been carried out in Bulgaria since 1989, and these have led to some reforms of university governance through the introduction of two Higher Education Acts along with numerous amendments. Until 1989, the university system in Bulgaria was closely controlled and regulated by the government. The Autonomy Act of 1989 removed most of the controls, and succeeding legislation changed the balance between autonomy and control close to another extreme. 7.25 The reforms gave university academics too much autonomy, and did not adequately satisfy the government’s need for accountability. The governance framework is characterized by a number of contradictions: (i) public universities can own assets, but they do not own the majority of their buildings; (ii) the universities can appoint their own rectors through elections without interference, but the government—until the reforms of 2002—required that all academic programs be approved and registered in the state register; and (iii) universities enjoy freedom in the allocation of the financial resources they receive from the government, and can carry money forward from one year to the next, while the Ministry of Education and Science (MES) dictates the number of students that they can recruit. The ultimate authority of the university resides in the University Council, a body comprised largely of the faculty of the university, and presided over by a Rector, elected by the same faculty. This system of governance ensures that universities are run primarily for the benefit of their faculty. The Rector is effectively the Chief Executive, but instead of being accountable to all stakeholders (the tax payers, their elected representatives, the students, the faculty, staff, and employers) the Rector is currently accountable to only the faculty of the university. Furthermore, management experience of the rectors, when first elected, is

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often limited, and is generally not used as a criterion for their appointment. Major reforms to tertiary education are unlikely to succeed unless the governance framework is changed. 7.26 The accountability of universities has several dimensions. First, universities receive substantial funds from the government, and should be expected to show that the money has been properly and costeffectively used.142 Second, they are also to be accountable for the quality and relevance of their programs, and at least in theory be subjected to the scrutiny of the National Evaluation and Accreditation Agency (NEAA). Third, to ensure reliance on the market rather than detailed MES control, the universities are expected to produce relevant information to ensure that all stakeholders can make informed choices. VII. FINANCING OF TERTIARY EDUCATION

7.27 Public spending on tertiary education in Bulgaria compares favorably with EU8 and EU15. At first glance it may appear that Bulgaria’s overall tertiary education expenditures compare slightly poorly with EU8 countries (see Table 7.11). The proportion of GDP devoted to tertiary education declined through the 1990s, was reversed in the late 1990s, but at 0.9 percent of GDP in 2004 was just slightly below the EU8 average level of one percent of GDP. However, a closer look at the expenditures on tertiary education per student and as percentage of the per capita GDP reveals that public spending per student compares favorably, and in fact exceeds, the levels in EU8 countries and the EU15 average (see Figure 7.2). The relatively high level of spending per student is explained by the low student-teacher ratio mentioned earlier, and resulting large spending on faculty salaries. Figure 7.2: Public Spending per Full-time Tertiary Student in 2005, percent of GDP per capita (source: Eurostat)

60 50 40 percent 30 20 10 Slovenia Slovak R. 39.2 37.4 33 33 35.8 34.9 34.8 35.7

54.5 34.9 37.4

Bulgaria

Poland

Hungary

EU8

7.28 Most European countries have come to accept that the beneficiaries of tertiary education have to contribute a fair share of the cost of their education through tuition fees, and not expect tertiary education to be fully subsidized by the state. This is viewed to increase the accountability of universities to students while also reducing the burden on the state budget. Having beneficiaries pay for a meaningful part of the education costs tends to increase the vigilance of students and their parents when it comes to the quality of education delivered. To ensure that the tuition fees will not adversely affect access to university

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Bulgarian universities are audited by MES, and are expected to account for the use of their funds.

Lithuania

Czech R.

Estonia

Latvia

121

EU15

0

education, in parallel student loan schemes have been established,143 or tax benefits.144 Further, to ensure equal access to tertiary education, grants and scholarships as a form of non-repayable aid are provided to the talented students from poor families. 7.29 The idea of tuition fees has been accepted in Bulgaria with little opposition. At present, students pay a fee which can be as high as 30 percent of the cost of provision of education per student, according to the Higher Education Act. However, in practice the fees charged are significantly less. They range from BGN200-300 for Bachelor’s programs, to BGN300-400 for a Masters program. The universities admit students beyond their state quota on the condition that they pay full cost. An estimated 25 percent of all students in 2005 were admitted on that basis. Universities may charge the full cost for Master’s degree programs, and about 35 percent of Master’s degree students indeed pay the full cost. This seems to indicate that the cost of education is not, at least at the present levels, a deterrent in Bulgaria. Table 7.11: Public Expenditures on Tertiary Education, percent of GDP
Country Czech Republic Estonia Latvia Lithuania Hungary Poland Slovenia Slovakia Bulgaria Romania Average EU8 Average EU15
Source: Eurostat

2000 0.8 1.1 0.9 1.0 1.0 0.7 0.7 0.9 0.4 0.9 1.1

2001 0.8 1.1 0.9 1.3 1.1 1.0 1.3 0.8 0.8 0.8 1.0 1.1

2002 0.9 1.1 0.9 1.4 1.2 1.1 1.3 0.9 0.8 0.7 1.1 1.1

2003 0.9 1.1 0.7 1.0 1.2 1.0 1.3 0.9 0.8 0.7 1.0 1.2

2004 1.0 1.1 0.7 1.1 1.3 1.1 1.4 0.9 0.9 0.7 1.0 1.2

VIII. FUNDING MECHANISMS 7.30 The present funding mechanism provides little incentive for universities to develop relevant programs, improve the quality of the learning environment or provide better services to students. Until recently, Bulgarian institutions of higher education have been funded using a framework of “deficit financing”: budget allocation for the current fiscal year being based on the previous year’s budget, but taking into account the cost of universities’ additional inputs, and approved enrolment targets. In 2003, the funding mechanism was amended to include the following reforms: (a) the provision of enrolmentbased subsidy using the enrolment targets approved by MES; and (b) a subject-specific weight to reflect the actual costs incurred by the universities in teaching costly subjects, such as medicine, engineering, or defense studies. MES provides funding to the universities using a program-weighted funding formula, which is summarized in Table 7.12. In sum, what this amounts to is that the government simply divides the number of student places among universities irrespective of their reputation and quality of their programs.

Salmi and Hauptman (2006) Innovation in Tertiary Education Financing: A Comparative Evaluation of Allocation Mechanisms, The World Bank. Student loan scheme are provided in over 60 countries around the world. They vary along a number of dimensions: the source of capital, the type of expenses covered, student eligibility criteria, and institutions eligibility criteria. Tax benefits have been introduced in Europe and North America. They are intended to help families offset a portion of the tuition fees paid for a son or daughter attending a university or tertiary institution.
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Table 7.12: Funding Formula for Tertiary Education in Bulgaria
Discipline Pedagogical Science and Education Social Science Natural Science and Engineering Veterinary Medicine Medicine Security and Police Studies Defense Studies Weight 1 1.6 2.3 4.3 5.0 7.8 10.6 Funding/ Student in BGN 696 1,136 1,600 2,993 3,480 5,435 7,357

Source: Ministry of Education and Science- Datasheet (2006)

7.31 To provide appropriate incentives to universities, the government should consider adjusting the formula slightly: instead of enrolment targets, linking the enrolment-based subsidy to actual enrolments. While this would only be a minor change in the formula, its impact in terms of incentives would likely be significant. Belgium for example is allocating funds based an actual enrolment with positive results. 7.32 In the medium term, to supplement the actual enrolment-based subsidy, a partial shift to performance-based funding could be considered. Although a number of university vice rectors interviewed indicated their readiness to consider the introduction of performance-based funding to improve the quality, relevance, and responsiveness of university programs to the needs of students and employers, arguments have been made by others that performance-based funding has disadvantages. First, the attempt to link funding to the desired outcomes, such as the employment rate of graduates, or greater responsiveness to market signals requires that the universities build the capacity to collect, analyze, and document data and relevant indicators to validate their claim. This capacity is said not to exist in Bulgaria. Second, the shift may have unintended consequences, as happened in Ontario, Canada, where the incentive to prove the occupational relevance of college programs gave rise to an unwelcome explosion in difficult-to-validate testimonials by employers. Third, many rectors of small specialized institutions and universities expressed concern that performance-based funding will reward the larger more powerful institutions at their expense. However, evidence from many OECD countries, including Denmark, New Zealand, Australia, and many U.S. States and Canadian Provinces, overwhelmingly indicates that there have been benefits outweighing the disadvantages from the introduction of a performance-based component in funding mechanisms. Its strengths are the following:145: (i) it is transparent compared to many other funding mechanisms, if the data for calculating the performance indicators are publicly available, (ii) it provides a strong link between funding and public policy objectives; and (iii) it encourages accountability in the use of public funds by linking results to funding levels. IX. FACULTY ISSUES

7.33 The autonomy of Bulgarian universities is reflected in their policies and practices with faculty employment and work conditions. The university hires and employs faculty, and has complete autonomy over their progress through the ranks, work load, and retirement. The retirement issue is a serious problem, because many faculty members remain on staff past the retirement age. This is contributing to the overstaffing in Bulgarian higher education, and the associated low student to staff ratio with two negative consequences: (i) a substantial portion of the financial resources are used to employ disproportionately large numbers of faculty, and as a result faculty salaries remain low and diminished

Salmi. J, and Hauptman.A (2006). Innovations in Tertiary Education Financing: A Comparative Evaluation of Allocation Mechanisms. The World Bank. Washington, D.C.

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funds are available for equipment, facilities, and learning resources; and (ii) there are little incentives for faculty to develop new courses, and apply modern learner-centered teaching methods. 7.34 Bulgarian academics are not well-paid and are ageing, a phenomenon witnessed in many countries, but one that needs to be addressed in an EU member country. This phenomenon is creating a number of concerns. First, the low income discourages the best graduate students from pursuing an academic career, given that they can earn substantially more working in the private sector. Second, the poorly paid faculty members are forced to "moonlight" by accepting teaching assignments in other institutions, especially the newly formed private universities, as mentioned earlier. The resulting lack of commitment of these professors to their parent university, and the additional draw on their time when teaching elsewhere, probably affects the quality of their teaching, and surely the time that they devote to doing research. Third, the salary distribution in Bulgarian universities is skewed in favor of senior professors, who are paid more than three times the salary of junior lecturers, adding another impediment to the ability to attract young faculty. Finally, the ageing of faculty coupled with the lack of resources leads to stagnation of academic program development and scholarly activities. Given all of this, as the first step towards the reform, it would be essential to enforce the retirement rules to make room in the system. 7.35 The high staffing levels have adverse consequences in terms of teaching processes, and program hours. First, high staffing levels in Bulgarian universities have led to a teacher-centered learning process—the teachers teaching, and the learners passively taking notes—instead of a learner-centered process, which encourages a spirit of enquiry, independent thinking, and autonomous study. Second, to justify the large number of teachers in their departments, academic managers approve structured programs that often exceed 30 contact hours per week. This preoccupation with student contact hours and the excessive in-class learning focus is not necessarily conducive to free enquiry that a learner-centered approach requires. Endemic over teaching is often defended on the grounds that contact with the teachers is the only way that students can learn in an environment where access to libraries, learning resources, and the Internet is limited. X. QUALITY ASSURANCE

7.36 The expansion of tertiary education in Bulgaria since 1989 and its slow, and sometimes painful, conversion from an elite system of higher education to a more open and diverse system of tertiary education, which includes both public and new private institutions, has given rise to a concern about quality. Quality in tertiary education has been traditionally viewed as an institution and/or program-based attribute. To ensure quality, governments typically make funding of public institutions and authorizing of private institutions conditional on their securing accreditation from an accrediting body. 7.37 In Bulgaria, the government established the National Evaluation and Accreditation Agency (NEAA) in 2004, with a mandate that includes both institutional and program accreditation. NEAA regulates rather than controls the quality of universities. It also ensures that information is provided to students and to all stakeholders to reassure them about the quality of provision, and to enable them to make informed choices about programs and institutions. NEAA has eight standing committees covering the following major disciplines: educational sciences, humanities and arts, social sciences and law, economic sciences and management, natural sciences, mathematics and computers, technical and military sciences, agrarian sciences and veterinary medicine, and healthcare and sports. These committees define the criteria for institutional accreditation in three major dimensions: (i) the educational dimension, which includes the goals and activities of the institutions, the policies and procedures governing the activities, the framework for monitoring, evaluation, and quality assurance, and student services; (ii) the research, development, and scholarly dimension, which includes the scientific research and creative initiatives, student participation, and outcomes of these activities; and (iii) the institutional management dimension,

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which includes the overall organization of the institution, its human resources and intangible assets, the educational resources and infrastructure, and domestic, and international cooperation initiatives. 7.38 While based on best practices in the European quality assurance agencies, the NEAA framework have two major drawbacks. First, it focuses on evaluating inputs, and to a limited extent learning processes, but rarely outputs and outcomes using tools, such as student and graduate satisfaction surveys, and indicators. Second, the NEAA evaluation teams are staffed only by full-time university faculty, who are assigned to evaluate programs in other universities delivered by fellow faculty members. No external professionals representing the private sector are included in these committees. This is exacerbating the governance problems in universities. NEAA needs to identify outcome indicators, and develop mechanisms for collecting and evaluating them. NEAA should also include self-evaluation by institutions and program faculty, and integrate it in its processes. Further, NEAA should make information sharing and dissemination an integral part of its mission. The success of the agency depends on the integrity of its standards, and the confidence that the tertiary institutions have in the integrity of these standards and procedures. All institutions and their staff, students and their families will rely on the integrity of the agency’s published information for making informed choices. XI. OPTIONS FOR REFORM OF TERTIARY EDUCATION

7.39 A modern knowledge-economy needs an adequate supply of skilled educated workers, and the bulk of workers are expected to have tertiary education. There is extensive evidence that effective tertiary education investment increases a country’s ability to make leading-edge innovations. Highly skilled people are also usually adaptable in the face of changing labor market needs. Further, tertiary education and research are among the key elements to promote European integration: through provision of skills and knowledge that promote labor mobility, and through participation in the European Higher Education Area (the Bologna process) and the European Research Area. Bulgaria should follow these trends and take measures to increase the quality, efficiency and effectiveness of its tertiary education to promote productivity growth. 7.40 Compared to other EU countries, Bulgaria’s tertiary education system is currently characterized by a relatively large number of small and specialized universities, relatively low participation rates, lack of program relevance, and weak accountability of universities. The often heard complaint about the lack of relevance of programs and the knowledge and skills they impart to graduates, reflects the current divide between universities and their external environment. 7.41 To address these issues and to strengthen the overall performance of the tertiary education sector and facilitate R&D (as will be discussed in Chapter 8), Bulgarian authorities are in the process of preparing a new higher education strategy. The aim of the strategy will be to improve the quality of tertiary education, expand access, and leverage public and private resources. The reforms are expected to focus on governance and financing systems, quality assurance, student admission policies, and expansion of university R&D. Initial steps have already been taken in establishing the Matura as the university entrance examination. In finalization of the strategy, the government may want to consider a set of short and medium-term reform options. There is no single measure that alone would fix the system. 7.42 In the short term, the following four reform options may be considered, in the order of priority. Of these recommendations, the first two options would be the most critical ones for improvement of the performance of universities : • Base the funding on actual student enrolments: To promote competition among universities and thereby provide them with incentives to improve quality and efficiency, as the first step the current funding formula could be adjusted so that instead of enrolment targets, the subsidy is based on actual enrolments. This change in the formula is critical to promote 125

competition and influence incentives. However, over time this kind of a formula could lead to distortions such as enrolment beyond optimum levels, delays in student completion, and a bias towards low-cost programs. Therefore, other complementary reforms should be considered in the medium term, as outlined below. • Strengthen university governance through the establishment of Boards of Trustees and a Tertiary Education Council: To enhance accountability of universities in terms of quality, relevance of programs, and use of resources, the Bulgarian authorities may consider instituting a contemporary governance structure for tertiary education, embodying many the reforms adopted in other EU or OECD countries. The governance reform would have two parts: First, change the role of government in tertiary education from directing and managing the system to that of “steering from a distance”. This change would require the establishment of a Council of Tertiary Education for the whole system, and perhaps two separate lower level councils for its two sectors—the university sector, and the alternative (or non-university) sector of tertiary institutions and colleges. These two councils would develop the appropriate policies relevant to their sectors. See Figure 7.3, which highlights the proposed revised governance framework. The Council of Tertiary Education would replace the existing Council of Rectors. It would be an independent body mandated to develop and implement a national strategy—and related policies—in tertiary education, and ensure that the practices of tertiary institutions comply with them and serve the public interest.146 The proposed two-tier framework is essential to ensure that the proposed new alternative tertiary sector (see Chapter 6) has a distinct and significant voice in the development of tertiary education policies in Bulgaria. Lessons learned from the experience of OECD countries that have introduced similar reforms over the past decades show the importance of such a two-tier governance structure147. The linkages between the councils and other tertiary education bodies would need to be determined during the preparation stage.

The Council’s mandate would include: (i) development of a national tertiary education strategy for Bulgaria; (ii) development of plans to support R&D tertiary education institutions; (iii) forecasting the number of students necessary for the country, and developing plans to rationalize enrolment in institutions; (iv) developing plans for continuous upgrading and improvement of the capacity and resources of all publicly funded tertiary institutions; (v) developing policies on public expenditures and funding of tertiary institutions; (vi) establishing the norms for employment in tertiary institutions; (vii) overseeing and approving the work of NEAA (viii) overseeing the work of the two other councils—the university council, and tertiary institutions council; (ix) submitting annual reports to the Minister of Education and Science, and to the Council of Ministers on the status of tertiary education Bulgaria; and (x) maintaining contacts with counterparts in Europe and in other countries. In other countries, a typical Council consists of 15 members; 9 (5 senior public sector and 4 private sector representatives) appointed by the Government, and 6 members representing the university council and the tertiary education council. In most countries, the Chair of the Council is a private sector representative appointed by the Government. The introduction of community colleges in Ontario in the mid-1960s, and the reform of higher education governance in California in the 1980s.
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Figure 7.3: Proposed Governance Structure for Tertiary Education
National Evaluation & Accreditation Agency NEAA

Tertiary Education Council
National Qualification Agency NQA

Universities
Council of Universities

New Tertiary Institutions
Council of Tertiary Institutions

University Board of Trustees University

Institution Board of Trustees New Institution

Second, establish a Board of Trustees for each university/tertiary institution and have them appoint the heads of institutions. The Board of Trustees would govern the affairs of the university/tertiary institution by: (a) developing broad administrative and management policies for the institution; (b) providing broad direction and coordination to the development of academic programs; (c) overseeing the efficient management of funds, property, facilities, and investments; (d) appointing the rector, as a chief executive of the institution; and (d) determining the representation of the institution on the Council of Universities/Tertiary Institutions.148 MES has recently proposed to establish Boards of Trustees, but only with an advisory function and with membership consisting primarily of faculty members. The implied (and continued) lack of authority, because of the composition of membership, is a concern. While these Boards, once in place, might be upgraded and provide proper authority, the concern is that until then they would simply further entrench the existing interests. This could tarnish the whole Board concept and make further adjustments unfeasible. • Strengthen links with labor markets: The relevance of tertiary programs could be enhanced by strengthening the links to employers. In many countries such links include work placement of students with private and public sector employers during the studies, and setting up strong professional orientation programs and services. These measures give the employers an opportunity to assess the knowledge, skills, and competencies of students, and the incentive to actively provide input and advice on academic program relevance. MES could also consider providing incentives to institutions to establish Program Advisory Committees (PACs) for all programs, and include employer representatives in sectors such as engineering, engineering technology, business, or medicine. The mandate of the proposed PACs would include: (i) validating market intelligence about the existing and future demand for graduates of various disciplines; and (ii) providing advice on the knowledge and skills

In other countries, the Board of Trustees is typically composed of 15-20 members, depending on the size of the institution. Two thirds of the trustees are typically appointed by the government to represent key external stakeholders, including the government, employers, civil society, and labor unions. One third is elected members who represent the key internal stakeholders of the institution: faculty, students, academic managers, staff, and alumni. The chair of the board is usually appointed by the government from the roster of appointed members.

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needed by employers. PACs and similar committees are used successfully in many EU countries, United States, provinces in Canada, Australia, and New Zealand. • Institute the Matura as access examination: To simplify the university application process and thereby improve access to tertiary education, the government may want to consider making the Matura a nation-wide end-of-secondary school examination and the basis for university admission. As a side benefit, a nation-wide exit (school-leavers) examination would also provide an objective basis for school evaluation. MES has already taken the initial steps of this reform, and expanded the mandate of the Center for Control and Assessment of the Quality of Education (CKOKO) to manage the Matura.

7.43 In the medium-run, the following reform options, which would require preparation and some structural changes, would be worth considering. The reform options are listed in a descending order of priority. • Increase tuition fees, establish a student loan scheme, and review scholarship programs: As the second step of financing reform, to provide incentives both to universities and students to perform, it is recommended that the tuition fees are raised to the maximum level of 30 percent of the actual tuition cost per student, i.e. to the maximum permitted by law. In parallel, to ensure that the access to universities will not be unduly affected by the increased fees, a means-tested and/or income-contingent student loan system would need to be rolled out together with a revised policy of existing scholarship programs to target qualified low income students and to encourage enrolment in public or private tertiary institutions. Taken together, these reforms would: (i) augment sector financing and potentially expand access and make it more equal; (ii) provide incentives for students and their parents to demand value for their money, and press for quality improvements; and (iii) improve graduation rates and throughput, since students who pay or borrow money are likely to be more vigilant about their studies. Introduce a performance-based component to tertiary institution funding: As the final step of financing reform, the authorities may want to consider introducing a performance-based component to tertiary funding, initially equivalent to 10 percent of the total state funding to an institution, but increasing it to 20-30 percent over five years. The performance-based component would be transparent, based on well understood set of indicators, and dependent on the performance of the institution in the previous year, or the moving average of the two most recent years. Performance could be assessed using key performance indicators (KPIs), which would measure the success of the institution in achieving the agreed outcomes, including cost-effectiveness of education delivery.149 This step would provide further incentives to universities to improve quality, and avoid delaying student completion or focus on low cost programs, if KPIs are appropriately selected. Consolidate universities and tertiary institutions: As discussed in this chapter, the large number of small, single discipline universities is a concern not just from the fiscal point of view, but above all for quality and R&D reasons. The large number of small universities

Examples of KPIs include: (i) a student satisfaction indicator (based on student surveys) measuring the quality of the learning process, learning resources, environment, and student services; (ii) a graduate satisfaction indicator assessing the graduates’ satisfaction with the institution and its programs, including the relevance and utility of the education received; (iii) employers’ satisfaction indicator (based on surveys of employers of graduates of the institution) assessing the occupational relevance of the education received; (iv) the employment rate of graduates six months after graduation, which would measure the relevance of the program content for labor markets (taking into account graduates who are pursuing further education instead of employment); and (v) a graduation rate indicator assessing academic programs’ efficiency and throughput.

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means that a large share of university funding goes to overhead costs finance administration, which implies that less is available for equipment and materials, with adverse implications for quality. Further, from the R&D point of view, a critical mass of researchers, usually across disciplines, would be required, which could not be assembled in such small institutions. Australia and Hungary provide examples of successful mergers by bold government action, despite considerable opposition from the universities. The Hungarian reform focused on the consolidation of 100 specialized institutions into about 30 larger comprehensive institutions. In Bulgaria, the government may consider merging some universities to create a smaller number of comprehensive universities with larger average enrolment than at present. The aim would be to reduce the number of small, specialized universities, and increase the student-faculty ratio to about 16:1 in all universities. An example of this kind of consolidation would be the establishment of a second comprehensive multi-campus technical university in Sofia by clustering the specialized small institutions of architecture, civil engineering and geodesy; chemical technology and metallurgy; forestry; mining and geology; transportation; and civil engineering. The consolidation or merger of universities is a classic example of change management involving strong vested interest. Hence, it would need to be managed by capable change managers using fair and transparent criteria. The benefits of the consolidation or mergers would need to be articulated to all affected parties, especially to the university faculty and rectors. • Strengthen accreditation and quality assurance of universities and their programs: The government may want to consider separating the institutional accreditation from the program accreditation. NEAA should continue its work on institutional accreditation using the framework developed. However, program accreditation would require the involvement of international experts and professional organizations, which can add value in assessing the quality of programs and in ensuring that the employers or employers’ associations are included in the assessment process. An assessment by an external body would also have a better chance of ensuring that program accreditation is rigorous, and that university faculty members are not directly involved in the evaluation of their peers. In addition, it is recommended that internal quality assurance units and procedures are established in each tertiary institution to promote a culture of quality and ownership of quality assurance reforms. Continued teacher and faculty training: For the above mentioned reforms to produce maximum results, they would need to be complemented with capacity building. While the proposed reforms in governance would need to be accompanied with leadership training for university faculty, in-career teacher development, and initial teacher education for newcomers would also be warranted. For these purposes, MES may want to consider establishing a Leadership and Faculty Development Institute (LFDI). The institute could be established in one of the leading universities, based on a competitive bidding process.

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Annex 1 : Bulgarian Institutions of Tertiary (Higher) Education
No University Location Students Faculty S/F Group I: Public Comprehensive and Technical Universities 1University of Sofia (St Kliment Ohrdiski) Sofia 22,000 1,650 13.3 2St. Cyril & St. Methodius University Veliko Tarnovo 10,500 550 19.1 3Rousse University (Angel Kanchev) Rousse 8,000 500 16.0 4University of Plovdiv ( Paisii Hildendarski) Plovdiv 13,000 550 23.6 5Prof. Assen Zlatarov University Bourgas 4,000 320 12.5 6University of Shoumen ( Konstantin Preslavsky) Shoumen 7,200 360 20.0 7South West University (Neofit Rilski) Balgoevgrad 11,000 500 22.0 8Technical University Sofia Sofia 12,000 1,300 9.2 9Technical University Gabrovo Gabrovo 8,000 225 35.6 10Technical University of Varna Varna 6,000 450 13.3 Subtotal Group I 101,700 6,405 15.9 Groip II: Public Specialized Universities and Institutions of Higher Learning 11University of National & World Economy Sofia 20,000 550 36.4 12University of Architecture, Civil Engineering & Geodesy Sofia 3,800 420 9.0 13University of Chemical Technology and Metallurgy Sofia 3,500 380 9.2 14National Academcy of Music "Pancho Vladigerov" Sofia 600 65 9.2 15University of Forestry Sofia 3,500 250 14.0 16University of Mining & Geology ( St. Ivan Rilski) Sofia 2,600 230 11.3 17Higher School of Transport (Todor Kableshkov) Sofia 1,000 157 6.4 18Liuben Karavelov Civil Engineering Higher School Sofia 700 75 9.3 19Medical University of Sofia Sofia 4,000 1,970 2.0 20National Academy of Theatre & Film Arts (Krastio Sarafov) Sofia 540 106 5.1 21National Academy of Fine Arts Sofia 900 130 6.9 22National Sports Academy ( Vasil Levski) Sofia 3,000 260 11.5 23Rakovski Defense & Staff College Sofia 100 138 0.7 24Ministry of the Interior Academy Sofia/ Varna 550 160 3.4 25Higher School of Libarary & Information Science Sofia 200 60 3.3 26Trakia University Stara Zagora 4,000 490 8.2 27Vasil Levski Military University Veliko Tarnovo 550 250 2.2 28Demitar Tsenov Academy of Economics Svishtov 10,000 250 40.0 29Medical University of Pleven Pleven 750 320 2.3 30Medical University of Plovdiv Plovdiv 6,300 240 26.3 31Agricultural University of Plovdiv Plovdiv 2,500 205 12.2 32The University of Food Technologies Plovdiv 4,000 200 20.0 33Academy of Music, Dance & Fine Arts Plovdiv 1,000 108 9.3 34University of Economics Varna 8,700 270 32.2 35Naval Academy (Nikola Vaptsarov) Varna 1,100 121 9.1 36Medical University of Varna Varna 800 360 2.2 Subtotal Group II 84,690 7,765 10.9 Group III: Public Short Cycle Colleges 37College for Islamic Studies Sofia 400 50 8.0 38College of Telecommunication & Posts Sofia 600 52 11.5 Subtotal Group III 1,000 102 9.8 Group IV: Private Comprehensive Universities 39New Bulgarian University Sofia 8,000 240 33.3

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40American University Balgoevgrad 41Bourgas Free University Bourgas 42Varna Free University (Chernorizets Hrabar) Varna Subtotal Group IV Group V: Private Specialized Institutions of Higher Learning 43European College of Economics and Management Plovdiv 44International Business School Botevgrad Subtotal Group V Group VI: Private Short Cycle Colleges 45International College of Albena Albena 46Higher School of Agriculture Plovdiv 47College of Management, Trade & Marketing Sofia 48College of Tourism Blagoevgrad 49College of Theatre "Lyuben Grois" Sofia 50Hristo Danov College of Commerce Plovdiv 51European College of Business & Management Plovdiv 52College of Economy & Administration Plovdiv 53College of Telematica Stara Zagora Subtotal Group VI

825 6,500 12,000 27,325 600 650 1,250 150 700 400 780 350 750 1,100 800 440 5,470

66 12.5 116 56.0 600 20.0 1,022 26.7 30 20.0 25 26.0 55 22.7 30 5.0 20 35.0 45 8.9 60 13.0 40 8.8 28 26.8 42 26.2 29 27.6 25 17.6 319 17.1

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8. TOWARDS RESEARCH AND DEVELOPMENT (R&D) STRUCTURES AND POLICIES SUPPORTING INNOVATION
8.1 The final piece of the productivity puzzle covered in this report deals with the R&D policies. As mentioned at the beginning of this report, the available empirical evidence indicates that R&D investments have a positive impact on productivity growth, among other things by enhancing technology transfer. While the other factors already discussed—improving functioning of product and labor markets, and strengthening the education delivery—are likely to have the largest impacts on productivity growth in the short and medium term, Bulgaria will need to start paying increasing attention as well to its R&D policies to sustain high productivity growth over time. 8.2 Scientific research, technological development and the ability to convert research results into economic and social benefits play an increasingly important role in determining economic development and international competitiveness of countries. Globalization and rapid distribution and transfer of knowledge by information and telecommunication technologies have also made investments in knowledge increasingly pertinent. This includes the generation and adoption of new knowledge created by scientific research and technological development, investments in education and research, adoption of best practices, and openness to social, economic, and cultural innovations. 8.3 Bulgarian R&D system faces many challenges and opportunities. The country’s recent entry into EU has brought along new competitive pressures, but also new windows of opportunity for improving R&D performance, and its operational and financial structures and instruments. Bulgaria joined EU at a time when R&D activities are gaining momentum in EU strategies. The Lisbon Agenda formulated in March 2000 sets the ambitious goal of making EU by 2010 "the most competitive and dynamic knowledge-based economy in the world, capable of sustainable economic growth with more and better jobs and greater social cohesion". In Lisbon, and two years later in Barcelona, a number of concrete objectives in terms of research quantity and quality were formulated. Box 8.1 summarizes these objectives/targets, which are part of the so called Lisbon goals. Lisbon goals apply primarily at the national level, since the bulk of R&D investments are made at that level. EU research programs account only for about five percent of the total R&D investments by the member states. 8.4 Lisbon goals call for all EU member states to increase their R&D investment to three percent of GDP by 2010, of which two-thirds—two percent of GDP—is expected to be financed by the private sector. To achieve these goals, member states are to improve the environment for private research investment, R&D partnerships, and high-technology start-ups. However, as can be expected, the quantity and quality of R&D investment varies significantly across EU countries. As will be discussed in this chapter, achieving these goals—in particular, the private sector investment goal—will be a significant challenge for Bulgaria, and unrealistic to achieve by 2010. But Bulgaria may wish to quicken its pace of progress in that direction. 8.5 This chapter will review the Bulgarian R&D and innovation system, assess its performance, and identify options for its strengthening. To put Bulgaria’s performance on the R&D and innovation front in perspective, Bulgaria will first be benchmarked against other countries in this area. This will help to identify Bulgaria’s relative strengths and weaknesses in the field of innovation. After benchmarking, the chapter will review select aspects of the Bulgarian R&D and innovation system, and highlight options to strengthen it.

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Box 8.1: Lisbon Strategy Targets/Objectives in R&D
1. 2. 3. 4. 5. 6. Increase R&D spending to 3 percent of GDP by 2010. The share financed by business should rise to two-thirds of that total (target set at Barcelona). Network national and joint research programs on a voluntary basis around freely chosen objectives and develop an open method of coordination for national research policies. Improve the environment for private research investment, R&D partnerships, and hightechnology start-ups. Harness new and frontier technologies, notably biotechnology and environmental technologies. Introduce a cost-effective community patent. Remove obstacles to the mobility of researchers, attract and retain high-quality research talent in Europe. Roll out a world-class research communications infrastructure.

7.

I.

BENCHMARKING OF BULGARIA IN R&D AND INNOVATION

8.6 To assess Bulgaria’s performance in R&D and innovation and to identify the country’s relative strengths and weaknesses, Bulgaria is benchmarked first against the other European countries using the European Innovation Scoreboard, and then against a broader set of international comparators using the Knowledge Assessment Methodology. In addition, to get a sense of potential gaps in the Bulgarian innovation environment, the structure of the Bulgarian innovation environment is roughly mapped out and compared with the structure in Finland, which is one of the Europe’s and world’s leaders in innovation. A. European Innovation Scoreboard

8.7 The European Commission publishes annually a European Innovation Scoreboard (EIS), which evaluates and compares innovation performance of EU member states as well as Turkey, Iceland, Norway, Switzerland, the US and Japan. EIS tracks 26 innovation indicators focusing on innovation inputs and outputs. Innovation inputs refer to indicators measuring: (i) structural conditions for innovation (which cover science and engineering graduates, population with tertiary education, life-long learning, youth education, broadband penetration); (ii) investment in R&D (which covers public and private investment, share of enterprises receiving public funding for innovation, share of university R&D expenditures financed by businesses); and (iii) innovation efforts at the firm level (which refer to innovation by SMEs, early-stage venture capital, ICT expenditures). Innovation outputs in turn cover indicators measuring: (i) application (which cover employment in high-tech services and in medium-high and high-tech manufacturing, exports of high technology products, sales of new-to-market products); (ii) the achieved results in terms of patents, trademarks, and designs. Based on these indicators a Summary Innovation Index (SII) is compiled. 8.8 The 2005 SII results indicate that Bulgaria not only has a sizeable innovation gap to the average EU25, but is also losing ground relative to the European innovation leaders. SII ranks Bulgaria 26th in a sample of 33 countries (including a few outside the EU) in terms of innovation performance. Further, Figure 8.1, which shows SII on the vertical axis and average growth rate of SII on the horizontal axis, suggests that Bulgaria is falling farther behind the leaders. Countries above the horizontal dotted line had innovation performance above the average EU25; and countries to the right of the vertical dotted line experienced a larger than the EU25 average increase in their SII value. Based on this, Switzerland,

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Finland, Sweden, Denmark, and Germany were the innovation leaders in Europe in 2005150, while Bulgaria, Estonia, Romania, and Spain were not just trailing behind, but actually losing ground. Figure 8.1: European Innovation Scoreboard 2005 and Bulgaria

0.80 CH 0.70 SE FI DK US 0.60 2005 Summary Innovation Index JP DE

Leading

0.50

UK FR IE LU

BE

AT NL IS

Average
HU

0.40

NO IT EE SI LT LV EL

0.30

ES PL BG

PT CY MT SK CZ

Losing ground

0.20 RO 0.10 TR 0.00 -5.0

Catching up

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Dotted lines show EU25 mean performance.

Average growth rate of SII

Source : European Innovation Scoreboard 2005 & European Trend Chart on Innovation http://trendchart.cordis.lu/tc_innovation_scoreboard.cfm

8.9 The results also suggest that Bulgaria has performed worse on innovation outputs than on inputs, indicating poor transformation of inputs to outputs. This suggests that Bulgaria would be well advised to focus its efforts on strengthening the gaps on the output side, instead of further strengthening the areas where it is already relatively well rated. Table 8.1 below reports Bulgaria’s performance by indicator relative to the EU25 average. The table indicates that Bulgaria is doing better on structural conditions and investment indicators than on the others. According to EIS, strengthening the intellectual property regime and transformation of R&D investments into marketable goods and services would be the areas requiring urgent attention by the government.

150

However, the SII results show that the US and Japan are still significantly ahead of EU25. While the innovation gap between EU25 and the US has remained relatively stable, the gap between EU25 and Japan has been increasing. In the US and Japan the number of different types of patents and the share of population with tertiary education are higher, and universities better integrated into the innovation process than in EU25.

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Table 8.1: Bulgaria’s performance relative to EU25 by indicator
Indicator
INPUT Structural Conditions for Innovation: Science and engineering graduates Population with tertiary education Broadband penetration rate Participation in life-long learning Youth education attainment level Investment in R&D: Public R&D expenditures Business R&D expenditures Share of medium-high/high-tech R&D Enterprises receiving public funding Business financed university R&D Innovation efforts at the firm level: SMEs innovating in-house Innovative SMEs co-operating with others Innovation expenditures Early-stage venture capital ICT expenditure SMEs using non-technological change OUTPUT Application: Employment in high-tech services Exports of high-technology products Sales new-to-market products Sales new-to-firm not new-to-market products Med-hi/high-tech manufacturing employment Achieve results/Intellectual property: New EPO patents New USPTO patents New Triad patents New community trademarks New community designs Summary Innovation Index, SII (2005) Source: European Innovation Progress Report, Trend Chart 2006.

% of EU25 average

68 99 -13 99 57 8 96 12 506 36 25 38 -137 20

84 16 35 32 71 3 1 -0 1 56

B.

Knowledge Assessment Methodology

8.10 The World Bank’s Knowledge Assessment Methodology (KAM) can be used to benchmark Bulgaria in the area of innovation on a world-wide basis. KAM provides a quick assessment of countries’ readiness for the knowledge economy, and helps to identify areas needing attention. It covers 132 countries, and uses more than 80 structural and qualitative indicators to measure countries’ performance in four areas: economic incentive and institutional regime; education; innovation; and information and communications technologies. Investments in all of these areas are considered necessary for sustained

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creation, adoption, adaptation, and use of knowledge in economic activities and production. Based on these indicators, a Knowledge Economy Index (KEI) is then constructed.151 8.11 The most recent KEI ranks Bulgaria 41st among the 132 countries that were rated (while Romania ranks 54th and Hungary 32nd). Denmark, Sweden, and Finland hold the top positions in KEI. Comparisons over time—comparing Bulgaria relative to other countries in 1995 and today—suggests that Bulgaria has been falling behind the world’s innovation leaders in the past decade. This reinforces the EIS results presented in the previous section. 8.12 Comparison of Bulgaria with other European and Central Asian countries on innovation indicators only (see Figure 8.2) highlights that Bulgaria is performing relatively poorly, in particular in the areas of royalty and license fee receipts and payments, science enrollment, numbers of researchers involved in R&D, total expenditure on R&D as a share of GDP (especially private sector investment in R&D), university-company research collaboration, and firm level technology absorption. According to the KAM methodology, these are the areas that would require attention to improve Bulgaria’s innovation performance. On the other hand, the comparison suggests that FDI inflows as a share of GDP, science and engineering enrollment, and manufacturing trade as a share of GDP are relative strengths of Bulgaria’s innovation system. Figure 8.2: Relative strengths and weaknesses of the Bulgarian innovation system152

Source: KAM, World Bank (2006d).

C.

Innovation Environment in Bulgaria versus Finland

8.13 Comparing the Bulgarian innovation environment—in terms of relative importance of various resources, funding, and focus of R&D—with one of the European innovation leaders can be illuminating and help identify the gaps in the system. Hence, Bulgaria is compared with Finland, and Figure 8.3
151 152

Variables are normalized on a scale of zero to ten relative to other countries in the comparison group.

The indicators are normalized from 0 (the worst) to ten (the best). Hence, the closer to the perimeter the spiderweb is, the better positioned the country is relative to the comparison group.

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roughly maps out the situation in these two countries. The horizontal axis describes the innovation chain starting with basic research at one end and the research moved to the markets at the other. The vertical axis in turn reflects a continuum from public to private funding. The size of different elements (different color bubbles) indicates their financial weights in the system. Figure 8.3: Innovation environment in Finland and Bulgaria153
FINLAND BULGARIA

Business angels Private Company R&D VC funds Collaborative R&D funding Public Universities Private Company R&D

Business angels VC funds Collaborative R&D funding Sectoral research

Public

Universities Sectoral research Research councils Basic Research Applied Research

Research councils Basic Research

Business Business R&D Development

Applied Research

Business Business R&D Development

Source (left panel): Dahlman, Routti, and Yla-Anttila (2006)

8.14 Figure 8.3 suggests that R&D in Finland is predominantly applied, business driven, and carried out and financed by the private sector. In Bulgaria R&D is heavily focused on basic research, financed largely by public funds, and carried out mainly by public research institutes and universities. R&D carried out by businesses is quite modest in Bulgaria.154 This is just the opposite of the Lisbon goals, and thus presenting Bulgaria with a significant challenge. 8.15 R&D done with public funding at universities and research institutes, and R&D with private funding in companies form the basic elements of an innovation system, but they are not sufficient for high performance. For innovation performance, these need to be complemented with public-private partnerships, national and international technology transfer, incubators and science parks for starting and growing research-based companies, and venture capital for financing start-up companies especially in high technology areas. In Bulgaria venture funds and business angel155 funding by individuals are largely lacking, and there is a disconnect between public and private efforts.

153

Note that in the case of Finland, “research councils” refers to funds allocated through the Academy of Finland, (see paragraph 8.48), while in the case of Bulgaria it refers to the National Science Fund (see paragraph 8.33)

Table 8.1 highlights that business financed university R&D is high a share of total university R&D in Bulgaria. However, this reflects the extremely low volume of total R&D carried out by universities. Centuries ago traders exploring the world called the merchants financially backing their efforts as business angels. The term was later used in the theatre in the context of financial backers who invested in a theatrical production. Today, the terms is used to refer to individuals who invest their capital (and sometimes also business skills) in a range of new and developing commercial ventures.
155

154

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8.16 Funding structures in Finland emphasize the competitive elements in both basic and applied research, and foster public-private partnership in applied research. For instance, the share of direct budget funding of universities accounts for less than half of the total (that is, more than half of the funds received by universities are allocated on a competitive basis). This is a result of about two decades of intensive restructuring of the system, often accompanied with debates among the stakeholders. In contrast, the share of competitive R&D funding in Bulgaria is still minor. 8.17 Further, compared to Finland, the different elements in the Bulgarian innovation system are disjointed: basic and sectoral research is largely detached from R&D carried out by the private sector. It would be important that the different elements in the innovation system link seamlessly but at the same time have clear and distinct roles. In terms of Figure 8.3, this would mean the various “bubbles” remaining distinct in their various remits, but growing much bigger in the case of Bulgaria and overlapping (indicating collaboration). 8.18 It is important to note that there are large differences in the funding systems of different countries. In United States, public funding is directed mostly to basic research, but also to defense goals. In France, funding of the Centre National de Research Scientific, and to a lesser extent in Germany with Max Planck Institutes, has been institutional, with competitive funding and public-private partnership funding having emerged only lately. One would thus expect Bulgaria to evolve its own distinct system that serves the country’s objectives, although the process of reaching them would be conceptually similar. D. How to Catch Up?

8.19 While Bulgaria may currently be trailing in rankings, rapid catching up is possible. The cases of Finland, Chile and Korea are a proof of that, as well as some of the EU8 countries, which have increased their rankings in the past couple of years. Many of these improvements in rankings were based on the countries increasing R&D investments and renewing the related structures. Bulgaria has that opportunity as well. 8.20 Taken together, the results of the above benchmarking and comparisons suggest that the key challenge facing Bulgaria is to increase private sector investments and involvement in R&D and innovation. In parallel, there is a need to make R&D efforts increasingly geared towards business and industry needs so that their results are likely to translate into economic benefits—that is, to be commercialized—through increased research collaboration between academia and business. Further, to make that happen, the enforcement of the intellectual property rights regime would need to be strengthened, number of researchers involved in R&D increased, and science enrolment expanded. What measures should the Government take to address these issues and to encourage increased private sector R&D expenditures and move them closer to the Lisbon targets? The next sections will explore select aspects of the Bulgarian R&D and innovation system, and highlight options to improve their performance. II. INSTITUTIONAL FRAMEWORK FOR R&D AND INNOVATION

8.21 The Bulgarian R&D and innovation system is in a period of transition, and new strategies, laws, and instruments have been introduced in the past years. There are, however, still several old structures dating from the earlier era of Bulgarian scientific research, which have not been reformed. To get the maximum benefit from the new structures that have been introduced, it is essential that the reform of the R&D and innovation system is continued and old structures renewed. With the recent EU accession, the EU framework program for research can be expected to further shape the system, and the availability of EU grants provides a unique opportunity to help finance the needed reforms.

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8.22 Figure 8.4 depicts the current institutional structure of the Bulgarian R&D and innovation system. This section will review its main components—the key policymaking bodies, financing instruments, actors, as well as the overall strategies that are being pursued. Figure 8.4: Institutional structure of the R&D and innovation system in Bulgaria
National Assembly Committee on Education and Science Council of Ministers

Ministry of Economy and Energy National Council on Innovation Bulgarian SME Agency

Ministry of Education and Science National Council for Scientific Research

Ministry of Transport and Communications

Ministry of Agriculture and Forestry

ICT Development Agency National Science Fund National Centre for Agrarian Sciences

National Innovation Fund

Enterprise sector

Bulgarian Academy of Sciences

Universities

Other Government Research Institutions

Note: Enterprises, BAS, universities and other government research institutions. Have been placed in the diagram to give a more complete picture of the innovation system in Bulgaria. These entities are not subordinate to the Council of Ministers; no lines connect them to the rest of the structure.

A.

National R&D and Innovation Strategies

8.23 Bulgaria has two key strategies156 that lay out government’s policy in the area of R&D and innovation. These are the National Strategy for Research and Development, and the National Innovation Strategy.157 8.24 The National Strategy for Research and Development (NSRD), approved by the Council of Ministers in May 2005 but not yet reviewed by the National Assembly, aims to help the integration into the European Research Area. The document highlights the low level of R&D funding, in particular by the
156

Other relevant national strategies that partially cover R&D and innovation include the National Strategy for Small and Medium-sized Enterprises Development and Promotion; the National Strategy for Life-long Learning in Professional Education for the period 2005-2010; Human Resource Development Strategy 2000-2006; Information Society Development Strategy of the Republic of Bulgaria; Strategy for the Establishment of e-Government; Strategy and Action Plan for Bulgaria’s Competitiveness on World ICT Markets; and the National Strategy for Regional Development until 2015. These documents can be accessed at (www.government.bg)

In addition, the Bulgarian Parliament adopted a law on scientific research promotion in October 2003, which stipulates that priorities for research need to be related to solving economic, social and human issues, national identity and culture, the development of the engineering science, innovations, and new knowledge.

157

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private sector; insufficient research infrastructure; low productivity of research; and the shortage of managerial skills as the main challenges and issues to address. It maps out concrete mechanisms and measures, which aim at strengthening the administrative capacity for forming a national policy towards science; R&D funding; raising the profile of the scientific potential; creation of new knowledge in areas that are traditionally strong and have won national and international recognition; increasing the market demand for research products; and innovations on the domestic and world markets. 8.25 The National Innovation Strategy (NIS) was adopted in September 2004. Its objective is to increase the productivity and value added created by the Bulgarian industry through creation of new knowledge, transfer and implementation of contemporary technologies, provision of financial resources for innovative products, and development of markets. The strategy envisages a series of financial and non-financial measures for creation of a framework for a proper innovation policy. Of these, the main financial measure to encourage innovation—the establishment of a National Innovation Fund—has already been implemented. The key non-financial measures include the employment of young specialist in SMEs, cluster development, attracting FDI in R&D activities, and establishment of technology parks. B. Coordination of R&D Policies

8.26 The Ministry of Education and Science, and the Ministry of Economy and Energy are the key ministries responsible for the implementation of the above-mentioned two strategies and R&D and innovation policy in general. As shown in Figure 8.4, other relevant ministries, which address R&D and innovation issues are the Ministry of Transport and Communications, and the Ministry of Agriculture and Forestry. 8.27 The Ministry of Education and Science is responsible for the national policy in the field of research, and the National Council for Scientific Research (NCSR) is the key coordinating body for the research policy. It is chaired by the Minister of Education and Science, has 19 members, including representatives of other ministries, umbrella organizations of employers, scientists, and universities. The council approves all major research policy documents, including the NSRD, and funding priorities and programs of the National Science Fund. 8.28 In parallel, the Ministry of Economy and Energy is responsible for the development and implementation of the national innovation policy, which contains several elements closely related to R&D. The National Council for Innovation (NCI) is the central coordinating body for innovation issues. However, unlike NCSR, NCI has less decision-making power and serves only as an advisory body to the Minister of Economy and Energy. 8.29 This dual structure—two parallel strategies, two responsible ministries, and two coordinating councils—raises concerns, since research and innovation are strongly related, and links between them need to be strong. Although there are some links between the two advisory councils (namely, each ministry is represented in them), a unified structure would arguably better support horizontal cooperation among the various bodies. For example, in Finland, like in Bulgaria, two ministries (Ministry of Education, Ministry of Trade and Industry) have the main responsibility for the implementation of R&D and innovation policies, but there is only a single council (Science and Technology Policy Council) in charge of strategic development and the coordination of the overall effort. This council is not under any particular ministry, but functions as an advisory body to the Government, and is chaired by the Prime Minister to underpin its importance and cross-cutting nature.158

158

The members of the council are from the government, academia, industry, and labor organizations.

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8.30 Also, leaving the R&D and innovation policies to individual ministries would merit reconsideration. While in Bulgaria the Council of Ministers oversees the activities of ministries, coordination and policy issues are largely left to the ministries. Given their importance, the policy questions related to R&D and innovation would need to be agreed at the level of the whole government rather than at the level of individual ministries. Experience from other countries suggests that successful implementation of R&D and innovation policies calls for consensus and support from the highest political level, as well as from other public and private actors in the Bulgarian innovation system. 8.31 R&D and innovation are issues that require a long-term vision. The pursuit of this vision needs to be based on societal consensus, and must hence involve all key actors and especially the politicians. To educate these actors about the issues on which consensus is needed, a number of countries have developed a continuous process of education for their politicians, high level policy makers, academia, industry, labor organizations, and the media (see Box 8.2 on Finland as an example). These courses and workshops have resulted in a better appreciation of the need of for substantial structural R&D investments that pay off only in the long run. This is often difficult for politicians, who are elected for short periods of time and are under pressure to deliver quickly. Nevertheless, the issue is so important that it must be addressed. Potential availability of EU grant funds should make it easier to tackle it. Box 8.2: Training of Policy makers on Economic Policy Management in Finland
Since 1977 programs on economic policy management and national strategies have been organized to policy makers in Finland. More than 1,500 policy makers so far have attended them. The participants include most members of the Parliament during their first terms, other decision makers in the public sector, as well as industry, labor market and media leaders. The program lasts about two weeks, including visits to relevant organizations. Programs are structured to define policy objectives and choose the policy instruments, such as taxation structures, allocation of resources in different sectors, investments and incentives, and interest rate policies. About 20-30 lectures are given by the best domestic and international experts, and followed by thorough discussions. The lecture series commences with fiscal and monetary policies, proceeds to structural questions in different sectors, and concludes with long-term development options. The most important part of the program is the exercise defining the policy objectives and the budgetary and other instruments to reach them. This exercise takes the form of simulating the work of government, with the workshop participants playing the role of key decision makers. The exercise is supported by competent economists and simulation models of the national economy, typically the same models used by the Ministry of Finance and the Bank of Finland. Source: Dahlman, Routti, Ylä-Anttila, eds, “Finland as a Knowledge Economy: Elements of Success and Lessons Learned.”World Bank Institute, 2006.

C.

Financing Instruments

8.32 In addition to private sector financing and direct budget financing, which primarily goes to finance the established research institutes, there are two potentially important public instruments to finance R&D investments in Bulgaria. These are the National Science Fund overseen by the Ministry of Education and Science, and the National Innovation Fund overseen by the Ministry of Economy and Energy (see Figure 8.4). These two funds are noteworthy because they operate and allocate funds on a competitive basis, which is still relatively new in Bulgaria. 8.33 The government finances R&D at universities through the National Science Fund (NSF), which provides funding on a competitive basis through seven instruments/programs: (i) a thematic project call; (ii) a general project call; (iii) support to the young scientists and researchers, (iv) promotion of research at universities (and between universities and the Bulgaria Academy of Science); (v) bilateral international

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cooperation; (vi) fostering cooperation between science and academia; and (vii) scientific publications. NSF’s flagship program is the annual call for Scientific Research, which accepts research proposals from any field of science by both public and private institutions. 8.34 The National Innovation Fund (NIF) is the first proactive and purely innovation-related policy measure in Bulgaria in the past few years. NIF finances on a competitive basis innovative projects in the pre-market phase of product development, as well as some advisory services for enterprises. It is managed by the Bulgarian Small and Medium-Size Enterprise Promotion Agency in the Ministry of Economy and Energy. 8.35 While NIF is an important step forward in policy making and implementation, its initial budget of EUR2.5 million is still too small to contribute significantly to the Bulgarian innovation performance. However, its annual budget is projected to increase to about EUR50 million by 2013, which could be expected to make a difference. D. Key Actors

8.36 The key entities carrying out the bulk of R&D in Bulgaria are universities, the Bulgarian Academy of Science, and the National Center for Agrarian Sciences. Both the Bulgarian Academy of Science and the National Center for Agrarian Sciences are government-funded, and are currently by far the most dominant actors in the R&D field. There are also other government research institutes, but they are relatively minor. Also, as mentioned earlier, R&D conducted by private sector enterprises is still limited. 8.37 Research at the universities: Research and university (including university hospitals) collaboration with industry have slowly started to gain prominence in the agenda of universities. This is consistent with NSRD. The 1995 law for higher education stipulates that universities are to carry out basic and applied research in addition to educational activities. Traditionally, Bulgarian universities have concentrated on their educational tasks. 8.38 However, universities face several challenges in trying to fulfill their mandate of having to improve the quality of research and forge strong partnerships with the industry in R&D. According to international evaluations,159 the quality of higher education has been in decline in the past decade. Inevitably this has also had an impact on the quality of research. In addition, Bulgaria is facing other, internationally shared, challenges such as unattractiveness of scientific careers among the younger population, ageing of scientific professionals, and increasing pressure for the universities to actively contribute to the overall economic and societal development. 8.39 The 1995 law stipulates that at least 10 percent of the funds allocated to universities should be devoted to research. While there are no detailed data on investment in research by universities, the universities are generally considered to spend less than that. According to the National Statistical Institute, the total higher education sector investment in R&D was about EUR10 million. Research activities of universities are often assigned to the Rector or Vice-Rector, or to specific research units at the larger universities. According to the estimates by the Ministry of Education and Science, roughly half of the university research is conducted on a collaborative basis and includes external funding.

159

OECD (2004b) Bulgaria: Research, Science and Technology and OECD (2003) Trends in Mathematic and Science Studies (TIMSS).

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8.40 The large number of small universities in Bulgaria160--that is, the fragmentation of the university system—in relation to the size of the economy is also an issue, since it is not conducive to research activities for which a critical mass would be required. Indeed, most university research is currently conducted by the largest ones (for example, the Sofia University, Technical University, and the University for the National and World Economy). These are the same universities that also actively collaborate with industry and participate in EU research projects. It would make sense to have some consolidation of the university system to improve the quality of research, in addition to the benefits that this is likely to bring to the quality of education (see Chapter 7). 8.41 Bulgarian Academy of Sciences (BAS): BAS is the leading and dominant research organization in Bulgaria, and is responsible for the implementation of the large part of Bulgarian R&D policies. Its central role is highlighted by the fact that it is the recipient of close to 70 percent of total government R&D funding in Bulgaria. This central role in Bulgarian R&D is further amplified by the fact that the private sector investment in R&D is so small. 8.42 BAS is a national autonomous association for scientific research, which includes 87 academic institutes, laboratories, and other independent research units in natural sciences, humanities, social sciences, and technical sciences. BAS has a Board of Directors, an Executive Board, and a General Assembly as its governing bodies. 8.43 BAS currently employs about 8,200 people. Of these, 3,600 are trained scientists and 2,600 experts with higher education degrees. At its largest, BAS had a staff of about 16,000 professionals and held virtual monopoly in Bulgarian science. After the collapse of the central planning system, BAS has been shrinking in size. The staff has been reduced by 45 percent and the number of units by 27 percent. 8.44 Being the largest research establishment in Bulgaria BAS accounts for more than half of the scientific output of Bulgaria. It has the largest number of research contracts both from Bulgarian organizations and from abroad, and has received favorable appraisals in international rankings of scientific organizations. However, it can not alone respond to the R&D needs of the country. Bulgaria's modest innovation performance is probably due to four major factors: (i) significant downsizing and reorientation of BAS as a result of transition to the market system; (ii) Bulgaria’s still underdeveloped business sector; (iii) weaknesses in the way R&D is funded; and (iv) weaknesses in the performance of the university sector. Experiences of other countries suggest that additional funding and new funding instruments can create R&D activities that better match the society's needs and can improve the overall innovation performance. Increased university research produces graduates with research experience that will increase competence and interest in R&D activities in corporations. In addition, increased corporate R&D, driven by the forces of competition, and aided by government funding creates clientele for research contracts that will also benefit BAS. 8.45 BAS conducts basic and applied research in a large number of disciplines. In both areas they will face increasing international and global competition. This would require focused basic research efforts on a more limited number of most promising areas, with strong international partners. This development is manifested in most advanced countries by the establishment and focus of centers of excellence and the increased funding for highly competitive frontier research in the EU programs. For educational reasons, university research tends to cover a greater number of disciplines. Yet, in many countries, universities too are increasingly focusing on their best units. In applied research and development work the leading role should be given to the clients and industrial partners, in order to give more emphasis to the demand side. Both wide strategic programs and product and process development projects are needed. To enhance market potential and returns to investments in research, increased collaboration with and contract
160

In 2006, there were altogether 42 universities and 10 colleges in Bulgaria.

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research from the private sector are the way forward. This can be facilitated by strong technology research funding agencies, as has been the case in many countries Many European research organizations would serve as good operational models to this end, such as Fraunhofer Gesellschaft in Germany, TNO in the Netherlands, Sintef in Norway, or the Technical Research Center of Finland (VTT). These organizations work in close cooperation with industries, service companies, and specialized government agencies. They carry out joint research projects with domestic and foreign companies, provide advanced technical services to companies, and exchange with them information and experiences on a regular basis. Over two-thirds of their financing comes from external sources—from companies, public funding agencies, and from EU research programs. Apart from strong industrial orientation, these institutes continue to perform cutting edge basic research in certain fields, in order to maintain their competitiveness in future technologies. 8.46 Today there are too many small institutions within BAS, and only some of them can be internationally competitive. There is a wide range of performance outcomes, relevance, and scope across the 87 research institutes. Some of the equipment in these entities is obsolete, and not conducive to contemporary research methods. Some units are doing research in areas and sectors which are no longer viable in Bulgaria. At the same time, some of the best ones have already received international recognition, such as the status of a Centre of Excellence under EU FP6, but these are few. Overall, however, resources are not necessarily optimally allocated and there is room for efficiency gains. 8.47 The institutional status of BAS is quite unusual when compared to its counterparts in other European countries of Bulgaria’s size. Many countries have a network of government research institutes, which have some similarities with BAS, but these institutes focus on applied research, and report to various ministries according to the type of work being carried out by the institute. In other words, the government research institutes are research arms of government sectors (such as, industry, agriculture, forestry, environment), with the aim of producing data and knowledge of relevance to the strategic and operational development of the sector. 8.48 Most European countries have a well-established research council system that provides competitive funding for basic research. For example, Finland has an agency called the Academy of Finland, but despite its misleading name, it is in fact a research council. It is a planning and funding agency for basic research carried out mainly by universities, and it does not have research institutes of its own. Of the Bulgarian organizations, it is NSF that resembles the Academy of Finland, not BAS. 8.49 Further, in other relatively small European countries including Finland, it is the universities that are mainly responsible for basic research. These countries do not have separate research institutes for basic research, such as BAS. This structure has been working well in these countries, and locating the strongest basic research units in universities is a rather universal trend in the world. 8.50 In order to identify the needed structural reforms and a refocusing of BAS activities, a thorough impact evaluation and functional review of all BAS institutes and functions would need to be carried out by an independent evaluator. No such evaluation of BAS exists currently. Through a carefully planned and implemented refocusing process, BAS could become more competitive, the quality of its research could be raised to an even higher level, and its impact on the Bulgarian economy and society could increase. 8.51 The Government would be well advised to increasingly shift to competitive R&D funding with incentives for collaboration, and make BAS also increasingly compete for funds. Directing funding increases to highly performing institutions on a competitive basis would provide incentives for reform also from inside, and encourage collaboration and institutional mergers.

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8.52 The National Center for Agrarian Studies (NCAS): There is also a need to review the role of the National Center for Agrarian Studies (NCAS), and prepare an appropriate reform program for it. NCAS is the other major government research institute in Bulgaria. However, unlike BAS, it is not autonomous, but under the Ministry of Agriculture and Forestry. It conducts scientific and applied research on agricultural issues in its 21 research institutes, and has a staff of over 3,600 people. NCAS also provides consulting services and training. In addition to the Ministry of Agriculture and Forestry, NCAS receives funding from its consulting and training activities.161 The Strategy for Development of the Science in the Agrarian Sector envisages that the share of competitive research funding will be increased. To this end, the Ministry of Agriculture and Forestry has initiated 18 programs for the development of integrated scientific projects. III. FUNDING AND TYPE OF R&D AND INNOVATION INVESTMENTS A. Investment in R&D and Innovation

8.53 Total investment in R&D amounted to about 0.5 percent of GDP in 2005. This was significantly below the EU15 average of 1.91 percent of GDP and lower than the EU8 average of 0.82 percent of GDP. Figure 8.5 below depicts the investment levels in select EU countries in 2005. As can be seen from the figure, only Cyprus and Romania recorded lower total R&D spending than Bulgaria. Investment in R&D in Bulgaria as well as in all the EU8 countries is substantially below the Lisbon target of three percent of GDP. Total R&D investment as a share of GDP has remained largely unchanged since 2001 in Bulgaria. Figure 8.5: Total R&D Investment by Sector in 2005, % of GDP

2 1.5 % of GDP 1 0.5 0
EU15 Bulgaria Czech Es to nia average Republic Cyprus Latvia Lithuania Hungary Malta P o land Romania Slovenia Slovakia

government

industry

higher education

private non-profit

8.54 The bulk of R&D investment is financed by the government and only a relatively small share by the industry (see Table 8.2). This is opposite to what is observed in most EU15 countries and what the Lisbon targets are striving for. In 2005, about 66 percent of total R&D Table 8.2: Investment in R&D in Bulgaria, percent of GDP 2001 2002 2003 2004 2005 investment (0.33 percent of GDP) was 0.47 0.49 0.50 0.51 0.50 financed by the government, which Total 0.31 0.35 0.35 0.34 0.33 was significantly above the shares in Government 0.10 0.09 0.10 0.12 0.11 any EU8 country and the EU15 Industry Higher education 0.06 0.05 0.05 0.05 0.05 average of 10 percent (or about 30 Private non-profit 0.00 0.00 0.00 0.00 0.01 percent, if government financed R&D Source: Eurostat channeled through universities is included). This is shown in Figure 8.6. In parallel, only about 22 percent (0.11 percent of GDP) of R&D
In 2004, NCAS carried out 255 scientific and research projects financed by the institute, 48 by the Ministry of Education and Science, 43 by other organizations, and 153 contracts under international and bilateral cooperation.
161

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expenditure was financed by industry, which was substantially lower than the EU15 average of 64 percent and the share in any EU8 country, except Lithuania (see Figure 8.7). R&D investment by higher education institutions accounted only for about ten percent of the total. Figure 8.6: Share of R&D Financed by Government in 2005, % of total R&D investment

70 60 50 40 30 20 10 0
Bulgaria P oland Romania Cyprus Slovakia Lithuania Hungary Latvia Czech Slovenia EU1 5 Republic average Es to nia Malta

Figure 8.7: Share of R&D Financed by Industry in 2005, % of total R&D investment

80 70 60 50 40 30 20 10 0

Slo venia

Malta

Czech EU15 Ro mania Slovakia Es to nia Hungary Republic average

Latvia

P o land

Cyprus

Bulgaria Lithuania

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8.55 This pattern of R&D financing—two-thirds funded by the government and the rest by industry and higher education institutions—has remained broadly unchanged during the period 2001-2005 (see Figure 8.8).162 Further, over 90 percent of R&D investment is used to cover current expenditures, and less than ten percent goes Figure 8.8: R&D Investment by Sector, % of total investment towards investment in capital. (Source: National Statistical Institute) This implies that minimal 100% scientific infrastructure 9.2 10 9.7 12.8 10 90% investments have been made at 18.5 20 80% 23.6 22 21.3 universities or research 70% 60% institutions, which limits the 50% type of research that can be 40% 71.4 70.1 67 65.9 66 carried out. In other EU 30% 20% countries, capital investments 10% represent typically 20-30 percent 0% of total public R&D investment. 2001 2002 2003 2004 2005 For example, in Finland, 27 percent of government R&D Government Industry Higher education Private non-profit expenditures were spent on research infrastructure and material investment. While Bulgaria’s pattern of investment may be consistent with its stage in the transition process and level of income, to facilitate the country’s shift to the next level of development and to raise productivity, increased private sector R&D would be called for. 8.56 Almost 70 percent of government R&D funds Figure 8.9: Allocation of Government R&D Investment in 2001-2005 go to BAS. As can be 100% seen from Figure 8.9,163 the share of government 80% funding going to BAS has increased from about 51 60% percent in 2001 to 67 40% percent in 2005. Since the overall level of R&D has 20% also increased during the period, it means that the 0% 2001 2002 2003 2004 2005 budget of BAS has been increasing strongly in the BAS Ministries State universities extrabudgetary funds past years, (see Table 8.3). Well over 90 percent of the BAS budget finances current spending, that is, staff salaries. 8.57 About one-third of government R&D funds go to the ministries. The Ministry of Agriculture receives about 27 percent of total funds, of which a large share goes to finance NCAS. The rest—about four percent—goes to the Ministry of Education and Science and the Ministry of Economy and Energy. In addition to NSF, the Ministry of Education and Science invests about the same amount of money as on the NSF budget on what is called evaluation, development, and preservation of the Bulgarian science
162

However, the situation used to be different in early 1990s. The 1996-1997 crisis adversely impacted Bulgarian businesses, and the share of industry-financed R&D fell from about 50 percent of total R&D expenditure to less than one fifth. In Figure 3.9, extra budgetary funds refer to international programs and grants not channelled through the budget.

163

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potential. In the case of the Ministry of Economy and Energy, the funds finance primarily NIF. However, the shares going to ministries have declined steadily in the past few years, while the share going to BAS has increased. Table 8.3: Allocation of Government R&D Investment
Total government R&D investment (BGN thousand) Of which, % allocated to: Ministry of Education and Science Ministry of Economy and Energy Ministry of Agriculture BAS Other
Source: Ministry of Finance, Staff calculations

2001 97,617

2002 118,993

2003 119,620 4.5 1.9 30.2 59.8 3.7

2004 129,696 4.7 1.0 29.0 62.5 2.8

2005 133,799 3.5 0.4 26.8 67.0 2.3

50.9

55.3

8.58 The allocation of a major part of government R&D financing as institutional funding (that is, as subsidies to maintain existing staff, facilities and equipment) suggests that the quality of government R&D investment has not yet adapted to the needs of Bulgaria’s market economy. Only a small fraction of government financing has been allocated to support what the government itself has defined as its priority objectives, and of that only a small share is currently distributed on the basis of competitive selection procedures. B. Type of R&D Financed

8.59 In the last ten years, the share of R&D funding allocated to basic research has increased steadily at the expense of applied research and Table 8.4: Allocation of R&D Funds by Type of experimental development164 (see Table 8.4). Research, % of total investment This trend is disconcerting, and opposite to the 1995 2003 trends in most EU countries. In recent years, Experimental development 20.4 15.5 most EU countries have increasingly shifted Applied research 54.7 46.7 public funding to application-oriented activities Basic research 24.9 37.8 and innovation, instead of basic research. Source: NSI Bulgaria would be well advised to follow this trend. Obviously, there will still be need for public investments in basic research as well, but the main emphasis should be on applied work. The objectives of basic research should thus be carefully reconsidered. C. Enhancing Industry Engagement in R&D and Applied R&D

8.60 To increase industry’s participation in R&D, while also shifting the R&D focus increasingly to applied research will be a formidable challenge for Bulgaria. In order to reach the Lisbon goal of R&D investment of one percent of GDP financed by the public sector (one-third of total spending), a three-fold increase in government R&D investment would be required, even if GDP remained constant. To reach the goal of private sector R&D investment of two percent of GDP (two-thirds of total R&D spending), a twenty-fold increase in spending by industry would be needed. It is obvious that the private sector will not achieve this sort of an increase by 2010. It will take increased competition to provide firms the incentives to invest in new technologies, and that will take years. Hence the public sector can be expected to dominate Bulgarian R&D for a while. To shift the course so that the Lisbon goals can eventually be met, a radical change in policy is probably needed.
164

Experimental development is the most applied form of research.

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8.61 Governments around the world have experimented with various ways of enhancing private sector R&D. Some governments have had the public sector undertake industrial R&D activities directly, but the results have been discouraging in most cases. Government is rarely in a position to judge what type of research would help firms and have market potential. Nor does it have the right incentives. Public R&D also tends to crowd out private R&D, unless public efforts are carefully designed to complement private activities. Some governments provide tax incentives, in-kind grants (for example, land), or cash grants to encourage private R&D efforts. However, since in the case of subsidies, except cash grants, it is difficult to estimate the costs involved, the process is effectively hidden from the public view, and becomes subject to abuse. 8.62 As shown earlier, in OECD and EU15 countries, the private sector finances the bulk of applied research and product development, even though public-private partnerships for R&D and knowledge creation remain important. It is worthwhile to note that Finland and Sweden, which were among the highest ranked in the EIS 2005, have high levels of private R&D and governments of these countries do not provide substantial direct government or tax support to the private sector for these purposes. How was this achieved? Much of the answer lies in the creation of an environment that makes it easy to start and grow a business. 8.63 The challenge posed by the Bulgarian industrial structure: The current industrial structure in Bulgaria, which is rather low-technology165, adds another dimension to the challenge of increasing industry financed R&D. According to the Bulgarian Association of Industries, the R&D capacity of Bulgarian industry is weak due to this industrial structure, in which low-tech SMEs and micro enterprises dominate and their R&D capacities are limited. Most large companies are foreign-owned. Hence their connections to Bulgarian universities or research institutions are only occasional, and their R&D is conducted abroad. The machine-building sector has little domestic product development, and is largely manufacturing for foreign companies. The same applies for other light industries in Bulgaria. There are no large domestic chains in the tourism sector that could benefit from R&D. In trade and commerce, large foreign chains dominate the market, with little development work in Bulgaria. Agriculture is a large sector, but suffers from fragmentation into many small units. In short, there are few Bulgarian global export products, and at the moment a limited number of companies have the capacity to carry out R&D work, though they all could benefit from it. 8.64 The EU Trend Chart on Innovation 2004-2005 report on Bulgaria (EC 2006d) lists many of the same factors as obstacles to innovation by Bulgarian enterprises: (i) low-technology product specialization and export structure of the economy; (ii) predominantly low-technology employment; (iii) short-term planning horizon of enterprises; (iv) poor human resources management system within enterprises; (v) lack of venture capital schemes; and (vi) lack of policy schemes for high-tech employment. 8.65 Experiences of advanced EU countries in the field of innovation yields the following lessons: • • • competitive markets and the accelerating pace of scientific and technological change force firms to innovate more rapidly; innovation increasingly relies on effective interaction between the science base and the business sector; networking and collaboration among firms are now more important than in the past and increasingly involve knowledge-intensive services;

165

Less than five percent of the manufacturing sector is high-tech.

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• •

SMEs, and especially those based on new technology play an important role in the development and diffusion of new technologies; and globalization is making countries’ innovation systems more interdependent.

8.66 These lessons suggest that the large SME base in Bulgaria is not necessarily a problem. What may be the problem, rather, are some aspects of the business environment. As was discussed in Chapter 3 there are a number of weaknesses in the quality of the regulatory environment that, by not fostering competition, reduce the pressure for innovating and raising productivity. Earlier sections of this chapter discussed the weak links between the science base and the business sector. Other parts of this report focused on measures needed to raise the quantity and quality of human capital. Much of the economy can be efficiently run by using people with medium-level skills of the type learned in general secondary and/or vocational schools. This includes to some extent the adoption of existing technologies. However, development of new technologies or moving the country closer to the world technology frontier depends on a large pool of people with higher education. A large proportion (at least 30 percent) of the labor force of the most innovative and competitive economies have a tertiary-level education. Chapters 5-7 covered the key reforms needed to raise Bulgaria’s quality of human capital, and Chapter 4 discussed the policies needed in the labor market to make the continuous reallocation of labor from lower to higher productivity levels as smooth and rapid as possible. When taken together, these measures would help create a business environment that would attract private investment, both foreign and domestic, in the process intensifying competition and thus creating incentives to innovate and raise productivity. Those will be the key policies that, in the long run, will lift the level of industry-financed R&D towards the Lisbon targets. However, there are areas in which the government may be able to assist in speeding up the process—one of them is through the retargeting of existing funding. 8.67 Initiating a shift through government funding instruments: The government has recently introduced incentives for private financing of R&D through the establishment of NIF and NSF discussed earlier. These funds provide opportunities for public-private partnership in R&D by providing up to 50 percent of R&D project financing on a competitive basis. In the case of an applied research project, NIF could finance up to 50 percent of R&D expenses (at most EUR250,000) over a period of three years. 8.68 The sizes of these funds would, however, need to be increased to have an impact on R&D and innovation and the government would be well-advised to reallocate part of the current institutional funding to these competitive funds. NSF still has insufficient volume to make a true impact on university research. A national target with appropriate incentives would need to be set to increase the level of competitive funding to about 30 percent of total university research expenditure. The purpose of this would be not so much to raise the volume of research, but rather to raise its quality and hence impact by increasing competition and thereby directing resources to high-performing units. 8.69 The establishment of NIF has been a significant step forward in boosting innovation in Bulgarian enterprises but it needs to be developed further. As in the case of NSF, the funding volume of NIF would need to be increased for it to have an impact. Also, in order to ensure that the funds are properly spent, it would be important to strengthen the capacities to manage these funds. Professional assessment, selection, monitoring and follow-up of R&D and innovation projects is of crucial importance. Further, NIF planning would need to be strengthened. There is a need for broader strategic programming than exists today to respond to the key industrial needs. The National Technology Programs of Tekes in Finland166 provide one example of such programming, which might be useful as a successful example when NIF is developed further. The promotion of public-private partnerships in R&D can be expected to

166

For more information, see www.tekes.fi.

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enhance the chances of commercialization of research results, which is a problem in Bulgaria. Industry involvement is likely to steer the R&D process in the direction of serving the business interests. 8.70 Additional innovation funding instruments to complement R&D grants could also be experimented with. NIF is still young and the available set of funding instruments limited. The funding instruments that could increase the chances of proper follow-up and commercialization include guarantee schemes/collaterals, or equity loans. These instruments should be designed in a way that would encourage collaboration between large and small companies, as well as between universities and industry. D. Opportunities Provided by EU Research Programs and Grants

8.71 Research, innovation and competitiveness are high on EU’s agenda. The EU grant funds, both research and structural, provide a unique opportunity for Bulgaria to reform and develop its R&D and innovation system. Bulgaria should take advantage of these. 8.72 EU Research Programs: At the EU level, the R&D allocations have been significantly increased. The seventh Framework Program for R&D (FP7) for the period 2007-2013 has a budget of over EUR50 billion, which is almost double the earlier program (see Table 8.5). FP7 has also a renewed structure, including competitive basic research funding, increased international academic-industry exchange of scientists and researchers, and building of research capacities in member states and at the level of EU, and an increased collaborative research component. Bulgaria has participated in the prior programs, and should continue doing so. 8.73 In 2004, about six percent Table 8.5: Budget of the EU seventh Framework Program (EUR6 million) of the total R&D for Research, 2007-2013 EUR54,587 million expenditure in Bulgaria was financed FP7 Specific Programs Cooperation–Collaborative Research EUR32,292 million through different EU programs. Though EUR7,460 million relatively low, EU funding plays an Ideas–Frontier Research 167 People–Marie Curie Actions EUR4,727 million important role in Bulgaria. If salaries EUR4,291 million and infrastructure support are excluded Capacities–Research Capacity + JRC non-nuclear research EUR1,751 million and only research projects and results + Euratom–nuclear fusion and fission EUR4,061 million are taken into account, EU research In + Euratom–nuclear fusion and fission EUR4,061 million financing might have exceeded the government R&D funding, given that the bulk of government funding goes to cover current costs. 8.74 EU grant funds: EU grant funds should be harnessed to advance Bulgaria’s R&D and innovation agenda. The country’s National Strategic Reference Framework (NSRF) is operationalized through six thematic Operational Programs (OP), of which three are linked to R&D and innovation: the OPs for human resource development; regional development; and for the development of competitiveness. Through these OPS, about six percent of all structural funds available to Bulgaria are proposed to be allocated to R&D and innovation. In comparison, during the 2000-2006 program period Objective 1 regions invested up to 15 percent of their grant funds into R&D and innovation, and Objective 2 regions up to 43 percent.168 Most EU8 countries allocated 2-10 percent. Since the emphasis in the current program period is on R&D and innovation, these shares can be expected to increase.

167 168

EC (2006) ERAWATCH Research Inventory Report: Bulgaria.

Objective 1 promotes development and structural adjustment of regions, whose development is lagging behind— that is, average per capita GDP is less than 75 percent of the EU average. Objective 2 supports economic and social conversion of regions in structural difficulties, but other than those eligible for Objective 1.

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8.75 The OP for human resource development covers the proposed allocation of available European Social Funds, and treats R&D and innovation as a horizontal policy, which is supported in each priority area. These include labor market policy (flexibility, innovative joint actions, start-ups), and education policy (community initiatives in education and training to promote collaboration between education institutes and the public, and quality of service delivery, ICT use, business-education system collaboration, mechanisms to foster international collaboration in research, loan instruments to facilitate research projects). The OP for regional development, which covers all development topics from the regional perspective, focuses primarily on infrastructure objectives but also covers R&D and innovation. About 30 percent of its budget is to be devoted to the Lisbon priority entitled “Establishing European Area of Research and Innovation”. The OP for competitiveness is the main vehicle for direct support to R&D and innovation, and several measures are proposed in that area. The program proposes to provide financial resources to implement the goals of the National Innovation Strategy, and shift Bulgaria towards a knowledge-based economy. This is to be done through: (i) promotion of R&D activities and commercialization of innovations in enterprises (for example, through provision of equity capital); (ii) protection of the intellectual property rights in Bulgarian enterprises and research institutions; and (iii) development of pro-innovative environment supporting enterprises. In total, about BGN155 million is to be allocated to these objectives. In addition, under the OP, cluster development activities are proposed to be launched, which can also be expected to have an impact on R&D and innovation. 8.76 All these proposed measures are highly relevant and much needed. A recently published strategic evaluation169 of structural funds in Bulgaria suggests the following actions to maximize the impact of innovation and knowledge interventions: (i) facilitate project preparation capacity for example through public-private partnerships, and targeted vouchers; and (ii) define clearly the innovation actions, and establish a proper process of monitoring them. Above all, with the simultaneous introduction of many new instruments and structures, attention should be paid to (i) competent management of resources, and whether they adequately respond to needs of industries, and (ii) whether they support structural change and economic progress of the country in the long run.

EC (2006c) Strategic Evaluation of Innovation and the Knowledge-based Economy in relation to the Structural and Cohesion Funds for the Programming Period 2007-2013, Bulgaria. .

169

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IV.

HUMAN RESOURCES AND R&D AND INNOVATION A. Availability of Researchers

8.77 Availability of well-trained researchers, scientists, and engineers is critical for innovation but, as highlighted by the benchmarking at the beginning of this chapter, this is an area, where Bulgaria is trailing behind. Having funds for R&D investments alone is not Figure 8.10: Employment of Researchers by Sector, 2004 sufficient. As in other countries of Central and Eastern Europe, the deep social and economic Higher transformation of Bulgaria during education the 1990s led to a significant 28% shrinking and restructuring of the Bulgarian scientific system. Lifting restrictions on emigration resulted Government in a substantial brain drain from Private sector 59% Bulgaria towards the US, Germany, 13% the United Kingdom, and Scandinavian countries. Scientific activities and employment dropped significantly. During 1995-2004, the total number of researchers in Bulgaria dropped by about 30 Source: Eurosta) percent, even though the share of basic research funding increased over the same period. Most significant drop was experienced in the higher education sector, where the number of researchers decreased by more than 50 percent (from 4,905 to 2,362). 8.78 The share of science and technology graduates in Bulgaria, at 8.5 per 1,000 people (in 2004), is significantly below the EU25 average of 12.6, Ireland at 23 and the United Kingdom at 18.170 Among the EU8 countries, only Hungary (5.1), and the Czech Republic (7.4) are below that. Also, the number of doctoral degree holders in science and engineering is small in Bulgaria, and fewer than half of those studying for a doctoral degree ever defend a dissertation and complete the degree. 8.79 Further, the bulk of scientists—59 percent in 2004—is employed by government research institutes, above all BAS (see Figure 8.10). About 28 percent were in universities in 2004. The share of scientists in Bulgarian enterprises is lowest among the EU countries: only 13 percent of them were employed by industry in 2004 compared to the EU15 average of 55 percent. As highlighted in the benchmarking, the low number of researchers involved in R&D, and the declining pipeline of scientists in light of a decline in the number of science enrolment in universities are concerns in the case of Bulgaria. 8.80 Apprenticeship system could be an effective way to encourage research work in enterprises, particularly in SMEs. Currently, the industrial training periods tend to be a formality instead of being a properly planned and implemented learning process. It also appears that the law on scientific titles and degrees of 1972 should be revised to enhance flexibility and improve career opportunities for young scientists. For example, the current law defines approval procedures for professorships, which are long, burdensome, and do not encourage new scientific directions or multi-disciplinary approaches.

170

Eurostat, 2005.

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8.81 Overall, the issue of availability of researchers and scientists is closely tied to the Bulgarian university system. The reforms recommended for the university system in the previous chapter (Chapter 7) would help to address some of the R&D needs as well. B. Developing Links with the International Research Community

8.82 Although the best performing research institutions of BAS and Bulgarian universities have already developed international connections, the majority of Bulgarian research units are still operating largely on a domestic basis. Science does not recognize borders. Internationalization is thus an essential element in improving the quality and relevance of research. There are many areas of research, such as climate change and other environmental issues, mapping genomic structures and functions, designing telecom and traffic instrumentation standards, where international collaboration is the only avenue for successful research. 8.83 Bulgaria could take the advantage of various EU programs to develop and further strengthen links with the international research community. Key instruments would be the EU Research Framework programs and other international co-operation mechanisms, such as Eureka. To this end, there would be a need to raise the general awareness of available EU instruments and their funding possibilities among the Bulgarian research institutions. To ensure a reasonable success in gaining funding, some investment in the preparation of competitive proposals would be required, though. 8.84 In addition, there is European collaboration in a number of science fields where research facilities typically cost billions of euros. The following separate organizations have been created: (i) in particle physics the European Organization for Nuclear Research (CERN); (ii) in space research the European Space Agency (ESA); (iii) in astronomy the European Southern Observatory (ESO); (iv) in molecular biology the European Molecular Biology Laboratory (EMBL); and (v) in synchrotron radiation the European Synchrotron Radiation Facility (ESRF). While Bulgaria has been a member of CERN since 1999, it may want to consider joining some of the other organizations as well in the future. V. INTELLECTUAL PROPERTY RIGHTS AND INNOVATION A. Legislative Framework

8.85 The Bulgarian legislative framework for ensuring the protection of intellectual properties is reasonably comprehensive, up-to-date, and consistent with the EU directives. In 2000, as the Bulgarian intellectual property rights regime was renewed, the Government ratified treaties of the World Organization of Intellectual Property, covering among other things software and the rights of artists. In 2002, Bulgaria joined the European Patent Convention, and obtained an observer status in the Administrative Council of the European Patent Organization. During the same year further legislative changes were introduced to address latest developments in ICT, digital technologies, and internet. Further, new legislation to provide better protection on the development of pharmaceutical products was adopted in 2003. Bulgaria has also been part of the Innovation Relay Center (IRC) Network since 1997.

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8.86 Ineffective enforcement of the intellectual property rights Figure 8.11: To what degree do you agree that the legal system regime is a concern, however, and will uphold contract and property rights? considered to be a barrier to 30 foreign investment and 25 innovation. This was also highlighted as an issue to address 20 by the benchmarking exercise. A 15 large scale EBRD-World Bank 10 business environment and enterprise performance survey 5 (BEEPS) of 2005 suggests that 0 problems remain with the fully agree agree in tend to tend to disagree in strongly enforcement of contract and most cases agree disagree most cases disagree property rights in general, with only half of the surveyed firms considering the current legal system upholding those rights (see Figure 8.11). In addition to strengthening enforcement, increased emphasis should also be put on raising general awareness about the importance of the protection of intellectual property rights. B. Patents and Scientific Outputs
percent (%)

8.87 In general, the Bulgarian culture is positive towards inventors—their social status has always been high, although commercial benefits to inventors have been rare. According to the Bulgarian Union of Inventors, there are about 10,000 inventors in Bulgaria. However, the economic impact of Bulgarian patenting, both domestic and international, is limited compared to the impact of absorbed foreign technologies through imported investment goods and/or foreign direct investment.171 8.88 In terms of the number of patent applications and the number of patents issued by the two major international patent offices—the European Patent Office (EPO) and the United States Patent and Trade Mark Office (USPTO)—Bulgaria lags behind EU8 countries. Following the 1997 crisis, the patenting activity in Bulgaria began to recover in 2001 and has remained relatively stable for the last five years. During 2001-2004, 18 patents were granted by USPTO to Bulgarian applicants (twice the number granted in 1997-2000), and Bulgarian USPTO patent applications returned to the two-digit zone and marked a historical record of 105 in 2004 (compared to the average of 40 per year in the 1970s and 1980s). Similarly, the number of Bulgarian EPO patent applications increased from three in 2002 to 16 in 2004. Yet Bulgaria clearly lags behind the average EU8 level in high-tech patenting. Most of the patenting activity is generated by the government research institutions and universities. 8.89 The number of scientific publications per million inhabitants is also low in Bulgaria at 182 compared to the EU15 average of 673 (see Figure 8.12). Further, the numbers fell during 1996-2002 Slovakia was the only other European country that experienced a decline during the period.

171

ARC Fund 2006.

155

Figure 8.12: Number of Scientific Publications per million Inhabitants, 2002
0 Switzerland Sweden Israel Denmark Finland Netherlands Island UK Norway Belgium Austria USA Germany Slovenia France EU15 Ireland Spain Japan Italy Greece Czech Rep Estonia Hungary Portugal Slovak Rep Poland Cyprus Luxembourg Bulgaria Lithuania Latvia Turkey Romania Malta 500 1000 1500 2000 1757 1598 1334 1332 1309 1093 1065 1021 972 929 871 774 731 726 712 673 647 567 550 545 458 415 379 374 339 291 266 209 196 182 164 142 103 84 79

Source: Key Figures 2003-2004, European Commission

VI.

ROLE OF FDI IN PROMOTING R&D AND INNOVATION

8.90 Large foreign direct investments (FDI) in Bulgaria provide an opportunity for importing foreign knowledge and technologies, and may have a positive effect on domestic R&D intensity. FDI stock in Bulgaria increased more than three-fold between 2000 and 2005 in absolute terms, and more than doubled relative to the country’s GDP (see Figure 8.13). The biggest recipients of FDI were the services sectors, such as financial intermediation, communication, trade, real estate, and business services. These sectors are usually the largest users of information and communication technology (ICT), and hence contribute to increased technology diffusion in the country, and increased demand for high-skilled labor. In industry, FDI was concentrated in non-ICT using sectors. Construction attracted most FDI, while FDI in manufacturing was concentrated mainly in basic metals and metal products; coke, refined petroleum products, and nuclear fuel; food, beverages, and tobacco; other non-metal mineral products; and, textiles and textile products. While investments in ICT have been found to have positive effect on growth and productivity, it is difficult to estimate their impact on the capacity of firms to innovate and to increase the level of domestic R&D investment. 8.91 Data limitations do not allow analysis of the size and scope of foreign R&D stock in Bulgaria, but the experience of some OECD countries suggests that the share of R&D funded and performed by

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foreign-owned companies is increasing172. This has contributed to increased R&D of domestic firms especially in countries where domestic policies create environment conducive to innovation—liberal product market regulation, Figure 8.13: Inward FDI Stock protection of intellectual property rights, and education and labor Figure 7.13: Inward FDI Stock market policies that improve the 10000 50 in million Euro availability of skilled labor force.
9000 %of GDP (RHS) 45 40 35 30

VII.

CONCLUSION AND POLICY RECOMMENDATIONS

8000 7000 6000

8.92 Despite major changes in 5000 25 the Bulgarian R&D and innovation 4000 20 system in the last decade, 3000 15 assessments and rankings of innovation performance across 2000 10 countries suggest that Bulgaria has 1000 5 started to fall farther behind the 0 0 European and world leaders in 2000 2001 2002 2003 2004 2005 innovation. Unless decisive action is taken to rethink these systems in Bulgaria, this gap may well continue to widen. This chapter has tried to do some of that rethinking, and has come up with a number of reform options that the Government may wish to consider. The options are grouped into those that should get priority attention (“short-run”) and those that are of a more mediumterm nature. 8.93 Five areas would need attention in the short term: • Increase the share of competitive R&D funding: Bulgarian R&D funding, above all by industry, remains small and is below the targets set by the Lisbon agenda. Over time it would need to be increased aiming at a better balance between public and private funding as well as between institutional and competitive funding. Bulgaria has recently established instruments for competitive R&D funding (such as NIF and NSF), but their share of budget allocations is still small and dwarfed by funding that maintains existing institutions (e.g. BAS and NCAS). Competitive funding has a number of advantages. It allows funds to be allocated directly to new research areas, rather than having to achieve desired changes through existing research programs of research institutions. It is likely to identify the best research proposals, and it rewards active teams, who are likely to use the additional resources effectively. Also, increasing the share of competitive funding would allow increased industry engagement in the R&D process. Except for the funding of big science facilities, all international funding is competitive, so why not establish and follow that practice at the national level. Competitive funding is better executed by independent agencies than by ministries. Strategic technology programs could also be planned and executed for key industries by pulling together the stakeholders from both industry and research. The strategic planning and direction of such programs should be in the hands of industry, which best knows the challenges and opportunities it is facing and for whom success may be a matter of survival.
172

Jaumotte and Pain, Innovation in the Business Sector, Economics Department Working Paper No. 459, OECD, Dec-02-2005.

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These programs could then be partly funded through the competitive processes. They could also be linked with the EU technology platform programs, which aim to provide industries with the best information about new enabling and generic technologies. • Encourage public-private partnerships in R&D: Public-private partnerships in R&D would help ensure that R&D carried out is relevant to business, and hence likely to have an economic impact through increased chances for commercialization. The government could promote public-private partnerships by making teaming up with industry increasingly a requirement for public R&D funding—both for competitively allocated and for institutional funding. R&D projects between companies, and universities and research centers would be particularly important for SMEs that can ill-afford research departments and facilities of their own. Also, to ensure that R&D results yield economic benefits, applied research projects should routinely have corporate partners. Re-evaluate the role of the Bulgarian Academy of Science: All Bulgarian research institutes would benefit from a functional and impact evaluation, but the Bulgarian Academy of Science, because of its size and potential, needs it most urgently. The size of BAS, with its 87 research centers, is massive—one of the largest in Europe—and does not appear particularly well justified in the current economic and industrial context of Bulgaria. It also suggests that there is room for improving efficiency and effectiveness of government resources. Some of the equipment and facilities in these entities is obsolete and not conducive to contemporary research methods, and some units are doing research in areas and sectors, which are no longer viable. Thus, a significant, but careful, reorientation of BAS is recommended, along with a concerted effort to shift the research conducted by BAS increasingly towards applied R&D, in order to respond to the needs of clients, including industrial corporations. By a carefully planned and executed reform process, BAS could become more competitive, the quality of its research could be raised to an even higher level and its impact on the Bulgarian economy and society could increase. In addition to the proposed re-evaluation of the role of BAS, efficiency gains might be achieved also by reviewing the roles and responsibilities of NCAS and other existing research entities under line ministries, which spend close to one-third of the government R&D budget. The role of NCAS could be important given Bulgaria’s agro-industrial potential. Introduce systematic evaluation of R&D policies, institutions, and programs: There is an urgent need to establish systematic, regular and independent evaluations of R&D policies, institutions, and programs in order to assess their functioning and impact, and to identify the needed adjustments and reforms. So far no evaluations seem to have been carried out. Also, regular periodic evaluations would need to be carried out of all funding mechanisms (such as NIF and NSF), to assess their instruments, operational methods, impact, and funding levels. Rethink the institutional R&D set-up. To keep up with the world and to become world-class in some niches, Bulgaria would be well-advised to rethink its institutional R&D set-up. The current dual structure—two parallel strategies, two responsible ministries, and two coordinating councils—raises concerns, since research and innovation are closely related, and links between them need to be strong. To promote horizontal coordination, the authorities may want to consider shifting to a more unified structure and elevating the coordination to a higher level of Government to give the issues greater prominence. R&D and innovation issues and activities are connected to the country’s economic performance and will continue to grow in importance as Bulgaria’s economy catches up with other EU economies, and approaches the technological frontier in an increasing number of sectors.

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8.94

In the medium term, the following issues would need to be considered: • Enhance industry-financed R&D: Enhancing industry investments in R&D offers the best way to improve the performance and economic impact of the Bulgarian R&D. Currently, R&D funding is unbalanced, with the government financing about two-thirds of all R&D investments. This is exactly the reverse of the EU15 average, if one group together direct funding of R&D from the budget with the indirect funding going through the universities. While Bulgaria’s pattern of investment in R&D may be consistent with its stage in the transition process and level of income, to facilitate the country’s shift to the next level of development and to raise productivity, increased private sector R&D would be called for over time. The challenge is how to get the Bulgarian industry to find it in its interest to raise its R&D expenditures. Given Bulgaria’s current industrial structure, a rapid increase in industry financed R&D is highly unlikely. It will take time. The government can best promote industry-financed R&D by providing an enabling environment that encourages it to increase over time. As discussed in previous chapters, this will include above all ensuring that the regulatory environment promotes competition and does not prevent entry and exit of firms, including those from abroad, since contested markets force firms to innovate and raise their productivity in order to stay afloat. There must be effective enforcement of intellectual property rights, and access to input markets such as capital, materials, and information needs to be unhindered. Finally, labor markets need to be flexible so that people can easily move from lower to higher productivity activities. • Encourage university research: The reform options presented in the previous Chapter for the tertiary education system would not only improve education delivery, but also facilitate R&D. In addition, university research could be boosted by linking the educational curricula with research activities. This would help to introduce students to research methods, and increase their interest and competence in professional work after graduation. Also, thesis projects addressing development needs of companies should be actively encouraged. In addition to promoting a shift to more applied research and practical problem-solving, this would provide a recruitment channel for students and companies. As was discussed in Chapters 4-7, strengthening the links between the higher education system and labor markets is a priority. Introduce new competitive funding instruments: A portfolio of further competitive funding instruments best suited for particular needs could be developed over time. Universities, research institutes, and perhaps SMEs would benefit primarily from grants (such as NIF and NSF), perhaps in the form of vouchers, larger corporations may benefit from risk loans, and high technology companies may need risk and profit-sharing venture capital. However, if and when this is done, caveats presented under the recommendation to “enhance industryfinanced R&D” should be kept in mind.

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9. BUDGET AND CAPACITY IMPLICATIONS
9.1 All the reform options suggested in this report could be carried out within Bulgaria’s currently projected budget envelopes for 2007-09. Investment costs could largely be covered by various grant funds available from EU. This would require some co-financing from Bulgaria’s budget, but the total amount might be on the order of EUR15-20 million, which is roughly 0.06-0.08 percent of GDP. Even these amounts can likely be fitted into preliminary budget allocations for current Operational Programs (OP), since they are all compatible with the OP goals. Additional current running costs of the options taken together are miniscule compared to the potential savings. This leaves room for a good portion of savings to be kept by the ministries concerned to give them incentive to carry out the reforms rapidly and efficiently. The savings could be redeployed for other reform and quality enhancement measures. This implies the need for leadership to make the case for the proposed reforms and build consensus. Since Bulgarian leaders have already been thinking about and planning a number of these reforms, this should be feasible. This report has tried to estimate some of the pay-offs to the reforms, which can be substantial, and thus help with the process of setting priorities. I. COSTS AND BENEFITS OF THE PROPOSED REFORMS A. Product Market Regulation

9.2 Costs of improvements in product market regulation (Chapter 3) were not calculated. However, they are all mostly improvements in the way the relevant ministries and agencies think about the problems, and implement the regulations. These can be handled through shifts in focus and budget allocations, but within existing budget envelopes. There may even be some savings, for example, through reductions in permits and licenses, since these require personnel for enforcement, who may no longer be needed. Pay-offs to the proposed reforms are potentially substantial. By one set of estimates—assuming Bulgaria would catch up with some of the best performers in the OECD—the ratio of private investment to GDP could increase by up to two percentage points of GDP, and help raise labor productivity growth by 1.5-2 percent per year. This would imply higher real earnings, as well as more jobs for the Bulgarian work force. B. Improving the Functioning of Labor Markets

9.3 Proposed reform actions in the labor markets area (see Chapter 4) that would have any fiscal implications have largely to do with ALMP activities. However, these can easily be expanded as the direct employment program is cut back, and accommodated within the existing budget envelope. C. Governance and Finance Reforms in Primary and General Secondary Education

9.4 The already on-going reforms in the primary and secondary education are estimated to be selffinanced through efficiency gains. Chapter 5 (see Figure 5.8) presents estimates that suggest that cost savings from the reforms would be on the order of 0.1 percent of GDP in the first year, rising to the 0.3 percent of GDP range over the next few years. These funds can be re-invested into quality improvements in that sector, including teacher training, improvements in facilities and teaching aids, reducing drop-out and repetition rates, and higher teacher salaries.

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D.

VET and Tertiary Education

9.5 The thirteen reform options in VET and tertiary education presented in Chapters 6 and 7 form a comprehensive reform program around four themes: (i) increasing access to vocational and tertiary education; (ii) improving the internal efficiency of the system; (iii) strengthening the capacity of the system: and (iv) improving the quality and external efficiency of the system. Figure 9.1 presents the four themes and the thirteen reform measures. The measures/options are numbered according to their sequence in Table 9.1, which provides a summary of the proposed investments, and anticipated annual savings and/or projected annual current expenditures. The first four reform options in Table 9.1 refer to the VET system. The rest refer to the tertiary education system and are listed in rough order of priority, ranging from short to medium term actions (see Chapters 6 and 7 in this volume and/or Table 9.1 of the Overview volume) Further details of approximate costs of the reform options are presented in Tables 9.2-9.8. Some of the thirteen options have no financial implications or their financial implications cannot be determined at this point. It is important to emphasize that these are rough estimates, and are presented here not as exact numbers but rather as “orders of magnitude”. They do not include many expenses that may happen, but are not now known. However, the big picture is not likely to change. The investments are presented in euros because they could be mostly covered by EU funds under the appropriate OP. They are assumed to be carried out between mid-2007 and mid-2010. Savings and/or recurrent expenditures are calculated in BGN and are assumed to start in 2011. Although they would in principle continue indefinitely into the future, they are likely to be important for only a few years. 9.6 Taken together, net savings (savings minus projected current expenditures) of the proposed reforms—even under their “minimal” variant—are expected to pay for the investments in well under two years. Even if the estimates of investments, additional costs and savings are off by a factor of two, the rate of return of the proposed reform package is still high. Figure 9.1: Reforms Themes in Vocational and Tertiary Education

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Table 9.1: Rough Estimated Costs (in 2007-2010) and Projected Annual Savings and Additional Operating Costs of the Proposed VET and Tertiary Education Reform Program
Proposed Reforms Proposed Investment (Euros) -6,650,000 42,700.000 500,000 -360,000 0 0 100,000 Anticipated Annual Savings (BGN) Min Average Max -12,960,000 3,750,000 0 -0 0 0 50,000,000 0 0 0 100,000,000 -25,920,000 7,500,000 0 --38,880,000 11.250,000 0 -0 0 0 150,000,000 Projected Annual Expenditures (BGN) -0 0 100,000 -150,000 0 o 0

1. Introduce student financing to VET 2. Rationalize vocational secondary schools (Table 9.2) 3. Establish occupationallyoriented regional colleges (Table 9.3) 4. Establish a National Qualifications Framework and Authority 5. Base tertiary institution funding on actual student enrolments 6. Strengthen university governance (Table 9.4) 7. Strengthen links with labor markets 8. Institute the Matura as access examination 9. Increase university tuition fees and establish a student loan scheme (Table 9.5) 10. Introduce a performancebased component to tertiary institution funding (Table 9.6) 11. Consolidate universities and tertiary institutions (Table 9.7) 12. Strengthen evaluation and accreditation of universities and their programs 13. Continued teacher and faculty training (Table 9.8) Total

100,000

30,000,000

30,000,000

30,000,000

0

0 0

30,600,000 0

67,800,000 0

105,000,000 0

0 0

500,000

0

0

0

200,000

50,910,000

127,300.000

231,220,000

335,130,000

450,000

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VET

9.7 Introduce per student financing to VET: To provide incentives for cost control, it was recommended in Chapter 6 that as the first step of VET reform, the ongoing governance and finance reforms in primary and general secondary would be extended to VET. Since further analysis on this would be required, no cost and savings estimates were prepared. 9.8 Start vocational education only after the completion of compulsory education, and develop curricula for VET that strike a balance between vocational and general studies: The rough estimated cost of delaying the introduction of VET until the completion of compulsory education, which would imply closing the vocational schools currently offering the early programs, and developing for the remaining VET schools curricula that strikes a balance between vocational and general studies would be about €6.65 million in 2007-2010. Projected annual savings from increasing the student-teacher ratio— by closing some of the existing vocational schools, keeping students in compulsory education, and expanding the size of the existing general secondary and remaining vocational schools—from its present level of 10:1 to 15:1 are estimated to reach on average BGN27 million. They would range from a minimum of BGN12.96 million to a maximum of BGN38.88 million, depending on the reduction in the net number of teachers (see Table 9.2). The shift in the allocation of resources would be expected to result in a more cost-effective operation of vocational secondary schools, with potential cost reduction of about 10-20 percent per student. Table 9.2: Rough Estimated Investment Costs (2007-10) and Savings (starting in 2011) associated with the Rationalization of Vocational Secondary Schools
Item Investment in the Period 2007-2010 (Euros): Identify, develop and test 10 key new joint course streams Procure equipment for new curricula for 250 schools Training of Teachers Total Investment Cost Projected Annual Operational Savings (BGN) starting in 2011: Scenario 1: 30 percent reduction in number of teachers Scenario 2: 10 percent reduction in number of teachers 100,000 6,250,000 300,000 6,650,000 38,880,000 12,960,000

9.9 Establish Occupationally-Oriented Regional Colleges: The rough estimated cost of merging select existing vocational schools and colleges into seven occupationally-oriented regional colleges would be about €43 million for the period 2007-2010 (see Table 9.3), and is based on the following assumptions: (i) 15 sq. meter/student for classroom, laboratory and workshop space; (ii) the occupancy rate of these spaces about 65 percent; and (iii) the average refurbishing cost of €75/sq.meter. It is assumed that these colleges would occupy already existing, but refurbished educational buildings. The assumed number of the proposed regional colleges (7) is arbitrary and would be adjusted to reflect the facts on the ground at the time of implementation, but their size (5000 or more students) is based on international experience. 9.10 The reform of higher education for example in Ireland and Ontario, Canada in the 1970s and 1980s show that, once established, these institutions can absorb 30-40 percent of the tertiary education students. Most of these students would otherwise have gone to the regular universities. The expenditures per student in the technical colleges average about 65-75 percent of the corresponding expenditures in the university sector. In Ireland and Canada, teachers in these institutions are not required to have a Ph.D.—a Masters degree with relevant work experience is usually sufficient—and as a result the cost of teaching is

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lower than in the university sector. Further savings in public expenditures can also be achieved once the quality and relevance of the new programs are ascertained and accepted by employers, because the graduates can have access to employment after 2-3 years of education, instead of the 4-5 years (at least) taken by a typical university student to graduate. To be conservative, the initial savings from this reform option were assumed to be in the range of 5-15 percent of current average student unit costs, and it was assumed that about 25,000 students currently heading for universities would, instead, choose to attend a technical college. It is also assumed that the teachers needed for the new colleges would come from the existing pool of teachers, and/or fresh recruits where necessary, but at no additional cost.

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Table 9.3: Rough Estimates of Investment Costs and Annual Operational Savings
Item Investment in the Period 2007 to 2010 ( Euros): Refurbishing Facilities for 7 Regional Institutions of 5000 students each Equipment and ICT Infrastructure Other Total Investment Cost Projected Annual Operational Savings starting in 2011 (BGN) : 10% reduction in expenditures per student in new tertiary institutions (25,000 students) Net Projected Annual Operational Savings 28,000,000 14,000,000 700,000 42,700,000 7,500,000 7,500,000

9.11 Establish a National Qualifications Framework and Authority to strengthen lifelong learning: The investment cost of setting up the framework and the authority are assumed to be on the order of Euros 500,000. The running costs are assumed to be around BGN 100,000 annually. Tertiary Education 9.12 Base tertiary institution funding on actual student enrolments: Basing the funding on actual student enrolments would be expected to generate savings, and have negligible costs. However, further analysis would be needed to determine the fiscal impact. 9.13 Strengthen university governance: Chapter 7 proposed a strengthened governance framework for universities. The cost of establishing the proposed governance structure would be roughly €380,000 for the period 2007-2010 (see Table 9.4). This assumes that the universities have been consolidated to 25 in the first five years, and that each Board of Trustees will have eight external private sector members, each devoting about 10 days per year. Once established, the expected annual operating budget for these Boards of Trustees is roughly estimated at BGN150,000 starting in 2011. Table 9.4: Rough Estimated Cost of Reform of the University Governance Structure
Item Investment in the Period 2007-2010 (Euros): Governance Coordinator and support staff ICT Infrastructure Board induction training, plus cost of Boards of Trustees and Boards of Governors Total Investment Cost Projected Annual Operating Costs 2011 (BGN) : Governance Coordinator and support staff Boards of Trustees and Boards of Governors Annual Operating Budget (BGN)

60,000 100,000 220,000 380,000 30,000 120,000 150,000

9.14 Strengthen links with labor markets: The proposal would be to strengthen links with employers by establishing Program Advisory Committees (PACs) for all university programs. PACs would include employer representatives in sectors such as engineering, technology, business, or medicine, 165

following the practice in other EU countries. The mandate of PACs would be to validate market intelligence about the existing and future level of demand for graduates of various disciplines, and to provide advice on the knowledge and skills likely to be needed by future employers. It should be possible to accommodate the cost of this process within the existing university budgets. 9.15 Institute the Matura as access examination: The proposed reform of instituting the Matura exam as a basis for entrance into the university would be consistent with the goal of facilitating access to tertiary education, and increasing participation rates. No cost calculations were carried out, since the authorities already have plans to pilot the examination, and based on that annual costs of the nation-wide examination and its management could be estimated. 9.16 Increase university tuition fees, establish a student loan scheme, and review the scholarship programs: To increase the accountability of universities to students and to reduce the burden on the state budget, it was proposed in Chapter 7 that tuition fees be increased in practice, and a student loan scheme be established in parallel to ensure access will not be adversely affected. A rough estimate of additional revenues from this measure would be about BGN100 million. The assumptions made in calculating this amount are: (i) that the student portion of tuition costs would be 30 percent of the average per student cost, or BGN900 per student; (ii) that at present, students pay only half of that amount—that is, about BGN450; and (iii) that there are roughly 220,000 students attending the university. The student loan scheme would, therefore, fund the extra BGN450 per student, which comes to roughly BGN100 million (see Table 9.5). 9.17 The loans could be distributed according to a variety of criteria that would need to be decided. But if access to higher education is to be maximized the criteria would need to include some sort of means-testing, with the poorest students obtaining larger amounts than the students whose parents’ income is higher. It may also be decided that the level of tuition to be paid should be lower than 30 percent of the average cost. Further, the management of the student loan scheme would have a cost (presumably it would be put out to bid to commercial banks that already have the infrastructure to administer loans), as would the interest rate subsidy, if any, and the risk of non-repayment. However, until the broad parameters of the scheme have been settled, they cannot be estimated. For all these reasons, the ultimate savings from a student loan scheme are uncertain, and a range of BGN50 million to BGN150 million was assumed, representing low and high variants, respectively. Nevertheless, regardless of the criteria and the size of the scheme, there could be substantial savings from shifting the burden of tertiary education financing partly onto students and away from the public purse, in addition to improved accountability of universities to its clients. Table 9.5: Rough Estimated Costs and Revenues (Savings) from Increased Tuition Fees and the Student Loan Scheme
Item Investment in the Period 2007-2010 (Euros): Student Loan Expert and Committee to decide on recommended approach Total Investment Projected Annual Savings from Student Loan Scheme starting in 2011 (BGN) : Additional revenues collected from students

100,000 100,000 100,000,000

9.18 Introduce a performance-based component to tertiary institution funding: To provide incentives for universities to improve quality and efficiency of resource utilization, it was proposed in Chapter 7 that a performance-based component be introduced to university funding in the medium-term.

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The rough estimated cost of setting up the performance-based funding framework would be € 100,000. The projected annual savings would be accrued as a result of anticipated: (i) faster progression of students through the system; (ii) reduced program and teacher contact hours; (iii) improved operational efficiency, and increased student-teacher ratios. Assuming these led to savings of 2-5 percent of the annual budget, the annual savings would be BGN30 million (see Table 9.6). The fiscal impact of adjusting the current funding formula so that it is based on actual rather than enrolment targets is not calculated, owing to lack of data on enrolment targets used.

Table 9.6: Rough Estimated Costs and Savings from Introduction of Performancebased Funding
Item Investment in the Period 2007-2010 (Euros): Funding Expert and Committee to decide on the recommended approach Total Investment in Euros Projected Annual Savings starting in 2011 (BGN): Projected improvement in throughput or rate of graduation (2% of graduating class) Reduction in teaching hours by one contact hour per week/student Total Projected Annual Savings Cost/Saving 100,000 100,000 6,000,000 24,000,000 30,000,000

9.19 Consolidate universities and tertiary institutions: The consolidation of universities through mergers or clustering of existing institutions could produce substantial savings in the operational costs. For example, merging universities into 20-25 large comprehensive universities operating at a costeffective student faculty ratio of about 16:1 could reduce the size of the faculty by about 8,000 through retirement and other incentives. This would bring the total size of the university faculty down from 24,000 to a more sustainable level of about 16,000. Estimated reductions in the annual operating costs would vary from a conservative BGN31 million to an optimistic BGN105 million annually (see Table 9.7). Table 9.7: Estimated Operating Cost Reductions from University Consolidation
Projected Annual Savings starting in 2011 (BGN) Total Cost Scenario 1: Staff Reduction by 33%: Faculty Administrators Total Scenario 1 Scenario 2: Staff Reduction by 10%: Faculty Administrators Total Scenario 2 96,000,000 9,000,000 105,000,000 28,800,000 1,800,000 30,600,000

9.20 Strengthen evaluation and accreditation and quality assurance of universities and their programs: To improve the existing processes and standards of university accreditation it was proposed in Chapter 7 that the National Evaluation and Accreditation Agency (NEAA) would be strengthened. The proposed reforms could be accommodated within the existing budgets of NEAA or MES, since the reform concerns largely guiding principles and the process of program assessment and accreditation. 9.21 Continued teacher and faculty training: To ensure the quality of teaching, continued teacher and faculty training was proposed to be established. Training would be carried out by the newly 167

established Leadership and Faculty Development Institute (LFDI). The estimated cost of setting up the LFDI during 2007-2010 would be about €500,000. Subsequent annual operating budget is estimated at BGN200 00 (see Table 9.8). Table 9.8: Rough Estimated Cost of Continued Teacher and Faculty Training
Item Investment in the Period 2007-2010 (Euros): LFDI Director, managers, staff and consultants ICT Infrastructure Development of LFDI Programs/Courses Delivery and Evaluation of LFDI Training Sessions Total Investment Projected Annual Operating Costs starting in 2011 (BGN): LFDI Director , managers, staff and consultants LFDI Program Delivery Annual Budget (BGN)

150,000 200,000 50,000 100,000 500,000 100,000 100,000 200,00

E.

R&D

9.22 Bulgaria has a long way to go to reach the Lisbon target of having the public and private sector spend jointly three percent of GDP on R&D and innovation. The shortfall is particularly acute in the case of the private sector. The problem is that private sector expenditures in this area come out of a process of competition. They cannot be willed by the public sector. Chapter 8 considered what could reasonably be done to provide incentives for enterprises to increasingly invest in R&D. 9.23 Most of the actions proposed can be undertaken within the currently proposed budgets for R&D (these would grow slightly faster than projected GDP) with reallocations across activities. The only action that could cost more is funds that would match efforts by the private sector to innovate, but these must be proposed and driven by the private sector. This will take time, so there are no or minimal fiscal implications for the next few years. However, should the private sector come up with a pleasant surprise, the issue can easily be revisited. II. CONSISTENCY OF THE PROPOSED REFORMS WITH THE OPERATIONAL PROGRAMS

9.24 The proposed reforms in this report are directly linked to two of the OPs under the National Strategic Framework for 2007-2013. These programs are: (i) Development of the Competitiveness of the Bulgarian Economy, and (ii) Human Resources Development. While some of the proposed reforms are already included in the two OPs, others may be included subsequently or just reinforce the reforms envisaged in the OPs. 9.25 The Competitiveness OP is consistent with the reforms outlined in Chapter 8 aimed at creating incentives to firms to innovate and invest in R&D. The objective of the Competitiveness OP is to create business environment conducive to higher productivity and efficiency of production. Specifically, it aims at: (i) development of a knowledge-based economy and innovation activities; (ii) increasing efficiency of enterprises and promoting supportive business environment; (iii) providing financial resources for developing enterprises; (iv) strengthening the international market position of the Bulgarian economy; and (v) providing technical assistance. EUR1.2 million has been allocated to cover the activities in this OP over the period 2007-13, of which EUR988 million is from the European Regional Development Fund, and EUR247 million of the state budget.

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9.26 Out of the total amount, EUR156 million is allocated to activities aimed at developing a knowledge-based economy and innovation activities. These include support for establishment and commercialization of innovations in enterprises, protection of intellectual property rights, and investments in innovation infrastructure—technology transfer centers, technology incubators, technology platforms, and technology parks—or investment in equipment in research organizations. These activities are in line with the reforms proposed in Chapter 8 for enhancing industry-financed R&D through subsidies, grant schemes, and the encouragement of public-private partnerships. 9.27 The largest portion of the Competitiveness OP funding, EUR775 million, is allocated to efforts to modernize technologies and management of firms, reduce energy intensity, information and consultancy services to business, and business networking and clustering. These efforts are to focus on firms purchasing or introducing innovative technologies, and introducing international market standards. Special financial instruments for SMEs have also been envisaged under this OP, totaling EUR180 million. These instruments include guarantee funds, micro-loan funds, venture capital funds, and establishment and/or upgrade of existing business angels’ networks. 9.28 The Human Resources Development OP is mostly consistent with the policies proposed in Chapters 4-7 labor markets and education. The objective of the Human Resources Development OP is to improve the quality of life through enhancing human capital, achieving higher levels of employment, increasing productivity, and enhancing social inclusion. Specific objectives of this OP are: (i) promotion of sustainable employment and development of inclusive labor market; (ii) increasing productivity and adaptability of the employed persons; (iii) improving the quality of education and training and its alignment with labor market needs; (iv) better access and integration to education and training; (v) social inclusion; (vi) improving the efficiency of labor market institutions and social and healthcare services; (vii) transnational cooperation; and (viii) support for human resources OP management. EUR1.2 million has been allocated to finance the activities under this program over the period 2007-13, with EUR1.0 financed out of the European Social Fund, and EUR182 financed out of the state budget. 9.29 However, the impact of these activities would be further strengthened, if the proposed activities were extended to cover policies and reforms suggested in Chapter 4. Close to 60 percent of the financing is currently slated to direct at activities promoting labor market development, institutions, and outcomes. It would be a pity if the effectiveness of those funds was compromised by the omission of some key reforms. The rest of the financing of the Human Resources Development OP is allocated to activities aimed at improving the quality and access to education and training. 9.30 Also, to improve the efficiency and effectiveness of the education system and to align it with the requirements of a knowledge-based economy, the activities envisaged under this OP could be complemented with education reforms suggested in this report. These include the extension of per student financing to all levels of education, consolidation of secondary, vocational, and tertiary education institutions; reforms in the governance of these institutions; and establishment of occupationally-oriented regional colleges. These reforms would help further improve the access to education, improve the quality, relevance, and external and internal efficiency of the education system in Bulgaria. III. IMPLEMENTATION CAPACITY

9.31 Much of the success of the reforms proposed in this report will depend on the capacity of Bulgaria’s institutions. Many of the reforms are complicated, and have to deal with vested interests. No matter how high the eventual pay-off to the proposed reforms might be, the short-term losers from the reforms are likely to resist them. Hence one needs leadership to explain the value of reforms and reduce resistance, and determined follow-through on implementation. That will involve many institutions and many individuals at all levels of government.

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9.32 Available evidence suggests that in a number of ways the capacity of Bulgaria’s institutions relative to that of other countries is lagging. It is thus implementation capacity rather than the cost of reforms that is a cause for concern. However, even that is a relative matter. Various indexes of governance and implementation capacity are typically highly correlated with per capita GDP, so it is likely just a matter of time before the capacity of Bulgaria’s institutions catches up with its per capital GDP. The problem for Bulgaria is that, because of its convergence and demographic challenges, it has to overachieve on the productivity growth front, and thus also in terms of its institutional framework that would make the rapid catching up possible. 9.33 Perhaps the most complete source of evidence on Bulgaria’s institutional capacity is the Global Competitiveness Report (World Economic Forum 2006). The 2006 GCR ranks the competitiveness of 125 countries around the world along dozens of dimensions, grouped into nine pillars (see also Chapter 3). Those in turn are divided into three broad groups: (i) basic requirements (that is, institutions, infrastructure, macro economy, health, and primary education); (ii) efficiency enhancers (that is, higher education and training, market efficiency, and technological readiness); and (iii) innovation factors (that is, business sophistication, and innovation). Countries are also divided into five groups, covering the various “stages of development” from “factor driven” through “efficiency driven” to finally “innovation driven”. 9.34 Bulgaria is considered now to be in the “efficiency driven” stage (stage 3). Its world ranking in 2006 was 72, down from 61 in 2005. In the same sample of 125 countries, it was ranked as 56th in its GDP per capita using the purchasing power parity method. The main factors dragging down its global competitiveness ranking fall under four pillars: (i) institutions (pillar 1); (ii) market efficiency (pillar 6); (iii) business sophistication (pillar 8); and (iv) innovation (pillar 9). This report has covered a number of the issues concerning market efficiency and innovation in other chapters. 9.35 Bulgaria’s institutions received the weakest ranking of all nine pillars (109th out of 125 countries). Of the 29 indicators on which the relative ranking of Bulgaria’s institutions is based, the ten that GCR ranks as the most serious “disadvantages” (institutions being one of only two pillars that list no “advantages” in the case of Bulgaria) are: (i) organized crime (ranking 118); (ii) reliability of police services (ranking 117); (iii) favoritism in decisions of government officials (ranking 112); (iv) diversion of public funds (ranking 108); (v) public trust in politicians (ranking 105); (vi) wastefulness of government spending (ranking 101); (v) judicial independence (ranking 100); (vi) business costs of crime and violence (ranking 97); (vii) burden of government compliance (ranking 92); and (viii) property rights (ranking 91). The factors concerning organized crime, reliability of police services, and judicial independence have been so prominent that they are already being attended to as urgent matters at the highest levels. 9.36 In terms of implementation of the recommendations of this report, it is issues such as wastefulness of public spending, burden of government compliance, and the diversion of public funds that matter, and could be the focus of the Ministries of Finance, and Economy and Energy. Interestingly, plain corruption is not a major issue. For example, responses to questions about “irregular payments” demanded by officials in customs, public utilities, and/or tax offices all gave Bulgaria a relatively good ranking of about 40. 9.37 Afonso et al (2006) analyzed public sector efficiency in new EU member states, using GCR 2003 data. The analysis covered 24 countries—EU8, Bulgaria, Romania, Cyprus, Malta, Greece, Ireland, Portugal, and 10 emerging market countries (Brazil, Chile, Korea, Mauritius, Mexico, Singapore, South Africa, Thailand and Turkey). Of these countries, all except Korea and Singapore are not far from Bulgaria’s current stage of development. The analysis covered a set of indicators expected to reflect how well the public sector has performed in different areas in which the countries spent public funds. The

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broad areas covered were administration, human capital, health, income distribution, economic stability, and economic performance. 9.38 Bulgaria ranked the lowest on the aggregate public sector efficiency among the countries included. However, the sample period covered the ten year period preceding 2003. If data for only the years since 2000 were used, Bulgaria’s performance in the economic, human capital, health, and income distribution areas would have been at least average compared to other countries. This would leave only the administration area ranked below the sample average. In that area, measured by aspects such as corruption, red tape, quality of the judiciary, and the size of the shadow economy, Bulgaria ranked behind all the other countries, except Turkey and Romania. On the corruption index, Bulgaria ranked above average. The picture is much the same with the performance indicators related to the public resources spent in each of the areas: Bulgaria again ranks at or above average in most areas. The only exception is again the administration area, in which Bulgaria ranks lowest, on par with Romania and Brazil. 9.39 In terms of cost-effectiveness of resource use, Bulgaria could do much better. According to the analysis, it could either achieve the same performance with only 50-60 percent of the resources, or it could produce 30-25 percent more output with the same resources. This is consistent with the results of PFPR of 2006 (WB 2006a), which argued that major efficiency gains should be possible in the use of public resources. A number of countries in the Afonso et al study have been able to grow at rates as rapid as Bulgaria’s in the past 7-8 years with public expenditures as proportion of GDP well below Bulgaria’s levels. Much of this shortfall, of course, cannot be just due to deficiencies in administrative capacity, but it does suggest that it is a problem. 9.40 The Government is aware of the administrative capacity problem, and is taking it seriously. There is a law that covers administrative reform, as well as a strategy and an action plan. Also, binding standards have been adopted for the quality of administrative services—these include, for example, what the clients can expect, ranging from specifying the working hours for the delivery of services, how fast the mail has to be answered, and obligation for civil servants to identify themselves in phone calls. Every administrative unit has to adopt a Client Charter that specifies what is expected, and every six months the various units are to report their progress in the delivery of services in an internet-based System for SelfAssessment of Administrative Services. Further, plans for laying a basis for an e-Government are well underway, which should raise the efficiency, transparency, and accountability of the process. Monitoring and evaluation (M&E), and the indicators needed to do that (from inputs to outcomes) are now mentioned in just about every document, with M&E to be done mostly internally, but from time to time to be carried out by independent external evaluators. One can hope that the results will soon be visible in future GCR rankings and other evaluative studies—but most of all, in the speed of Bulgaria’s convergence with the rest of EU countries.

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