ROMANIA’S PATH TO PROSPERITY

Systematic Country DiagnosticOnline Consultations

October 18 – November 30, 2017

OUTLINE OF PRESENTATION

1

1. Purpose and Process of the Systematic Country Diagnostic (SCD)

2. Romania Country Context

3. Recent Poverty and Shared Prosperity Patterns

4. What Should Romania Do to Boost Its Long-Term Growth Potential?

5. How Can the Benefits of Growth Be Spread More Equitably Across Society and Regions?

6. How Can Growth Be Made Environmentally Sustainable?

7. How Can Institutions be Strengthened to Achieve Sustainable and Equitable Growth?

PURPOSE AND PROCESS OF THE SCD

2

The purpose of the SCD is to identify a set of priorities through which a country may most

effectively and sustainably reduce poverty and increase shared prosperity;

SCD will help the World Bank Group define its strategy for Romania for the period 2018-

23 as part of a new Country Partnership Framework;

SCD takes stock of key development challenges in Romania and progress attained;

SCD identifies and, where possible, fills in the existing knowledge gaps;

SCD process includes intensive consultations with key stakeholders across private sector,

civil society, academia, local and national public authorities and other sectors.

SOCIAL AND REGIONAL

DISPARITIES

LARGE INFRASTRUCTURE

GAP

HIGH LEVEL OF POVERTY

INCOMPLETE INSTITUTIONAL CONVERGENCE

HOW CAN ROMANIA REACH THE TWIN

GOALS OF REDUCING POVERTY

AND ENHANCING SHARED

PROSPERITY?

Boosting the Economy’s Growth

Potential

Making Growth More Inclusive

Greening Growth

LOGICAL FRAMEWORK

Strengthening Institutions

DEMOGRAPHIC CHALLENGES

LOW QUALITY OF GROWTH

A CONDITIONAL SUCCESS IN REDUCING MACROECONOMIC

VULNERABILITY

ROMANIA’S CONVERGENCE WITH THE EU-28 IS STILL SOME WAY OFF

5

Czech Republic

Slovakia

Hungary

Poland

Romania

Bulgaria

EU-28

Portugal

25

35

45

55

65

75

85

95

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

20

20

20

21

GDP per capita, EU-28 =100 (PPS)

Source: Eurostat, projections 2017-2020 based on the last five-year growth average

Number of years to achieve convergence with EU-28

Romania’s growth rate

Number of years

4% 29

5% 19

6% 14

7% 11

8% 9

Source: WB staff calculations based on Eurostat data on GDP per capita in PPSNote: Annual growth rate of EU-28 is equal with EU-28 last five-year growth

POOR QUALITY OF GROWTH

6

-5

-3

-1

1

3

5

7

9

2010 2011 2012 2013 2014 2015 2016

in percentPublic ConsumptionGross fixed capital formationPrivate ConsumptionNet exportsGDP

Contributions to Annual GDP Growth(expenditure approach)

Source: Eurostat, WB staff calculations

• Consumption is the main driver of growth while the weak performance of investment negatively affects the potential of the economy.

• Romania’s external position has improved, but recent consumption boom has reversed the trend.

• Pro-cyclical fiscal behavior widened the fiscal deficit and threatens the stability of public debt.

SECTORAL DRIVERS OF GROWTH REFLECT THE STRONG PERFORMANCE OF PRIVATE CONSUMPTION

7

Contributions to Annual GDP Growth(production approach)

Source: Eurostat, WB staff calculations

• Wholesale and retail trade are driving growth in recent years reflecting robust domestic demand

• Romanian ICT is one of the main contributors to growth and the 5th largest (as % of GDP) in the EU as of 2016.

• Romanian agriculture still has a higher impact on GDP growth compared to regional peers.

-6

-4

-2

0

2

4

6

2010 2011 2012 2013 2014 2015 2016

in percent

Wholesale and retail trade, transport, accomodation and food service activitiesInformation and communicationIndustryProfessional, scientific and technical activities; administrative and support service activitiesConstructionAgriculture, forestry and fishing

A PRECARIOUS SUCCESS IN REDUCING POVERTY AND SHARING

PROSPERITY

PROGRESS IN POVERTY REDUCTION

9

7000

7500

8000

8500

9000

9500

10000

10

15

20

25

30

35

40

45

50

$5/day poverty (2005 PPP)At risk of poverty or social exclusion (AROPE)Anchored at-risk-of-poverty rateGDP per capita (constant 2005$) (right axis)

Source: WB ECAPOV, WDI and EUROSTAT Source: WB Staff estimation using EU-SILC 2013

• Success in poverty reduction in the last decade

• Poverty reduction was partially reversed by the crisis

• Poverty remains the highest in the EU, significantly higher than in Bulgaria, Poland

Poverty at $5/day

LARGE DISPARITIES PERSIST ACROSS SOCIAL GROUPS AND ACROSS REGIONS

10

Poverty rates by occupational status: self-

employed, unemployed, inactive vs employees

Poverty for people with primary education is ten times higher than for people with tertiary education;

70 percent of Roma vs 25 percent general pop are poor.

At-risk-of-poverty rate by NUTS3 region, 2011

Source: World Bank, 2016.

SYSTEMATIC COUNTRY DIAGNOSTIC PILLAR I

BOOSTING THE ECONOMY’S GROWTH POTENTIAL

GROWTH HAS BEEN DRIVEN BY PHYSICAL CAPITAL

ACCUMULATION AND EFFICIENCY GAINS (TFP)12

6880

50

3

3

-1

-22 -22-5

5038 56

1

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2000-2016 2000-2008 2009-2016

Sh

are

of

Re

al G

DP

Gro

wth Capital Stock (α * gK)

Labor ((1-α) * gL*)

Human Capital per Labor ((1-α) * gh)

Total Factor Productivity(gA)

Total Period

Source: World Bank calculations, based on a human capital adjusted Solow model

Efficiency gains (TFP) have been an important driver of Romania’s growth (transition to a market economy)

A higher growth trajectory can be attained with more and better investment in physical and human capital and productivity improvements within firms (competition, skilled labor and technological upgrading)

CORRECTING MISALLOCATION OF RESOURCES WOULD INCREASE AGGREGATE PRODUCTIVITY

13

2.78

2.06

0.22

2.19

1.71

0.53

0.0

0.5

1.0

1.5

2.0

2.5

3.0

State Control Barriers toEntrepreneurship

Barriers to Trade andInvestment

Romania OECD Average

In Romania misallocation is likely due to weak competition in regulated sectors with spillovers for the rest of the economy.

Source: OECD indicators of product market regulation (PMR) 2013.

Product market regulation index (0-6 from the least to most restrictive)

REMOVING BARRIERS TO AGGLOMERATION OF ECONOMIC ACTIVITY IN REGIONAL GROWTH POLES WOULD INCREASE AGGREGATE PRODUCTIVITY

14

.

0

20,000

40,000

60,000

80,000

100,000

120,000

Bu

lgaria

Ro

man

ia

Latvia

Hu

ngary

Eston

ia

Po

land

Lithu

ania

Po

rtugal

Czech

Re

pu

blic

Sloven

ia

Cro

atia

Slovakia

Gre

ece

Spain

Un

ited

Kin

gdo

m

Germ

any

Finlan

d

Italy

Au

stria

Ne

therlan

ds

Swe

de

n

Den

mark

France

Belgiu

m

Irelan

d

PP

S

National Primary city Secondary cities

Romania’s secondary cities are lagging

Source: Eurostat. Note: GDP per Employed person (PPS) in 2014, employed persons include both employees and the self-employed.

Cities and functional urban zones are performing below their economic potential

REMOVING CONTRAINTS TO WITHIN-FIRM PRODUCTIVITY

15

Romania is a modest innovator

34

3.5.1. RESEARCH AND INNOVATION (R&I)

Structural shortcomings in the R&I system are

holding back its growth contribution. Structural

challenges to R&I remain unchanged (European

Commission, 2016a). These include insufficient

funding, institutional fragmentation, low quality of

the public science base, and weak public-private

collaboration. In 2015, the European Innovation

Scoreboard (European Commission, 2016j) placed

Romania in the lowest country category ('modest

innovator'), with scores well below the EU average

on all dimensions and indicators (Graph 3.5.1).

The lack of dynamism in R&I has implications for

long-term competitiveness and growth prospects.

Graph 3.5.1: Innovation performance of EU Member States

in 2015

Source: European Commission EIS2016

R&D intensity improved but the lack of

investment impedes R&I capacities take-off.

Although R&D intensity (56

) improved in 2015

(Graph 3.5.2), Romania still has one of the lowest

levels among EU Member States. Out of the total

2014-2020 structural funds allocated only 3.4 %

were allocated for R&I, far from the EU average of

10.6 % for the same period. The 2016 budget

provided for a slight increase in public R&D

expenditure up to 0.29 % of GDP, largely

(56) Research and development (R&D) is the statistical proxy

for expenditure in the R&I system (Eurostat). Intensity is

measured as R&D expenditure in percent of GDP.

insufficient to reach the 1 % of GDP target of

public investments in R&D (57

) by 2020.

Recently adopted measures to stimulate

business investment have yet to gain traction. In

2015, less than 200 business entities applied for

the 50 % supplementary corporate tax deduction

for R&D expenditure, even fewer than the 223

entities in 2014. Despite the slight increase in

business R&D intensity in 2015, at 0.21 % of GDP

it is still one of the lowest in the EU. To stimulate

business R&D activities, the government

introduced in August 2016 an exemption from

paying the salary income tax for all R&D

activities. Also, to stimulate the activity of

computer programmes development, a measure of

payroll taxes exemption was set up and is in place

starting with 2017, for employees in start-ups with

main activity in this area.

Graph 3.5.2: Evolution of business R&D intensity and public

R&D intensity in Romania, 2000-2015

Source: European Commission

Pervasive bottlenecks obstruct SMEs'

investment in innovation. SMEs have a low level

of innovation and knowledge flows between public

R&D and the business sector (Graph 3.5.3) are

weak, as borne out by Romania ranking at the

bottom of the 'Linkages & Entrepreneurship'

dimension of the Scoreboard (58

). Red tape, poor

(57) Romania's Europe 2020 target is 2 % of GDP investments

in R&D, with 1 % from the public sector and 1 % from the

private sector.

(58) It covers performance indicators on SMEs innovating in-

house, innovative SMEs collaborating with others and

public-private scientific co-publications.

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

RO

BG

HR LV LT PL

SK

HU

ES EL

PT IT CZ

MT

EE

CY SI

EU

FR AT

LU UK

BE IE NL

DE FI

DK

SE

Innovation leaders Strong innovators

Moderate innovators Modest innovators

0.0

0.1

0.2

0.3

0.4

0.5

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

%GDP

Public R&D intensity

Business R&D intensity

3.5. SECTORAL POLICIES

In Romania within-firm

productivity improvements and

the ability to move up global value

chains are constrained by:

➢ underdeveloped infrastructure,

➢ inadequate skills and

➢ a scarce propensity to innovate

Source: European Commission, EIS2016.Note: Summary Innovation Index calculated as the unweighted average of the re-scaled scores for all indicators

INCREASING THE QUANTITY AND QUALITY OF CAPITAL AND LABOR KEY FOREXPANDING THE PRODUCTION

16

0

10

20

30

40

50

60

70

80

90

Ital

yR

om

ania

Cro

atia

Be

lgiu

mG

ree

ceB

ulg

aria

Po

lan

dM

alta

Luxe

mb

ou

rgH

un

gary

Ire

lan

dFr

ance

Slo

ven

iaSl

ova

kia

EU2

8C

ypru

sP

ort

uga

lSp

ain

Cze

ch R

epu

blic

Lith

uan

iaFi

nla

nd

Au

stri

aLa

tvia

Un

ite

d K

ingd

om

Esto

nia

Ger

man

yN

eth

erla

nd

sD

en

mar

kSw

ede

n

% o

f p

op

ula

tio

n

Total Male Female

Infrastructure quality vs. investment expenditure Romania has one of the lowest activity rates in Europe

Source: Eurostat, World Competitiveness Report 2014-2015 Source: Eurostat Note: Activity rates for population aged 15-64 in EU countries (2016)

CHALLENGES TO BOOSTING THE ECONOMY’S GROWTH POTENTIALKEY QUESTIONS WHERE WE SEEK YOUR VIEWS

17

How can Romania allocate resources better across sectors and firms?

What are the barriers to the economic activity in regional growth poles?

What are the incentives for Romanian firms to become more innovative and productive?

What would increase the quality and quantity of capital and labor force in the Romanian economy?

SYSTEMATIC COUNTRY DIAGNOSTIC PILLAR II

MAKING GROWTH MORE INCLUSIVE

POVERTY REDUCTION WAS DRIVEN BY PENSIONS AND LABOR INCOME

19

Source: WB staff estimation using EU-SILC

❖ Pensions and labor income contributed to poverty reduction before the financial crisis

❖ Jobs (labor income) are generally the most important and sustainable driver of poverty reduction

❖ Market income can be boosted by investing in the productive capacity of households, providing more and better employment opportunities, and by addressing constraints to the efficient use of human capital, land and other assets.

Drivers of poverty reduction

ENHANCE THE PRODUCTIVE CAPACITY OF HOUSEHOLDS

20

Source: Eurostat

❖ Romania has one of the highest early school-leaving rates in the EU, which impacts the Roma in particular

❖ But disparities start early in kindergarten: 88% Romania vs 95% EU-average

❖ On health, infant mortality is three times the EU average, mortality from non-communicable diseases is among the highest, life expectancy is among the lowest

Early leavers from education and training(age group 18-24)

INCREASE LABOR FORCE PARTICIPATION AND ACCESS TO BETTER JOBS

21

Source: World Bank, forthcoming

❖ Lack of employment opportunities and low labor earnings have a strong association with poverty

❖ Labor force participation is particularly low among women, the youth and the Roma

❖ The Roma face systematic challenges in access to services and employment

Employment and gender gap by income

ENHANCE RETURNS TO PRODUCTIVE ASSETS

22

Source: Eurostat

❖ While many Romanians migrate externally, internal mobility is the lowest in the EU;

❖ Severe lack of service provision in rural areas: 87% lack public water supply, 96% lack

public sewerage One of the lowest road network density

in the EU Physical infrastructure for education,

health on downward trend

❖ Formalization of land ownership could increase returns to capital (only 15% of rural and 51% of urban real estate is registered in Romania).

% Population that moved in the last five years

THE TAX-BENEFIT SYSTEM CAN HELP REDUCE POVERTY AND INEQUALITY

23

Source: Eurostat

Poverty before and after social transfers

❖ In Romania, social transfers are not effective in reducing poverty.

❖ Low targetingHigh prevalence of categorical

programs: many funds go to non-poor households.

❖ Sustainability and adequacy of pensions.

CHALLENGES TO POVERTY REDUCTION AND INCLUSIONKEY QUESTIONS WHERE WE SEEK YOUR VIEWS

24

What are the main constraints for reducing early school leaving?

What are the main constraints for increasing labor force participation in Romania?

What are the constraints to increasing returns to labor and capital?

What are the challenges for Roma inclusion?

What are the challenges to improving the effectiveness of social transfers for poverty reduction?

SYSTEMATIC COUNTRY DIAGNOSTIC PILLAR III

GREENING GROWTH

LINKING ECONOMIC AND ENVIRONMENTAL POLICIES TO LEVERAGE NATURAL RESOURCES AND TRANSITION TO LOW-CARBON ECONOMY

26

Source: Environmental Performance Index 2016

Romania performs better in ecosystem vitality than in environmental health

❖ Environmentally sustainable growth is a priority for Romania

❖ Romania does well in climate and energy (carbon intensity), agriculture (nitrogen use), and forests (tree cover) but scores worse in environmental health: health impacts (environmental risk exposure), air quality (household air quality and air pollution), and water and sanitation (drinking water quality and unsafe sanitation)

LINKING ECONOMIC AND ENVIRONMENTAL POLICIES TO LEVERAGE NATURAL RESOURCES AND TRANSITION TO LOW-CARBON ECONOMY

27

Source: Eurostat

Romania’s greenhouse gas emission

❖ Romania made progress in reducing greenhouse gas emissions thanks to structural transformation of economy.

❖ Romania lags in measures of air and water pollution management, waste management, biodiversity conservation and natural resources protection.

❖ Insufficient climate change adaptation actionso Prevention of flooding, reduce impact of

droughts.

TRANSITION TO CIRCULAR ECONOMY

28

Source: Eurostat Resource productivity=GDP/domestic material consumption (EUR/kg).

Romania has the second-lowest resource productivity in the EU

❖Romania has the second-lowest resource productivity, the worst waste intensity and the second-lowest recycling rate in the EU

❖ Institutional failures related to the revision of national waste prevention program and adaptation of national measures on waste management and prevention led to repeated actions by EU institutions

CHALLENGES TO MAKING GROWTH ENVIRONMENTALLY SUSTAINABLE

KEY QUESTIONS WHERE WE SEEK YOUR VIEWS

29

How can Romania make better use of its natural capital?

What are the constraints to improving climate change adaptation?

What are the main challenges to transitioning to a circular economy?

How can environmental health outcomes be improved?

What are the challenges to the planning and administrative capacity of the public sector?

SYSTEMATIC COUNTRY DIAGNOSTIC PILLAR IV

STRENGTHENING INSTITUTIONS

QUALITY OF ROMANIAN INSTITUTIONS LAG EUROPEAN STANDARDS

31

Source: World Governance Indicators

Romania and the EU in several dimensions of governance

❖ Romania lags in all dimensions of governance, although more in some than others.

❖ Significant lags observed in government effectiveness, control of corruption, voice and accountability, and rule of law.

COMMITMENT TO POLICY, COORDINATION ACROSS STATE FUNCTIONS AND COOPERATION BETWEEN THE STATE AND CITIZENS

32

Source: European Commission

Romania’s trust in institutions is low

❖Reducing corruption is essential to build trust between citizens and the government, and enhance cooperation.

❖Trust in institutions is low and corruption high by European standards, although the fight against corruption is stepping up.

COMMITMENT TO FORMAL RULES FOR MONETARY AND FISCAL MANAGEMENT AND FINANCIAL SYSTEM STABILITY IS ESSENTIAL FOR FISCAL EFFECTIVENESS

33

Romania had the highest economic risk rating in the EU in 2000-15

❖ Improving macroeconomic management is essential for economic stability and sustainability.

❖However, Romania’s economic management remains subject to riskso Fiscal policy is heavily pro-cyclical.

IMPROVE DELIVERY OF PUBLIC SERVICES (HEALTH, EDUCATION, INFRASTRUCTURE)

34

Health and Education top the list of public services expected by citizens

❖ Inefficiencies in public administration hamper capacity for delivery of public services in education, health and infrastructure:o High bureaucracy;o Inadequate digital framework;o Restricted access for poor.

❖ Limited resources and low efficiency of public spending.

❖ Public investment management suffers from capacity constraints, leading to delays in project preparation and implementation.

CHANLLENGES TO STRENGTHENING INSTITUTIONSKEY QUESTIONS WHERE WE SEEK YOUR VIEWS

35

What are the main challenges to policy commitment?

What are the main challenges to commitment to formal rules for better macroeconomic management?

How can trust in the State and institutions be enhanced?

How can capacity be strengthened for better management of public investment?

How can public spending be made more efficient for better service delivery in health and education?