public disclosure authorized eu10 regular economic report...slowdown differs across the eu10...

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The World Bank

EU10 Regular Economic Report

Main Report Securing Recovery Amid Headwinds

November 2011 Focus Note: Skills, Not Just Diplomas This report is prepared by a team including Simon Davies, Stella Ilieva, Ewa Korczyc, Matija Laco, Sanja Madzarevic-Sujster, Catalin Pauna, Kaspar Richter (task manager, [email protected]) and Emilia Skrok. The team is very grateful to Lars Sondergaard for the focus note, and to Marcin Piatkowski, Lucio Vinhas de Souza and the World Bank Global Prospect Group, coordinated by Annette De Kleine, for excellent inputs. EU10 refers to Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, the Slovak Republic and Slovenia. EU10+1 includes Croatia.

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At the beginning of the year, EU10 countries were looking forward to an acceleration of growth and progress on fiscal consolidation supported by a rebound in private domestic demand, an increase in credit growth, a decline in unemployment and a stable external environment. As 2011 is drawing to a close, the year has not quite turned out as expected. Progress has been difficult to achieve in some areas, although the region has shown remarkable resilience in others.

We start with the strong points. First, regional growth in 2011 has been solid. The EU10 region has taken advantage of its openness, and supported growth through a strong expansion in exports. Second, Estonia, Lithuania and Latvia, the growth laggards in 2009, have turned within two years into growth leaders, reaping the benefits of the flexibility of their economies. Third, EU10 countries have delivered on their promises to make good on fiscal consolidation. Fiscal deficits have declined in 2011 across the region to the lowest level in three years. As governments are preparing the budgets for next year, all EU10 countries are broadly on track with meeting their fiscal targets in line with their commitments of the EU Stability and Growth Pact.

These achievements are impressive, as they have come in spite of a fair share of disappointments. The external environment has been more challenging than hoped for, especially in the second half of the year. Growth of the global economy is losing momentum, and the expansion in the EU15 is grinding to a halt towards the end of the year, as the sovereign debt crisis originating from the periphery of the euro area continues to rattle financial markets. Since the EU10 is closely tied through production, trade and finance with the EU15, adverse developments can spread just as much as desirable ones from the west to the east of the EU.

While EU10 financial markets weathered well euro area volatility earlier in the year, they took a turn for the worse later in the year. As worries about sovereign debt in some euro area countries translated into concerns about European banking groups holding these sovereign bonds, currencies depreciated, stock markets contracted and financial flows dwindled. Even though financial markets recovered somewhat in recent weeks in response to policy action, volatility remains elevated. In addition, with global prospects worsening and financial markets stalling, private demand has not been able to pick up the slack from public demand. As a result, with the exception of Estonia, Latvia, Lithuania and Poland, domestic demand remains weak. Furthermore, as domestic demand has failed to take off, unemployment persists at elevated levels. Only Estonia, Lithuania and Latvia have made some headway in reducing unemployment rates from

the peaks during the crisis, and even there they are still more than three times the pre-crisis levels.

A challenging external environment, weakening sentiments among businesses and consumers, and persistent unemployment translate into weak growth prospects. Growth in 2012 is set to drop almost one percentage point, returning to the 2010 level. Even such sluggish growth is at risk in case the situation deteriorates further in the euro area or the global economy.

A weak and uncertain economic outlook means that strong, three-pronged policy action is essential. First, governments, central banks and financial supervisory authority across the EU have to shore up confidence of financial markets. Building on recent policy measures, priorities include prudent risk assessments, following-up plans for recapitalization and restructuring of banks as needed, and bolstering the resilience and stability of the financial system through macro-prudential regulations. Second, while monetary policy can be supportive of the recovery in light of low inflation pressures, most EU10 countries have to pursue reductions in fiscal deficits to rebuild fiscal buffers in line with their plans. This would ensure that weak fiscal balances do not become a source for financial market volatility. Many countries still have to adopt specific additional measures to bring about the envisioned fiscal adjustments, especially in case the economic outlook worsens further. Finally, structural policies in support of growth can help to overcome the financial, labor and fiscal challenges. This means making workers and businesses more productive through EU funds and FDI flows, improving technology and strengthening skills. Deepening economic and financial ties between the EU10 and the EU15 is part of this agenda. The strong record of convergence over the last two decades demonstrates the benefits of closer integration in spite of today’s economic problems.

EU10 Growth prospects

2010 2011 2012

EU10 2.1 3.0 2.1

Bulgaria 0.2 2.0 2.0

Czech Republic 2.2 2.1 1.0

Estonia 3.1 7.6 3.5

Latvia ‐0.3 4.0 2.8

Lithuania 1.3 5.8 3.5

Hungary 1.2 1.7 0.5

Poland 3.8 4.0 2.9

Romania ‐1.3 1.5 2.0

Slovenia 1.4 1.3 1.4

Slovak Republic 4.0 3.0 1.5

Note: The 2012 GDP growth forecast for Romania is an interval from 1.8 to 2.1 percent.

EU10 November 2011 Summary of Main Report

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Recent Developments and Future Prospects

Output The economic recovery in the EU10 is slowing down as the global economy has been pounded by a series of shocks. An earthquake and tsunami in Japan, high oil prices, strains in financial and sovereign debt markets of the euro area, and the slowing recovery in the US have dampened global economic activity, which was already under pressure from the end of the inventory cycle and fiscal consolidation. As a result, the economic sentiment in key OECD countries deteriorated during the course of the year (Figure 1). Driven by weaker performance of high income countries, growth of the global economy is set to slow down in 2011 (Table 1).

Figure 1. OECD Composite Leading Indicator Table 1. Global growth prospects, percent

2010 2011f 2012f

World 4.0 2.7 2.7 High income 2.9 1.6 1.7 Developing countries 7.3 6.1 5.6 Euro area 1.7 1.6 0.5 EU10 2.1 3.0 2.1

Source: OECD, World Bank staff calculations.

Notes: Major Five Asia refers to China, India, Indonesia, Japan and South Korea.

Source: World Bank DEC Prospects Group.

The recovery of the EU10 countries was well on track in the first half of 2011. EU10 output growth accelerated to 3.4 percent year-on-year in the first half of 2011 from 2.9 percent in the second half of 2010. Growth benefited from the base effect, as the region returned to growth only in early 2010. It also reflected the dynamism of the economies. The quarter-on-quarter growth rates of the EU10 exceeded those of the EU15 for the sixth quarter in a row. The recovery reflected both the global upturn and policy action, including sizeable fiscal consolidation, to shore up market confidence.

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Figure 2. GDP growth in EU10 countries and EU15, percent

year-on-year not seasonally adjusted quarter-on-quarter seasonally adjusted

Source: Eurostat, World Bank staff calculations

The expansion relied on both domestic and external demand. The breakdown of GDP components shows that the inventory cycle, the most important growth driver in 2010, was less important in the first half of 2011. Instead, net exports made the largest growth contribution, and consumption and investment further boosted growth (Figure 3).

Figure 3. Contribution to GDP growth in the EU10 and the EU10 countries, year-on-year, not seasonally adjusted, percent

EU10 EU10 countries

Source: Eurostat, Central Statistical Offices, World Bank staff calculations

The recovery remained multi-speed. Growth was highest in Estonia, Lithuania and Latvia, which had seen the sharpest contraction in 2009, thanks to a strong export performance and a recovery in domestic demand. Growth in Poland relied mainly on solid domestic demand. By contrast, the Czech Republic, Hungary, Slovakia, and Slovenia took advantage of a strong rebound in global trade as their open economies are well integrated in European production networks. Estonia and Bulgaria also benefited from export-driven growth. Weak domestic demand lowered growth in Slovenia, Bulgaria, Hungary and Romania. Indeed, investment in the second quarter of 2011 remained below pre-crisis levels in all countries but Poland. Consumption exceeded pre-crisis levels only in Poland, Slovakia, Slovenia and the Czech Republic.

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Figure 4. Recovery in gross fixed investment and final consumption from pre-crisis peak to 2Q 2011, index, peak = 100, seasonally adjusted

Gross fixed capital formation Final consumption expenditure


Notes: Pre-crisis peak refers to the best quarter within the period 2006-2008

EU10 economic activity is moderating in the second half of 2011 in response to the worsening of the external environment. Growth is slowing across Europe, dampened by the crisis in parts of the euro area and worries about the global economy. High frequency indicators, such as retail sales, industrial production, exports and imports, show declining growth in the third quarter for both the EU15 and EU10 (Figure 5). While businesses in the EU10 and EU15 were optimistic about their prospects in April 2011, their sentiment reversed in the summer, although more in the EU15 than in the EU10 (Figure 6). Consumer confidence also worsened in the EU15, and remained depressed in the EU10. However, the timing of the slowdown differs across the EU10 countries. In particular, flash estimates for year-on-year growth in the third quarter of 2011 suggest that economic performance remained strong in Latvia, Lithuania, Estonia, and Slovakia, and improved in Romania.

Figure 5. High frequency indicators for EU10 and EU15 countries

Industrial production and retail sales Exports and imports


Notes: 3M moving average growth rates

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Figure 6. Industry and consumer confidence indicators for EU10 and EU15

Industry Consumer


Notes: Consumer confidence indicator represents the arithmetic average of the answers (balances) to the four questions on the financial situation of households and general economic situation (past and future) together with that on the advisability of making major purchases. Industry confidence indicator is the arithmetic average of the answers to the questions on production expectations, order books and stocks of finished products.

Although the momentum is weakening, growth in 2011 remains robust. The slowdown towards the end of the year is balanced by the strong expansion early in the year. EU10 growth is expected to reach 3.0 percent in 2011, just slightly below government projections of 3.2 percent from spring 2011. For the first time since the crisis, all EU10 countries are projected to grow this year. EU15 growth is projected to be only 1.5 percent, half the rate of EU10 countries (Figure 7). Two EU15 countries are expected to remain in recession in 2011. Among the EU10 countries, Estonia, Latvia, Lithuania and Poland are projected to grow by 4 percent or more, thanks to a higher contribution from domestic demand and improving labor markets. Hungary, Romania and Slovenia are set to expand by less than 2 percent, as growth is held back by weak investment (Hungary and Slovenia) or consumption (Romania). Slovakia, Bulgaria and the Czech Republic grow at between 2 and 3 percent, aided by exports.

Figure 7. Comparison of 2011 growth forecast and Convergence or Stability programs projections

Source: World Bank staff calculations, Convergence/ Stability Program Summer 2011

Notes: *For EU15 data is from EC November 2011 forecast

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Trade and External Developments While global trade eased after last year’s cyclical rebound, it remained crucial for growth in Europe. Global trade lost momentum in the second quarter of 2011, as output growth weakened in advanced economies and the oil price peaked. Nevertheless, it stayed more vibrant than expected in Europe. For example, the IMF upgraded in September its April projections for 2011 export volumes from 7.8 percent to 8.8 percent for the EU15, and from 7.9 to 11.0 percent for the EU10 (Figure 8).

Figure 8. Exports and imports performance in 2011 relative to April 2011 expectations

Source: World Bank staff calculations, WEO April 2011 and Sept 2011

Trade contributed to EU10 growth through strong exports and weak imports. Export volumes in 2011 are set to expand more than 10 percent in Estonia, Romania, the Czech Republic, Slovakia and Latvia. Compared to the same period in 2008, during the first eight months of the year, EU10 exports exceeded their pre-crisis level by 16 percent. Estonia, Latvia and Romania, which underwent large recessions during the crisis, boosted their exports more than 25 percent compared to the pre-crisis period (Figure 9). They took advantage of higher demand for intermediate goods, and, in the case of Estonia and Romania, also for capital goods. In addition, Estonia and Latvia did well on diversifying their trade from EU countries to other regions, including Asia, and improving competitiveness. However, export growth in July and August dropped in most countries noticeably compared to the beginning of the year in response to the global slowdown. The reduction in export growth was large in Bulgaria and Romania whose intermediate goods trade is especially dependent on the global demand cycle, although it remained high in both countries (Figure 10). Going forward, with growth in Europe and other major economies rapidly slowing down, demand for EU10 goods is set to slow down further. In contrast to exports, imports remained in most countries below pre-crisis levels in light of weak domestic demand.

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Figure 9. January to August import and export for EU10 countries, Jan-Aug 2008=100

Figure 10. Composition of export, EU10, January 2008-July 2011 (billion Euro)


The EU10’s current account deficit increased relative to 2010, but remained at a moderate level and adequately funded through portfolio and FDI investments. The EU10 current account deficit increased from 2 percent of GDP in 2010 to 4 percent in the first half of 2011. This reflected solid demand for foreign goods in a number of countries, including Poland and the Czech Republic, as well as large income transfers. Current account deficits were funded mainly through FDI in the Czech Republic and Romania, through portfolio investments in Poland, and portfolio investments and other flows in Slovakia.

Figure 11. Current account developments in EU10 countries (% of GDP)

Figure 12. Current account financing in EU10 countries (% of GDP)

Source: Eurostat, Central Banks, World Bank staff calculations

Notes: On cumulative basis

Trade and current account balances have improved substantially since 2008. The EU10 trade balance, which improved for all ten countries, moved from a deficit of 5 percent of GDP in 2008 to a balanced position in the first half of 2011. The current account improved in line, driven by contracting domestic demand and a sharp slowdown in capital flows. Only in the Czech Republic, which had a moderate current account deficit going into the crisis, the current account deficit worsened somewhat due to large income transfers to foreigners. The EU10 countries with the highest pre-crisis current account deficits saw the largest improvements, including Bulgaria, Estonia, Latvia, Lithuania, Hungary and Romania, in response to dwindling capital inflows. For example, the current account balance in Bulgaria moved from a deficit of 23 percent of GDP in 2008 to a surplus of close to 2 percent of GDP in the first half of 2011 (Figure 13).

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Figure 13. CAB and trade balance in EU10 countries (% of GDP)

Source: Eurostat, Central Banks, World Bank staff calculations

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Gross external debt-to-GDP ratios contracted over the last year and a half, helped by lower external borrowing due to improved current account balances. For the EU10, external debt declined slightly from 83 percent of GDP at end-2009 to 81 percent of GDP at mid-2011 (Figure 14). The current account improvements helped Estonia, Bulgaria and Lithuania to lower external borrowing. Hungary’s external debt dropped almost 30 percent of GDP. The government utilized one-off receipts from dissolving the private pension pillar to lower outstanding debt. Government external debt exceeded bank external debt in some EU10 countries as banks continue to deleverage while governments tapped international markets to finance fiscal deficits (Figure 15). External government debt, however, remained at less than 7 percent of GDP in Bulgaria and Estonia and declined substantially in Slovakia.

Figure 14. Gross external debt developments 2009 - 2Q 2011, percent of GDP

Figure 15. Structure of the gross external debt in June 2011 (% of GDP)

Source: Central Banks, World Bank staff calculation

Notes: Calculations refer to data in EUR.


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Inflation and Exchange Rates With an easing of international commodity prices, a slowdown in growth and monetary policy tightening in some countries, inflation has moderated in the second half of the year. EU10 headline inflation dropped from 4.4 percent in May 2011, the highest level since April 2009, to 3.4 percent in September 2011. EU10 core inflation, which excludes energy and unprocessed food, was 3.0 percent September 2011, down by 0.3 percentage points since its peak in June 2011 (Figure 16). Headline inflation eased more than core inflation, as the international commodity price index declined 13 percent for energy and 6 percent for food from April 2011 to October 2011. Core inflation declined in light of persistent unemployment, weak growth prospects and increases in policy rates in a few countries.

The picture varies across the region reflecting country specific factors. The largest declines in inflation took place in Bulgaria, where inflation dropped from 3.5 percent in June to 2.9 percent in September, and Romania, where it slowed down from 8.5 percent in May to 3.5 percent in September, the lowest level in the last two decades (Figure 17). In both countries, a good agricultural year helped to lower prices of food items, which account for a high share in the consumption basket. In addition, the impact of the VAT increase in July 2010 on year-on-year inflation tapered off in Romania. As a result of strong domestic demand and/or tax increases, inflation runs highest in Estonia, Lithuania and Latvia.

Figure 16. HICP overall index and core index for EU10 and EU15, annual rate of change, percent

Figure 17. HICP overall index for EU10, annual rate of change


Note: HICP is a harmonized index of consumer prices.

The renewed volatility in euro area financial markets led to depreciation of several currencies in the region. Similar to the responses to the Lehmann crisis in fall 2008, the exchange rate impact was smallest on the Czech koruna, in line with the country’s strong economic fundamentals, and largest on the Polish zloty, reflecting the large size and liquidity of Polish financial markets. However, more recently, the Hungarian forint depreciated noticeably in response to weak economic data. Overall, real effective exchange rates for Poland, Romania, and Hungary remain visibly below pre-crisis levels, in contrast to the Czech Republic, and Estonia and Slovakia, both euro area member countries (Figure 18, Figure 19). The third EU10 euro area country, Slovenia, has seen less appreciation of its real exchange rate than Estonia and Slovakia.

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Figure 18. Nominal exchange rates to EUR, August 2008=100

Figure 19. Real effective exchange rates, August 2008=100


Notes: Downward movement denotes depreciation.

Source: BIS, World Bank staff calculations

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Finance Financial markets have taken a turn to the worse since the summer. Renewed market turbulence originating from the euro area, along with weaker global growth prospects, have increased market risk aversion across asset classes (Figure 20). Sovereign and banking group risk spreads have increased and stock markets have declined since April 2011. Interbank spreads have remained more stable thanks to the ECB’s liquidity provision. Investors remain concerned about progress in shoring up fiscal sustainability in countries of the euro area periphery, the links between sovereign and banking risks in parts of the euro area, large funding needs of European banking groups for refinancing and recapitalization, and the implementation of the policy actions needed to restore market confidence.

Gross capital inflows to EU10 countries slowed down noticeably in the third quarter of 2011. As risk appetite declined, gross capital inflows to the EU10 contracted from USD25 billion to less than USD10 billion in the third quarter of 2011 (Figure 21). Bank and bond flows declined, while equity flows remained robust. After a boost to bank-related flows in the second quarter due to lumpy transactions, bank-related flows returned to a low level in view of the ongoing deleveraging of European banking groups (Box 1). This reflects a number of factors, including weak growth prospects, funding constraints, sluggish credit demand, and regulatory changes to increase capital adequacy ratios. Public bond flows declined as governments postponed bond placements in view of elevated market risks.

Figure 20. Asset class performance in the EU10 region, in basis points

Figure 21. Gross capital inflows to EU10 markets, USD billions

Source: Reuters, Bloomberg, World Bank staff calculations

Notes: For stocks right axis applies, pre-crisis peak =100

Source: World Bank DEC PG, staff calculations

Box 1. Bank’s cross-border claims in the EU10

Strong parent and subsidiary links have been a source of resilience in the recovery from the 2008/09 crisis in the region. At the same time, financial conditions remain more difficult than before the crisis and the increase in sovereign debt burdens poses risks to financial stability. Many countries are exposed to the same external lenders via cross-border loans to banks from their international parent banks. From a creditor perspective, bank claims are concentrated in few countries—Austria, Belgium, France, Germany, Italy, the Netherlands, Greece and Sweden—which account for three-quarters of total claims on the region. In light of ongoing uncertainty and the quality of bank assets, markets are exerting pressure on banks to improve their risk profile and build up capital buffers. With about three-quarters of the EU10 banking assets in foreign ownership, cross-border capital flows in the banking sector remain central to the stability of the financial system and credit provision.

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As reported by the Bank for International Settlement (BIS), banks’ claims on the EU10 countries in June 2011 totaled USD452bn (Figure 22). This was 4 percent less than in March 2011 but 16 percent more than in the same period last year. In the second quarter in particular, claims decreased in banking sector, while they remained almost stagnant in the non-banking sector. Claims decreased 7 percent on the banking sector, but increased 1 percent on the non-banking sector. Banking sector claims declined in Hungary, Poland, Czech Republic, Romania and Slovakia, although they improved in Bulgaria, Estonia, Latvia, Lithuania and Slovenia.

Figure 22. Banks’ claims on EU10 region, USD bln

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Note: Adjusted for exchange rates

Source: World Bank staff.

Spreads on sovereign debt have risen, as markets have become increasingly worried about fiscal positions in countries of the euro area periphery. The volatility of sovereign credit default swap spreads remains high in line with fragile market sentiment. The risk perception of the EU10 countries was remarkably robust in the face of sovereign debt concerns in the euro area early in the year. However, the latest phase of euro area turbulence has triggered repercussions throughout the region (Figure 23). Nevertheless, markets continued to differentiate across countries. The impact was largest on Hungary, marked by the highest public debt ratio among the EU10 countries and sluggish economic data. It was lowest on Estonia and the Czech Republic in line with their strong fiscal and economic indicators. Mirroring the pattern of sovereign spreads, government bond yields of the Czech Republic remained far lower than those of Hungary, and they remained below the peaks of March 2009 in all EU10 countries (Figure 24).

Figure 23. 5Y CDS spreads for EU10 countries (basis points)

Figure 24. 10Y bond yields in the Czech Republic, Hungary, Poland, Romania and Bulgaria, percent

Source: Bloomberg, World Bank staff calculations Source: Reuters, World Bank staff calculations

Notes: RO– pre-crisis not available, BG – data prior to 2011 not available

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Notes: GIPS stands Greece, Ireland, Portugal and Spain.

Banks’ funding pressures have remained elevated. Spreads of major European banking groups operating in the EU10 increased over the last six months (Figure 26). Banking risks are high in peripheral euro area countries where financial stress interacts with fiscal pressures and low growth. The sovereign debt crisis in some euro area countries makes the roll-over of wholesale funding more difficult for credit institutions, especially as governments compete with banks for financing. Furthermore, the rise in the sovereign credit risk of banks is amplified through the high interconnectivity and leverage of the banking sector.

Figure 26. Parent banks’ CDS spreads

Source: Bloomberg, Reuters, World Bank staff calculations

Market volatility spread to the stock markets in the late summer. By early November 2011, EU10 stock markets remained 50 percent below the pre-crisis 2008 peak, and 16 percent above the March 2009 trough. The downward adjustments were largest in countries that had seen the biggest increases early in the year, including Poland, Estonia and Hungary (Figure 27).

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Figure 27. Stock exchange indices in EU10 countries and selected countries from the EU15, pre-crisis peak = 100

Figure 28. Interbank rates spreads, basis points

Source: Bloomberg, World Bank staff calculations

Credit growth to the private sector remained sluggish. While credit provision improved in early in 2011, credit growth has slowed down again in recent months (Figure 29). About three years after the crisis, taking into account inflation, the amount of outstanding private sector credit was around 15 to 20 percent below October 2008 level in Lithuania, Latvia, Estonia, Romania and Hungary (Figure 30). In addition, with the exception of Bulgaria, credit to enterprises was below the October 2008 level in all EU10 countries. Only Slovakia, the Czech Republic and Poland have seen increases in real private sector credit thanks to a solid expansion of credits to households. The recovery in credit growth is delayed in part due to the reduction in bank-related inflows and the rise in non-performing loans (Figure 31). However, banks’ capital positioned improved early in the year in most countries and the banks’ regulatory capital, relative to risk-weighted assets, is especially high in Estonia and Bulgaria (Figure 32). Banks' credit standards for new lending also remain tighter than before the crisis (Figure 33). Nevertheless, demand side factors also play a role, as credit and GDP growth are closely linked (Figure 34). Credit growth could accelerate again once downside risks to growth in Europe fade. However, sustaining healthy credit growth will require measures to strengthen the resilience of EU10 banking sectors against contagion from selected euro area markets.

Figure 29. Real credit growth, percent, year-on-year

Figure 30. Contribution to real credit growth from Oct 2008 to August 2011

Source: European Central Bank, World Bank staff calculations

Source: European Central Bank, World Bank staff calculations

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Figure 32. Bank regulatory capital to risk-weighted assets (%)

Source: IMF Global Financial Stability Report September 2011, World Bank staff calculations

Notes: EU10 and EU15 aggregates show median, 2011 refers to March 2011

Figure 33. Credit growth Oct 2008 - Aug 2011 vs. increase in non-performing loans (2008-2011), percent

Figure 34. Real credit growth Oct 2008 – Aug 2011 vs. output level in 2Q 11 relative to 3Q 08, percent

Source: IMF Global Financial Stability Report September 2011, Eurostat, ECB, World Bank staff calculations

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Jobs

The economy remains too sluggish to create jobs in most countries. Employment increased in the second quarter of 2011 in the EU10. The number of workers with a job rose from 42.8 million in the first quarter to 43.6 million in the second quarter (Figure 35). Employment increased in all EU10 countries apart from Bulgaria, Romania and Slovenia where weak economic activity and structural adjustments continued to lead to job losses. Employment growth was particularly strong in Estonia, Latvia and Lithuania, backed by improvements in export-led manufacturing. While this looks at first sight to be a noticeable improvement, three numbers suggest that employment in the EU10 continues to be weak. First, the increase from the first quarter was in line with standard seasonal patterns. EU10 employment was roughly unchanged from the level one year ago, and some 2 million less than the pre-crisis employment peak. Second, relative to the working age population, defined as the 20 to 64 year old population, the employment share was 65 percent, some 2 percentage points below the level in the second quarter of 2008 (Figure 36). Third, while employment was still below pre-crisis levels in the second quarter of 2011, the output was above pre-crisis level for the EU10, although the picture differs across countries. In Bulgaria, employment losses reflect mainly the contraction of construction. In Slovakia, the manufacturing sector remained cautious in expanding hiring but instead sought to boost output through productivity gains (Figure 37).

Figure 35.Employed population in EU10 and EU15 countries, million

Figure 36. Share of unemployed and inactive in working age population in EU10 and EU15


Figure 37. Employment and output in 2Q 11 as percent of 2Q 08, seasonally adjusted

Source: Eurostat, World Bank staff calculation

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The employment performance would have been even weaker without increases in fixed-term contracts and part time work in most EU10 countries. Such types of employment can be important to boost the flexibility of labor markets and allow parents to combine work with family. However, they need to be balanced with concerns of segmenting labor markets into regular and irregular employment. The share of fixed-time employment contracts increased by about one percentage point to almost 11 percent, close to the EU15 level (Figure 38). It increased in all countries over the last three years with the exception of Bulgaria where job losses were concentrated on workers on fixed-term contracts. More than one in five jobs in Poland is on a fixed-term basis. Legislation remains favorable for such employment which enables enterprises to reduce labor costs. The part-time work increased also in the last three years in all EU10 countries except Poland, although it remains to be seen whether this reflects a cyclical or structural change (Figure 39). In Poland, at around seven percent, it remained at only one third of the level in the EU15, where legislative efforts to encourage part-time work are more advanced.

Figure 38.Fixed-term employed as percent of total employed, percent

Figure 39. Part-time employed as percent of total employed, percent


Unemployment also stayed high. Two and a half years after growth resumed, unemployment remains stubbornly elevated. It reached 9.6 percent in September 2011, only 0.6 percentage points below the crisis peak (Figure 40). In fact, while unemployment fell somewhat during 2010, it remained more or less flat in 2011, roughly at the same level as in the EU15. In September 2011, some 4.3 million people were out of a job and actively looking for work in the EU10 (Figure 41).

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Figure 41. Harmonized unemployment rates, weighted average, percent

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The regional unemployment average masks a fair amount of country variation. Helped by a strong rebound and flexible labor markets, unemployment rates fell noticeably in Estonia, Latvia and Lithuania although it remained in excess of 15 percent in Latvia and Lithuania. By contrast, unemployment stayed high relative to pre-crisis levels in Romania, Bulgaria and Slovenia, as domestic demand remained weak, structural adjustment continued and public sectors employment was under pressure. Despite the strong recovery of manufacturing, Slovakia’s unemployment rate remained high at over 13 percent reflecting weaknesses in skills and labor market policies.

Job market conditions remain especially difficult for workers with low education and little work experience as well as long-term unemployed. For example, unemployment rates among 20-24 year-olds was on average 13 percentage points higher than for the 20-64 year-olds in the second quarter of 2011. With headline unemployment having remained high for two years, more unemployed have been looking for work for more than a year. Long-term unemployment as a share of total unemployment reached almost 45 percent in the second half of 2011, up from 43 percent in the first quarter of 2011. It remained in excess of 7 percent of the labor force in Slovakia, Latvia, Estonia and Lithuania, the countries with the highest overall unemployment rate. While this reflected longer-standing structural issues in Slovakia, it was driven by large output reductions during the crisis in Latvia, Estonia and Lithuania.

Figure 42.Unemployment rates for 20-24 and 20-64 year-olds in 2Q 11, percent

Figure 43. Increase in long-term unemployed vs. change in output 2Q 08 – 2Q 11, percent


Persistent unemployment reflects also a difficult job search process. The number of unemployed per job vacancy in the EU10 declined from 30 in the first quarter of 2010 to 26 in the first quarter of 2011, and 24 in the second quarter of 2011 (Figure 44). However, this compares to a pre-crisis level of only 6. In addition, more businesses complained about labor shortages even though unemployment remained unchanged (Figure 45). This could imply that the job matching process has deteriorated. Indeed, the experience from EU15 countries in the 1980s documents that low job finding rates might boost the duration of unemployment, which in turn can lead to rising mismatches between vacancies and job seekers as the skills of the unemployed are eroded. This in turn would make unemployment more persistent.

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Figure 44.Unemployed per vacancy ratio Figure 45. Labor shortages and unemployment in EU10, 3Q 08 – 2Q 11


Notes: Labor shortage = % of manufacturing firms indicating labor as a factor limiting the production

Businesses continue to cater for higher demand through increases in labor productivity, which is delaying job creation. While quarter-on-quarter growth in labor productivity stalled in the EU15 in the second quarter of 2011, it remained positive for the ninth quarter in a row in the EU10. Over the last year, labor productivity increased faster in the EU10 than in the EU15, helping to boost output growth at existing employment levels (Figure 46).

Figure 46. Change in real labor productivity per person employed in EU10 and EU15, quarter-to-quarter, seasonally adjusted


Wage pressures remain subdued across the region, strengthening competitiveness. As the increase in compensation per worker lagged behind improvements in labor productivity in the first half of 2011, real unit labor costs trended downwards (Figure 47). This suggests that job markets could improve once domestic and external demand strengthens. However, consumers have become more concerned about unemployment in recent months. As the region enters the winter season, job markets continue to face an uphill battle (Figure 48).

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Figure 47. Real unit labor cost in EU10 countries in 1H 2011, total economy, annual rate of change, not seasonally adjusted, percent

Figure 48. EU10 Consumer unemployment expectations

Source: Eurostat, World Bank staff calculation Source: EC, World Bank staff calculation

Notes: Increase in the indicator means increased unemployment expectations.

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Prospects Europe’s growth is slowing down in 2012. Against the backdrop of a weaker global outlook, the rebound in the European Union is tapering off. As concerns spread from the periphery to core countries of the euro area, and the growth in global trade and industrial production is slowing, confidence of consumers, entrepreneurs and investors in many EU countries has taken a hit. As a result, private demand is not picking up the slack from public demand, which is tightening with fiscal consolidation, and the pace of the recovery is slowing. Assuming that there is no escalation of the euro area crisis, growth in the EU15 is set to moderate from 1.5 percent in 2011 to 0.5 percent in 2012.

Growth in the EU10 will also weaken but remain higher than in the EU15. The deep economic integration of the EU10 with the EU15 means that the slowdown in the EU15 will spread to the EU10. Growth in the EU10 is set to decline from 3.0 percent in 2011 to 2.1 percent in 2012. This compares to government growth projections of 3.1 percent for 2011 and 3.7 percent for 2012 from summer 2011. While growth is slowing and falling short of expectations earlier in the year, it will be higher in the EU10 than in the EU15 (Figure 49). The EU10 will continue to catch up with the EU15, even though growth is slowing in both regions. The difference between EU10 and EU15 growth is set to rise from 0.4 percent in 2010 to 1.5 percent in 2011 and 1.6 percent in 2012. This compares to an average difference of 2.5 percent of GDP from 1993 to 2008 (Figure 50).

Figure 49. EU10 growth forecasts Figure 50. Growth in EU10 and EU15, 2005 to 2012

Source: World Bank staff Note: EU15 countries forecasts are from Autumn Forecasts of the EC, November 2011.

Source: EC Autumn Forecast November 2011, World Bank staff

Growth differences among the EU10 countries are set to diminish. With the 2008/09 crisis, economic performance diverged across the region, as countries with larger macroeconomic imbalances underwent sharper contractions. During 2010 and 2011, countries with strong export linkages and rapidly adjusting macroeconomic imbalances saw a stronger economic rebound than other countries. In 2012, the difference in the growth performance across the EU10 is set to diminish (Figure 51). Growth in Estonia, Lithuania and Latvia, the leader in growth in 2011, is expected to decline in line with weakening export markets. Growth will moderate in the Czech Republic, Poland and Slovakia on the back of slowdown in the EU15. By contrast, growth in Bulgaria is set to remain unchanged. In Slovenia, the laggard in growth in 2011, growth will pick up moderately as the drag from construction is fading. In Romania, a gradual rebound in private demand is projected to boost growth in 2012 in spite of fiscal consolidation and lower export growth. Growth in Hungary is set to be more moderate than elsewhere, held back in addition to external factors by weak credit and continued balance sheet adjustment in the private sector.

The slowdown in growth means that it is taking longer than expected for countries to reach pre-crisis output levels. Only in Poland, Slovakia and the Czech Republic, 2012 output is

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projected to exceed pre-crisis levels (Figure 52). These countries had the lowest macroeconomic imbalances going into the crisis and were well placed to take advantage of the global recovery through trade and production ties with EU15 countries. By contrast, Latvia, which faced the largest contraction in the EU in 2009, could still be more than 15 percentage points below pre-crisis level at end 2012. The gap is estimated to be between 1 and 6 percentage points for the other EU10 countries.

Figure 51. Growth rate difference between worst and best performer in 2009-2012

Figure 52. Projected output levels in 2011 and 2012 as percent of the pre-crisis peak output

Source: Eurostat, World Bank forecasts from November 2011. Source: World Bank staff calculations

The 2008/09 crisis might have lowered growth for years to come. Comparing growth projections from the eve of the crisis to actual developments and current forecasts suggests that the crisis led to both a downward shift and a flattening of the growth trajectory. (Figure 53) Two points are noteworthy. First, the growth moderation is starker for the EU10 than the EU15. The EU10 has been hit harder by the slowdown in inflows of capital and credit, and high growth rate in some EU10 countries in the run-up to the crisis reflected an overheating of the economies. Nevertheless, the growth trajectory in the EU10 remains steeper than in the EU15, as the EU10 has still vast potential to close the productivity gap with the EU15 through capital accumulation, skill development and technology absorption. Second, there are differences within the EU10. The impact is smallest in Poland, the only EU country with continuous growth over the last four years. But even in Poland, growth is unlikely to return to pre-crisis levels. Estonia, Latvia and Lithuania underwent the largest contractions during the crisis, but are rebounding with growth rates similar to those seen prior to the crisis (Annex Figure 1). Bulgaria, the Czech Republic, Hungary, Romania, Slovakia and Slovenia experienced both recession during the crisis and are now facing lower growth trajectories for the coming years. Lower growth translates into slower improvements in living standards and slower convergence, even though EU15 growth prospects have also weakened.

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Figure 53. Comparison of growth projections from April 2008 and November 2011 – EU10 and EU15 to 2012

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EU10 growth is not only weaker, but also more uncertain. Downside risks to the outlook have increased significantly. With around two-thirds of EU10’s exports going to the EU, and around four-fifths of EU10’s banking assets in foreign ownership, recent European and global tensions make adverse shocks more likely. In particular, a loss of confidence in sovereign debt and in the banking sectors’ asset sheets in the euro area could make investors more risk averse and spread to the EU10 (Box 2). In a severe tail-risk event affecting both the core and periphery of the euro area, the EU10 could face financial distress despite improved capital and liquidity positions of parent banks, subsidiaries, and domestic banks. However, liquidity support from the ECB and national central banks, support schemes from governments, and measures from host supervisors could limit spillovers to EU10 countries, as was the case during the crisis of 2008/09. Nevertheless, in such a scenario, European banking groups could still scale back their exposure to subsidiaries in the region over time, slowing down credit growth. The EU10’s policy challenges entail preparing for such short-term risks and boosting sustainable long-term growth. As discussed in the next sections, this will include supportive monetary policy, bolstering financial sector resilience, strengthening the fiscal framework, and advancing structural reforms.

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Box 2. EU10 and euro area – contagion channels

The principal channels of contagion between the euro area and the EU10, which includes the euro area member countries Estonia, Slovakia and Slovenia, are trade and financial flows.

While the EU10 countries make up only around 7.5 percent of the EU’s 2010 GDP, the wider euro area constitutes their largest market. For instance, over half of the total trade of the EU10 during the first three quarters of 2011 was with the euro area (EA) (Figure 54). Germany is the most important EU10 trading partner. The euro area was also the source of around four-fifths of the FDI flows into the region in 2009.

Figure 54. EU10 trade by destination Jan-Sept 2011


The banking sector is another channel of transmission, with almost four-fifths of the assets in the EU10 banking system being foreign-owned, and overwhelmingly so by euro area banks (Figure 55). The potential financial contagion would likely be transmitted mainly via this foreign-owned component of the EU10 banking system, as direct exposure to stressed euro area sovereign assets by the domestic EU10 banks is negligible.

Figure 55. Share of consolidated foreign claims


Source: Based on internal World Bank note.

Note: Chapter 4 of the October 2011 IMF Regional Economic Outlook for Europe discusses east-west linkages in Europe.

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Policies

Monetary and Financial Policy Monetary policy is likely to remain supportive for growth. The ongoing tensions in Europe’s financial markets have tightened financing conditions and undermined confidence, which are likely to dampen the pace of economic growth in the EU10 in late 2011 and beyond. The slowdown of the global economy is likely to moderate international commodity prices. With weak domestic and international demand, inflation rates are expected to go down, in spite of selective increases in indirect taxes and administered prices and exchange rate depreciation for some countries. At the same time, most countries have little room to slow the pace of fiscal consolidation in light of market pressures and large fiscal imbalances. Instead, monetary policy might be better suited to respond to the weaker economic outlook. Central banks might keep on hold further increases in policy rates, or even reduce them, as the economic recovery is losing strength and inflation pressures are receding. The pace and timing of the adjustment depends, among other factors, on the size of the output gap, the pass-through from international commodity prices and exchange rate volatility, and increases in taxes and administrative prices. Since the worsened economic outlook is likely to moderate price, cost and wage pressures going forward, the European Central Bank decreased in early November 2011 the key policy rate by 25 basis points to 1.25 percent (Figure 56). This reversed the increase in the policy rate of 25 basis points in April 2011. In response to the improvement in the short-term inflation outlook, the National Bank of Romania also cut its policy rate in early November 2011 by 25 basis points to 6.00 percent.

Bolstering the resilience of financial markets is also crucial for the recovery. The renewed market turbulence from the euro area periphery, along with concerns about the strength of the recovery in major economies, has also increased tension in EU10 markets. In view of the large foreign ownership of the EU10 banking system, reforms of EU financial markets are central for the EU10 region. Important recent steps included the acceleration of fiscal consolidation in some countries, the agreement of burden-sharing between the private and public sectors on Greek debt in the euro area, the decision to leverage the capacity of the temporary European Financial Stability Facility, the agreement on a coordinated mechanism to recapitalize euro area banks and boost their funding, and the strengthening of the economic and fiscal coordination within the euro area. Building on these measures, priorities going forward include a steadfast implementation of the agreed steps, with follow-up plans for recapitalization and restructuring, strengthening the euro area wide resolution mechanism, and bolstering the resilience and stability of the financial system through macro-prudential regulations, including at the global level. While the EU10 banking system is overall well-positioned to withstand further volatility, it is essential that supervisory authorities and banks assess risks prudently, make appropriate loan loss provisions, and increase capital as required.

Figure 56. Policy rates in selected EU countries and euro area


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Fiscal Policy Shoring up fiscal sustainability remains central for economic stability. With the recovery losing steam four years after the Lehman crisis broke, EU10 governments would like to focus on creating jobs and generating growth. Instead, putting the fiscal house in order remains a key preoccupation of policy makers. Markets pay close attention to fiscal balances as public debt levels increased during the crisis, economic prospects remain uncertain in the coming years and population aging is accelerating in the coming decades. While government bond spreads in the EU bore little relation to public debt prior to the crisis, bond spreads are now rising with higher public debt (Figure 57).

Figure 57. 5Y CDS spreads and public debt in the EU countries

Pre-crisis, 2008 Latest, Nov. 2011

Source: Eurostat, EDP notification October 2011, Bloomberg, World Bank staff calculation

As markets watch public finances closely, EU10 governments have proceeded with fiscal consolidation in 2011 in spite of weakening growth. Based on the October fiscal notifications, fiscal deficits are expected to go down across the region, reaching 4.0 percent of GDP in 2011, the lowest level in three years. The fiscal deficit reduction of 2.5 percent of GDP is slightly more than envisioned in spring, and somewhat more than what is expected for the EU15 (Figure 58). Fiscal balances improved in all EU10 countries. Only Slovakia is set to exceed the targeted fiscal deficit on the back of the Eurostat requirement to assign outstanding debt of state-owned railway companies and hospitals over 2008-2010 to 2011 (0.9 percent of GDP). Building on the substantial fiscal effort in 2010, Bulgaria is on track to meet its commitment to reduce the fiscal deficit below 3 percent of GDP under the EU’s excessive deficit procedure in 2011. While Hungary is well on track to meet its fiscal deficit target, the expected fiscal surplus relies to a large extent on one-off adjustments.

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800

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0 20 40 60 80 100

5Y CDS spreads, Nov 2011

Public debt as % of GDP, 2011

28

Figure 58. Planned and projected general government fiscal deficits in EU10 and EU15 countries, 2010-2011

Source: Eurostat, October 2011 EDP notifications, June 2011 Updates of Stability/Convergence Programs, World Bank staff calculations.

Fiscal consolidation along with the rebound in growth has helped to moderate the rise in public debt-to-GDP ratios in 2011. They are set to increase for the fifth year in a row, and somewhat more than was planned in spring. However, the increase in the EU10 is less than in the EU15, and public indebtedness relative to the size of the economies remains far lower in the EU10 than in the EU15. Public debt is set to be some 2 percentage points higher than projected in the June 2011 Convergence Program in Poland, as the depreciation of the zloty over recent months has boosted the local currency value of public debt denominated in foreign currency.

Figure 59. Planned and projected general government public debt in EU10 and EU15 countries, 2010-11


Elevated fiscal deficits have not spilled over into public debt service burdens thanks to low interest rates. Across the EU10, payments to holders of government debt remain largely unchanged from the last year, in line with plans. Thanks to strong fiscal credentials, the Czech Republic is set to keep its interest rate burden 0.3 percent of GDP below the projected amount. However, the recurrent volatility in euro area markets is a reminder how quickly doubts over fiscal solvency can trigger a loss of confidence in financial markets and a rise in interest rates.

‐6.6 ‐6.5

‐4.5‐4.0

‐5.0

‐4.2

‐7

‐6

‐5

‐4

‐3

‐2

‐1

0

EU15 EU10

2010 2011 Projected 2011 Planned

‐10

‐8

‐6

‐4

‐2

0

2

4

6

SK PL SI LT RO LV CZ BG EE HU


82.9

46.7

85.9

48.0

84.5

47.4

0

10

20

30

40

50

60

70

80

90

100

EU15 EU10


0

10

20

30

40

50

60

70

80

90

100

HU PL LV SI SK CZ LT RO BG EE


29

Figure 60. Planned and projected interest payments in EU10 and EU15 countries, 2010-11


Many EU10 countries have executed strong public investment programs in spite of the difficult fiscal situation. This helps to strengthen growth prospects without undermining fiscal balances to the extent that this spending is financed through EU structural funds which are over time budget neutral. Public investment is likely to have increased in 2011 in the EU10 but decrease in the EU15. Along with Latvia and Lithuania, Poland continues to step up public investment ahead of the Euro 2012 championships. In contrast, Estonia, Hungary and the Czech Republic have cut back on investment plans due to tight co-financing and implementation delays.

Figure 61. Planned and projected public investment in EU10 and EU15 countries, 2010-11


EU10 governments have tabled draft budgets that envisage further fiscal consolidation in 2012. In light of elevated fiscal deficits and continued market pressures, EU10 countries are moving ahead with fiscal adjustment. Most countries are still finalizing the draft 2012 budget for submission to parliament and aim to ensure that fiscal targets are met in spite of the weaker growth outlook. In many countries, key expenditure measures for bringing about the reduction in fiscal deficits are freezes or reductions in public sector wages and pensions, consolidation of discretionary spending and increases in the flexibility of government expenditures. All EU10 members have proposed freezing, or cutting, public wages, and Bulgaria, Latvia, Lithuania, Romania and Slovenia have taken steps to limit increases in public pension. Efforts on the expenditure side are in some countries complemented with measures to broaden the tax base and strengthen tax administration. Since the crisis has undermined the tax base and weakened tax compliance, such policies are crucial to bolster revenue collection.

2.72.2

2.92.3

2.8

2.3

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

EU15 EU10


0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

HU PL SI LT RO LV SK CZ BG EE


2.6

4.9

2.4

5.02.4

5.3

0

1

2

3

4

5

6

7

EU15 EU10


0

1

2

3

4

5

6

7

PL RO LT LV CZ BG SI HU EE SK


30

Table 2. Fiscal measures in 2012 draft budgets

Pensions

Public wages

New revenue measures

Freeze

Freeze (or cut)

VAT Direct Tax

Others

BG

CZ

EE

HU

LV

LT

PL

RO * *

SK

SI

Source: World Bank staff. Note: *In case of Romania, the public sector wage and pensions might be increased in the second half of 2012 if the economic situation improves sufficiently.

Fiscal deficits are set to decline noticeably between 2010 and 2012 through a combination of expenditure and revenue adjustments. The pace and the structure of the projected fiscal adjustment vary among the countries. This reflects mainly differences in initial fiscal positions, economy prospects, and market pressures. Countries with larger fiscal deficits are envisioning larger adjustments up to 2012, with Latvia, Slovakia, Romania, Poland and Lithuania envisioning adjustments of 3 percent of GDP or more (Figure 62). The planned fiscal consolidations aim to meet commitments to reduce fiscal deficits to below 3 percent of GDP in 2012 (Latvia Lithuania, Poland and Romania) and 2013 (Czech Republic, Slovakia, Slovenia). However, some countries still have to underpin the envisioned adjustments in fiscal balances through specific measures and prepare additional measures in case the economic outlook worsens further. Until 2012, most EU10 governments target mainly expenditure reductions, often of structural nature (Figure 63). This is justified for two reasons. Coming into the crisis, many countries had poor structural primary fiscal balances. This reflected the lack of progress in public expenditure reforms, generous spending and weak public expenditure controls. In addition, governments are unwinding increases in social expenditures intended to protect vulnerable populations during the crisis. However, such measures have to be balanced with the objective of maintaining effective provision of public services to poor and vulnerable families, also because such reforms are more sustainable. In addition, measures to improve revenue collection are needed, since the crisis led to permanent revenue losses as output declined and weakened tax compliance. Revenue measures can also help to make the fiscal adjustment fairer.

31

Figure 62. Decomposition of fiscal deficit adjustment into revenue and expenditures 2010 vs. 2012, percent of GDP

Source: June 2011 Updates of Stability/Convergence Programs, EC Autumn Forecast, November 2011, World Bank staff calculations.

Figure 63. Decomposition of fiscal deficit adjustment into cyclical and structural component 2010 vs. 2012, percent of GDP

Source: EC Autumn Forecast, November 2011, World Bank staff calculations.

EU10 countries have made further efforts in strengthening fiscal institutions. These measures can enhance the credibility of commitments to reduce debt-to-GDP ratios, and thereby strengthen market confidence in the sustainability of public finances. Medium-term budgetary frameworks, an effective budget process, and independent fiscal agencies that monitor policy design and implementation all make fiscal policy more effective (Table 3). For example, fiscal rules that limit public expenditure increases during an economic upturn could, together with multi-year and performance-based budgeting, contribute to sustainable fiscal finances over the long-term. Many EU10 countries have moved in this direction. For example, Latvia is preparing a new Fiscal Responsibility Law and constitutional amendments to strengthen the medium-term budgetary framework; and Poland is planning to introduce a permanent expenditure rule. Through amending its organic budget law, Bulgaria introduced an expenditure limit of 40 percent of GDP and a deficit limit of 2 percent of GDP effective from 2012 onwards.

‐4

‐3

‐2

‐1

0

1

2

3

4

5

6

CP/SP EC

CP/SP EC

CP/SP EC

CP/SP EC

CP/SP EC

CP/SP EC

CP/SP EC

CP/SP EC

CP/SP EC

CP/SP EC

CP/SP EC

CP/SP EC

EU15 EU10 LV SK PL RO LT BG SI HU CZ EE

Increase in rev Decrease in exp Deficit reduction

‐6

‐4

‐2

0

2

4

6

EU15 EU10 LV LT PL RO SK HU BG CZ SI EE

Structural Cyclical Overall

32

Table 3. European Council Recommendations on Fiscal Issues, Summer 2011

Fiscal Institutions Social Security Other

Bulgaria *Design FR and MTBF *Implement PR

Czech Republic *Implement PR *Improve efficiency of PI *Shift from labor to indirect taxation

Estonia *Improve efficiency of PE

Hungary *Implement fiscal framework *Broaden remit of FC

*Adopt permanent fiscal measures

Latvia *Introduce fiscal responsibility law

*Introduce comprehensive PR *Introduce targeted SSN

Lithuania *Introduce expenditure ceilings in MTBF

*Strengthen tax compliance

Poland *Introduce ER in 2013 *Strengthen coordination across levels of government

*Raise retirement age for uniformed services *Increase the effective retirement age *Initiate reform of farmers’ social security contributions

Romania *Reform tax administration *Improve PFM

Slovenia *Implement more binding MTBF

*Strengthen long‐term sustainability of pension system

Slovakia *Implement multi‐annual expenditure ceilings in 2012 *Introduce FC

*Strengthen long‐term sustainability of public pillar of pension system

*Increase environmental and property taxes and increase VAT collection efficiency

Notes: CD correction deadline; ER expenditure rule; FC fiscal council; FR fiscal rules; MTBF medium-term budgetary framework; PE public expenditures; PFM public financial management; PI public investment; PR pension reform; SSN social safety net

Source: WB staff, Official Journal of the European Union.

33

Structural Policy

Boosting competitiveness to bolster growth in a sustainable way makes a real difference in strengthening financial market confidence and fiscal sustainability. It can trigger a virtuous cycle between improving financial and fiscal balances sheets and a flourishing economy. Growth helps private and public sectors to bring debt levels in line with incomes, and to mobilize resources for investments and innovation. In expanding economies, governments have an easier time in lowering fiscal deficits and markets see less risk (Figure 64, Figure 65).

Figure 64. CDS spreads vs. GDP growth 2011 Figure 65. Fiscal deficit in 2011 vs. average GDP growth in 2011/12

Source: Bloomberg, EU10 World Bank staff forecasts for 2011 and 2012.

Structural reforms are also important to keep convergence to EU living standards on track. GDP is not as good a measure of well being as we would like it to be. However, GDP per capita, adjusted for difference in price levels, is still the most commonly used measure to proxy a country’s living standards. The EU10’s convergence to EU15’s income levels has proceeded during the crisis (Figure 66), although Estonia and Latvia have fallen behind due to the stark recession during the peak of the crisis. The EU10 reduced the gap to the EU15 from 47.6 percent in 2007 to 43.0 percent in 2010.

Figure 66. Comparison of GDP per capita 2007 and 2011 adjusted for purchasing power parities – EU10 Countries,

EU15 = 100

Source: Eurostat, World Bank calculations.

Revitalizing growth without bringing back the unsustainable pre-crisis domestic demand booms requires removing structural barriers. In response to the Europe 2020 strategy, EU member states submitted this April their National Reform Programs, in which they specified their reform priorities for the next years. In June, the European Council endorsed the country-

‐8

‐6

‐4

‐2

0

2

4

6

8

0 500 1000 1500 2000 2500

GDP growth in

2011

5Y CDS spreads in Nov 2011

‐4

‐3

‐2

‐1

0

1

2

3

4

5

6

‐10 ‐5 0 5

Average

GDP growth in 2011/12

Fiscal balance in 2011

58

40 41

49

57 58 5862

6875 78

0

10

20

30

40

50

60

70

80

90

EU10 BG RO LV LT HU PL EE SK CZ SI

2007 2011

34

specific recommendations to boost growth and employment (Table 3). However, all countries face an agenda of enabling workers and entrepreneurs to contribute to and benefits from economic prosperity. Easing the cost of doing business remains central to these efforts (Box 2).

35

Table 4. European Council Recommendations on Structural Reform Agenda, Summer 2011 Human capital development Governance and public

procurement Energy and transport Business Environment

Labor market and wage policy Education and early child care

BG *Ensure longer stay in employment for older workers *Increase effectiveness of PES in ALMPs *Link skills with labor market needs *Strengthen link between wage policies and productivity growth

*Promote social inclusion of vulnerable groups *Advance the reform in pre‐school / school and higher education

*Improve governance and quality of public administration *Introduce better control of public procurement

*Liberalize gas and electricity markets *Introduce incentives for EE investment in buildings

CZ *Increase effectiveness of PES in ALMPs *Promote flexible forms of employment *Increase LM participation

*Increase availability of early childcare facilities *Introduce quality evaluation in tertiary education and link it to funding

*Implement anti‐corruption strategy *Adopt Public Servants Act

EE *Increase effectiveness of ALMPs *Reduce tax wedge in budgetary neutral way

*Increase availability of pre‐school education *Enhance availability of vocational education and LL programs

*Increase EE in buildings and transport

HU *Increase effectiveness of PES in ALMPs *Alleviate the impact of tax reform on low‐earners *Increase LM participation of women

*Expand pre‐school and early child care facilities

*Implement regulatory reform *Lower the administrative burden for businesses *Improve SME access to non‐bank financing

LV *Increase effectiveness of ALMPs

*Reform pre‐school and higher‐education

*Improve governance and public admin through HRM institution *Improve public procurement system *Remove bottlenecks to EU funds use

*Increase EE

*Improve business environment *Privatize state‐owned banks

LT *Promote flexible forms of employment *Reduce disincentives to work embedded in social assistance programs

*Improve EE in buildings *Strengthen competition in energy sector

*Improve business start‐up conditions and construction permits *Reform SOEs

PL *Link education with labor market needs *Increase LM participation of women

*Implement LL strategy *Enhance vocational education *Strengthen links between science and industry *Expand pre‐school and early child care facilities

*Introduce incentives for EE investment *Develop cross‐border electricity grid connections *Develop plan for railway investment *Implement rail master plan

*Simplify legal procedures involved in enforcing contracts *Revise construction and zoning legislation

RO *Streamline wage setting institutions *Increase labor supply incentives *Reduce undeclared work

*Remove bottlenecks to EU funds use

SI *Increase effectiveness of ALMPs *Reduce asymmetries between permanent and fixed term contracts *Evaluate PES *Link skills with labor market needs

*Promote LL programs *Improve business environment *Increase access to credit, improve banks’ balance sheets

SK *Increase effectiveness of PES in ALMPs *Reduce tax wedge for low‐paid workers *Link higher education with labor market needs

*Reform general and vocational education *Promote LL programs for low‐skilled

*Improve public procurement system *Increase transparency of the judicial system

Notes: LL – lifelong learning, PES – public employment service, EE – energy efficiency, HRM – human resources management. Source: WB staff based on European Council Recommendations on National Reform Programs and Convergence/Stability Program Updates, Summer 2011.

36

Box 3. Doing Business 2012 for the EU10 region

The World Bank’s Doing Business 2012 report indicates that the EU10 has fallen behind in the ranking over the last year as the pace of reforms slowed compared to other regions. The report assesses regulations affecting domestic firms in 183 economies, and ranks the economies in 10 areas of business regulation, such as starting a business, resolving insolvency, and trading across borders. The study’s methodology expanded this year to include indicators on getting electricity connections.

In Doing Business 2012, the EU10 is ranked in 47nd place worldwide, a slippage of two places relative to last year's recalculated ranking, and of four places relative to the old methodology. The EU10 ranks thirteen places behind the EU15. While the EU10 performs better than the EU15 in the areas of registering property, getting credit and starting a business, it has room for improvement in the areas of enforcing contracts, dealing with construction permits, paying taxes and closing a business (Figure 54).

Figure 67. Average EU10 and EU15 Rankings in Doing Business 2012

Source: World Bank staff calculations.

Estonia, Latvia and Lithuania are the most business friendly countries in the region. They perform better than the EU15 average (Figure 68). Among the EU10 countries, Estonia is the best-performer on trading across borders, and paying taxes, Latvia on getting credit and resolving insolvency, and Lithuania on registering property, enforcing contracts and dealing with construction permits (Figure 69).

Figure 68. Ease of Doing Business rank in 2012 and the change since 2011

Figure 69. Best performers in EU 10 by reform area

Source: World Bank staff calculations. Source: World Bank staff calculations.

The 2012 Doing Business Report shows that the EU10 made 18 reforms which made doing business in the region easier (Table 5). Six countries made resolving insolvency easier for firms; three took steps to facilitate registering property; three smoothed trading across borders; one made accessing credit easier; and two made improvements in credit access. Of these 18 reforms, seven involved increased use of

47

72

92

4433

69

98

54 5059

33

65

47

76

54

7155

2838

23

0

20

40

60

80

100

120

Ease of Doing

Business

Starting a Business

Dealing with

Construction Perm

its

Registering Property

Getting Credit

Protecting investors

Paying Taxes

Trading Across

Borders

Enforcing contracts

Resolving Insolvency

EU10 EU15

47

33

21 24 2737

48 5159 62 64

72

‐1

‐2

10‐6

‐2

0

‐5‐5

‐2‐3 6

‐7

0

10

20

30

40

50

60

70

80

EU10 EU15 LV EE LT SI SK HU BG PL CZ RO

213 4 7 15

2428

32

4751

LV

EE LV LTLT

SISI

LV

LTEE

0

10

20

30

40

50

60

Ease of Doing Business

Trading Across Borders

Getting Credit

Registering Property

Enforcing contracts

Protecting investors

Starting a Business

Resolving Insolvency

Dealing with

Construction Perm

its

Paying Taxes

37

information technology, for example, by allowing for the payment of taxes or the submission of documents online, notably to register property or submit customs forms. Across the region, particularly good progress was made in indicators related to access to credit with most countries increasing the percentage of adults covered by private credit bureaus. Significant progress was also made by some countries in reducing the amount of time required to trade across borders. For example, Bulgaria introduced online submission of customs declaration forms.

Table 5. “Easing Doing Business” and “Burdening Doing Business” reforms in Doing Business 2012

Source: World Bank staff calculations.

The rankings of Estonia, Hungary and Romania declined five places or more over the last year.* They introduced measures that made doing business more difficult. Estonia introduced a municipal sales tax in Tallinn and Hungary a sector-specific surtax. However, these are both short-term taxes designed to raise necessary funds in the difficult economic climate and both will be eliminated by 2013. Aside from such temporary fiscal measures, Hungary made accessing credit more difficult by making reducing the amount of information available from private credit bureaus; Romania made starting a business more difficult by requiring a tax clearance certificate for a new company’s headquarters before company registration; and Lithuania made getting electricity more difficult by abolishing the one-stop shop for obtaining technical conditions for utility services.

While fiscal consolidation is important for market confidence, EU10 countries need to be cautious about introducing reforms that make doing business more burdensome. It is important to continue structural reforms to progress towards the EU15 standard. In addition, many countries outside the region, including South Korea, Malaysia, and Macedonia, continue making fast progress in easing doing business. Past year’s experience suggests that greater use of information technology can facilitate procedures for firms.

Source: World Bank staff, http://www.doingbusiness.org/

*For Dealing with Construction Permits, Estonia’s data point on cost was corrected. Rankings will be adjusted in the next published report.

BG CZ EE HU LV LT PL RO SK SI

Starting a business 1 1

Dealing with construction permits 0 0

Getting electricity 1 1

Registering property (E) (E) (E) 3 0

Getting credit 1 1

Protecting investors 1 0

Paying taxes (E) 2 2

Trading across borders (E) (E) (E) 3 0

Enforcing contracts 0 0

Resolving insolvency 6 0

Easing Doing Business reforms 2 2 0 0 4 2 2 2 1 3 19

Burdening Doing Business reforms 0 0 1 2 0 1 0 1 0 0 5

(E) indicates an Electronic (Information Technology) related reform

38

Annex Figure 1. Comparison of growth projections from April 2008 and November 2011 – EU10 countries

April 2008 forecasts November 2011 forecasts

80

90

100

110

120

130

140

2005 2006 2007 2008 2009 2010 2011 2012

Bulgaria

80

90

100

110

120

130

140

2005 2006 2007 2008 2009 2010 2011 2012

Czech Republic

80

90

100

110

120

130

140

2005 2006 2007 2008 2009 2010 2011 2012

Estonia

70

80

90

100

110

120

130

140

2005 2006 2007 2008 2009 2010 2011 2012

Latvia

80

90

100

110

120

130

140

2005 2006 2007 2008 2009 2010 2011 2012

Hungary

80

90

100

110

120

130

140

2005 2006 2007 2008 2009 2010 2011 2012

Lithuania

80

90

100

110

120

130

140

2005 2006 2007 2008 2009 2010 2011 2012

Poland

80

90

100

110

120

130

140

2005 2006 2007 2008 2009 2010 2011 2012

Slovenia

80

90

100

110

120

130

140

2005 2006 2007 2008 2009 2010 2011 2012

Romania

80

90

100

110

120

130

140

2005 2006 2007 2008 2009 2010 2011 2012

Slovakia

39

Introduction1

As EU10 governments are struggling to respond to high unemployment and low labor productivity, there is a renewed urgency in addressing the skills gap. Along with measures to strengthen labor market and structural policies, education policies are central in tackling skills mismatch. This note discusses that better information is vital for government to reform the education system in order to bridge the skills gap.

Paradoxically, for a region with relatively high and expanding educational attainment (as measured by the number of years of completed schooling) and relatively high-quality education in the early years of schooling, a shortage of worker skills has emerged as one of the most important constraints to firm expansion in the countries in EU10. A recent regional World Bank publication entitled “Skills, Not Just Diplomas” looks at the 29 countries located in Eastern Europe and Central Asia (ECA) and seeks to answer the questions: Why do ECA firms increasingly complain that they cannot find graduates with the right skills? What can ECA countries do to close the skills gap?

A main message of the book is that policy makers cannot design policies to close skills gaps unless they first close an important information gap: across the region, data exist on the number of students who graduate (i.e., how many diplomas are issued), but internationally comparable data on whether graduates of upper secondary and tertiary institutions (from which the bulk of ECA graduates now enter the labor market) have the right skills and competencies for the job market do not exist. To close this gap, more tests to measure students, graduates and adults’ skills and competencies are needed. Moreover, to better understand graduates’ transition (or lack thereof) from their education institution to a job, tracer studies – surveys that survey graduates 1, and 5 years after graduation) are needed. Similarly, better and more detailed firm surveys on what skills firms cannot find are needed: is it technical, cognitive or non-cognitive (or socio-emotional) skills that they cannot find? Only by understanding better what firms demand and what education institutions supply, can policy makers design effective policies to improve the matching.

Better information is not only needed by policy makers; firms and students need better information to help them make informed decision and become a stronger force in pushing education and training facilities to improve course and program’s alignment with labor market needs. One of the first large big decisions in the life of a young adult is the decision of what and where to study. Currently, this decision is being made in ECA’s countries without very limited information about likely employment and earnings prospects.

This “focus note” summarizes the messages from Skills, Not Just Diplomas that relate to the darkness that cloud the skills debate, and presents the report recommendations on how to “turn the lights on” in this debate.

The skills challenge is real: firms struggle to find skilled workers The European Bank for Reconstruction and Development (EBRD)–World Bank Business Environment and Enterprise Performance Surveys (BEEPS) show that ECA firms’ perception of skills constraints changed dramatically around 2005. By 2008, skilled labor shortages had become the second most commonly reported constraint to growth in the BEEPS survey across all countries in the region, second only to tax rates (Figure 70). On average, 30 percent of firms considered education and skills to be a major or

1 This Focus Note prepared by Lars Sondergaard is based on the World Bank report “Skills, Not Just Diplomas: Managing Education for Results in Eastern Europe and Central Asia”. The report can be downloaded in its entirety from http://www.worldbank.org/eca/skills.

EU10 November 2011 In Focus: Skills, Not Just Diplomas

40

severe constraint in 2008. The highest proportion of firms reporting constraints were found among the middle-income CIS countries, where upwards of 40 percent of firms were dissatisfied with the availability of skilled workers. A smaller proportion of firms in the Western Balkans reported similar levels of dissatisfaction, with significant variability in the dissatisfaction levels of firms in the EU10 and Turkey (BEEPS dataset 2008). While the recession may have provided something of a respite from these labor shortages, as the economies in the region recover, labor demand will tighten once again and skilled labor shortages will likely be worse than before.

Figure 70. Distribution of Firms in ECA Region that Consider Worker Skills a “Major” or “Very Severe” Constraint, 2008

Source: Authors’ calculations based on BEEPS 2008.

Note: LI = Low Income, MI = Middle Income, x = % of firms (in respective countries) that consider education as an obstacle, Figure shows data obtained from the fourth round of the BEEPS carried out in 2008–09, which covered approximately 11,800 enterprises in 29 countries.

To understand what skills firms are struggling to find, additional surveys were carried out in a number of countries in the region to probe further. In principle, the fact that firms are increasingly complaining about shortages of skilled works could imply a number of things: first, graduates may not have the necessary technical skills to do the jobs that employers have on offer. This is not solely a matter of educational attainment, that is, of completing a certain level of education. It is also a matter of whether students have the skills needed on the job—the relevant knowledge, the ability to apply that knowledge, and the know-how to complete tasks and solve problems—when they graduate. Second, graduates of education and training systems in the region may lack the necessary behavioral (or “soft”) skills needed by employers, such as job attitudes and teamwork skills (see Box 4 for the different types of skills that firms may be seeking). There is widespread evidence from across the ECA region that firms seek graduates who not only have knowledge as well as technical and general skills, but who also have behavioral skills. For instance, recent surveys of employers in Poland (Figure 71) show that firms – both innovative and traditional firms -- value such behavioral skills as highly (in some instances, more highly) as knowledge and routine cognitive skills (e.g., mathematics, computer skills)—important as the latter may be 21.

41

Figure 71. Employers’ Valuation of How important the following type of skills are in prospective workers, Poland, 2008

Sources: World Bank 2010b.

Box 4. Higher-Order Skills for the World of Work in the 21st Century

In common-day language, the term “skills” tends to be associated with skills that involve manual dexterity -- that is skill and grace in physical movements -- and the use of methods, materials, tools and instruments. These are the skills commonly associated with vocational schools and with specific occupations. In Skills, Not Just Diplomas, these skills are referred to as “technical skills”.

However, it is now widely recognized that individuals need a broad set of skills to succeed in life and in the work place. Therefore, in Skills, Not Just Diplomas use the term “skills” more broadly to talk about three distinct type of skills: (1) “cognitive”; (2) “non-cognitive” (or socio-emotional skills); and (3) technical skills. Cognitive skills are skills that involve the use of logical, intuitive and creative thinking. And the skills commonly associated with cognitive skills are skills such as verbal ability, numeracy and problem solving skills.

However, evidence is emerging that non-cognitive skills are as important to succeed in life (e.g. see World Bank 2011 for recent evidence from Peru). In common-day language, non-cognitive skills are often called interpersonal, soft, or life-skills and they are closely related to what common-day language might also call “personality traits”: “self-regulation”, perseverance, decision making skills, team skills, and the ability to set life goals and preserve in their pursuit.

At present, standardized tests of secondary school students measure cognitive skills – both basic cognitive skills such as the ability to read as well as some higher-order cognitive skills such as critical thinking and analytical reasoning, but not behavioral skills. Recent research in Peru provides an example of how to incorporate the testing of behavioral skills into regular household surveys (see World Bank 2011b).

Source: Authors, based on OECD (1999a) and materials available on the following Web sites: State Secretariat for Economic Affairs of Switzerland (www.seco.admin.ch), Australian National Centre for Vocational Education Research (www.ncver.edu.au), American Society for Training and Development (www.astd.org); all URLs accessed September 2010.

0

10

20

30

40

50

60

70

80

Advanced technical/vocational

Basic technical/vocational

Literacy

Problem solving

Use of inform

ation and

communication technology

Numeracy

Foreign language

Responsibility and reliability

Motivation & commitmen

t

Team

‐work ability

Communication

Initiative and ability to work

independently

Planning and organizing

Customer care

General and technical skills "Soft skills"

% of firm

s responding

Innovative firms Traditional firms

42

What skills is it that education and training institutions are failing to deliver?

From the surveys of firms, it is clear that – from the demand side – there is a perception that skills are not being provided. Turning to the supply side, it is a lot more difficult to pinpoint where, exactly, education and training institutions are failing to deliver them. The main problem – and this is a worldwide problem – is that that educational data tends to focus on quantity—for example, the number of enrolled and graduating students—and not the skills that students acquire (or fail to acquire). Moreover, data exists on the education attainment of the adult population but not on their mastery (or lack thereof) of technical, cognitive and non-cognitive skills. Where international comparative data are available, they focus on the quality of primary or lower secondary education. This focus on inputs and on youngster’s level of skills is particularly problematic because very few young people in the region enter the labor market with only a lower secondary education. As Figure 72 shows, most ECA students complete at least an upper secondary degree. But with no international assessment of the skills and competencies of upper secondary or tertiary graduates, it is impossible to quantify the gap in competencies between recent labor market entrants in, say, Poland and Germany. The data that is available today documents how many students graduate in a particular year, not what they offer employers in terms of competencies.

Figure 72. Educational Background of 25–34-year-olds in the ECA Region, 2006

Source: Author’s calculations, based on EBRD-World Bank 2006

Lack of relevant data on students and their individual performance is particularly acute in the vocational sector because of the large variety of vocational schools in the ECA region and the (likely) heterogeneity of their student populations. The tendency of educational data to focus on quantity, rather than quality and relevance, is also acute in adult education and training. At best, current surveys in that sector measure the number of training hours and courses in which individuals participate, or whether a firm offers training. But no international comparative data yet exists to compare the quality or relevance of such training.

Similarly, with enrollment in universities booming across the region, the lack of tests to measure the skills that students acquire during their studies is particularly constraining in terms of pinpoint problem areas. At the current juncture, neither students, employers nor policy makers know whether students acquiring skills and knowledge during their years of study. And, no one knows where in the system – e.g. by fields of study, by type of university –students are on a particular steep learning curve compared to other places. In part, such information exists for certain professions where the profession itself has developed “professional exams” to certify that graduates are qualified. In many countries, such professional exam exists for lawyers, for teachers, for medical doctors and for architects. However, in many countries, in many countries the largest growth in enrollment has been in areas for which there are no professional certification exams, e.g. in economics, and business.

Moreover, even these “professional exams” have their limitations in terms of the evidence of they generate on skills: they only generate for graduates who decide to take the exam; and they only

143

2712

63

61

57

56

61

31

2540

1726

6

0

10

20

30

40

50

60

70

80

90

100

EU+1 Mid‐CIS W. Balkans Low‐CIS Turkey

Compulsory or less Upper secondary Beyond upper secondary

43

provide a pass-fail score, not an assessment of the mastery each graduate has vis-à-vis particular desired competencies (e.g. in the form of a score on a scale from 1-100). And, alongside the exam, no socio-economic and other background information about the students are collected, making it impossible for a researcher to parse out whether a graduate’s performance on the exam is due to the value-added of the university, or due to he student’s background characteristics (e.g. parental education background, high school graduation marks etc). Take the following concrete example of how this gap in data on skills limit the ability of key actors in taking informed decisions and improving the quality of the sector: In Romania, there are 41 HE institutions teaching finance: 22 private and 19 state:

Student’s perspective: which institution does a better job at teaching me the skills I need to succeed? Without such information, the powerful force of students “voting with the feet” is significantly limited.

Employer’s perspective: which graduates outside of the prestigious institutions (which may already have found jobs) have acquired mastery of skills and competencies that my firm needs?

Higher education institution’s (teaching finance) perspective: how does my program compare to other programs? Are my students acquiring as solid mastery in the core competencies in this field as other institutions? If so, how do I demonstrate that to prospective students, and potential employers of my graduates?

Policy maker’s perspective: how does the performance (in terms of quality and relevance of the education provided) compare with other fields? Which institutions are doing a good teaching imparting skills, and which are not? Which institutions need more support/guidance?

Turning the lights on

To provide policy makers with the information needed to design better policies, and for students to become a stronger force to vote with their feet, the report recommends the following ways of “turning the lights on”:

• Continue participation in international assessments (e.g. TIMSS2 and PISA3)

• Expand the use of national assessments of student, placing more emphasis on identifying strengths of weaknesses of the education and training systems as opposed to only testing students (e.g. are there groups of students that systematically fail to acquire the desired level of competencies?).

• Introduce graduate tracer studies to track whether graduates find job (see Box 5)

• Introduce tests of skills of tertiary students

More data, alone, will not result in better policies; information has to be analyzed, dissemination and used for policy making. Countries that have succeeded in getting data on student performance used for policy making – e.g. Singapore, Poland, or Chile provide lessons for others to replicate. Some of these lessons include:

• Building (domestic) technical capacity to design and analyze tests. In Singapore, this capacity was gradually build by working closely with Cambridge University researchers who, initially, designed and ran the tests. In Chile, the initial analysis was done on a pilot basis by a local university. Only gradually, was the assessment function moved to an autonomous agency.

• Expanding access to data sets to encourage researchers to identify strengths and weaknesses. For instance, the OECD makes the entire PISA dataset publicly available for researchers to download online (http://pisa2009.acer.edu.au/; accessed December 2010).

• Changing policies to make data matter, such as making improved student learning outcomes a component of teacher and school evaluations. (If the results of assessments have no impact, whether directly or indirectly, on policies or people’s careers, it is very difficult to mobilize and sustain resources to maintain assessment centers and train people to analyze results.)

2 Trends in International Mathematics and Science Study 3 Program for International Student Assessment (www.pisa.oecd.org)

44

• Actively disseminating results to all levels of the education system to ensure that curriculum design, and teacher training can be influenced by the strengths and weaknesses identified by the test results.

Box 5. Are graduates getting a job? Introducing graduate tracer studies in Romania and Hungary

With respect to tracer studies, two countries in the region—Hungary and Romania—are making rapid progress. In fact, these studies are becoming a core element of tertiary management in these countries. In Hungary, 2010 marked the first year that results from the new “Graduate Career Tracking System” were produced (spanning graduates from 25–30 institutions). This project is the culmination of work that began in 2008 and involved 30 ongoing EU-financed projects. In Romania, data from a graduate survey will be available in 2011. By that time, policy makers will have results from surveys of students who graduated in 2008–09 (i.e., 12 months after they graduated), as well of students who graduated in 2004–05 (i.e., five years after they graduated). As is the case with Hungary, the development of the tracer study in Romania is being financed by EU Social Funds.

Hungary is moving ahead rapidly on tracer surveys for several reasons. In the first place, central policy makers in the country are pressuring tertiary institutions to start collecting such data. The 2005 Higher Education Act of Hungary, for example, makes it mandatory for every university and college to carry out surveys of graduates. The central government has also made tracer studies a part of quality assurance discussions, with the availability of such surveys now (or soon to be) tied to institutions’ accreditation agreements. In addition, the government is using the power of the purse, tying tracer survey data (or their availability) to three-year financing agreements. In the second place, institutions of higher education in Hungary themselves consider tracer data useful for a number of reasons: (1) they want labor market feedback to help them design better programs; (2) the data can be used in marketing; (3) the data is valuable for internal quality assurance; and (4) tracer surveys are one of many engagement tools for strengthening an alumni network.

Similarly, several OECD countries provide examples of how data on graduation can be collected and disseminated. Norway has tracked such data since 1972; Italy, since 1998; and the Netherlands, since 1989. In the Netherlands, almost all graduates of higher education institutions are surveyed a year and a half after they graduate. The survey collects comprehensive information on a range of different topics, including information on the school-to-work transition (asking such questions as: How long did it take to find a job? Did it involve unemployment spells?); the type and quality of employment, if any (e.g., sector and educational and skills requirements); and students’ satisfaction with the education that they have completed (Did it provide a solid basis for entering the labor market? Did it develop the relevant skills? Did it achieve the right mix between practical and theoretical knowledge?). Table 1 below shows the types of information that the survey collects.

Table 6. Information Collected from Tracer Study of Dutch University Graduates, 2007

Source: Table provided by the Research Centre for Education and the Labor Market (ROA), The Netherlands, 2008, at request of the author.

Duration

of job

search

(in

months)

Full time

employment

(%)

Unlimited

term

contract

(%)

Managerial

or

professional

(% ISCO 1 or

2)

High

utilization

of skills

(%)

High job

satisfaction (%)

Mean Mean Mean Mean Median Mean Mean Mean

Science and math 0.7 88.4 45.6 2499 2429 83.6 71.0 77.5

Medicine and health 0.7 79.0 41.0 2904 2783 82.6 78.9 81.7

Engineering 1.0 94.4 66.2 2772 2631 87.4 75.2 72.8

Economics 1.0 96.1 71.3 2954 2783 70.3 65.6 70.1

Law 1.2 92.7 57.5 2864 2732 87.8 66.0 70.2

Humanities and arts 1.2 59.1 43.0 2188 2226 66.0 50.4 61.3

Social sciences 1.3 60.6 45.4 2317 2350 72.0 63.9 65.4

Agriculture 1.5 86.7 45.6 2137 2328 84.2 73.2 71.2

Monthly gross

income (euros)

45

World Bank initiatives to help close the information gaps Across the globe, policy makers in the field of education are increasingly focusing on whether their systems provide the skills demanded by firms. And, across the world, the message from the World Bank’s analytical work has been the same: to close the skills gap, the information gap has to be narrowed.

As a result, the World Bank has developed and launched skills and employer surveys that will be launched in 2012 in more than 17 countries around the world. The firm surveys will be probing what, exactly, firms are looking for in terms of skills needs. And skills surveys measuring both cognitive and non-cognitive skills will be administered to representative samples of the entire populations – not just youngsters. The surveys will be administered during the early part of 2012 with results available later that year.

Similarly, to better understand the policies and institutions that support high performing education and training systems, the World Bank has launched an ambitious global initiative called “SABER”: System Assessment Benchmarking for Education Results4. SABER is one of the most ambitious undertaking the World Bank’s education sector have embarked on: across the globe, teams are in the process of developing and piloting “SABERs” in key thematic areas ranging from “assessment systems”, “teacher policies”, early child development – and, most closely related to the skills agenda, “workforce development”. The aim of SABER is to have frameworks to organize how policies are discussed within each of these thematic areas; to provide tools for diagnosis; to facilitate self-evaluation and comparisons; highlight areas for improvement; identify areas for further research, and inform the policy dialogue.

Notes The countries included in the Europe and Central Asia (ECA) Region include Albania, Armenia, Azerbaijan, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Georgia, Hungary, Kazakhstan, Kosovo, Kyrgyz Republic, Latvia, Lithuania, the former Yugoslav Republic of Macedonia, Moldova, Montenegro, Poland, Romania, the Russian Federation, Serbia, the Slovak Republic, Slovenia, Tajikistan, Turkey, Turkmenistan, Ukraine, and Uzbekistan.

4 For more information about SABER, please visit http://www.worldbank.org/education/saber

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