The World Bank Bosnia and Herzegovina: Challenges and Directions for Reform

1. The World Bank Bosnia and Herzegovina: Challenges and Directions for Reform A Public Expenditure and Institutional Review Sarajevo February 28, 2012

2. Main Messages Political problems and government structures are serious impediment to effective public expenditure planning and execution. Many opportunities for improving overall fiscal management and sectoral spending: Pensions and social transfers Public sector wages Health Education Forestry Energy

3. Political Challenges and Government Structures Significant duplication and parallelism in the structure of public sector institutions. Serious weaknesses in high level coordination and decision-making in the allocation of public resources. The greatest gains in efficiency in the provision of public services must come from addressing these problems.

4. Fiscal Diagnostic The public sector is too large. The tax system involves significant economic distortions particularly because of high labor taxation. Both revenue and expenditure reforms are needed. Fiscal policy needs to reflect the currently very constrained access to international finance and the limited development of local financial markets.

5. Fiscal Recommendations Strengthen the role of the Fiscal Council. Reduce the magnitude of the tax burden on labor while maintaining fiscal sustainability. Reshape public expenditures which at present are excessively concentrated on current. spending including wages, pensions and social transfers. Reverse the excessive growth of the public sector.

6. Pension Diagnostic High benefits. High dependency ratios. Low contributor numbers. Large numbers of early retirees. Inappropriate scaling and qualification criteria for disability benefits. Significant unfunded “privileged” pensions. Complex system of “coefficients” (FBH).

7. High Pension spending • as share of GDP (FBH)

8. High Dependency Ratio FBH

9. Low Numbers of Contributors as Percent of Working Age Population

10. Revamp the benefit structure, eliminating the coefficient system. • Introduce strict curbs on early retirement. • Establish actuarial pension reductions for those who retire early. • Eliminate double-dipping between war-related benefits and pension fund benefits. • Tighten the eligibility conditions for disability and revamp the benefit structure to correspond with the new old age structure. • Provide survivor pensions only at retirement age and withdraw them if remarriage occurs. • Separate privileged pensions from the general pension pool, fund them separately and align them more closely with general pensions. • Limit benefit indexation to prices rather than wages. Pension Recommendations (FBH)

11. Pension Recommendations (RS) Introduce strict curbs on early retirement. Establish actuarial pension reductions for those who do retire early. Eliminate double-dipping between war-related benefits and pension fund benefits. Revise the disability benefit formula to provide higher benefits for the fewer people who will qualify as disabled. Provide survivor pensions only at retirement age and withdraw them if remarriage occurs.

12. Social Transfers Diagnostic High and fiscally unsustainable. Dominated by programs for veterans. Poorly targeted.

13. ST Spending Across Countries

14. Social Transfer Recommendations Avoid addition of new benefits. Revise the current Law on Basic Elements of Social Protection in FBH to support better targeting. Undertake legal, administrative and fiscal measures to curtail the costs of the veterans’ benefits by enforcing the legislation which was adopted on paper and scheduled for enactment as of January 2011. Develop updated tools to improve the targeting of non-contributory benefits for civilians aimed at reaching the poor and most vulnerable.

15. ST Recommendations (continued) Develop effective targeting mechanisms for veteran benefits. Diversify the support for veterans who would lose cash benefits as a result of reforms. Introduce design changes in the social assistance programs to eliminate work disincentives. Improve the cost-efficiency, transparency and accountability of benefit administration. Step up eligibility audit efforts.

16. Public Sector Wage Diagnostic 1. At close to 13 percent of GDP the public sector wage bill is not sustainable

17. PS wages as share of GDP

18. Wage Recommendations Institute meaningful establishment controls. Rationalize the large number of currently vacant posts and cut wage bill appropriations accordingly. Systematically monitor staffing numbers to ensure the observance of establishment and hiring controls. Regularly monitor employment and pay levels in sectors other than the public administration, as these sectors make up the bulk of public employment. Reduce the cost of various salary increments: Abolish discretionary fees Eliminate universal entitlements to allowances Restrict allowance eligibility

19. Wage Recommendations (continued) Cut other categories of recurrent spending related to staff numbers, such as official travel, rental of buildings, and telecommunications. Reduce the number of auxiliary staff by outsourcing these functions or transferring these employees to labor law contracts. Increase flexibility in negotiations with public sector trade unions to avoid disorderly wage bill cutbacks in the future. Improve coordination in wage bill planning in the Fiscal Council.

20. Health Diagnostic Expenditure growing unsustainably. Contribution rates are high. 50 percent of those covered are exempt from contributing. Arrears mounting (especially in RS). High private out-of-pocket payments. High drug costs.

21. Health Recommendations Expand the insurance risk pool related to hospital and pharmaceutical care. Review exemptions from contributions and consider shifting the collection and control of health contributions to at least the entity level to help improve collection. Address health sector arrears. Reduce fragmentation and duplicate functions.

22. Health Recommendations (continued) Leverage family medicine reforms to increase Primary Health Care productivity and increase preventive medicine. Consider hospital financing reforms e.g. Diagnostic Related Groups. Centralize procurement of drugs to at least the entity level.

23. Education Diagnostic Overall spending is not excessive. Allocation of spending within the sector needs refinement and is affecting efficiency. Wage expenditures are crowding out non-wage spending. Upper secondary enrollment rates are very low signaling quality problems. BH’s student performance on international test could be better if resources were used more effectively.

24. Education Recommendations Limit further teacher wage increases. Develop a more decompressed wage structure. Rebalance spending between school levels to enhance pre-school and tertiary education and Address the quality issues in upper secondary that are at the root of low enrollment rates. Introduce per capita financing of schools to replace the existing the input-based financing system. Establish an Education Management Information System.

25. Forestry Diagnostic Forest resource is larger than previously thought. Could contribute more to the economy perhaps as much as an additional 1.5% of GDP. Government plays a major role in sector. Institutional and policy reforms are needed to better exploit forest resource.

26. Forestry Recommendations Improve road access to forests. Identify and reduce unproductive labor in public forest-sector institutions. Invest significantly in human resources especially in business and management skills. Implement institutional changes in FBH:

27. Forestry Recommendations (continued) Have the larger Cantonal Forest Management Companies and JPS Šume RS conduct a comprehensive Business Process Review. Develop a transparent and market-based mechanism for timber sales. Reset the overall level of the OKFŠ tax. At this stage, privatization of forest management companies is not judged to be a sustainable option in BH.

28. Energy Diagnostic Large existing and potential future fiscal impact. High degree of government ownership. Large capital expenditure needs. Problems in coal sector because of below-cost pricing and large liabilities. Power utilization is highly inefficient especially for heating. Without tariff reforms the sector cannot finance needed invest and will continue to burden the budget.

29. Energy Recommendations Continue the restructuring and modernization of coal mines. Continue restructuring of the electricity sector and set tariffs at their full cost-recovery levels, while putting in place targeted social protection mechanisms to protect vulnerable groups. Prepare and adopt an investment strategy for each of the power utilities based on a comparative least-cost investment plan Implement the energy efficiency program for public buildings (schools and hospitals). Develop a basic legal framework for implementation of energy efficiency programs. Establish a financing support mechanism for energy efficiency investments. Set up a comprehensive and systematic energy data gathering and reporting system.

30. Conclusions Reforms suggested in this report will help to: Reduce the overall size of the public sector which is currently too large. Improve the efficiency of public service delivery. Improve the efficiency of the revenue system. Reduce financing pressures which in the current international environment are constraining.