Team Leaders:
   Josef Brada and Taki Fiti

Domestic Commision Members                         International Commission Members
   Ksente Bogoev                                       Marek Dabrowski
   Gligor Bishev                                       Vlado Dimovski
   Vladimir Filipovski                                 Zdenek Drabek
   Gazmend Kadriu                                      Karel Dyba
   Gordan Kalajdziev                                   Paul Hare
   Vladimir Kandikjan                                  Malgorzata Markiewicz
   Srgjan Kerim                                        Kalman Mizsei
   Mihail Petkovski                                    Marcus Noland
   Goce Petreski                                       Gabor Peteri
   Trajko Slaveski                                     Ben Slay
                                                       Colin Talbot
Secretary                                              Frederick Thompson.
   Aleksandar Stojkov
UNDP Project Team:                                    Maksim Aceski                                 1
  Project Manager - Ljupco Gjorgjinski                Dragan Gjorcev
  Research Assistant - Lilian Kandikjan               Snezana Miloseska-Kostadinoska
                                                      Marija Risteska
                                                      Fimka Tozija

 The views expressed herein are those of the authors and do not necessarily reflect the official
 position of the United Nations Development Programme.

 The designations employed and the presentation of the material do not imply the expressions
 of any opinion whatsoever on the part of the United Nations Development Programme or the
 Secretariat of the United Nations concerning the legal status of any country, territory, city or
 area, or of its authors, or concerning the delimitation of its frontiers or boundaries. Mention
 of firm names and commercial products does not imply the endorsement of United Nations.

 Pursuant to Resolution 817 of the United Nations Security Council, the United Nations pro-
 visionally refers to the country for all its purposes as "the former Yugoslav Republic of Mace-

                                                                             Blue Ribbon Report

     EXECUTIVE SUMMARY .........................................................................................................................4
     FOREWORD BY MLS ...............................................................................................................................8
     INTRODUCTION BY TEAM LEADERS ............................................................................................10
     I. INTRODUCTION ................................................................................................................................12
       A. How to Achieve Dynamic and Sustainable Growth ....................................................................12
       B. The Current Situation .........................................................................................................................13
       C. Three Structural Weaknesses of the Macedonian Economy ........................................................15
         1. Inadequate Globalisation .......................................................................................................................................................15
         2. The Microeconomic Foundations of Prosperity ....................................................................................................................16
         3. Limited State Capacity and the Political System ..................................................................................................................16
       D. Guideposts for the Way Ahead ........................................................................................................19
         1. Sound Macroeconomic Policies .............................................................................................................................................19
         2. EU Accession .........................................................................................................................................................................20
         3. Reform Roadmap ...................................................................................................................................................................23
     II. WHAT IS THE MAGNITUDE OF THE TASK AT HAND? .....................................................27
     III. ADJUSTMENT OF THE EXTERNAL SECTOR .........................................................................28
         1. Current Status of Policies Affecting the External Sector .....................................................................................................29
         2. Policy and Institutional Recommendations ..........................................................................................................................30
       A. Market Access .....................................................................................................................................30
       B. Domestic Policies Affecting Trade ....................................................................................................31
         1. Exchange Rate and Domestic Prices .....................................................................................................................................32
2        2. Stimulating New Exports and Import Competing Industries - Role of Structural Policies ................................................33
       C. Trade Policy .........................................................................................................................................34
         1. Domestic Regulations and Institutions ................................................................................................................................34
         2. Trade Facilitation ...................................................................................................................................................................36
         3. Promoting Trade in Services .................................................................................................................................................38
         4. Foreign Investment Promotion .............................................................................................................................................40
      D. The Capital Account ..........................................................................................................................41
     IV. STRUCTURAL REFORMS FOR MICROECONOMIC EFFICIENCY ..................................43
      A. Improving Macedonia's Business Climate ...................................................................................43
         1. Processes and practices ..........................................................................................................................................................44
         2. Outcomes ...............................................................................................................................................................................45
       B. Restructuring of the Enterprise Sector .............................................................................................45
         1. Mobilizing Existing Capacities .............................................................................................................................................45
         2. Improvement of Corporate Governance ................................................................................................................................47
         3. Support for Small and Medium Size Enterprises .................................................................................................................48
       C. Increasing the Efficiency of the Financial System .........................................................................48
         1. Improving Financial Intermediation by the Banking Sector ................................................................................................48
         2. Development of the Debt and Equity Markets .....................................................................................................................51
         3. Reforms of the Pension System .............................................................................................................................................52
       D. Creation of a Favourable Investment Climate ...............................................................................54
       E. Institutions for the Support and Regulation of Markets ..............................................................54
         1. Judicial Reforms ....................................................................................................................................................................55
         2. Market-regulating Institutions .............................................................................................................................................56
       F. Agriculture ............................................................................................................................................56
         1. Market and Institutional Improvements ..............................................................................................................................56
         2. Macedonian agriculture in a global setting ..........................................................................................................................59
       G. Labour Market Reforms ....................................................................................................................60

    Blue Ribbon Report
GROWTH ............................................................................................................................................64
 A. Public Administration and the Political Process ..........................................................................64
 B. Making Public Administration Effective ........................................................................................65
  1. The Evolving Concept of Public Administration .................................................................................................65
  2. Public Value from Public Administration and Public Services ..........................................................65
 C. Building Blocks of Public Value .......................................................................................................66
    1. Trust and Legitimacy ............................................................................................................................................................66
    2. Public Value and Resources ...................................................................................................................................................67
    3. Public Value and Processes ....................................................................................................................................................68
    4. Public Value and Services ......................................................................................................................................................69
    5. Public Value and Social Outcomes ........................................................................................................................................70
    6. Public Value and Leadership .................................................................................................................................................70
    7. Conclusions ...........................................................................................................................................................................71
  D. Fiscal decentralisation: a key element of public sector reform ...................................................72
    1. Raising own-source revenues ................................................................................................................................................73
    2. Intergovernmental transfers .................................................................................................................................................74
    3. Transparent and objective revenue sharing and grant allocation .........................................................................................74
    4. Municipal debt ......................................................................................................................................................................75
    5. Municipal Budgets ................................................................................................................................................................76
    6. Representation and Rights of Ethnic Communities .............................................................................................................77
    7. Financial management ..........................................................................................................................................................78
    7.1 External and internal audit at local governments ....................................................................................................................................78
    7.2 Improved staffing and management capacity ...........................................................................................................................................78
    7.3 Strengthening local government ...............................................................................................................................................................78
    8. Fiscal Decentralisation - basis of a new effective local government .....................................................................................78
  E. Reforms in Education ........................................................................................................................80
  F. Reforms of Health Insurance and the Health Care System .......................................................82
    1. Organization of the Health Care System ..............................................................................................................................82
    2. Funding Health Care Providers ............................................................................................................................................83
    3. The Health Insurance System ...............................................................................................................................................83
  Endnotes ...................................................................................................................................................85

                                                                                                                                                            Blue Ribbon Report
     EXECUTIVE SUMMARY                                             Macedonia’s government will carry out
                                                               its functions efficiently. Corruption and
     BACKGROUND                                                overregulation will be significantly reduced,
     At the behest of the Government of Mace-                  and the functioning of the legal system will
     donia,1 the United Nations Development                    approach European norms. Government
     Program organised a Blue Ribbon Commis-                   functions will be depoliticised, and stream-
     sion consisting of domestic and foreign ex-               lined. Important government responsibili-
     perts to review the economic situation of the             ties will have been decentralised, with local
     country and to provide a programme to ac-                 governments adequately financed and able
     celerate the country’s growth, to alleviate               to provide key public services to meet the
     unemployment and to prepare the country                   needs of their residents.
     for entry into the European Union.

     KEY GOALS OF THE REPORT                                  The key to the achievement of this vision lies
                                                              in concrete steps needed to bring about dy-
     Members of the Macedonian Blue Ribbon                    namic and sustainable growth and in the im-
     Commission believe that in the ten year pe-              plementation of a new wave of reforms in the
     riod following the implementation of the rec-            key segments of the country’s economic and
     ommendations of this report, Macedonia will              political system. These reforms are directed
     have made major progress toward the follow-              toward:
     ing objectives:
                                                                  increasing Macedonia’s integration into
4                                                               the global economy and moving the coun-
            The Macedonian economy will have ex-
         perienced a period of sustained economic               try toward membership in the European
         growth and created a substantial number of             Union (EU);
         new jobs, cutting unemployment by at least               raising the dynamism of the private sec-
         one half. Poverty and inequality will have             tor through tax reform, deregulation and
         been sharply reduced, and the education,               privatisation and the creation of effective
         health and pension systems will have been              institutions combined with the elimination
         reformed.                                              of institutions that are not providing suffi-
                                                                cient social benefits;
             The Macedonian economy will be fully                 increasing the efficiency of the govern-
         integrated into the global economy. The                ment’s functioning through fundamental
         share of exports in GDP will be significantly          changes in government operations, re-
         higher than it is now, there will be a substan-        forms in the functioning of the judiciary
         tially higher level of foreign direct invest-          and the civil service, and the creation of ef-
         ment in the country, on a per capita level             fective methods of fiscal decentralisation.
         comparable to other transition economies in
         the region, and the capital account will be          KEY ASSUMPTIONS
         fully liberalised.
                                                              Macedonia will affirm itself as a citizen-ori-
               Macedonia will have considerably               ented, stable and democratic country. Re-
         stronger, more efficient, and more credible          gional political stability will contribute to
         institutions required for membership in the          favourable business climate and the Mace-
         European Union.                                      donian economy will not be faced with the
                                                              sort of economic and political shocks ob-
                                                              served during much of the transition period.
                                                              We assume that the policies proposed in this
                                                              Report will receive broad public support as
      The former Yugoslav Republic of Macedonia, hereina er   well as the support of most, if not all, of
     referred to as Macedonia.
    Blue Ribbon Report
Macedonia’s political parties and thus they          MAIN RECOMMENDATIONS OF THE
will be consistently and intensively pursued         BLUE RIBBON COMMISSION
by all governments over the next decade.             Although the Blue Ribbon Commission Report fol-
                                                     lows a somewhat different structure, we present
THREE MAJOR STRUCTURAL WEAK-                         the main recommendations in seven broad areas:
NESSES                                                    Preserving sound and credible macro-
                                                        economic policies
In the 1990s, Macedonia implemented impor-                  Greater exposure of Macedonia to
tant first-generation reforms associated with           globalisation;
macroeconomic transition. Reforms pertain-                Reducing the costs of doing business;
ing to price stability, price liberalisation, for-        Revisiting the role of the state;
eign trade liberalisation, and small                      Building a trust in institutions,
privatisation were carried out with some suc-             Preparing for EU accession, and
cess, but other reforms now require further               Reforms aimed at securing future eco-
efforts. The implementation of the so-called            nomic prosperity.
second-generation reforms, important for
achieving dynamic and sustainable growth,
                                                     PRESERVING SOUND AND CREDIBLE
has been slow and unsatisfactory. As a result,
throughout the transition period, aggregate          MACROECONOMIC POLICIES
output growth in Macedonia has been insuf-                Pursue a flexible macroeconomic pol-
ficiently robust to overcome interruptions             icy of government budgets that are bal-
from external shocks, while the unemploy-              anced over a medium-term time horizon
                                                          Improve the planning and manage-             5
ment rate has remained exceptionally high.
Therefore, structural and institutional re-            ment of public expenditures
forms must play a key role in accelerating                 Preserve the current exchange rate
economic growth and creating new jobs. The             regime and prepare an exit strategy for
Report identifies three major structural weak-         abandoning the Denar-Euro peg in the
nesses that are responsible for Macedonia’s            longer term
slow growth and high unemployment:
                                                     GREATER EXPOSURE TO GLOBALI-
     Insufficient integration into the world         SATION
  economy (low globalisation), which limits
  the level of competition on the domestic           Deepening trade integration
  market;                                                 Fully exploit export opportunities of-
     Unfavourable business environment,                fered by the Free Trade Agreements
  which is characterised by an excessive reg-          (FTAs)
  ulatory and tax burden, insecure property               Negotiate reduction of non-tariff barri-
  rights, perceived corruption, poor corpo-             ers imposed by regional trading partners
  rate governance, etc., and which acts as an             Provide for cumulative rules of origin
  impediment to the creation of a dynamic               Expand FTAs to provide for easier trade
  and vibrant private sector, and                       in services
      Poorly functioning domestic institu-                Harmonisation and unification of the
  tions and excessive political influence in            regional free trade agreements
  the economy, as seen by the instability in               Establish effective mechanisms for
  government policies, an institutionally               trade dispute settlements
  weak civil service and ineffective judiciary,           Expand lending for exports, promote
  excessive connections between the inter-             export insurance, reduce administrative
  ests of government officials and large com-          barriers to foreign trade
  panies, etc.                                            Reduce customs procedures and sim-
                                                       plify and expedite formalities for firms

                                                                              Blue Ribbon Report
       engaged in international trade                     Ensure level-playing field for compa-
           Invest in airport and other interna-         nies
       tional transport infrastructures                   Invest in the communications and
          Reduce differences in effective tariff      transportation infrastructure
       protection across sectors
          Ensure predictability, transparency and    REVISITING THE ROLE OF THE
       speed of border crossings                     STATE
           Strengthen commercial diplomacy –             Privatise non-core government activi-
       promotion of trade, FDI and tourism            ties
                                                         Reduce government regulation, stress
     Increasing the capital mobility                  the use of international standards, em-
          Rapid capital account liberalisation in     phasise rules over the discretion of offi-
       the medium term                                cials, and reduce administrative staff
           Encourage foreign competition in the            Constantly re-evaluate and widely
         banking system                               publicise judicial reform
           Increase visibility of Macedonia on           Upgrade and specialise judicial expert-
         global capital markets                       ise
           Gradually relax restrictions on outward        Resolve government claims against
         portfolio investments                        large companies
                                                         Imposing hard budget constraints by
     Encouraging the knowledge transfers and          the public enterprises
6    spillovers
          Increase student mobility                  BUILDING TRUST IN THE INSTITU-
          Enhance participation of the academic      TIONS
       community in international research net-
       works                                            Visible results in combating corruption
                                                        Protection of ownership rights and en-
     CREATING A BUSINESS-FRIENDLY                     forcements of contracts
     ENVIRONMENT                                         Introduction of merit-based personnel
                                                      policy in the civil service
          Reduce the tax burden on wages and             Depolitisation of the administration
       business activity                                 Equitable representation in the public
           Visible (and frontal) anti-corruption      administration based on criteria of com-
       campaign to reduce the “bribe tax” and         petence and political neutrality
       shrink the “grey” sector of the economy           Introduction of performance manage-
          Reduce the regulatory and administra-       ment
       tive burden on business                           Strengthening transparency, accounta-
           Streamline and simplify regulations        bility and control (external and internal
            Introduce regulatory impact assess-       audit) at all levels
                                                        Encourage participatory budgeting and
           Improve access to financing through        budget monitoring by citizens
       increased foreign competition, bank con-
                                                         Easier access to justice: quicker, more
       solidation and enhanced bank supervi-
                                                      efficient and simpler legal protection sys-
            Modernise and complete the land
          Ensure strict law enforcement
           Rapid resolution of contract and prop-
         erty disputes

    Blue Ribbon Report
    Proper sequencing of the approxima-        Broaden access to primary and second-
 tion of national legislation                ary education
    Strengthen regulatory bodies in EU           Dissemination of entrepreneurship
 context                                     culture from the primary education
    Preparation for management and ad-          Large-scale formation of English lan-
 ministration of structural funds            guage skills
    Negotiation of individual chapters of      Management education
 the Acquis                                    Update state universities’ curricula and
    Strengthening the role of the Parlia-    introduce mechanisms for quality assur-
 ment in directing and monitoring of the     ance
 EU integration process


                                                                  Blue Ribbon Report
     Foreword                                          released into the public realm when the new
                                                       Government – of whichever colours consti-
     The Blue Ribbon Commission for Macedonia          tuted – was fully assembled and ready to go.
     was formed in the spring of 2005 by the
     United Nations Development Programme              Second is the independence of the members
     (UNDP) in response to a request by the Gov-       of the Commission as well as the consensual
     ernment of Macedonia. Under the leadership        nature of their analyses and recommenda-
     of Kalman Miszei, then Assistant Administra-      tions. The idea behind this formula is to find
     tor and Regional Director of the UNDP Re-         the most competent domestic and interna-
     gional Bureau for Europe and CIS, the UNDP        tional experts to address the topic and then
     has established Blue Ribbon Commissions in        let them write, rewrite and edit the report.
     several other transition countries. The pur-      The period it took to produce the Macedon-
     pose of these Commissions was to produce          ian Report has been filled with stimulating
     “Blue Ribbon Reports,” which have achieved        discussions, numerous choices and compro-
     in each of them great success in terms of fo-     mises, but also with a clear focus toward pro-
     cusing on the key development concern,            ducing a report that can truly have an impact.
     analysing it thoroughly, considering alterna-     Some would say it already has.
     tive policy solutions and then putting to-
     gether a set of policy proposals that are given   The Blue Ribbon Report we have in front of
     to the Government for consideration.              us is a synthesis of the thoughts of extremely
                                                       knowledgeable people with one focus on all
     Common to them all is that they each address      their minds: how to provide the best set of
8    the most urgent reform needs of the country       policies and incentives that would drive the
     in question and then propose remedies to          Macedonian economy toward dynamic eco-
     newly formed governments right at the out-        nomic growth. Most of the members of the
     set of their mandate. While the focus in other    Blue Ribbon Commission are economists,
     countries, for instance, was on general gover-    some are lawyers; the majority have an aca-
     nance problems and the need for reform of         demic background along with a practical po-
     the state, the Macedonian Blue Ribbon Com-        litical experience; many Commission
     mission identified the situation of continued     members are either currently involved in the
     sluggish economic growth as the most press-       private sector or have been at some point,
     ing development problem in the country. For       thus enjoying an in-depth understanding of
     this reason, the topic Achieving Dynamic Eco-     the incentives needed for business to succeed
     nomic Growth became the focus of the Report.      in today’s global environment.

     In our view, there are two features which         The process of preparing such a comprehen-
     make this report different to the many other      sive report never occurs in vacuum. It is filled
     reports prepared by International Organisa-       with extremely competent and committed
     tions that also address key development con-      people. The Macedonian Blue Ribbon Com-
     cerns affecting a given country.                  mission was co-chaired ably by Dr. Josef
                                                       Brada and Dr. Taki Fiti, and consisted of the
     First, the timing chosen for the preparation      following members: Dr. Ksente Bogoev, Dr.
     and release of these reports is in advance of     Gligor Bishev, Dr. Vladimir Filipovski, Gaz-
     elections and soon after the new Government       mend Kadriu, Dr. Gordan Kalajdziev, Dr.
     takes Office. This is in part due to a convic-    Vladimir Kandikjan, Dr. Srgjan Kerim, Dr.
     tion that there is no better time for a govern-   Mihail Petkovski, Dr. Goce Petreski, Dr. Tra-
     ment to take decisive steps toward a desired      jko Slaveski, Dr. Marek Dabrowski, Dr. Vlado
     direction than at the beginning of its man-       Dimovski, Dr. Zdenek Drabek, Dr. Karel
     date. This was also the reason why the Blue       Dyba, Dr. Paul Hare, Dr. Malgorzata
     Ribbon Report for Macedonia was set to be         Markiewicz, Dr. Kalman Mizsei, Dr. Marcus

    Blue Ribbon Report
Noland, Dr. Gabor Peteri, Dr. Ben Slay, Dr.     This Report, in short, is about a simple idea
Colin Talbot and Dr. Frederick Thompson. I      whose time has come: Macedonia to start ex-
would like to thank them for their commit-      periencing dynamic and sustainable eco-
ment. I would also like to thank our own        nomic growth. It is, moreover, about how
Norimasa Shimomura, Vesna Dzuteska-Bi-          best to achieve that. The Blue Ribbon Report
sheva, Lilian Kandikjan and particularly        contains policy proposals that its commission
Ljupco Gjorgjinski who worked tirelessly        members think are best suited to achieve this
until the Blue Ribbon Report was finally com-   aim. It is now up to the future to retrospec-
pleted.                                         tively adjudicate their virtues, though the
                                                present may certainly bear witness that the
                                                preparation of these proposals was incredibly

                                                Skopje, September ‘06
                                                               Maria Luisa Silva Mejias
                                                             UNDP Resident Representative
                                                              UN Resident Coordinator


                                                                        Blue Ribbon Report
      Introduction by Team Leaders                         served as the basis for intensive meetings of
                                                           the entire Commission in January of 2006 in
      The Blue Ribbon Commission for Macedonia             Skopje. During these meetings, various pol-
      was formed by the United Nations Develop-            icy options and approaches were discussed
      ment Programme (UNDP) in response to a re-           with the objective of developing a coherent
      quest from the Prime Minister of Macedonia.          economic program that:
      In making this request, the Prime Minister re-
      flected on the success that similar UNDP Blue            had clear and measurable objectives so
      Ribbon Commissions have had in influencing             that progress in its implementation could
      policy in other transition economies. While            be easily judged by the Macedonian pub-
      these countries, like Macedonia, have already          lic;
      received much advice from many sources, the              was internally consistent so that the poli-
      strength of the Blue Ribbon Commissions                cies recommended were mutually sup-
      comes from two unique features. The first is           porting;
      that they combine local experts with foreign             addressed three key areas of concern –
      experts, thus bringing together those who              globalising the economy, promoting a
      have a deep knowledge of local conditions,             business-friendly environment and mak-
      aspirations and obstacles to progress with             ing the government a partner, rather than
      those who have encountered similar prob-               an obstacle, to economic prosperity.
      lems and developed creative solutions in dif-
      ferent settings around the world. The second         Once that overall strategy was agreed upon,
      strength is that each Blue Ribbon Commis-            existing chapters of the report were finalised
10                                                         and additional chapters were commissioned
      sion, by reflecting on the country’s goals and
      aspirations, is free to decide for itself both the   on topics that required more extensive analy-
      problems to be addressed and the policies ap-        sis and policy recommendations deemed im-
      propriate to resolving those problems.               portant to include in the Report.

      Given the record of these Commissions in             In developing this Report, the members of the
      meeting this objective, there was a legitimate       Commission acted as independent agents,
      expectation that a Blue Ribbon Commission            and neither the Government of the Republic
      for Macedonia could provide policy guidance          of Macedonia nor the UNDP sought to influ-
      that would help any Macedonian govern-               ence the recommendations contained in this
      ment to meet the most important economic             report. Of course, individual members of the
      desires of Macedonia’s citizens. These desires       Commission did bring different viewpoints
      include faster economic growth, a reduction          and approaches to their work, based on their
      in unemployment, a deeper integration of             individual experiences in economic policy
      Macedonia in the global economy through in-          making and analysis, whether in the Republic
      creased trade and foreign direct investment, a       of Macedonia or in other countries. Thus, the
      positive and effective role for the government       degree of consensus that was achieved with
      in promoting the private sector and provid-          respect to the final draft reflects the broad
      ing public services, and, above all, making the      agreement reached from many different start-
      Republic of Macedonia a credible and attrac-         ing points about the problems facing the
      tive candidate for membership in the Euro-           Macedonian economy and also about the
      pean Union.                                          ways in which the country’s economic future
                                                           can best be secured.
      Some members of the Commission met and
      consulted during the Summer and Autumn               As mentioned above, this Report and its rec-
      of 2005, and these consultations resulted in a       ommendations are mainly for the purposes of
      draft report on Macedonia’s economic                 the Government of the Republic of Macedo-
      prospects and policy options. This draft             nia. However, there could very well be a

     Blue Ribbon Report
wider group of potential users of the Report,    In writing this report, members of the Com-
including the Parliament of the Republic of      mission have sought to produce a document
Macedonia and its various commissions, the       that is accessible to all, not just to specialists
business community, the academic commu-          in economic policy. We have tried to present
nity, and all the other institutions that must   a realistic vision of what Macedonia can
contribute to a more dynamic growth of           achieve in the next ten years, and we have
Macedonia’s economy. Indeed, we encourage        provided a road map for the way ahead.
public discussion of the Report, because such    What needs to be done is sufficiently com-
discussion is the surest way of embedding        pelling that any Macedonian government
pro-growth and pro-globalisation policies        should be able to subscribe to nearly all of
into the country’s political dialogue. While     these recommendations, and citizens should
such public discussion may uncover addi-         be able to judge the extent to which the rec-
tional ways of addressing Macedonia’s eco-       ommendations of this report are being imple-
nomic future, we believe that a sound and        mented and the results that they achieve.
productive discussion of the report does have
to be based on an understanding and accept-
ance of the weaknesses in Macedonia’s polit-     Skopje, September 2006
ical and economic life that the report                                                Josef Brada
identifies. A denial of these weaknesses or an                                          Taki Fiti
underestimation of their impact on the coun-
try’s prosperity will undermine the urgency
with which these problems have to be ad-
dressed.                                                                                              11

The members of the Commission are grateful
to the UNDP for accepting the request of the
Macedonian Government to have this report
produced. The UNDP Office in Skopje did an
excellent job of organising the work of the
Commission and of securing the funding for
it. The leadership and support of Mr. Frode
Mauring and Ms. Maria Luisa Silva Mejias,
the two UNDP Resident Representatives dur-
ing the time in which the Commission was
active, were critical for the success of the
Commission’s work. The members of the
Commission also wish to thank Mr. Norimasa
Shimomura, Mrs. Vesna Dzuteska-Bisheva,
Mr. Ljupco Gjorgjinski, and Ms. Lilian
Kandikjan of the Skopje UNDP Office for
their contributions in organising the funding
and logistics of the Commission’s work as
well as for the information, suggestions and
research they provided during the course of
the Report’s presentation. Finally, the mem-
bers of the Commission wish to thank Dr. Ben
Slay, Director of the UNDP Regional Centre
in Bratislava for his support and encourage-
ment during the course of this project and his
staff for their valuable advice.

                                                                            Blue Ribbon Report
      I. Introduction                                    the measures and created most of the in-
                                                         stitutions required for membership in the
      A. How to Achieve Dynamic and Sus-                 European Union.
      tainable Growth
                                                       The key to the achievement of this vision lies
                                                       in concrete steps needed to bring about dy-
      Members of the Macedonian Blue Ribbon
                                                       namic and sustainable growth and in the im-
      Commission expect that, ten years after this
                                                       plementation of a new wave of reforms in the
      Report is published and its recommendations
                                                       key segments of the country’s economic and
      are effectively implemented, the Republic of
                                                       political system. These reforms are directed
      Macedonia will have made significant
      progress in the key areas of its economic and
      social development:
                                                           increasing Macedonia’s integration into
                                                         the global economy and moving the coun-
          The Macedonian economy will have ex-
                                                         try toward membership in the European
        perienced a period of sustained economic
                                                         Union (EU);
        growth and created a substantial number
                                                           raising the dynamism of the private sec-
        of new jobs, cutting unemployment by at
                                                         tor through tax reform, deregulation and
        least one half.
                                                         privatisation and the creation of effective
          The Macedonian economy will be fully
                                                         institutions combined with the elimina-
        integrated into the global economy. The
                                                         tion of institutions that are not providing
        share of exports in GDP will be signifi-
                                                         sufficient social benefits;
12      cantly higher than it is now, there will be
                                                           increasing the efficiency of the govern-
        a substantially higher level of foreign di-
                                                         ment’s functioning through fundamental
        rect investment in the country, on a per
                                                         changes in government operations and in
        capita level comparable to other transi-
                                                         the tax system, reforms in the functioning
        tion economies in the region, and the cap-
                                                         of the judiciary and the civil service, and
        ital account will be fully liberalised.
                                                         the creation of effective methods of fiscal
           Macedonia will have considerably
        stronger, more efficient, and more credible
          Macedonia will affirm itself as a citizen-
        oriented, stable and democratic country.
        Macedonia’s government will carry out its
        functions efficiently. Corruption and over-
        regulation will be significantly reduced,
        and the functioning of the legal system
        will approach European norms. Govern-
        ment functions will be depoliticised and
        streamlined. Important government re-
        sponsibilities will have been decen-
        tralised,    with     local    governments
        adequately financed and able to provide
        key public services to meet the needs of
        their residents.
          Poverty and inequality will have been
        sharply reduced, and the education, health
        and pension systems will have been re-
          Macedonia will have adopted most of

     Blue Ribbon Report
B. The Current Situation                             interruptions from external shocks, while the
The Republic of Macedonia has experienced            unemployment rate has remained exception-
almost fifteen years of transition since gaining     ally high. Hence, structural and institutional
its independence in September 1991. The              reforms must play a key role in accelerating
transition process in the country started            economic growth and creating new jobs. The
under very difficult circumstances. On one           reforms of the highest priority must be di-
hand, macroeconomic conditions inherited             rected toward the creation of a favourable
from the former state were extremely un-             business climate. These include the reform of
favourable: negative GDP growth rates, a             the tax system, a decrease in regulation, the
high inflation rate, a high unemployment rate        reduction of corruption, the promotion of en-
and relatively high domestic and foreign             trepreneurship and labour market reform.
debt. On the other hand, immediately follow-
ing the gaining of independence, Macedonia           The Republic of Macedonia has also made
was confronted with the problems relating to         important economic strides since its emer-
the international recognition of its entity, aris-   gence as an independent state. It has created
ing from the dispute over the country’s name         a functioning government that provides its
with Greece. Various external shocks have            citizens with vital services and an economic
plagued the country almost throughout the            environment that is characterised by a high
transition period - the UN embargo against           level of price stability. Partly as a result of
FR Yugoslavia from the spring of 1992 to fall        these achievements, the European Union
of 1995, the Greek unilateral embargo from           (EU) now sees Macedonia as a potential fu-
February 1994 to September 1995, the Kosovo          ture member, granting it EU candidate status
refugee crisis in 1999 and the six-month inter-      in December 2005. These achievements are a        13
nal conflict in 2001.                                tribute to the country’s capacity to devise and
                                                     implement sound economic policies, and
Despite unfavourable initial conditions,             they lend confidence to the expectation that
Macedonia implemented important reforms              the recommendations to be found in this re-
in key segments of the economic system.              port can be implemented in an expeditious
Practically, first-generation reforms, although      and effective manner so as to move the Mace-
implemented with variable success, have              donian economy forward. Macedonia has en-
been completed. In this respect, reforms per-        joyed over 10 years of stable prices and a
taining to price stability, price liberalisation,    stable relationship between the Macedonian
foreign trade liberalisation, and small privati-     denar and the deutschemark and subse-
sation have been accomplished successfully,          quently the euro. While this stability does
as is also confirmed by the EBRD transition          represent an important achievement for eco-
indicators. Somewhat poorer are the assess-          nomic policy, the growth of the Macedonian
ment marks in relation to the large privatisa-       economy in terms of aggregate output and in
tion and banking sector reforms. More                terms of creating opportunities for increased
important is the fact that the effect of reforms     employment has been unsatisfactory,
is cumulative and mutually reinforcing, so           whether weighed against the legitimate aspi-
that key weaknesses in some areas have offset        rations of the country’s population, against
the potentially positive effects of well-de-         the performance of other transition
signed and effectively executed reforms in           economies or against what the Macedonian
other areas of the economy. Moreover, imple-         economy needs to accomplish to ensure suc-
mentation of the so-called second-generation         cessful entry into the EU. Until the past three
reforms, important for achieving dynamic             years, real GDP has grown slowly, and meas-
and sustainable growth, is slow and unsatis-         ured unemployment has remained at high
factory. As a result, throughout the transition      levels.
period, aggregate output growth in Macedo-
nia has been insufficiently robust to overcome

                                                                              Blue Ribbon Report
      Figures 1 and 2 show Macedonia’s real GDP
      and its growth. Like other transition
      economies, Macedonia experienced a decline
      in aggregate output in the early 1990s fol-
      lowed by recovery, which, in Macedonia’s
      case, was impeded partly by exogenous
      forces as well as by structural shortcomings
      in the economy and in the ways in which re-
14    forms were carried out. As a result, the econ-
      omy was not able to sustain consistent
      growth and high levels of job creation.

     Blue Ribbon Report
C. Three Structural Weaknesses of the               1. Inadequate Globalisation
Macedonian Economy                                  Macedonia, despite its small size, is an insuf-
The shortcomings in the performance of the          ficiently globalised economy, whether meas-
real sector of the Macedonian economy are           ured in terms of its trade, its FDI or in its
strongly interconnected with three structural       reliance on international standards and insti-
weaknesses that need to be overcome.                tutions to supplement domestic regulatory
                                                    organs and institutions. For example, despite
First, Macedonia is inadequately integrated         its small size, Macedonia’s export to GDP
into the world economy. This means that             ratio is low in comparison to most transition
Macedonia does not benefit from the gains           economies, as Figure 3 shows; Macedonia’s
from trade and foreign direct investment to         participation in world trade is inadequate for
the degree that it needs to. Low globalisation      its economic goals.
limits the level of competition on the domes-
tic market. Moreover, there is a strong corre-
lation between a country’s globalisation and
its ability to follow policies that promote
growth and increase the incomes and eco-
nomic freedom of its citizens.

Second, microeconomic forces and institu-
tions that support a dynamic private sector
that can adapt to emerging domestic and in-
ternational market and technological devel-
opments and that can create new jobs and
provide high incomes are absent or do not
work well. Moreover, the country is not per-
ceived in a favourable light by domestic and
foreign observers. It is seen as a country that     Similarly, the inflows of FDI into the country
has problems with corruption, poor corporate        appreciably lag those achieved by many of
governance and ethnic tensions and as a             the more successful transition economies, as
country that does not have a business-              Table 1 shows.
friendly environment.
                                                    Table 1. FDI Inflows per capita for Transi-
Third, the involvement of the government in         tion Economies, 2000-2004.
economic regulation and the application of
the laws need improvement. The tax system
needs to be to be revised to make it more
transparent, easy to administer and to pro-
vide incentives that are consistent with Mace-
donia’s economic needs. The government’s
ability to regulate the economy must be con-
centrated on those functions that are of great-
est importance. The government now faces
the challenges of the regional decentralisation
of its activities and ensuring that the interests
of political parties do not impede the effective
functioning of the state administration and of
the legal system.

                                                                             Blue Ribbon Report
      2. The Microeconomic Foundations of Pros-          this are structural, and a consolidation of ex-
      perity                                             isting small banks, the rapid entry of foreign
      Macedonian economic policy has created a           banks and improved bank regulation are
      stable macroeconomic environment that can          needed if the financial constraint on enter-
      serve as the basis for further development of      prise growth is to be overcome.
      the business sector, and the main barriers to
      growth are currently to be found in the mi-        Macedonian agriculture has been under con-
      croeconomic sphere. What Macedonia needs           siderable competitive pressure from abroad,
      now is a series of more subtle and intercon-       and such pressures will continue. The future
      nected reforms that create a vibrant market        of the system largely lies in the ability of
      economy, one that can create jobs, promote         Macedonian farmers to respond to these pres-
      structural change and the creation of new          sures and to restructure production toward a
      firms and provide the flexibility for structural   more focused output pattern that will be bet-
      change that Macedonia will require in order        ter integrated with the processing industries
      to succeed on international markets and to         and also more export oriented. To this end,
      adjust to the challenges of EU accession. Over     the government should provide assistance in
      the period of Macedonia’s statehood, new           the form of information about foreign mar-
      firm formation has not been dynamic, and the       kets and on phytosanitary and other regula-
      number of new jobs created has thus not been       tions that need to be introduced if
      sufficient to reduce a level of unemployment       Macedonian food production is to penetrate
      that Macedonian society finds unacceptable.        European markets.
      Structural change has largely been of the neg-
16    ative variety, with firms shutting down or         High unemployment is a major concern for
      downsizing their operations, but business ex-      most Macedonians. In part, the lack of job cre-
      pansion, and especially expansion into new         ation is due to barriers to entrepreneurship
      lines of business, has not offset the job shed-    already discussed above. However, there are
      ding that has occurred.                            weaknesses in the Macedonian labour market
                                                         that have to be addressed as well. One is the
      A key need is to improve the business climate      high taxes imposed on labour expenditures
      so that it will be easy for entrepreneurs to       of businesses. These both discourage employ-
      start new businesses and also for existing         ers from hiring more workers and stimulate
      businesses to alter their profiles. The govern-    the growth of the grey economy. Macedonia’s
      ment has attempted to introduce some meas-         unemployment statistics, as well as the via-
      ures for streamlining the process for staring      bility of the legal sector, are compromised by
      firms, but additional measures need to be          the large size of unreported employment.
      taken to accelerate new firm formation. The        Also distorting the unemployment statistics
      government should also review the regula-          is the linking of registered unemployed status
      tory and tax burden faced by firms of all sizes    with the access to health care, and decoupling
      and make a credible commitment to reduce           of this connection would be a positive step to-
      these barriers to entrepreneurship, both do-       ward providing a truer picture of unemploy-
      mestic and foreign. The private sector re-         ment in Macedonia as well as rationalising
      quires a functioning legal system, the rapid       the basis for providing health care to Mace-
      resolution of contract and property disputes,      donian citizens.
      better and cheaper infrastructure, and relief
      from regulatory burdens. In particular, the        3. Limited State Capacity and the Political
      tax burden on wages should be reduced.             System
                                                         Third, the limited state capacity of Macedonia
      The current financial system does not provide      represents a serious barrier to development
      adequate support to the financing of new and       and growth. This problem needs to be ad-
      existing businesses. Many of the reasons for       dressed through deregulation and the early

     Blue Ribbon Report
adoption of international standards, espe-          As a result of these shortcomings, some of the
cially the standards of the European Union.         key functions of government are not carried
As a small country, Macedonia must recog-           out effectively. Among the most important
nize that the capacity of the state to intervene    are:
in the economy, to regulate economic activity          1. Protecting citizens, their property and their
and to create and support effective economic           right to use it as they see fit, and enforcing con-
institutions is limited. This is in part due to        tracts. The issue is whether the state can ef-
limited resources, both human and financial,           fectively impose the rule of law on
as well as to the fact that many of these gov-         economic activity. This depends, in part,
ernment functions are characterised by im-             on whether the right laws and regulations
portant economies of scale and high fixed              are in place, and, in part, on the ability of
costs; in a small state, it is better to focus on      the government to administer the police,
doing fewer things well and to either out-             the courts and the regulatory authorities.
source others to international organisations           There are grave defects in all of these re-
or foreign institutions or even to foreign pri-        quirements in the case of Macedonia, and
vate-sector providers. Moreover, regulation            their negative effect on economic develop-
that is not consistent with international              ment is clear throughout this report. Regu-
norms and standards represents an added                latory reform, promoting competition and
cost for Macedonian firms seeking to sell their        effective corporate governance, complet-
products and services on foreign markets,              ing privatisation and strengthening the
and such costs cannot easily be liquidated             functioning of the market mechanism are
through sales on Macedonia’s limited domes-            the keys to creating a dynamic private sec-
tic market.                                            tor.                                                  17
                                                       2. Collecting taxes. Given the existence of a
The government in its role of public admin-            large grey economy, variously estimated at
istrator, the civil service as the implementer         30-40 % of GDP, there is room to increase
of these administrative tasks, and the judici-         tax collections while reducing the tax bur-
ary as special agent in the governance struc-          den on legitimate economic activity. The
ture, are weak, while the political parties are        tax system should be made more transpar-
too influential for the good of the country and        ent and easier and less costly to administer.
its economic progress. The excessive influ-            Moreover, the design of the tax system
ence of political parties on the staffing, com-        should reflect Macedonia’s economic
position and individual careers in the civil           needs: to increase employment, to shrink
service and the judiciary, and possibly also on        the size of the grey economy, to provide in-
high-level positions in state-owned compa-             centives for economic growth and to en-
nies, the linking of party interests to those of       sure microeconomic efficiency by
certain large corporate supporters, political          maintaining low and relatively uniform
corruption and so on, create excessive insta-          tax rates on different economic activities
bility in government policies and in the eco-          and sources of income. There may be sig-
nomic environment, and they hamper                     nificant tax avoidance and fraud as well.
economic growth and needed reforms. The                This undermines respect for the law and
rules for financing political parties and elec-        places an undue burden on legal business
tion campaigns should be analysed and                  activity, and it is a major barrier to foreign
changed if the existing ones are found to en-          direct investment. Improvements in the tax
courage political corruption. The civil service        system to simplify taxes and to make tax
and the judiciary need to be strengthened,             collection more transparent and simpler to
their efficient functioning improved and their         administer are an urgent need.
independence assured.                                  3. Provide public services. In some respects,
                                                       the provision of public services is good.
                                                       The economic incentives to provide them

                                                                                 Blue Ribbon Report
        and to use them wisely are often lacking,         political-party-based staff selection, which
        and thus there is considerable waste in the       considerably weakens the ability of govern-
        delivery of such services. Decentralisation       ment institutions to implement the necessary
        is both an opportunity to improve the de-         reforms, and to establish an independent and
        livery of such services as well as a major        effective civil service. Also, it is necessary to
        risk if it is done badly.                         break off with the practice of making politi-
        4. Regulate economic activity. Macedonia has      cal-party-motivated decisions on key eco-
        built up many of the regulatory agencies          nomic issues. Ending such practice will
        that are to be found in a modern market           increase the efficiency of the markets, speed
        economy. Given its size and capacity, it          up the reforms and facilitate the fight against
        may have too many. Moreover, many do              corruption. Without major changes in the
        not function well, or function in a perfunc-      way that the Macedonian political process
        tory way. Worst of all, some are simply the       functions, it is hard to see how the country’s
        basis for corruption and rent seeking.            economic potential can be realised.
        Thus, Macedonia should review all these
        agencies and abolish those that are of sec-       The implementation of government activity
        ondary importance or not functioning ef-          also depends on the division of tasks between
        fectively. Under current conditions,              the central government and local govern-
        regulation based on rules rather than on          ments. Local governments should be able to
        the discretion of regulatory authorities          implement their responsibilities with as much
        should be preferred to reduce the` poten-         freedom as possible. They should be account-
        tial for corruption and the application of        able for the results they achieve, but they
18      regulations in a discriminatory way. Em-          must have the freedom and resources to pur-
        phasis should also be placed on making            sue objectives in the way that they see fit.
        use of international organisations and
        norms to replace or supplement domestic           Equally important are reforms aimed at es-
        regulatory bodies.                                tablishing greater effectiveness of the govern-
                                                          ment as an organ of administration. This
      The carrying out of government activity and         involves reform of the judiciary to ensure an
      implementation of policies depends on the           effective role for the courts in national gover-
      organisation of government organs. In part          nance, strengthening the rule of law in Mace-
      this is a political matter. The civil service and   donia, and achieving greater efficiency of the
      the courts are institutionally weak relative to     judicial system. Government administration,
      the parties in power. As a result, they cannot      too, must be strengthened, so that the civil
      serve as an independent check on what               service will be an independent organ whose
      elected officials can do, and this leads to the     mission is to implement the policies of elected
      abuse of government power by those cur-             governments efficiently but not to be part of
      rently holding elected office and to unstable       the party system. Moreover, Macedonia is
      polices that hamper long-run development.           committed to a significant decentralisation of
      A further problem is that the political parties     government services, and this will be a task
      themselves are beholden to narrow interests,        that will require the creation of new capaci-
      as is evident by the financial involvement of       ties at the local level as well as the ability of
      the business sector in the political process.       the central government to effectively devolve
      The turn towards dynamic growth cannot be           both responsibilities and resources to local
      made without strong, efficient and credible         governments.
      institutions. The capacity of institutions to
      perform their intended function is critically
      dependent on the quality, creativity and com-
      petence of their staff. Therefore, it is neces-
      sary to abandon the practice of

     Blue Ribbon Report
D. Guideposts for the Way Ahead                     must be an important part of fiscal policy.
                                                    Achieving the right fiscal and monetary pol-
1. Sound Macroeconomic Policies                     icy mix will not be easy as the country faces
                                                    new challenges, including fiscal decentralisa-
The concept of accelerating growth we are           tion, reform of the pension system, the need
proposing rests on three key pillars, globali-      for significant improvements in infrastruc-
sation, strengthening the microeconomic             ture, the eventual introduction of EU rules
foundations of the private sector and im-           and institutions as well as the need to reform
provements in the functioning of the govern-        the tax system and the management of gov-
ment, whose elements are elabourated in             ernment expenditures.
detail in the individual parts of the Report. A
prerequisite for these pillars to fully support     Fiscal policy should be managed on the basis
economic progress is that their influence can       of the eventual need to conform to the so-
be fully felt, and this can come about only in      called Maastricht Criteria, which will become
an environment of macroeconomic stability.          increasingly important as Macedonia comes
At the macroeconomic level, appropriate             closer to EU membership. The implication is
growth and efficiency-supporting economic           that a balanced budget should be pursued on
policies need to be put into place. To date,        a medium-term basis rather than on a yearly
Macedonia has achieved and maintained               basis. Moreover, the size of the government
price and currency stability. However, both         sector must be constrained and the country’s
monetary and fiscal policies have had to be         domestic and external borrowing should not
reactive, responding in short-term fashion to       increase too rapidly. The government must
                                                    find broader sources of revenue than payroll       19
external shocks as well as to unforeseen do-
mestic developments. Partly as the result of        taxes and contributions because their cur-
these external shocks, monetary policy has          rently high level has a strong negative impact
been tight, and fiscal policy has been marked       on labour costs and the growth of the private
by large swings in the budget balance. Conse-       sector. Such a change in the tax system will
quently, it is difficult to perceive a functional   increase employment, help the private sector
relationship between the budget surplus or          grow and increase export competitiveness. To
deficit and changes in aggregate output.            the extent that budget deficits are planned,
                                                    they can be financed, at least in part, by for-
In the future, as Macedonia faces a more sta-       eign borrowing (including Eurobonds), but
ble environment, greater attention will have        expenditures should be used mainly for re-
to be given to the role of fiscal and monetary      moving bottlenecks in infrastructure and for
policy as mechanisms for the regulation of          investments in education.
the economy and for creating the conditions
for high and stable growth rather than as in-       At the same time, the state’s capacity to man-
struments that are used primarily to offset         age such infrastructure expenditures effec-
random economic and political shocks. Mak-          tively must be strengthened so that there are
ing the budget a stable instrument of eco-          clear priorities on what needs to be built and
nomic policy will require greater                   that projects are finished in timely fashion
administrative capacity on the part of state        and without major cost overruns. While it
organs, both those charged with the collec-         may be possible to develop such a capacity
tion of taxes and those that are responsible for    internally in the longer term, it may be useful
state expenditures. Moreover, it is not only        to retain the services of an outside firm to re-
the budget surplus or deficit that matters for      view the country’s infrastructure, to recom-
economic growth, but, as well, whether the          mend the most pressing needs and to oversee
tax structure and budgetary expenditures en-        the initiation and timely completion of high-
courage the growth of economic activity or          priority projects. Significant improvements to
whether they impede it. Thus, tax reform            the telecommunications and air transport in-

                                                                              Blue Ribbon Report
      frastructure are particularly urgent.              quisition of human capital rather than narrow
      The most critical need in terms of tax reform      firm- and sector-specific incentives.
      is to reduce the excessive taxes on the em-
      ployment of labour and to make the tax sys-        Second, in the medium- and the long term,
      tem more transparent and efficient. By             the effects of the quick and thorough imple-
      efficient we mean a tax system that is both        mentation of the structural and institutional
      easy and inexpensive to administer and also        reforms of the second generation should be
      a tax system that does not encourage un-           fully felt. The benefits of structural and insti-
      wanted behaviour on the part of tax payers.        tutional reforms are being felt even now, and
      The current system needs to more fully incor-      additional results will be evident relatively
      porate these characteristics. We strongly rec-     soon – the process of restarting large compa-
      ommend that in the next few years a flat tax       nies is being completed, small industrial ca-
      be adopted. Because we lack the data needed        pacities are also being activated, the
      to calculate tax rates and exemption limits        one-stop-shop system for foreign investors is
      that would make such a change in the tax sys-      being implemented, judicial system reforms
      tem, in combination with the other changes         are under way, the quality of government reg-
      that we propose, revenue neutral, we do not        ulation is improving. These factors will con-
      suggest a rate for this tax. Such a tax has been   tribute to the improvement of the investment
      adopted with good results in a number of           climate and to the encouragement of domes-
      transition economies, and it offers clear ad-      tic and foreign investors.
      vantages in terms of ease of administration
      and general neutrality between activities.         The key growth impetus must come from the
20    Moreover, a major overhaul of the tax system       private sector, as only the private sector can
      in favour of such a tax will be seen as an im-     create wealth and jobs in the long term. Eco-
      portant indicator of Macedonia’s willingness       nomic policy must therefore not only create
      to undertake strong pro-growth reforms by          an attractive macroeconomic environment to
      both its citizens and by foreign investors.        maintain the confidence of investors and en-
      Subsequent to the reform of the tax system,        trepreneurs as well as of the international
      the stability of tax rates should also become a    community, but microeconomic reforms must
      policy objective in order to provide tax payers    also clear the way for the private sector to
      with a measure of certainty about their tax li-    flourish. To start businesses, to invest and to
      abilities.                                         wind up business ventures must be both easy
                                                         to do and at the same time assisted by institu-
      The tax base should also be broadened by           tions, laws and regulations that give market
      eliminating exemptions that are often ad hoc       participants confidence in their ability to
      and serve little purpose (such as the tax re-      enter into contracts and ventures that will be
      duction for firms choosing to list their shares    subject to objective market criteria and pro-
      on the stock exchange) and by shrinking the        tected by the efficient administration of jus-
      size of the grey sector by reducing the tax        tice.
      rates on legal businesses, by liberalising
      labour laws and lowering wage taxes, and by        2. EU Accession
      both punitive measures and positive incen-
      tives to turn grey economy firms into legal        Macedonia’s desire to become a member of
      ones. We do not believe that the tax system is     the European Union (EU) is an objective that
      a useful tool for social engineering, but if the   enjoys broad national consensus. This desire
      tax system is to provide any incentives for        for EU membership thus must shape national
      certain types of economic activities, these in-    policy, both foreign and domestic, the reform
      centives should be broad and growth-en-            initiatives, and the economic agenda and
      hancing ones promoting saving, investment,         business strategies. Macedonia’s EU aspira-
      the formation of small companies, and the ac-      tion provided the compass for the reforms

     Blue Ribbon Report
that were implemented in the transition             Fulfilment of the economic criteria for mem-
process, and it still anchors the social agree-     bership must be a top priority for Macedonia,
ment among virtually all Macedonian citi-           not only in order to meet the standards of the
zens.                                               EU, but also because they are crucial for
                                                    Macedonia’s economic and social progress.
It is important for this reason to review here      Macedonia needs to fully develop a function-
what has been achieved and what is to come,         ing market economy that will allow an even
bearing in mind that EU integration reaches         ground for competition and weed out all the
into every aspect discussed in the Blue Rib-        oligarchic elements in the economy that stifle
bon Report. Economic growth is increasingly         its overall growth. The Macedonian economy
important for Macedonia for its own sake as         needs to be able to cope with the intense com-
well as for the country’s path toward the EU;       petitive pressures and market forces within
equally important is the growth of its institu-     the EU. Consequently, Macedonia needs to be
tional and administrative capacity at all levels    aiming for where the EU economy will be at
of government, from the local to the interna-       the end of the reporting period not where the
tional. As discussed below, the main objec-         EU economy is today.
tives and stepping stones in the next stages of
Macedonia’s EU integration will be economic         The capacity of Macedonian institutions to ef-
growth, economic and social opening to the          fectively manage the requirements implied
EU and institutional preparedness.                  by EU membership and, before membership,
                                                    the administration of processes such as the
An important milestone in Macedonia’s path          implementation of laws and the management
toward EU membership was the signing of             of funds, needs to be strengthened. Answer-       21
the Stabilisation and Association Agreement         ing the European Commission Questionnaire
(SAA) in 2001. This agreement provided a            revealed that Macedonia has the potential to
strong motivation for the intensification of        meet the administrative requirements of EU
the adjustments necessary for the fulfilment        membership, but this potential cannot remain
of EU membership criteria. One positive out-        latent and needs to become the norm. Firm
come of the SAA was the establishment of an         political commitment and leadership, not
appropriate administrative structure and of         only management, is needed to prepare these
an institutional framework for implementa-          institutions and the Macedonian economy for
tion of the Agreement as well as for monitor-       European integration. Municipalities need to
ing of its implementation.                          be able to administer funds effectively and
                                                    transparently. They need to be able to effec-
The next important step occurred in December        tively interact with EU organs and to formu-
2005, when Macedonia achieved the status of a       late sound and comprehensive policies
candidate country. This was an important po-        Public and civil servants from all levels of
litical recognition of the progress and reforms     government need to be trained to work
achieved; however, an important reservation to      within European standards and processes, to
this positive assessment of Macedonia’s             effectively plan, budget and administer
progress is the fact that a date for negotiations   funds, to create projects and manage them
has not been set because the country is not yet     ably and to be capable of being a positive and
ready. The acquisition of candidate status does     proactive member of the EU that can fully
not mean fulfilment of the strict EU criteria for   participate in European governance and in
membership. In fact, Macedonia has only             the formulation of EU policies. The role of
reached the point at which the complex process      Parliament will be essential in the process of
of negotiation about the individual chapters of     creating these capabilities, in monitoring the
the Acquis Communautaire and of fulfilment of       implementation of EU-oriented policies and
the membership criteria, especially the eco-        activities and especially in the process of ne-
nomic ones, begins.                                 gotiating accession.

                                                                             Blue Ribbon Report
      The next step ahead is the negotiation               considerable thought must be given to the
      process, which is both a great opportunity           phasing in of various EU-related laws and
      and a great threat. If Macedonia proceeds ef-        regulations. Consequently, Macedonia must
      ficiently in this process, it will demonstrate to    create the capacity to weigh the costs and
      itself and to the world its institutional readi-     benefits of adopting specific EU laws and reg-
      ness for membership; if it fails to do so, its       ulations at any given time and to develop a
      image as a modern state will suffer corre-           comprehensive plan for doing so. Preparing
      spondingly. A successful negotiation will            for EU membership will be a major task for
      have important positive economic benefits            the Macedonian government and society, as
      and solidify a fragile national consensus; a         well as for the business sector. While the ex-
      negative outcome to the negotiation may nur-         perience of other countries suggests that the
      ture Euro scepticism and a general resistance        pace with which changes are implemented
      to any further reform processes since these          may accelerate over time, it is critical that
      will be seen as having high costs and few ben-       Macedonia have a clear roadmap of the
      efits.                                               process, one that identifies costs and benefits
                                                           of adopting specific measures and weighs
      Macedonia will not be in a position to nego-         them against Macedonia’s ability to absorb
      tiate parallel chapters at the same time, as         such changes as well as their congruence with
      other countries have done; it will need to do        Macedonia’s economic strategy at any period
      so sequentially. This may slow the overall           of time.
      process. It is the view of this Commission that
      Macedonia need not rush this process, but,           Macedonia has an enormous potential mar-
22    rather, it should strategically adopt segments       ket open to it because of the free trade agree-
      of the Acquis if it is to its benefit to do so and   ments (FTAs) it has signed, including the one
      leave those segments that may be hardest for         with the European Union. Overall, the FTA’s
      its economy and society to internalise for last.     did not initially stimulate Macedonian ex-
      Furthermore, it is very important that there         ports very much, suggesting a weak supply
      be some continuity among Macedonia’s nego-           response on the part of Macedonian exporters
      tiators. They will also need to communicate          or ineffective implementation of the FTAs. In
      intensively with the general public and ex-          the past three years, exports to countries with
      plain the process so as to maintain the na-          which Macedonia has signed FTAs have
      tional consensus for EU membership.                  shown greater dynamism, and these export
      Consequently, the process of negotiating             gains must be consolidated and continued.
      Macedonia’s entry into the EU must be as             Macedonian producers must pay greater at-
      transparent as possible.                             tention to such factors as environmental stan-
                                                           dards, packaging, quality, marketing,
      The time between achieving candidate status          management techniques and market study to
      and the negotiations leading to future mem-          prepare for the EU market.
      bership will be challenging, both politically
      and economically. While issues of political          It is hence worthy of mention that one of the
      stability and interethnic dialogue have dom-         elements of the pre-accession process is ac-
      inated the discussions between European and          cess to EU funds which will be channelled
      Macedonian politicians thus far, economics           through the new Instrument for Pre-Acces-
      will dominate the next stage leading toward          sion Assistance (IPA). The main goal of the
      EU membership. Macedonia needs to under-             pre-accession funds is to prepare the institu-
      take a major overhaul of its laws and institu-       tions of future member countries for the man-
      tions to prepare for EU membership. Such a           agement and administration of the much
      large revision of laws, regulations and institu-     larger Structural Funds that the country will
      tions should, in the long term, be beneficial.       have access to once it becomes a member of
      However, there will be transition costs, and         the EU. Indeed, in order to obtain the pre-ac-

     Blue Ribbon Report
cession funds, the country needs to define its       importance of Corridors 8 and 10, for both
development and investment priorities for            Macedonia’s regional and European perspec-
the medium-term, as well as clearly define           tives. Corridor 10 has a greater perspective
and organise the institutional mechanisms for        of realisation and natural evolution, being
using the funds. The IPA funds will have a           also important to Greece. However, Corridor
positive effect on economic growth through           8 will require more of a push by Albania,
creation of a more attractive business climate       Macedonia and Bulgaria. Although corridors
by contributing to investments in infrastruc-        8 and 10 were effectively taken off the Euro-
ture, institution-building, human resources,         pean transport map, their importance is in-
agriculture, competitiveness of firms, all with      creasing as EU foreign policy progressively
a consideration for balanced internal regional       turns toward Asia. This, along with Macedo-
development.                                         nia’s candidacy, makes now a good time to
                                                     press the issue to its conclusion.
Within the region, Macedonia has an advan-
tage in bordering the EU, in the form of             The importance of diplomacy will be crucial
Greece, to the south. Indeed, the bulk of for-       in the EU integration process and its speci-
eign investments that have come in the past          ficity needs due attention because the current
years have been from Greece. However, the            diplomatic connections with EU partners will
possibility of exporting to the rest of the EU is    become governance relationships once mem-
significantly hampered by the numerous bor-          bership is achieved. So, on the one hand,
ders that need to be crossed to reach the            these need to be made very strong now, even
biggest part of the EU market. For this reason,      as some Macedonian diplomatic and consular
it is in Macedonia’s interest that the rest of the   offices may need to be closed or reduced.        23
Western Balkan countries also enter the EU as        Now is a good time to start thinking of these
soon as possible, or alternatively, that the ini-    issues.
tiative toward a customs union for South East
European (SEE) countries that seems to be            All reforms addressed in this Report are im-
prevalent now be intensified. The EU has a           portant for the convergence of the country to
market of over 300 million people, but there is      the EU and for full EU membership. Macedo-
a market of sixty million customers within           nia must accelerate its growth and help the
this region that also can be tapped if unifica-      economy become capable of creating new
tion of sorts occurs regardless of, or as a prel-    jobs. Therefore, the EU integration process,
ude to, Macedonia’s entry into the EU;               the process of reforms and that of creating an
indeed, regional cooperation of increasing in-       environment conducive to economic growth
tensity is an important aspect of the Stabilisa-     are intertwined. Macedonia needs to make
tion and Association Agreement.                An    best use of this great opportunity.
encouraging move in this direction is the re-
cent political commitment to, and the start of       3. Reform Roadmap
in 2007, a single free trade agreement (FTA)
for the countries of SEE.                            Apart from a good reform program, equally
                                                     important is its implementation strategy, in-
Improvement of land and air communication            cluding its proper sequencing. The experi-
must be Macedonia’s top priority. The airport        ence of other countries demonstrates that fast
is Macedonia’s gateway to the world and is in        and consistent reforms, well coordinated and
dire need of investments, which will come            properly implemented are more effective, less
most easily if it is fully privatised. Except for    painful and bring their benefits quicker than
Greece, all EU countries are a considerable          do slow reforms that entail compromises on
distance from Macedonia, and air connec-             key issues. A clear commitment to complex
tions are critical for trade and business. Nev-      policy and systemic changes backed by swift
ertheless, this does not undermine the               action where possible and a clear timetable

                                                                              Blue Ribbon Report
      where more extensive study is needed prior         themselves are conceptually more complex
      to implementation help to build political mo-      and require a longer time to develop and im-
      mentum for change and take advantage of a          plement properly and because the visible eco-
      political “window of opportunity”; give re-        nomic payoffs from such policy changes may
      forms and reformers greater credibility with       be slower to reveal themselves. Fortunately,
      both domestic constituencies and foreign           there are at least three important circum-
      governments, international agencies and for-       stances that can help to make this process eas-
      eign investors; and help to organise a pro-re-     ier in the case of Macedonia.
      form coalition and neutralize or compensate
      losers. They minimise the danger of having         First, planning and implementation of a sig-
      the reform process captured by its intermedi-      nificant part of the proposed reform package
      ate-term winners who may not be interested         has been already started: for example, the re-
      in the continuation of the reform to its in-       form of the labour law, government decen-
      tended conclusion.                                 tralisation, judiciary reform, and, to lesser
                                                         extent, public administration reform. These
      A further lesson is that the most difficult and    reforms need to be refined and their applica-
      painful steps, especially those related to the     tion must be accelerated, but there is not the
      rationalisation of welfare programs or the         need for a fundamental conceptual debate
      limiting of the privileges of influential social   about their desirability or for a major political
      groups, must be taken at the very beginning        effort to initiate them.
      when the support for the government and its
      reform program is the highest.                     Second, most of the required reforms will be
24                                                       very closely connected with the forthcoming
      Complex institutional reforms such as public       EU accession process and EU membership
      administration reforms, government decen-          negotiations, which will provide the govern-
      tralisation or reform of the judiciary, require    ment of Macedonia and Macedonian society
      more time and bring their fruits with a sub-       with strong external incentives and a power-
      stantial time lag. This is the major difference    ful anchor. The recently obtained EU candi-
      between them and, for example, macroeco-           date status should thus serve as a very
      nomic stabilisation or domestic or external        positive stimulus to accelerate these reforms
      liberalisation, which can and should be con-       and create a pro-reform momentum.
      ducted in a shorter period of time and bring
      visible benefits sooner. However, the longer       Third, the last two years have seen some im-
      time span required by institutional reforms        provement in the previously disappointing
      cannot serve as an excuse for abandoning or        economic growth record of Macedonia. There
      postponing them. On the contrary, they             are also some signs of an acceleration of the
      should be started early enough and con-            growth of exports and increasing interest in
      ducted in the fastest possible way to be com-      Macedonia among foreign investors. Mace-
      pleted on time.                                    donia finally seems to be entering the phase
                                                         of catching-up growth, which can reduce the
      Macedonia has already completed the first          social costs and social resistance to many pro-
      stage of its transition process and does not       posed reforms, for example, to labour market
      need a radical stabilisation program or major      and social reforms, and to help in social and
      changes in its macroeconomic policy. Most of       political consolidation.
      the remaining reform agenda involves com-
      plex and time-consuming structural and in-         While the strategic goals of this Report con-
      stitutional reforms that are of an urgency         cern a ten-year development perspective, i.e.,
      equal to that attached to stabilisation and lib-   a period most likely required to complete the
      eralisation of markets in the early transition     EU accession process, the detailed reform
      period, but which differ because the policies      work plan of the new government should

     Blue Ribbon Report
cover four years, the period of its constitu-      publicly-owned enterprises; and undertaking
tional mandate.                                    major privatisation transactions followed up
                                                   by the wide-scale privatisation program in
To demonstrate its reform commitment and           many sectors including social services. Other
build its reform credibility, the government of    measures that can be implemented quickly
Macedonia should present publicly a com-           include the liberalisation of business forma-
plex program of economic and institutional         tion; the improvement of conditions for for-
change, and this document should contain           eign trade, including improved customs
not only major reform objectives and their di-     services, faster payments of rebates to ex-
rections but also a concrete timetable for their   porters, speeding up border transit and facil-
implementation, subject to subsequent peri-        itating the movement of goods and
odical, for example, annual, reporting and         individuals internationally; and the develop-
updating. It is critical that the government’s     ment of a broad anti-corruption program
reform program stress that the proposed pro-       with tangible objectives.
gram has two key features that must be un-
derstood and accepted by all elements of           Many of the above objectives can be imple-
Macedonian society:                                mented, at least in part, through administra-
                                                   tive measures and thus should begin as
The first is that the program is closely linked    promptly as possible in the new govern-
to the country’s EU accession strategy, both in    ment’s period of office. To the extent that leg-
terms of making Macedonia a prosperous             islation is required, a complex deregulation
and dynamic economy whose economic per-            package including business registration, li-
formance will be stronger than that of other       censing, administrative permissions, the sys-       25
candidate countries, and in terms of making        tem of administrative inspections, etc.,
Macedonia a country that has fully imple-          aiming generally to increase the ease of doing
mented EU laws, regulations and directives         business in Macedonia and decreasing the
into its daily life.                               business sector’s transaction and operational
                                                   costs should be prepared and introduced
The second is that the reform program pro-         within the first six months of the govern-
posed here consists of interlocking elements       ment’s mandate.
all of which have to be implemented with
equal thoroughness and within approxi-             Forming a new government is also the best
mately the same time period. The reform pro-       moment to reform and simplify its institu-
posed here is a complex program of mutually        tional structure and to reduce the excessive
supportive measures, and it cannot be seen as      number of administrative staff. From the very
a cafeteria from which politicians can accept      beginning, the new government should also
some elements and reject others while expect-      declare and adopt in practice a new merit-
ing sound results.                                 based personnel policy in public administra-
                                                   tion. While the institutions and the legislation
As we suggested before, the reform process         to create a politically independent and merit-
should start with the most unpopular and so-       based civil service will take time and consul-
cially painful actions such as the continuation    tation with all elements of the political
of labour market reform, including the issues      spectrum in Macedonia, the new government
of minimal wage and collective bargaining;         should avoid politically motivated dismissals
increasing the retirement age and other meas-      and nominations and resist pressures from
ures aimed at decreasing the liabilities of the    the political parties and business interest
pay-as-you-go pension pillar; review of other      groups to promote their protégées. Only in
social welfare programs; elimination of vari-      this way can the stage be set for a civil service
ous group privileges; imposing hard-budget         reform that will have broad and lasting sup-
constraints and closing down loss-making           port. The same should apply to state-owned

                                                                             Blue Ribbon Report
      corporations and other public institutions.        means to address them immediately. In each
      Even if the entire set of public administration    case, clear reform objectives and a detailed
      and civil service reform measures cannot be        road map and timetable of reform implemen-
      elabourated and initiated immediately be-          tation should be publicly presented to avoid
      cause many of them require conceptual de-          the subsequent dilution or reversal of the pro-
      bate, additional legislation and, sometimes,       gram or its capture by special interest groups.
      financial resources, this kind of visible change   Such an approach can help to build pro-re-
      in personnel policy would signal the govern-       form support and credibility for the govern-
      ment’s determination to introduce a new way        ment’s intentions and actions. It can also
      of governing and increase its reform credibil-     create positive expectations among the popu-
      ity. The government should press to imple-         lation and business community, including
      ment new legislation creating an independent       foreign investors and greatly improve the
      merit-based civil service by mid-2007.             country’s international reputation.

      Taking into consideration that tax reforms         Perhaps the most time-consuming reforms
      proposed in this Report, particularly the in-      will be those involving fiscal decentralisation.
      troduction of a flat personal income tax and       While the legislative underpinnings are in
      changing the source of financing of the health     place, the process requires considerable
      care sector, require some preparatory work         preparation on the part of both the central
      such as the simulation of their fiscal conse-      government and of municipalities. Moreover,
      quences, projecting fiscal compensatory            there is considerable uncertainty about how
      measures, changing tax legislation, informing      well all the municipalities will be able to fulfil
26    taxpayers and the technical preparation of tax     their new obligations. As a result, it is critical
      administration to implement a new system,          that the government stress the correctness of
      the realistic date of their launching seems to     the principles that underpin the existing
      be January 1, 2008, which would require that       roadmap for fiscal decentralisation while re-
      fiscal analyses of these measures be com-          maining flexible in dealing with unexpected
      pleted by early 2007, and that the necessary       developments in the course of its implemen-
      legislation be enacted later in 2007. They         tation.
      should be implemented as a single package
      to minimise the number of necessary changes        Most of the proposed structural and institu-
      in tax legislation and to avoid a perception of    tional reforms have a direct importance for
      instability in the tax system among taxpayers.     the EU accession process and, for this reason,
                                                         their detailed design should be harmonised
      Parallel to tax and labour market reforms, the     with the Acquis Communautaire as much as
      long-term institutional reforms such as those      possible to avoid second round modifications
      of the judiciary, that are already in train        at a later date. Their timetable should be coor-
      should be continued and, where possible, ac-       dinated with either Macedonia’s already ex-
      celerated. While the government may wish           isting EU commitments, stemming, for
      to revisit the specific measures entailed in the   example, from the SAA, or with the expected
      existing reform programs through annual re-        accession roadmap.
      views or more formal analyses, halting or
      slowing these much needed reforms to re-           Compared to many of its Central and Eastern
      view and redesign these badly-needed im-           European neighbors, Macedonia is already
      provements in the functioning of social            delayed in its European integration process.
      institutions would be a serious setback to         The small size of the country, the fact that it
      Macedonia’s progress. In those cases where         will have to negotiate its accession alone, in
      reforms are needed but programs are not yet        contrast to the “collective” character of the
      in place, it is critical that the government       2004 Enlargement negotiations, plus the visi-
      specify the desired objectives and the general     ble enlargement “fatigue” in Western Europe

     Blue Ribbon Report
seriously weakens Macedonia’s bargaining              The first is that Macedonia’s balance of trade
position. So it is very unlikely that any future      deficit will continue to grow, potentially to
government can obtain too many waivers and            unsustainable size. Second, even if the labour
exemptions from the Acquis, no matter how             force remains constant, the decline in unem-
good its negotiating skills may be. Too much          ployment will be modest, not falling below
bargaining will only delay the country’s EU           20% in the next 10 years.
accession. Macedonia cannot lose the win-
dow of opportunity opened by the recently             Table 2. Baseline Economic Scenario.
obtained EU candidate status by delaying the
most important structural and institutional
reforms or diverting them in wrong direction.
Instead, Macedonia must impose on itself the
task of exceeding the readiness for EU mem-
bership achieved by the transition countries
that have preceded it in gaining EU member-

II. What is the Magnitude of the
Task at Hand?

The members of the Commission do not be-                                                               27
lieve that it is useful to set quantitative targets
for Macedonia’s future economic perform-
ance. Nevertheless, in view of the public con-
cern over slow growth, high unemployment
and the need to integrate Macedonia more
                                                      A strategy that accelerated growth of output
fully into the global economy, we do believe it
                                                      by some 2% over the baseline 4% growth rate
to be useful for policymakers as well for
                                                      and that accelerated Macedonia’s globalisa-
Macedonian citizens to understand the impli-
                                                      tion by increasing the growth of exports so
cations of current economic performance as
                                                      that they would be 60% of GDP by 2015 could
well as to have some conception of whether
                                                      achieve results that appreciably improve
the goals of higher growth and greater glob-
                                                      Macedonia’s economic situation. In Table 3
alisation are feasible and worthwhile.
                                                      we assume that exports, generated by manu-
                                                      facturing, agriculture and trade, grow suffi-
For example, Figure 2 suggests that a growth
                                                      ciently fast so that they account for 60% of
rate of real GDP of 4% would be feasible for
                                                      GDP by 2015. In this situation, incomes
Macedonia under the current economic sys-
                                                      would be higher than in the foregoing sce-
tem because such a growth rate has been ob-
                                                      nario, but, more important, even if the labour
tained on several occasions, including the
                                                      force is assumed to grow rather than remain-
past several years. Table 2 provides a simple
                                                      ing stagnant, unemployment falls sharply
projection of what would happen to the
                                                      and exports and imports would effectively be
Macedonian economy in the future if such
                                                      in balance.
performance could be sustained. With real
GDP growth of 4% per annum and no struc-
tural changes and a 2% growth in labour pro-
ductivity, Macedonians will enjoy a higher
standard of living, but this will be under-
mined by several structural shortcomings.

                                                                               Blue Ribbon Report
                                                       III. Adjustment of the External

                                                       We have previously pointed out Macedonia’s
                                                       under-globalisation, which is both a barrier
                                                       to the country’s economic progress and to its
                                                       structural and economic reform. This under-
                                                       globalisation is manifested in Macedonia’s
                                                       relatively low trade-to-GDP ratio, by the low
                                                       volume of FDI and by the low level of Mace-
                                                       donia’s integration in global capital markets.
                                                       In turn, the low level of foreign trade is a
                                                       major contributor to, as well as the result of,
                                                       the lack of competitiveness of Macedonian
                                                       products, the passivity of Macedonian firms
                                                       and their ineffective corporate governance
                                                       and the lack of responsiveness of Macedonian
      Table 3. Increased Globalisation Scenario.       firms to opportunities on foreign markets.
                                                       Among the manifestations of this interaction
      These, of course, are simple projections, and    between globalisation and the performance of
      we do not mean to represent them as compre-      the domestic economy are:
28    hensive models of the Macedonian economy,
      in part because they embody rather mechan-          1. Monopolisation of the domestic market
      ical assumptions, for example, about the re-        makes exporting look unprofitable to
      lationship between the level of output and the      many Macedonian firms because of the
      level of employment. Rather, our objective is       lack of competitive pressure on the do-
      to show that such a change in the perform-          mestic market. Moreover, their profits are
      ance of the Macedonian economy can, over            not competed away by imports because
      time, generate a qualitatively more                 import channels themselves are often mo-
      favourable set of outcomes than that implied        nopolised.
      by the baseline scenario. The more optimistic
      of our scenarios does, however, rest on the         2. Macedonia has export capacities in
      three pillars for economic progress we set out      products that face severe competition on
      above. It embodies a grater globalisation of        international markets – textiles, shoes, etc.
      the Macedonian economy, explicitly through          Yet, for products for which global demand
      a faster growth of exports and implicitly be-       is now booming, e.g., steel, there appears
      cause such growth to some extent presup-            to be little dynamism beyond bringing
      poses an increase in foreign direct investment      some capacity on stream via FDI.
      (FDI). The latter, as well as increased dy-
      namism of the domestic economy, require             3. Macedonian products do not appear to
      better functioning institutions as well as a        face extensive foreign barriers – the EU
      supportive business climate, both requiring         provides preferential access to its market
      government policies in support of a the             and Macedonia has concluded free trade
      micro-foundations of the economy. Finally,          agreements (FTAs) with many neighbour-
      employment gains will also require tax re-          ing countries. As these FTAs were put into
      form as well as labour market reform to make        place, there was little or no “supply re-
      hiring additional workers appealing to pri-         sponse” on the part of Macedonian ex-
      vate sector firms.                                  porters. It could be that these agreements
                                                          failed to match Macedonia’s export poten-

     Blue Ribbon Report
    tials or this could be evidence that Mace-    the conduct of economic policy and in the
    donian firms lack the incentives or the       performance of institutions important for in-
    ability to expand their sales abroad and      ternational trade. These problems are dis-
    thus would not respond to other export        cussed in the following sections, which also
    incentives like devaluation either. Mace-     offer various recommendations for their so-
    donian managers may not be aware of in-       lutions. All recommendations are intended to
    ternational opportunities or sufficiently     improve trade performance directly through
    well versed in international business.        changes in trade policy or indirectly through
Of the many concrete measures that the gov-       other policy measures that have strong link-
ernment can implement to help to promote          ages to trade.
Macedonia’s globalisation, we prefer those
measures that reduce barriers to trade, in-       It should be noted at the outset that the major
cluding tariffs and administrative barriers,      constraint on the performance of the external
and barriers created by lack of information       sector does not appear to have an origin in
because these will, in the end, also strengthen   the conduct of trade policy. The origin of the
the microeconomic basis for Macedonia’s           difficulties appears to be microeconomic and
global competitiveness, on which its prosper-     to lie in the operations of domestic firms and
ity must rest. We see measures designed to        markets, the problematic nature of other eco-
provide direct government aid to export ac-       nomic policies and poorly functioning do-
tivities as both inconsistent with Macedonia’s    mestic institutions. These are discussed at
international obligations and likely to create    length elsewhere in the Report, but here we
problems by creating further opportunities        remind the reader of this important connec-
for corruption and favouritism, thus actually     tion.                                              29
weakening Macedonia’s competitiveness on
world markets.                                    Nonetheless, the discussion that follows
                                                  below will raise issues from those areas in
                                                  order to highlight their linkages to the per-
1. Current Status of Policies Affecting the Ex-   formance of the external sector. Future devel-
ternal Sector                                     opment of the external sector will depend
                                                  critically on political stability in the region.
The policies affecting the external sector have   Regional political stability is necessary for
been radically changed over timei. In general     further cooperation with neighbouring states
terms, the broad elements of Macedonia’s          with which Macedonia will have to negotiate
trade policy are liberal, allowing foreign        more comprehensive and far-reaching meas-
goods de jure fairly unrestricted access into     ures to enhance its trade relations and eco-
the Macedonian market. Macedonia does not         nomic cooperation. For example, Macedonia’s
provide any serious import restrictions. Tar-     most important trading partners are its neigh-
iffs are on average quite low – the World         bours to the North, which take about a quar-
Bank reports that Macedonia’s average tariff      ter of Macedonia’s exports. About one half of
rate in 2004 was 8.1 percent, quotas have been    those exports are directed towards the
eliminated with some exceptions, licensing        Kosovo market. It is clear, therefore, that the
procedures streamlined. The country has           prospects for a successful export drive de-
been a Member of the WTO since 4 April            pend to a significant degree on good neigh-
2003. On the surface, trade policy does not       bourly relations with these countries. Thus
seem to constitute a major impediment to the      Macedonian foreign policy and its commer-
foreign trade performance.                        cial policy component must both be actively
                                                  directed at promoting regional initiatives that
Nevertheless, the level of Macedonia’s inte-      reduce tensions and promote commerce with
gration in the global economy is very low for     its neighbours.
its size, and this signals serious problems in

                                                                            Blue Ribbon Report
      2. Policy and Institutional Recommenda-             phytosanitary (SPS) regulations and technical
      tions                                               regulations imposed by importing countries
                                                          as well as by other operating rules, and (2) the
      Given the progress made by the authorities in       treatment of “sensitive” products and (3) a
      liberalising the external sector there are rela-    variety of restrictions imposed on trade in
      tively few outstanding issues to be addressed       services, and (4) the degree of cooperation
      that relate to that sector alone. Nevertheless,     with Macedonia’s important trading partners.
      some areas of policy concern still remain and
      will need the attention of the Macedonian           The restrictiveness of SPS regulations is ex-
      government. The following discussion is di-         tremely serious for Macedonian exporters be-
      vided into three broad categories of outstand-      cause they affect the country’s agriculture,
      ing issues – (1) those affecting the access of      which has significant export potential, and
      Macedonian exporters to external markets,           because of difficulties faced by exporters in
      (2) those affecting domestic incentives and in-     complying with such regulations. The latter
      stitutions that are critical for enhancing the      is partly a question of costs of compliance and
      role of the external sector and (3) outstanding     partly a matter of inadequate knowledge and
      issues of trade policy per se. Even though the      technical facilities. It is the latter that the
      market access issues relate to measures that        Macedonian authorities should improve, and,
      are to some extent under the control of for-        to do so, they should seek the necessary tech-
      eign governments, they can be addressed by          nical and financial support from external
      Macedonian authorities through negotiations         donors and trading partners such as the Eu-
      with their foreign partners.                        ropean Union.
      A. Market Access.                                   Access to foreign markets has been also com-
                                                          plicated in the past by the introduction of cus-
      Macedonia’s exports depend, inter alia, on the      toms administration in the independent
      ease with which exporters can access foreign        states neighbouring Macedonia. Even if those
      markets. At the present time, most of Mace-         countries were to administer their customs in
      donia’s main trading partners provide fairly        the most efficient way, customs administra-
      liberal access to Macedonian exporters, but         tion always adds to the costs of trade. It is,
      some barriers still exist. Many of those restric-   therefore, in the interest of all parties con-
      tions will be further liberalised or completely     cerned to ensure that customs administration
      removed under the terms of the existing re-         officials fully cooperate in order to facilitate
      gional agreements. The remaining barriers           exchange of goods. The most sensible step is
      should be targeted by the government as is-         to ensure that procedures be harmonised as
      sues for further negotiations – either in the       closely as possible in order to ensure compli-
      WTO or through regional arrangements. In-           ance with the WTO and the EU rules, and
      deed, because Macedonia’s underglobalisa-           Macedonia should take the lead in develop-
      tion is a characteristic that it shares with        ing regional agreements on such procedures.
      many of its neighbours (see Figure 3), creative
      solutions for regional trade liberalisation pro-    The second set of issues concerns the scope of
      posed by Macedonia should be favourably re-         liberalisation in markets of export interest to
      ceived by its neighbours.                           Macedonia. The access to those markets is
                                                          typically adversely affected by restrictions on
      The remaining barriers against Macedonian           imports of so-called sensitive products. That
      exports affect trade both in goods and in serv-     is the case even when trade flows are regu-
      ices. The following three groups of barriers        lated by free trade agreements. FTAs typically
      should be singled out as constituting a partic-     include provisions for sensitive products
      ularly serious constraint on exports – (1) non-     whose trade is often limited by export quotas.
      tariff barriers such as sanitary and                Unfortunately, the sensitive products are also

     Blue Ribbon Report
often products of considerable interest to          towards liberalising trade in goods while
many exporting countries. Macedonia, too,           services have not been opened up to the same
has been subject to such restrictions, and it is,   extent. This is unfortunate given the historical
therefore, extremely important that these re-       ties among the countries in the region. The
strictions be removed as quickly as possible.       authorities should, therefore, consider ex-
                                                    panding the scope of existing regional agree-
The third area of concern is the access of          ments to the area of services. Moreover, the
Macedonian service providers to foreign mar-        Macedonian government should ensure that
kets. Macedonia has been a traditional ex-          domestic laws and regulations do not dis-
porter of such services as construction and         courage domestic firms from establishing
transport – two markets that continue to be         strategic alliances with foreign partners
heavily protected abroad.      Macedonian           whenever there are opportunities to do so.
diplomacy must therefore seek multilateral
solutions to this problem.                          A final comment concerns the implementa-
                                                    tion of the existing FTAs. The business com-
Many of these issues are already addressed          munity in the region has often complained
in the existing FTAs that Macedonia has ne-         about problems of non-compliance with the
gotiated. However, there are considerable dif-      terms of the FTAs. This clearly indicates that
ferences among the FTAs signed bilaterally          there is a need for the establishment of an ef-
by Macedonia with other countries and by            fective mechanism for the resolution of trade
the latter countries among themselves. There        conflicts. The existing provisions for dispute
are also some serious shortcomings in these         settlements should be reviewed and changed
FTAs. First, the FTA initiatives have primarily     if necessary. Mechanisms used by other FTAs,       31
taken the form of bilateral agreements. While       such as NAFTA, could serve as a model. The
such arrangements are a step towards market         alternative for members of FTAs who are also
opening, their bilateral nature is quite risky      WTO Members is fairly straightforward –
and potentially damaging. This is because the       these countries can use the existing WTO
bilateral FTAs together with the Stability and      mechanism for dispute resolution. Whatever
Association Agreement (SAA) with the EU             measures are taken, they must include train-
will most likely create a “hub-and-spoke” re-       ing of lawyers in international trade law.
lationship with the EU in which the major
beneficiaries would be EU firms. Moreover,          B. Domestic Policies Affecting Trade
the existing differences among the bilateral
FTAs are large enough to significantly limit        Trade performance of countries depends on
the potential gains from the increased size of      factors that can be grouped into three classes
the market for foreign businesses and in-           – macroeconomic conditions such as infla-
vestors. The proposed harmonisation and             tion, external debt or current account imbal-
unification of the regional FTAs should thus        ance, structural factors such as poor
be a priority for Macedonia. The harmonisa-         infrastructure, inflexible labour markets or
tion should cover areas such as customs ad-         problems of financial sector, shortage of
ministration and rules of origin. Specific          skilled labour and so on. Trade policy and in-
proposals are made in the text below. In addi-      stitutions are typically included in this group
tion, it would be highly desirable to include       of structural policies. It is clear that, ulti-
rules concerning competition, provisions for        mately, all of these factors are closely con-
state aid and for mergers and acquisitions.         nected and should be considered by the
                                                    authorities whenever they seek to enhance
The FTAs have been quite successful in re-          the role of external sector. Both macroeco-
moving tariff and quota restrictions on the ex-     nomic policy and various elements of struc-
ports of Macedonia to its FTA partners.             tural policies are discussed in detail
However, the current FTAs are heavily tilted        elsewhere in the Report. This section will

                                                                              Blue Ribbon Report
      only address the macroeconomic and struc-            These trends could be in part explained by
      tural issues in so far as it is necessary to high-   relatively high costs of doing business in
      light the important linkages with trade              Macedonia. For example, the level of real in-
      performance and policy.                              terest rates has been high, payroll taxes on
                                                           labour are also quite high, and there are many
      1. Exchange Rate and Domestic Prices.                bureaucratic burdens on firms. All of these
                                                           high costs point to the fact that the ability of
      Economic growth in small countries such as           domestic firms to compete on foreign mar-
      Macedonia is critically dependent on the             kets is seriously impeded.
      growth of exports and the active participation
      of the external sector in the mobilisation of re-    On the other hand, the rapid growth of im-
      sources for economic growth. However, the            ports relative to exports seems to reflect an
      present role of the external sector is below its     expanding domestic demand and strong in-
      potential as evidenced by the relatively low         centives for domestic firms to produce for the
      share of exports and imports in GDP. It is           domestic market and not for export. Even
      clear that the share must increase if economic       though exports have been adversely affected
      growth is to accelerate and reach a higher           by disruptions of production, there are indi-
      sustainable level.                                   cations that the incentives to export are lack-
                                                           ing in view of the poorly functioning
      In order to stimulate the growth of the exter-       trade-related institutions.
      nal sector of the economy, it is essential that
      domestic incentives to export and to compete         Some observers, incorrectly in our view, have
32    with foreign firms are not distorted. Unfortu-       attributed Macedonia’s poor export perform-
      nately, there are strong indications that the        ance to the management of the exchange rate,
      competitiveness of domestic firms is gener-          arguing that a devaluation of the Denar is
      ally very low. The current account has been          necessary. In the case of Macedonia, a strong
      under pressure, even though the trade gap            case can be made against a devaluation of the
      has been partially offset by labour remit-           exchange rate under present circumstances
      tances. The production base is extremely nar-        and in favour of mechanisms that would pro-
      row, which exposes the country to market             vide for the realization of a more outward ori-
      fluctuations. The low trade-GDP ratio noted          ented strategy based on higher productivity
      above reflects problems of low competitive-          on the part of Macedonian producers. This is
      ness of Macedonian industry and service              in part due to the fact that devaluation would
      providers across the board. Total exports in-        have only a short-term effect on exports until
      creased by only 38 percent during the ten            domestic prices and wages adjusted upward,
      year period between 1995 and 2004. There             and it would thus delay the implementation
      were only three commodity groups that actu-          of more fundamental economic reforms that
      ally expanded, iron and steel, clothing and re-      are critical to Macedonia’s long term export
      exported fuels. The country has been a net           success.
      importer of most commodity groups, and its
      competitive position as measured by indices          Moreover, the current exchange rate regime
      of “revealed comparative advantage” has              and its objective of maintaining a stable ex-
      been steadily deteriorating. Most importantly,       change rate are consistent with the govern-
      labour productivity and the real effective ex-       ment’s over-arching objective of achieving
      change rate have declined in recent years, in        and maintaining financial, macroeconomic
      contrast to developments in neighbouring             and political stability. The management of the
      countries.                                           exchange rate thus cannot be seen as the key
                                                           obstacle to Macedonia’s internationalisation,
                                                           but the need for designing an exit strategy
                                                           from the current de facto pegged exchange

     Blue Ribbon Report
rate must not be downplayed in the medium           ing the right business environment and by
term as Macedonia prepares its strategy for         encouraging new entries into markets, both
entry into the Euro Zone. This strategy will        from incumbent firms seeking to diversify
be dictated by the speed of convergence to-         their output and from newcomers, by elimi-
wards the economic performance of the Eu-           nating all barriers to entry.
ropean Union.
                                                    In addition, the supply response will depend
In conclusion, the long term international          on the ability of the government to address
competitiveness of domestic firms can only          three additional structural problems – the
be achieved through sufficient flexibility of       structure of incentives generated by the exist-
domestic prices and an increased level of mi-       ing system of taxes and tariffs; problems of
croeconomic efficiency that would raise real        physical infrastructure; and problems of cor-
productivity in the “tradables” sector. The lat-    porate governance, the efficiency of the judi-
ter will require that domestic product and          ciary and of property rights.
factor markets are sufficiently flexible which,
in turn, will call for a reform of the system of    (i) Market Entry and Business Environment.
payroll taxes and other fiscal levies that affect   Entry into new foreign markets is dependent
businesses.                                         on the overall business environment and poli-
                                                    cies to encourage the establishment of firms,
2. Stimulating New Exports and Import               the competition among firms, and the ease
Competing Industries - Role of Structural           with which banks can support new produc-
Policies.                                           tion activities. The easier the terms of setting
The success of Macedonia’s outward oriented         up and conducting business, the stronger will      33
strategy will depend on the supply response         be incentives for entrepreneurs to enter new
of the economy. However, this response is           markets. Policies needed to create an envi-
currently subject to major structural impedi-       ronment conducive to good business must
ments. The production structure in Macedo-          also include measures to facilitate exit from
nia is extremely narrow, which leads to a           markets. Otherwise, business activities will
high concentration of exports and to depend-        slow down due to unresolved commercial
ence on a few export commodities. Extremely         disputes, increased indebtedness of firms, de-
narrow production and export structures are         teriorating balance sheets of banks and of
a major developmental problem and con-              other creditors and, in general, high costs of
straint. It is clear that expansion of the exter-   doing business.
nal sector will only be possible through a
greater diversification and increased invest-       This will call for an overhaul of the existing
ment in the manufacturing sector and in serv-       system of licensing trading rights (see section
ices.                                               3.2 below), creating incentives for businesses
                                                    to leave the grey economy and join the formal
However, these changes cannot be achieved           economy, and strengthening the bankruptcy
by direct government intervention (policies         code. These policy areas are discussed in
of “picking winners”) but by entrepreneurs          more detail elsewhere in this Report. It
who are taking business risks and are guided        should be sufficient to note at this point, how-
by market forces. In brief, such changes will       ever, that a strong link exists between busi-
only take place in an environment in which          ness environment and structural constraints
markets are not subject to serious distortions      in the Macedonian economy on the one hand
and are supported by strong institutions.           and the relatively narrow production base,
Economic diversification will not take place        low trade – GDP ratio and relatively slow
by government fiat and the role of industrial       economic growth on the other.
policies should be minimised. Instead, the au-
thorities should put their emphasis on creat-

                                                                              Blue Ribbon Report
      (ii) Taxation and Tariff Policy. Incentives to       C. Trade Policy
      trade are also dependent on the level and
      structure of indirect taxes and tariffs. While       1. Domestic Regulations and Institutions
      the level of tariff protection is not very high      (i) Customs Valuation and Rules of Origin.
      by international standards, the existing tariff      Being a Member of the WTO, Macedonia
      schedule provides different effective protec-        must comply with the regulations concerning
      tion to different sectors and firms. Macedonia       valuation of goods for customs purposes. Un-
      has the highest dispersion of tariff rates in the    fortunately, importers often report difficulties
      region. Such dispersion of tariff rates seri-        in dealing with customs officers who often
      ously distorts trade and is a source of corrup-      use the so-called reference prices rather than
      tion. In the long run, tariff protection should      actual prices as the basis for valuation of
      be similar across sectors and ideally as low as      goods. This could be a violation of Article VII
      possible. In the medium term, changes in the         of the GATT and represents additional costs
      tariff schedules should fully take into account      to domestic firms. Customs officers should
      the need for harmonisation with the Euro-            therefore ensure that the WTO provisions for
      pean Union, targeting all sectors of the econ-       goods valuation are strictly observed. They
      omy.                                                 may be assisted in this process through train-
                                                           ing from or through the WTO.
      In the short run, the government should con-
      sider a rationalisation of its VAT system. The       Another issue of the Customs Law concerns
      system should not discourage production ac-          rules of origin, which can be a major source
      tivities of sectors that have a strong export        of protection of domestic industries as well as
34    potential. For example, VAT rates on agricul-        an impediment to exports. These restrictive
      tural products are relatively high, which dis-       effects apply particularly to countries with
      courages      domestic      production     and       free trade agreements in order to avoid diver-
      processing of agricultural products as well as       sion of trade due to different level of external
      investment in these activities. In reviewing         protection among the participating countries.
      the VAT rates, the government should take            The problem is particularly serious for Mace-
      care not to discriminate between activities at       donia, which has signed several such agree-
      different stages of processing.                      ments. The empirical evidence suggests that
                                                           there are large gains to be made from expan-
      (iii) Physical Infrastructure. Expansion of exist-   sion of trade with other Balkan countries. A
      ing trade and the development of new trade           solution to the problem is to seek closer coop-
      activities depend crucially on a well function-      eration in trade policy by more closely har-
      ing and efficient infrastructure. The success-       monizing external tariff and trade policy
      ful economies of South East Asia have                instruments with countries in those regional
      benefited from highly efficient telecommuni-         trading arrangements. Another important
      cations, modern facilities for transport - rail-     measure is to provide for cumulative rules of
      way, road, airport- and efficient and honest         origin, which would facilitate the exchange of
      customs administration. The authorities              goods across the region.
      should address key issues of infrastructure
      and related services – customs administration        (ii) Technical Regulations and Standards Mace-
      and other elements of trade facilitation, finan-     donia is a member of most relevant interna-
      cial services, telecommunications, tourism           tional bodies involved in the coordination of
      and business services and transport services.        activities dealing with technical standards,
      Both the issues of physical infrastructure and       quality control, metrology and accreditation.
      of selected services are discussed further           While the legal provisions of technical stan-
      below.                                               dards and regulations seem to be in place, the
                                                           enforcement of those standards continues to
                                                           be problematic and costly, particularly where

     Blue Ribbon Report
those problems affect exports. The inspection      in export financing. The government should
services should therefore be considerably im-      also provide further support to the banking
proved, and the government should enhance          sector to help the latter expand lending for
the services through training of inspectors.       exports. This will require possibly two steps –
The government should seek financial assis-        the provision of guarantees for pre-export fi-
tance from the EU and technical expertise          nancing and the establishment of hybrid lines
from the new members of the EU to provide          of credit for foreign banks or foreign buyers.
the training, to introduce the best practices      The institution that could provide these re-
and to provide the local staff with the essen-     sources and the service already exists, the
tial equipment. The WTO could also provide         MBDP, but the bank’s operations will have to
assistance in the implementation of the provi-     be strengthened by injecting new capital and
sions of the TBT Agreement. Alternatively,         through training.
Macedonia may wish to contract out some or
all of these administrative tasks to a foreign     The government would also be well advised
private service provider.                          to follow the current negotiations in the
                                                   WTO, which will most likely introduce rules
(iii) Sanitary and Phytosanitary (SPS) Measures.   and limits on export credits and other trade
Similar comments as those noted with regard        financing instruments. Finally, the govern-
to technical standards apply to the SPS meas-      ment should also help to introduce export in-
ures. Macedonia has signed major interna-          surance into the market. This may require
tional agreements concerning sanitary and          first an assessment of the existing impedi-
phytosanitary measures, it has adopted the         ments to the establishments export insurance
relevant legislation, but the enforcement of       by private providers and should be accompa-         35
strict SPS standards is not effective, it is       nied by proposals to remove these bottle-
costly, and it constitutes a major constraint      necks.
for exporters. The solutions to this problem
are similar to those proposed in the case of       Refunding of the VAT to exporters lags seri-
technical standards – external assistance from     ously, and, given the level of interest rates, is
the EU to install the best SPS practices in the    a major cost to Macedonian firms who export
country through advice in loco and to finance      a significant part of their output. The govern-
the essential equipment. The WTO could pro-        ment should commit itself to making refund
vide assistance with regard to Macedonia’s         payments on exports within 30 days after
compliance with the SPS provisions of the          which unpaid exporters would receive inter-
WTO agreements.                                    est on overdue refunds at the going market
                                                   rate of interest.
(iv) Export Financing. The traditional lending
practices in Macedonia constitute a major          (v) Trade Promotion. Trade promotion will also
constraint for export promotion. They are          be critical to develop the external sector. A
heavily biased towards collateral- based lend-     system that would help identify new export
ing, which limits the scope of banks’ opera-       opportunities and open up new export mar-
tions to lending towards incumbents and            kets for Macedonian exporters is needed. This
makes new entry into export markets ex-            calls for an active role of Macedonian em-
tremely difficult, especially for small firms,     bassies, which should shift their emphasis to-
and discourages project and investment lend-       wards such commercial activities. It will be
ing.                                               also extremely important to considerably
Foreign banks and other financial institutions     strengthen the teams of trade negotiators – in
with experience in project lending should be       the WTO and with Macedonia’s trading part-
encouraged to enter the domestic market. The       ners – in order to obtain concessions in areas
government should also facilitate the entry of     that constitute serious barriers to Macedonian
factoring firms, which play an important role      exports. Finally, it is important that business

                                                                             Blue Ribbon Report
      associations and the Chambers of Commerce          backs should only be applied in the case of
      play an increased role in the provision of in-     duties on imports of raw materials and other
      formation about export opportunities and           intermediate products but not in the case of
      markets.                                           imports of capital equipment. The govern-
                                                         ment should refund money expeditiously
      (vi) Trade Agreements. Like the rest of the re-    and set a time limit of maximum 30 days.
      gion, Macedonia regulates its trade through        Late payments should carry an interest
      bilateral free trade agreements. As noted          charge at the going market rate. Given the
      above, it is important that these agreements       close ties of Macedonia with the EU, the pro-
      are superseded by a single free trade agree-       cedures should be harmonised as closely as
      ment with the country’s neighbours. The            possible with those of the EU.
      agreements should keep the range of “sensi-
      tive” products to a minimum, and, given the        (ii) Publication of trade regulations. Trans-
      ambition to join the European Union in the         parency of government policies can be of
      future, they should seek to harmonise the tar-     enormous value. It helps provide for a level
      iff and non-tariff structures with those of the    playing field and thus encourages fair and ef-
      EU.                                                ficient competition. It creates opportunities
                                                         for new entrants into the market and helps,
      2. Trade Facilitation.                             therefore, increase competition and create
                                                         new markets. Last but not least, transparency
      The trade exposure of the Macedonian econ-         is an effective tool for fighting corruption.
      omy can be enhanced by government meas-
36    ures that facilitate trade. The Macedonian         Transparency implies that government regu-
      government is fully aware that it can play an      lations concerning trade are effectively publi-
      extremely positive role in facilitating trade,     cised. The effectiveness depends, inter alia, on
      and it has already adopted various measures        the scope of such information, and the au-
      to that effect. It should also consider the fol-   thorities should, therefore, make sure that
      lowing measures, which are the “best prac-         they have properly defined the scope. They
      tices” based on the experience of other            should also consider different methods of
      countries.                                         publication in order to ensure the most effec-
                                                         tive and efficient method of disseminating
      (i) Duty drawbacks. Any tax levied on imports      this information. Currently, the technical and
      acts as a tax on exports and thus on their com-    SPS standards are not easily found by domes-
      petitiveness. The more direct is the use of im-    tic firms. Transparency will be enhanced
      ports in the production of “exportables”, the      through the establishment of “enquiry
      stronger is the adverse effect on exports.         points”. Such information must be clearly dis-
      Countries that impose tariffs on imported in-      played on official government websites, in
      puts are, therefore, well advised to allow ex-     both Macedonian and English. Their location
      porters to purchase imported inputs free of        should be discussed and agreed between the
      duties. The practice is known as duty draw-        government and private sector representa-
      backs, and it is recommended that the policy       tives.
      of duty drawbacks be adopted by the Mace-
      donian authorities.                                (iii) Fees and charges. It is a frequent practice
                                                         of governments to levy various fees and
      The duty drawback system should be as sim-         charges on foreign trade transactions. While
      ple as possible and preferably automatic and       in theory such practices may be fully rational,
      without conditions. The drawbacks for tem-         their usefulness in practice is highly question-
      porary imports are very expensive (especially      able. They increase costs of doing business
      for small shippers) since they involve bank        and thus affect the competitiveness of firms,
      guarantees. The general policy of duty draw-       and they are rarely a useful source of govern-

     Blue Ribbon Report
ment revenue, but they do act as a brake on         established to facilitate the information gath-
international trade, especially for small firms.    ering process.
Moreover, the practice is frequently another
source of corruption. As a general policy, it is,   (vi) Tariff classification. The tariff classification
therefore, advisable that the authorities either    system used most frequently by countries –
reduce the practice of charging fees and levies     the Harmonised System – is the general stan-
to the absolute minimum or, better, eliminate       dard used by all WTO Members. However,
the practice altogether.                            the system is undergoing almost permanent
                                                    revisions to reflect changes in international
Fees and charges of the banking sector also         trade and improvements in the methods of
tend to be very high. Charges for bank guar-        classification. Countries may also differ in the
antees and for letters of credit – two impor-       level of disaggregation of their trade and tar-
tant financial instruments in international         iff data. There is a wide-ranging agreement
trade – are seen as particularly expensive by       among WTO Members in the on-going WTO
Macedonian exporters. Increased competition         negotiations on trade facilitation to adopt
in the market would help to reduce these            whatever revisions the technical experts rec-
charges, but the authorities should also re-        ommend. It is, therefore, highly advisable
view banking regulations to ensure that they        that the Macedonian authorities follow these
are not a contributor to these high costs.          negotiations very closely and make sure that
                                                    their tariff classification system is up-to-date.
(iv) Release of goods. Foreign trade transactions
also depend on the efficient release of goods       (vii) Border crossing. Border crossing can be a
into the market. It is known that the release       critical bottleneck in international trade. The         37
of goods constitutes a major problem under          evidence from other countries shows that
current Macedonian conditions, and that the         costs incurred in delays at borders, costly ad-
physical inspection of exports is excessive         ministrative procedures and the costs of cor-
and too frequent. It is recommended that            ruption can exceed the costs of tariff barriers
Macedonian customs officials adopt an alter-        by multiple factors. The dissolution of the for-
native system of inspection based on statisti-      mer Yugoslavia has made the question of ef-
cal techniques that could be developed with         ficient border crossing particularly important.
the assistance of outside experts. A program        For example, it has been shown in research
of “trusted shipper” and of cooperation with        for the United States and Canada, two coun-
freight forwarders should be implemented. It        tries with almost completely “free” trade, that
may also be useful to note that efficient re-       trade between Canadian provinces is 2200 %
lease of goods typically involves practices         larger than between Canadian provinces and
based on the proper, transparent and widely         US states of similar distance and size, mean-
used classification of goods, generally accept-     ing that national borders continue to be a
able principles of customs valuation, and a         major barrier to trade.2 These findings sug-
system that avoids an excessive use of guar-        gest that the Macedonian authorities must
antees such as bonds and sureties.                  take especially radical steps to offset the effect
                                                    of new borders on international trade.
(v) Documentation. It is, of course, evident that
foreign trade transactions must be accompa-         The general policy advice to all governments
nied by proper documentation. However, it           is to ensure that the administration of border
is also essential that the relevant and accom-      crossings is governed by three fundamental
panying documentation not be “excessive”            principles – predictability, transparency and
and that the requirements for documentation         speed. The insistence on efficient border
be, therefore, minimised. Prior publication of      crossings is crucial in Macedonia which is an
documentation requirements is also neces-           active transit country. In addition, some bor-
sary. A single national focal point should be       der crossing of Macedonia can be made diffi-

                                                                                 Blue Ribbon Report
      cult by inundations and will require mainte-       3. Promoting Trade in Services
      nance investments. Their efficiency could be
      increased by considering increasing the num-       The service sector of Macedonia must repre-
      ber of crossing points and by expanding their      sent a major source of future economic
      capacity, and by moving some inspections           growth as well as a source of expansion of the
      and other control activities away from the         external sector. At present, the sector remains
      customs checkpoints to avoid overcrowding.         relatively undeveloped, and its contribution
      Inspections should be random rather than           to foreign trade is small. Its expansion is vital
      total. Moreover, key customs facilities should     because the efficient delivery of various serv-
      operate 24 hours each day. It should also be       ices is needed to support the activities of the
      noted that corresponding improvements will         manufacturing and agricultural sectors and
      be required of neighbouring countries, so          to create additional income-generating activ-
      Macedonian policy must be directed at creat-       ities. This section provides suggestions con-
      ing regional cooperation in the improvement        cerning the development of the services
      of border facilities and increases in their num-   sector, a process in which the government
      ber. Visa regulations should also be facilitated   should play a promoting role by facilitating
      both for foreigners arriving to Macedonia and      the process.
      for Macedonian citizens on business abroad.
                                                         Domestic banks should be able to compete
      (viii) Licensing and Auditing. The current sys-    for deposits from neighbouring states or for
      tem of licenses, permits and certificates is       domestic deposits which may otherwise end
      seen by many in the business community as          up in bank accounts abroad. With the expan-
38    being in need of an overhaul. The system can       sion of foreign investment in the country, do-
      be burdensome and excessive and thus costly,       mestic banks should be able to attract the
      adversely affecting the competitiveness of         business of foreign firms that would other-
      firms in Macedonia. Trading is extremely           wise be served by foreign banks. The author-
      concentrated, and the entry into the sector        ities should review their bank regulations
      has proved to be difficult.                        and consider the time path for the adoption
                                                         of Basel 2 Rules. Remaining restrictions on
      The government should, therefore, review           the access of foreign investors into the bank-
      the current situation, streamline and 0sim-        ing sector should be removed. Measures to
      plify the procedures to ensure that the licens-    strengthen bank supervision will also have to
      ing requirements are kept to the absolute          be adopted.
      minimum. Simplified procedures for SMEs
      are required. Establishment of a separate unit     Tourism is a service sector with a considerable
      within one single ministry charged with the        trade potential. At present, tourist services
      task of issuing trade licenses, permits and cer-   are not well developed, which is reflected in
      tificates should be considered.                    a low participation of major hotel chains in
                                                         the Macedonian market. All efforts should,
      With regard to auditing standards, firms are       therefore, be made to attract those chains to
      still required to prepare two sets of financial    invest in the country. Development of
      statements corresponding to domestic ac-           tourism also requires good airline and airport
      counting standards and to IAS/IFRS interna-        services, reliable and efficient foreign cur-
      tional standards. This is clearly a requirement    rency operations and facilities, and tourist
      that increases costs of doing business and         guide services. The authorities should up-
      should be eliminated as soon as possible. The      grade and reconstruct the airport facilities,
      sole use of international standards should be      possibly through a contract with a foreign air-
      a matter of priority as soon as practicable, and   port service provider. The tourist market
      it is a conditio sine qua non for firms involved   should be opened to foreign tour operators,
      in international business.                         in part by enforcing full foreign currency lib-

     Blue Ribbon Report
eralisation on current account transactions.        munication facilities and, in the case of activ-
The government should expand English lan-           ities such as accounting, qualification stan-
guage training in the tourist sector and organ-     dards that meet the requirements of foreign
ise “road shows” abroad to promote                  firms. The government policies to attract such
Macedonian tourism. Above all, the govern-          a foreign interest should be “bound” in the
ment should design a well thought out strat-        schedules of Macedonia in the WTO to make
egy to develop tourism in the country that          the policies not only fully transparent but
would identify major infrastructure invest-         “binding”, i.e. predictable and reliable.
ment projects and guide all other decisions         Labour laws may need to be adjusted to meet
concerning investments, identify different          the needs of some of these activities, such as
segments of tourist infrastructure that need        call centres and back office service providers
to be developed, specify conditions for mar-        to operate around the clock and every day.
ket access and so on. Embassies should play a
very active role in promoting tourism in            Transport services are another promising sec-
Macedonia.                                          tor. Macedonia is a cross-road (transit) coun-
                                                    try and could be a major “hub” for other
The authorities could also consider expansion       markets. At the same time, Macedonia is de-
of medical services for foreigners. Such services   pendent on the transport services of other
have become a major source of income and            countries, but the mutual dependence with
foreign currency earnings in countries such         neighbouring countries should facilitate ne-
as Hungary and the Czech Republic, and the          gotiations on access to common road, rail and
potential also exists in Macedonia. Demand          port market services. Transport services
for medical services is high in the EU and          could be enhanced without major investment,         39
Switzerland and the services are often pro-         at least initially, by streamlining customs ad-
vided abroad on the grounds of far lower            ministration to facilitate cross- border move-
costs and high quality service. This is partic-     ments of goods and expanding the scope for
ularly the case for dentistry, plastic surgery      cabotage.
and spa services. The Macedonian authorities
should ensure that high quality skills con-         The development of auditing services is impor-
tinue to be offered in the country and that         tant for another reason - to allow easier inte-
doctors and nurses are not tempted to leave         gration of Macedonian firms into global
for better opportunities abroad and that they       markets. Access of domestic firms to first-
have access to modern medical equipment.            class services of reputable auditing firms is
Innovative approaches will be required to           critical to enhance their credibility and build
provide credit financing and operations of          trust with their business partners. No credible
the services providers. The authorities should      listing on foreign stock markets will be possi-
harmonise qualification requirements for            ble without audit of those firms. Major merg-
health service provision as closely as possible     ers and acquisitions will also require audit of
with those of the EU.                               Macedonian firms whether they are being ac-
                                                    quired by foreign firms or they are acquiring
Business services are another activity of con-      firms abroad.
siderable potential for Macedonia. There are
many global companies that are seeking to           One sector that has been historically fairly
obtain access to low cost back-office corporate     successful in exporting its services is construc-
activities abroad. Such activities include ac-      tion. However, exports of construction serv-
counting services, call centres, design activi-     ices have dropped over time, reflecting
ties, IT support etc. In order to attract foreign   changes in the traditional markets such as
firms for those activities it will be necessary     Central Europe. A revitalisation of exports of
to offer a pool of well trained and foreign lan-    construction services will require a major ef-
guage speaking personnel, first rate telecom-       fort on the part of the government and the in-

                                                                              Blue Ribbon Report
      dustry. Marketing of construction services          the size of its market, low labour costs, qual-
      will have to receive a priority. Construction       ified labour, access to other markets, natural
      firms should not be constrained by restric-         resources, etc. In other words, the market has
      tions of the Central Bank concerning outflows       to offer a business opportunity that is prof-
      of foreign currency. Otherwise, the firms           itable and based purely on commercial inter-
      would be unable to finance their services           est. Some, if not all, of these factors are
      abroad.                                             present in every country. What matters most
                                                          on the list of fundamental determinants of
      4. Foreign Investment Promotion                     FDI are: macroeconomic, financial and polit-
      There is arguably no better, faster and more        ical stability; respect for property rights; well
      effective way of increasing the participation       functioning courts; and a business-friendly
      of Macedonia in global markets than through         administrative environment. Financial incen-
      foreign investment in the Macedonian econ-          tives also matter, of course, and the govern-
      omy. Foreign direct investment (FDI) has            ment should ensure that its tax regime is
      played an extremely important and positive          competitive in relation to those of other coun-
      role in the economic progress of countries          tries. However, financial incentives provided
      such as China and other South East Asian na-        on a discriminatory basis, i.e., offering special
      tions, Chile, Czech Republic, Hungary,              incentives to foreign investors, may only mat-
      Poland, the Baltic States and many others.          ter if some of the above fundamental factors
      FDI typically brings the host country’s firms       are not present in the host country and when
      to foreign markets, helps increase the compet-      the country is forced to compete with other
      itiveness of domestic firms, expands exports        FDI-seeking countries.
40    and establishes import competing industries.
      At present, Macedonia is a country with one         The government could consider those meas-
      of the smallest inflows of FDI among all tran-      ures to encourage FDI that have proved suc-
      sition countries.                                   cessful in other countries. First, the list of
                                                          permissions required by the authorities from
      Macedonia certainly offers a variety of factors     foreign investors to have their businesses es-
      of potential interest to foreign firms, and it is   tablished in Macedonia should be kept to a
      only a matter of creating the correct policies      minimum. Complex bureaucratic regulations
      and institutions so that foreign firms will “no-    are costly and tend to be a strong disincentive
      tice” Macedonia on the map of attractive mar-       to invest in the country concerned, not only
      kets. Sectors such as tobacco, wine                 because they make entry costly and time con-
      production, banking and other financial serv-       suming but also because they are a signal to
      ices, iron and steel, chemicals, textiles and       the foreign investor of long-term problems of
      clothing as well as non-ferrous metals – all        doing business in the country. As part of these
      sectors with a large weight in the Macedonian       reforms, eliminating barriers to the ability of
      economy but also experiencing considerable          foreign investors to purchase land for their
      difficulties – can be interesting for foreign in-   business activities is important, and laws
      vestors.                                            should be in place to ensure that investors’
                                                          ability to acquire real estate is not abridged
      Governments are often tempted to “fine–             or made more difficult than it would be for a
      tune” various domestic policies to attract FDI      domestic buyer.
      by introducing policies that provide
      favourable incentives on a preferential basis       Second, information about investment oppor-
      to foreign firms. Such policies are a mistake       tunities in the host country can effectively be
      that originates in the lack of understanding of     provided by a foreign investment promotion
      the motivations of highly competitive foreign       agency, and such an agency has recently been
      firms. Clearly, a country has to offer a busi-      established. In making its activities effective,
      ness opportunity to foreign investors such as       it is critical to ensure that the agency operates

     Blue Ribbon Report
with at least two key objectives: the agency
should be an important source of information        Fifth, under the current rules, Macedonia cur-
and advice to potential foreign investors           rently levies taxes on foreign companies and
about investment opportunities and condi-           their profits repatriated to their home coun-
tions in Macedonia, and it should also act as       tries. This may lead to double taxation of
a very effective “one-stop-shop” to help for-       those companies’ incomes which, in turn, is a
eign investors in processing the administra-        strong disincentive for foreign investors to in-
tive requirements for establishment. Ideally,       vest in Macedonia. The solution to this prob-
such agencies should always be independent,         lem is double taxation treaties that the
i.e., outside the formal government struc-          government should sign with Macedonia’s
tures, or semi-independent institutions in          current and potential important foreign in-
order to avoid government interference in           vestor countries without delay.
project selection and promotion. Further-
more, the agency statutes should provide for        Finally, foreign investors require business
transparent incentives to reward the agency         conditions that are based on transparency, the
and its staff in cases of successful FDI transac-   rule of law, and contract enforcement. An ob-
tions. In reviewing the activities of the           vious barrier to FDI inflows to Macedonia is
agency, the founders should draw on the ex-         the perception that Macedonia suffers from
perience of other successful agencies of this       corruption and an anti-business climate.
kind in other countries such as Thailand or         Macedonia needs to fight corruption, but the
the Czech Republic, and they could also con-        popular global rankings of corruption that
sult with experts in the FIAS/World Bank.           guide many businesses in their investment
                                                    decisions may be a lagging indicator of real-      41
Third, Macedonia is an economy with the po-         ity. Macedonia needs a visible anti-corruption
tential to attract foreign investment. How-         campaign. There is advice available from in-
ever, its market is extremely small, and it will    ternational organisations such as the World
be attractive to foreign investors only if it is    Bank on how to do this and Macedonia
seen as a part of a large and integrated re-        should also publicly declare a goal to im-
gional market. It is for this reason that Mace-     prove its international rankings in this respect
donian authorities should strive to intensify       – to rank in the top 50% of all countries in 5
their cooperation with other countries in the       years and in the top 25% in 15 years. More-
region. The first step in that direction would      over, both privatisation and corporate gover-
be a harmonisation of the FTAs that the coun-       nance reforms should be designed with a
try has already signed with its neighbours.         view to finding foreign investors.

Fourth, as beautiful as the country may be,         Above all, foreign investors need to see a gov-
and as well-educated and industrious as its         ernment strategy for growth and develop-
citizens may be, Macedonia is not well              ment that is backed by investment in
known abroad and its image is sometimes             education and greater availability of infra-
confused or marred by association with eth-         structure (e.g., reducing the high costs of
nic strife, political instability or corruption.    telecommunications), and protection of for-
The country would, therefore, greatly benefit       eign investors from local predation.
from a clever “country branding”. The gov-
ernment should hire an experienced public           D. The Capital Account
relations firm with strong credentials to es-
tablish Macedonia as a country that is attrac-      Finally, Macedonia is not very open on the
tive to foreign businesses and tourists by          capital account, and we encourage the gov-
promoting a clear and attractive message re-        ernment to move toward full capital account
garding Macedonia’s attractive features to          liberalisation within three to five years. It is
foreigners.                                         impossible for Macedonia to achieve its

                                                                              Blue Ribbon Report
      growth targets based on domestic savings            capital and FDI, and also strengthen corpo-
      and capital formation alone. Moreover, the          rate governance.
      lack of entry of foreign banks into Macedonia
      is one of the causes of, as well as the obvious     In the short run, however, the government
      remedy for, the relatively undeveloped state        must balance the efficiency considerations
      of the banking system and of the high interest      against those of financial stability. The latter is
      rates that prevail in Macedonia. Thus, the un-      typically conditioned by a certain degree of
      developed state of the banking system cannot        financial depth, effective financial oversight,
      be an excuse for keeping out foreign compe-         reasonable level of currency reserves, a track
      tition. Elimination of foreign currency restric-    record of financial stability, and other factors.
      tions will also allow Macedonian firms and          While Macedonia has already made a consid-
      financial institutions to tap cheaper sources       erable progress in those directions, the open-
      of credit and to access markets for risk capital.   ing of the capital account cannot be
      In general, the elimination of foreign ex-          immediate, but should be as rapid as possi-
      change restrictions is desirable on efficiency      ble. The government should immediately
      grounds.                                            allow FDI inflows and those foreign currency
                                                          outflows that are essential for their operations
      Nor will limiting Macedonian citizens to in-        in the meaning of Article XI of GATT. The
      vesting only in domestic assets encourage           government should also consider a gradual
      saving or direct it to the best investments.        relaxation of restrictions on outward long-
      Rather it will encourage capital flight and off-    term portfolio investment and, subject to
      shoring of assets. Macedonia thus needs to          punitive taxation, short-term and highly
42    liberalise outward capital outflows. While          speculative portfolio investment.
      such outward flows may reduce the amount
      of money available for investment domesti-          In the years to come, the Macedonian econ-
      cally in the short run, the opportunity to in-      omy will become increasingly integrated in
      vest abroad can increase domestic saving.           the world economy and will be more inten-
      Moreover, there may now be considerable             sively exposed to globalisation and liberalisa-
      unmeasured capital flight out of Macedonia,         tion. As a result, the balance of payments
      and this capital would be repatriated if the        deficit may become a constraint on accelerat-
      opportunity to return it to Macedonia and           ing growth and development policy may
      then to move it abroad again legally exists.        need to be directed towards strengthening
      Clearly, the ability of foreign direct investors    the external position and export stimulation.
      to move funds out of Macedonia should be as         Given Macedonia’s aspirations for EU inte-
      liberal as possible; generally, such investors      gration and the need to achieve faster growth
      are more likely to be influenced by the overall     than the more advanced transition countries,
      liberalisation of outflows rather than to spe-      Macedonia will be forced to minimise the use
      cial regimes that affect only foreign direct in-    of external trade protection and to radically
      vestors.                                            open its economy. Care should be taken to
                                                          avoid the introduction of distortionary tariffs
      In addition, Macedonia needs to be better           and the use of non-tariff barriers. Rather
      known on global capital markets. Its visibility     Macedonia should maintain low and rela-
      will benefit from some borrowing by the gov-        tively flat tariffs. The intensification of Mace-
      ernment on the Eurobond market to establish         donia’s integration in the global economy is
      the country’s financial “reputation;” in the        critical for its economic success, and, given
      course of privatising large firms, the govern-      the emphasis on EU accession, it is clearly the
      ment should consider seeking listings on for-       centrepiece of the country’s hopes for the fu-
      eign exchanges for the shares of these              ture.
      companies. This will increase Macedonia’s
      visibility in global financial markets, attract

     Blue Ribbon Report
IV. Structural Reforms for Micro-                  tive environment. If firms seek only to sur-
economic Efficiency                                vive or are protected from competition, if
                                                   their owners seek to preserve what they have
                                                   rather than to aggressively compete for more,
Macedonia has made significant progress in
                                                   then they will opt for defensive strategies,
creating a market economy and the institu-
                                                   seeking government aid, trying to preserve
tions needed to sustain it. Nevertheless, in
                                                   their value, product mix and markets rather
some important aspects, economic perform-
                                                   than responding to new developments. Sim-
ance has been unsatisfactory, and most Mace-
                                                   ilarly, workers naturally fear the severe conse-
donians are deeply concerned about the
                                                   quences of losing their jobs in an
country’s ability to provide for a better eco-
                                                   environment of high unemployment, and, as
nomic future for themselves and for their
                                                   a result, labour mobility is limited, thereby re-
children. In particular, they view high unem-
                                                   ducing the ability of the economy to develop
ployment as a critical economic issue. Mace-
                                                   in new and more productive directions.
donia has recently changed its fundamental
labour legislation, and it is also taking impor-
                                                   Given Macedonia’s size, microeconomic deci-
tant steps forward in privatisation, regulatory
                                                   sions must reflect and respond to global
reform, improvements in the functioning of
                                                   trends, and many of these decisions will be
the judiciary, etc. Moreover, many additional
                                                   made by foreign firms doing business in the
changes will have to be made in the near fu-
                                                   country as well as by Macedonian firms
ture to make the country a viable candidate
                                                   doing business overseas. Thus, globalisation
for EU membership. Microeconomic reforms,
                                                   and microeconomic reform are deeply inter-
meaning reforms that promote the efficient                                                             43
functioning of markets, that bring the disci-
pline of competition to firms and to their
                                                   A. Improving Macedonia’s Business Cli-
managers, and that underpin and reduce the
costs of business transactions are the key to      mate
creating wealth and prosperity.
                                                   From international experience across many
Given Macedonia’s current situation and its        countries we already know a great deal about
economic and social objectives, these micro-       the factors that make for a good business en-
economic reforms must be bold, widespread          vironment and, within that, a favourable en-
and undertaken with a vigour and thorough-         vironment for productive investment.
ness that surpasses efforts previously seen in     Assessing the quality of a business environ-
other successful transition economies. Pros-       ment can be done in two principal ways,
perity will only come to Macedonia if it can       namely: (a) by studying the processes and prac-
raise the productivity of workers, of capital      tices concerning business conditions in a given
and of natural resources located within its        country, and then comparing these with best
borders. While social, macroeconomic and           practice, by which we mean the typical envi-
political stability and the rule of law are pre-   ronmental conditions prevailing in countries
requisites for productivity gains, in them-        considered to have a very good business en-
selves they cannot create prosperity. Gains in     vironment; and (b) by studying the outcomes
incomes and wealth are only brought about          in terms of indicators such as the rate of new
by individuals’ decisions to invest, to start      business formation, the stock and size distri-
new businesses, to liquidate existing ones or      bution of businesses, rates of business invest-
to alter their activities, and, on the part of     ment, and so on, and again comparing these
both workers and managers, to change jobs.         indicators with international best practice. A
Decisions about investments and business           careful review of both (a) and (b) is needed in
strategy must be driven by the desire of firms     order to move forward to the design of more
to create value for their owners in a competi-     effective business sector policies for Macedo-

                                                                             Blue Ribbon Report
      It is important to stress at this point that in   owned, presumably because the latter still
      making the comparisons referred to in regard      enjoy close personal links with political elites
      to both (a) and (b), the most relevant compar-    that help them bypass regulation and evade
      ison is not really that with Macedonia’s own      the consequences of competition. In South
      past situation and policies, with respect to      Eastern Europe (SEE), new private and re-
      which there has undoubtedly been some no-         cently privatised firms also find themselves
      table improvement over the past decade or         having to pay a higher “bribe tax” than do the
      so; rather, it is with other, more successful     remaining state-owned firms.
      economies in the region and in the world. In
      our view, the people of Macedonia cannot          Overall, then, we find an improving picture,
      enjoy sustained growth and rising living          but still with a long way to go. This is espe-
      standards without much stronger and more          cially so for the small SEE countries such as
      active participation in the world economy,        Macedonia, because previous surveys
      both through trade and through FDI inflows        showed that their business environments
      and eventually FDI outflows as well. To suc-      were rated substantially behind those of the
      ceed at this, the country needs business con-     leading Central and Eastern European (CEE)
      ditions that are well above average by world      countries, and they were only a little better
      standards; nothing else will do.                  than the average of the CIS.

      1. Processes and practices                        These observations are reinforced by a recent
      EBRD (2005)3 reports on the most recent Busi-     World Bank study of international trading
      ness Environment and Enterprise Perform-          patterns of the transition economies that
44    ance Survey (BEEPS) of the transition             notes the substantial opening up that has oc-
      economies; this surveyed 9500 firms across 26     curred in all transition economies in the past
      transition economies plus Turkey, with com-       decade and a half, with formal trade barriers
      parative data obtained for a selection of ma-     like tariffs and conventional NTBs mostly
      ture market economies. The latest BEEPS           down to quite low levels except in parts of the
      study follows on similar exercises carried out    CIS. However, in terms of trade patterns, the
      in 1999 and 2002, so there is now enough data     entire region is exhibiting a tendency to split
      to identify some clear trends. The surveys        into two groups, with the CEE countries at
      cover both business processes, discussed          one pole, largely trading within the EU and
      here, and some performance measures, dis-         with developed market economies, increas-
      cussed below.                                     ingly trading in high-value-added goods and
                                                        services involving much innovation and in-
      The business environment is assessed using        vestment. At the other pole stand the CIS
      seven main categories. These are: business        countries, increasingly engaging in commod-
      regulation, labour market conditions, taxa-       ity trade, such as oil and gas, and in trade
      tion, institutions and property rights, infra-    with each other or even disengaging from the
      structure, finance, and finally the               world economy. The resulting trade patterns
      macroeconomic environment. In regard to all       are not especially conducive to innovation
      of these, the three BEEPS studies show steady     and productivity enhancement, so they are
      improvement on average across the transition      not very favourable for longer term growth.
      economies, though the 2005 survey also re-
      veals that for every indicator, except for        In between these two poles are the SEE coun-
      labour market regulation, the mature market       tries, with Macedonia currently closer to the
      economies remain ahead of the transition          CIS pole in its trading practices and patterns.
      economy average. Interestingly, new private       In order to change this situation and shift
      firms and recently privatised firms generally     Macedonia more towards the CEE group,
      report more severe constraints on their busi-     much deeper reforms are needed to further
      ness practices than do firms that remain state    enhance the business environment.

     Blue Ribbon Report
2. Outcomes                                        remainder of this section, we examine areas
Concerning outcomes in terms of business           where additional improvements should be
performance, the picture painted by the latest     sought.
BEEPS survey as reported in EBRD (2005) is
more mixed. However, a few common fea-             Table 4. Number of Enterprises in South-
tures emerge from the survey, and are worth        eastern Europe (2000)
noting here. Specifically, foreign-owned
firms generally have both significantly higher
sales per worker and higher total factor pro-
ductivity than do state-owned firms, recently
privatised firms with domestic owners, and
new private firms. In general, firms in the
CEE countries have much higher efficiency
levels than those in the SEE region, showing
that a competitive environment spurs firms
to improve efficiency more rapidly and that
the overall business environment signifi-
cantly affects performance at the firm level.
These findings therefore reinforce what we
said above.

The other outcome data that are of great in-
terest are those on the size distribution of       Note: According to the old European Union         45
firms and their total numbers. Unfortunately,      (EU) definition, an SME is defined as an en-
recent information on this is quite scanty, but    terprise with less than 250 employees, and a
we refer here to some comparative data for         micro-enterprise is one with 1-9 employees.
the year 2000 published in Falcetti et al.         These definitions have recently been revised
(2003).4 This is reported in Table 4.              by the EU to incorporate annual turnover lim-
                                                   its, but these are not used here. “Large” en-
Studies of the United States, the United King-     terprises in Moldova are those with more
dom and other mature market economies              than 50 employees, and most are therefore
suggest that it would be normal to expect a        medium-sized according to the EU definition.
well functioning economy to have in the            Source: EBRD survey of national authorities;
order of 50-60 SMEs per 1000 inhabitants, and      table taken from Falcetti et al. (2003).
this expectation is confirmed by the data for
the Czech Republic and Poland in the above
table; Hungary and Slovakia, though per-           B. Restructuring of the Enterprise Sector
forming well in many ways, have lower fig-
ures in the table. Macedonia in 2000 was           1. Mobilizing Existing Capacities
reported to have only about a third the num-       During the early period of transition in the
ber of SMEs that it would have if it were to       Republic of Macedonia, as in other countries
compare to the former two Central European         in the region, a decline in industry’s share of
countries , and this seems to provide quite        value added in GDP was evident. Although
strong evidence that the business environ-         the decline has to some extent been reversed
ment is far less favourable and encouraging        (see Figure 4), the effects of this decline, in
than it needs to be. Macedonia has made sig-       terms of idle industrial plants and facilities,
nificant strides in facilitating business start    continue to serve as a drag on the economy.
ups since the data for Table 4 were compiled,      The large number of inactive manufacturing
but, as yet, the results, while positive, have     capacities, in which large amounts of capital
not created a critical mass of new firms. In the   had been invested in the past, indicates either

                                                                            Blue Ribbon Report
      a non-rational use of the available resources         or even a significant minority state share in
      or the fact that these assets no longer have          their ownership structure, the Government
      any economic value to anyone. There is a              has both an obligation and the responsibility
      need for quick reactivation and modernisa-            actively to seek potential investors.
      tion of all those enterprises, or their parts, that
      have prospects to work successfully under             The reforms in the judiciary are crucial for the
      market principles. Those that cannot be sold          protection of ownership rights and for in-
      or even given away clearly have no economic           creased efficiency of the contracts, thus en-
      value, and they should be scrapped expedi-            couraging firms to invest productively.
      tiously. This program must be executed                However, the reforms of the judiciary are pro-
      quickly, through a program of tenders by do-          jected on a medium-term basis. In the mean-
      mestic or foreign buyers. Assets that do not          time, the judicial authorities should be
      find a buyer quickly should be liquidated,            required to quickly solve outstanding dis-
      and local governments should be allowed to            putes in the firms related to ownership rights.
      sell or lease the land on which they stand.           The Government, of course, has no right to
                                                            suggest to the courts what the outcomes of
      Figure 4. Share of industry in total value            the disputes should be, but it does have the
      added (%)                                             right and the responsibility to ask the courts
                                                            to solve them quickly because significant cap-
                                                            ital assets are idle until then. The government
                                                            should also enact clarifying legislation, which
                                                            would help resolve at least some of these
46                                                          cases.

                                                            The same should be done with small firms.
                                                            There is a need to speed up the procedures
                                                            for restarting firms by conceding them under
                                                            favourable conditions to interested entrepre-
                                                            neurs. Considering the fact that local govern-
      Source: State Statistical Office                      ment units and local authorities are given
                                                            certain economic competencies and responsi-
      There is a need to quickly resolve the status of      bilities, we suggest that legal possibilities
      the claims of the Government against large            should be examined for transferring state
      companies on all grounds (outstanding liabil-         ownership of the facilities to the local govern-
      ities towards the Electric Power Company of           ment units. These units can then be actively
      Macedonia, the Macedonian Railway Com-                involved in the process of restarting the facil-
      pany, the Public Revenue Office, the Agency           ities on their territory. The advantages of such
      for Bank Rehabilitation, and the Agency for           a practice are reflected in the fact that local
      Commodity Reserves) so that these compa-              authorities are better acquainted with the
      nies, in a transparent way, could then be of-         local situation, and they can come to accept-
      fered for sale to interested foreign and              able solutions faster, and contacts between
      domestic investors. The government should             potential investors and local authorities can
      provide for simple tenders that do not force          be established faster and in a simpler manner.
      investors to make complex promises about              A strong preference in this system of selling
      their future plans; correspondingly, the gov-         firms should be for cash sales, even at lower
      ernment should not enter into any agree-              prices, in preference to deferred payments
      ments that involve commitments to                     even at a higher price, and strict time limits
      subsidised sales of electricity or other serv-        should be placed on selling all assets. Those
      ices, tax benefits, etc., to buyers of such firms.    not sold will be returned to the State for dis-
      In the firms with a predominant state share           position.

     Blue Ribbon Report
Amendments to the Law on Bankruptcy that             Macedonia is a small country with limited re-
particularly focus on increasing creditors’          sources. Its production structure (mines, fer-
protection and reducing the deadlines con-           rous and non-ferrous metallurgy facilities
siderably – that is, the duration of bankruptcy      etc.) highlights the risk of environmental
proceedings – are good solutions that should         degradation. Therefore, it is very important
be applied consistently. It is essential, also, to   to enforce the prescribed environmental stan-
provide training for the trustees and court          dards and to bring those standards into line
staff for the purposes of implementing the           with those of the EU. Doing so now will give
new legal solutions efficiently.                     Macedonia and its products a positive image
                                                     in EU markets, and it will ensure that invest-
In the public enterprises that have been accu-       ments being made now are not rendered inef-
mulating losses on a continuous basis and            ficient when Macedonia joins the EU. There
where the problems of “soft budget con-              is also a need for further advancement of the
straints” (the losses are ultimately borne by        environmental standards in the direction of
the budget) and “moral hazard” (if losses are        internalization of the externalities – so that
covered this year, they will also be covered         the costs are borne by the polluters. In mod-
next year) are present, the government               ern market economies, there are two main
should immediately proceed with a triage.            types of governmental regulation of the envi-
Clearly not all public enterprises are running       ronmental pollution: direct government con-
at a loss because managers are doing a bad           trol (the maximum allowed quantity of
job – they may be, but often it is the policies      harmful substances that an enterprise may
imposed on these firms (high employment,             discharge into the environment is prescribed        47
keeping prices low, providing loss-making            by law), and taxes for the discharge of harm-
services/goods to the public) that lead to           ful substances that are paid by the polluters.
losses. The government should identify those         Research in this field expresses a preference
firms that can be privatised and sold, perhaps       for taxes that act as incentives for the eco-
after a cleanup of arrears, preferably to out-       nomic entities to reduce their pollution, i.e.,
side owners rather than to workers or exist-         to reduce the degradation of the environ-
ing managers. Those that cannot be sold              ment.
should be shut down; and those that provide
indispensable public services but at a loss          2. Improvement of Corporate Governance
should be given a clear subsidy – either a
lump sum or per unit of output.                      The improvement of corporate governance is
                                                     particularly important for better performance
For the latter firms, the establishment of the       of firms and for private sector development.
institution “management contracts on the             The 2004 Law on Trading Companies re-
basis of public announcement” would be use-          moved a large number of barriers to the effi-
ful. We suggest that such management con-            ciency of corporate governance. It is
tracts be introduced in public enterprises.          necessary to speed up the process of comple-
Hence, we would particularly like to under-          tion of the legislation in this area according to
line that managerial agreements must not pri-        the best international practices. In this con-
marily protect the interests of managers of          text, it is of particular importance that the EU
public enterprises - in case of their replace-       directives on transparency be incorporated in
ment after privatisation is completed. On the        the Law on Securities. This would improve
contrary, they should act according to the           the quality of provision of information to the
logic of incentives and rewards in cases of im-      shareholders and the general public about the
proved performance of public enterprises,            performance of the firms and the quality of
and penalties, e.g., replacement of managers,        their managers, which is essential for in-
when the anticipated results are not achieved.       creased efficiency of the capital market. The

                                                                               Blue Ribbon Report
      adoption of the Code of Conduct in the area        introduce business disciplines in the curricula
      of corporate governance will act in this direc-    (and not only in economics or business facul-
      tion. The consistent enforcement of the legis-     ties, but much more widely), as well as add
      lation concerning the rights of the                these topics to the curricula of the secondary
      shareholders is also important, because it         schools.
      helps investors to be more informed about
      the performance of the firms.                      C. Increasing the Efficiency of the Finan-
                                                         cial System
      3. Support for Small and Medium Size Enter-
      prises                                             A dynamic investment climate and the ability
                                                         of firms to finance their growth and their ex-
      Given the great importance of the small and        pansion to new activities as well as the ability
      medium enterprises for job creation, the ef-       to finance newly-formed firms requires an ef-
      fective use of local resources, increases in the   ficient financial system, one that provides suf-
      supply of goods and services, and for ensur-       ficient funds for growing businesses and that
      ing the sustainability of development, they        can also avoid channelling funds to failing
      should be supported mainly with the new            firms. The availability of such financing ap-
      measures and instruments that are currently        pears to be a major barrier to Macedonia’s
      applied in other market economies. The gov-        economic progress. Barth et al 5 rank Macedo-
      ernment has reduced barriers to forming and        nia 74th out of 121 countries, on a par with
      registering new companies. The efficacy of         Kenya and Pakistan, in a global capital access
      this law should be closely monitored, and          index that seeks to measure the ease with
48    needed adjustments should be enacted               which new and existing firms can access
      quickly.                                           needed capital. Neither small size nor being a
                                                         transition economy is a bar to scoring well in
      The Agency for Support of Entrepreneurship,        this ranking; Estonia ranks 21st, the Czech Re-
      the regional centres, the business incubators      public 32nd. Moreover, Macedonia is tied
      and the local authorities should participate in    with countries such as Germany and Japan
      promoting business networks for connecting         for 22nd place in terms of “macroeconomic sta-
      small businesses with complementary pro-           bility”, one of the subcomponents of the over-
      grams including supplier networks, access to       all index. However, Macedonia does very
      bank credit, etc. at the local and regional        poorly relative to its overall ranking in some
      level. There is a need for caution in the estab-   other sub-indexes such as “economic institu-
      lishment of new institutions for the direct        tions”, by which the authors mean contract
      support of SMEs and entrepreneurship.              enforcement, property rights, lenders’ and
      Worldwide experiences have confirmed that          borrowers’ rights and the efficiency of the
      increased participation in the entrepreneur-       bankruptcy process, judicial independence
      ship process can be ensured through other          and efficiency, etc. and in “banking institu-
      forms such as student internships, temporary       tions”, meaning the strength and efficiency of
      engagement of graduates, experts and local         the banking system. These findings are con-
      consultants on concrete projects, etc.             sistent with the views of the Macedonian
                                                         business and financial community, and they
      Experiences of developed countries confirm         suggest that improvements in the financial
      that the dissemination of entrepreneurship         system and its supporting institutions are
      culture must be a well thought out process         needed if economic progress is to accelerate.
      that includes young people from an early age
      – as early as primary school. Therefore, we        1. Improving Financial Intermediation by the
      suggest that the Ministry of Economy, in co-       Banking Sector
      operation with the Ministry of Education and       Given Macedonia’s economic needs and
      the State Universities in the country, should      structure, the banking system is likely to play

     Blue Ribbon Report
a very large part in the financing of Macedon-          accepted, and other means, such as im-
ian firms and farms. A well-functioning sys-            proving competition in the banking sector,
tem that can attract both domestic savings as           will have to be used to lower interest rates.
well as foreign funds is a critical need, and
policies to create such a system must be im-          The reform processes in the banking sector
plemented quickly and thoroughly.                     should, in the future, be directed towards
                                                      remedying these weaknesses. There should
By the standards of other transition                  be further intensification of effective compe-
economies, the role of the Macedonian bank-           tition in the banking sector by encouraging
ing sector in financing the business sector is        the entry of quality foreign banks, which will
low, and lending rates as well as interest rate       result in a wider variety of banking services
spreads appear to be quite high, suggesting           and more competition. In this context, the
poor financial intermediation by the banking          legal restriction against opening branches of
system. While some observers attribute these          foreign banks in the country until 1 January
high interest rates to monetary policy, we be-        2008 should be abolished. The Macedonian
lieve that they also reflect to a greater or lesser   banking market should be open on very lib-
extent all or some of the following factors:          eral conditions (in terms of acquiring the
   1. The structure of the banking system, in-        rights to operate on the territory of the Re-
   cluding weak governance of banks, lack of          public of Macedonia) to any bank that is
   competition, the existence of weak banks,          domiciled in a country with bank regulation
   and ownership of banks by other firms.             a priori deemed acceptable to Macedonian
   2. The financial situation of many borrow-         regulators and whose size or capitalization
   ing firms is not good. The state of corpo-         meets a pre-determined and uniform stan-          49
   rate governance in borrowing firms often           dard set either by Macedonian legislation or
   makes owners willing to borrow in order            by the regulatory authority. At a minimum,
   to keep their firms afloat and to avoid pos-       this should allow the nearly free entry of
   sible changes in their ownership structure.        large and medium-sized banks from the EU,
   Many firms are also financially troubled,          the US, and many OECD countries. Also, the
   making lending risky, especially if bank-          ability of Macedonian banks to seek deposits
   ruptcy procedures are not effectively im-          overseas should be enhanced, especially be-
   plemented. Lending to weak firms not               cause of the large number of Macedonians
   only misdirects funds to sectors of low            working outside the country.
   productivity, it also starves more dynamic
   firms of needed funds.                             There should be a much faster process of con-
   3. Macedonia is a partially Euroised econ-         solidation of the banking sector by encourag-
   omy. Some financial transactions are de-           ing mergers and acquisitions among the
   nominated in Euros, others in Denars, and          existing banks. Capital requirements should
   some Denar loans carry currency clauses            be raised either by legislation or by the regu-
   protecting the lender against Denar deval-         latory authorities as a way of promoting con-
   uation. The level of Euroisation is close to       solidation as well as of improving the quality
   the level of other small and open                  of banks. This would reduce the risks associ-
   economies. Neither ending the Euroisation          ated with the presence of a fairly large group
   of deposits and loans nor moving toward            of very small banks. Regulators should also
   full Euroisation of the Macedonian econ-           focus on the quality of bank owners, and
   omy appear to be realistic options in the in-      firms in obvious financial difficulty should be
   termediate term although, of course, this          forced to divest their holdings of bank shares
   issue must be tackled at the final stages of       and to give up their representation on bank
   the adoption of Euro. Therefore, the cur-          boards. These measures should also have a
   rent arrangements and their contribution           positive impact on the inflow of FDI into the
   to high interest rate spreads will have to be      banking sector, as small banks that cannot

                                                                               Blue Ribbon Report
      raise their capital would thus become avail-      survive. Russia comes to mind, as does quite
      able for sale, and low-quality owners forced      a number of developing countries in South
      to divest their shares would have to sell them    America and elsewhere in South East Europe
      to new owners.                                    (e.g., Bosnia, Moldova, and Serbia). What
                                                        seems to be important for economic success
      It is also necessary to further improve the       in these contexts is a combination of compe-
      quality of credit analysis and the monitoring     tition within each conglomerate due to the
      of loans in order to increase the efficiency of   operation of a sort of internal capital market,
      the allocation of bank loans by the inclusion     with weaker firms denied funding; competi-
      of new, financially healthier borrowers, espe-    tion between conglomerates; and a strong ori-
      cially from the sector of small and medium        entation in the whole system, including from
      firms. This would be supported by the use of      the political elite, towards growth and devel-
      the loan registry established within the cen-     opment. It is at present doubtful whether all
      tral bank, which will provide information         of these conditions hold for Macedonia.
      necessary in the credit analysis not only for
      the banks, but also for other non-banking fi-     This regulation on related lending should be
      nancial institutions (leasing and factoring       implemented in conjunction with new regu-
      companies), as well as for the development of     lations strengthening the independence of
      credit ratings during a possible issue of cor-    banks’ Boards of Directors, improving the
      porate bonds on the capital market. The reg-      systems of internal control and promoting the
      istry should also provide information about       role of the risk management bodies. If Mace-
      creditors’ tax and utility payments or arrears.   donia chooses not to ban all related lending
50    Therefore, all the regulatory aspects of the      (which may be difficult to do in practice), we
      use of the credit registry need to be devel-      would recommend that, at the least, strict
      oped.                                             limits be placed on the amount of such lend-
                                                        ing and that the regulatory authorities and
      Improvements are needed in the corporate          banks’ Boards of Directors, and especially in-
      governance of banks in terms of strictly lim-     dependent directors, have the means and in-
      iting the loan exposure of banks to related       centives to monitor such lending.
      persons (legal and natural) because lending
      to related parties raises conflicts of interest   There is a need for strengthening the rights of
      between the bank as the ”owner” of a firm,        creditors and the responsibilities of the bank-
      and its role as lender to the same firm. The      ruptcy managers with new amendments to
      issue is even more complicated when the           the Bankruptcy Law. In addition, in the Law
      firms themselves hold shares of their own         for Collateral, further definitions should be
      banks. Such cross shareholdings are not un-       made as to the issues regarding the foreclo-
      common in some countries, where banks             sure of collateral by the creditor, the priority
      hold shares in the larger firms, especially in    of claims of the creditors etc.
      countries where stock markets are weak or
      non-existent or developed late.                   In the future, bank supervision in the Repub-
                                                        lic of Macedonia will be confronted with the
      Some countries have found the resulting con-      important challenge of implementation of the
      glomerates a successful vehicle for promoting     new international supervision standards,
      high investment and rapid development.            known under the general name of the Second
      Japan and later Korea are examples of such a      Basel Agreement. These standards are, above
      successful relationship between firms and         all, relevant for developed banking systems,
      banks. However, there are far more countries      and they are quite complex and sophisticated
      where such nepotistic relationships between       in their methodological framework. Their rel-
      banks and firms have not fostered growth at       evance for Macedonia will grow with the
      all. They have simply enabled bad firms to        pace of technological modernisation, includ-

     Blue Ribbon Report
ing progress in information technology and        tutions or reforms. Indeed, the government
in electronic banking, of the Macedonian          has chosen to provide significant tax breaks
banks and the pace with which they will be        to induce firms to list their shares on the stock
enlarging their activities involving financial    exchange, and the tepid response of the firms
instruments on the capital market. The new        to these financial subsidies is a clear signal of
Basel standards will also introduce a new ap-     the limited benefits they perceive. We deplore
proach to the supervision of, inter alia, the     such “targeted” tax measures.
“traditional” and, for Macedonia, still the
most relevant type of risk, credit risk.          Nevertheless, we acknowledge the ultimate
                                                  value of the liquidity of shares for share hold-
All these steps, including increased foreign      ers, but we would encourage the Macedonian
competition, reducing operating costs, and        government to consider less costly ways of
the increasing the deposit base of the banks      achieving this, for example by allowing com-
should contribute, as they did in other transi-   mercial banks to make a market for key secu-
tion countries, to a decrease in the general      rities. The issue of insufficient liquidity of the
level of interest rates and margins and to a      securities market could be dealt with indi-
better allocation of funds among firms.           rectly in the medium term by encouraging
                                                  the process of integrating the Macedonian
2. Development of the Debt and Equity Mar-        Stock Exchange (MSE) into international cap-
kets                                              ital markets. The first possibility would be
Even in the most developed market                 that the MSE becomes a part (a subsidiary) of
economies, much of the investment by pri-         a major European stock exchange, something
vate business is funded from retained earn-       similar to what has happened with stock ex-          51
ings, including, of course, depreciation          changes in the Baltic countries. In this case,
allowances, with many small businesses also       the Macedonian Exchange could still retain
getting initial financial support from family,    its legal personality as a domestic institution.
friends and business associates. Issuing          The second option would be for the MSE to
bonds and new shares is therefore not the         link to regional markets – a “joint trading
only means of financing investment. As a re-      platform” possibly led by the Slovenian
sult, the great bulk of stock market transac-     and/or Greek stock market. In principle, both
tions involve redistributing existing financial   options could allow, even under the existing
assets rather than issuing new ones to raise      foreign exchange regulations, for Macedon-
capital for expansion.                            ian residents to invest in foreign securities,
                                                  and could also enlarge the pool of liquidity
The development of an equity market in            for trading in Macedonian securities. It is ob-
Macedonia is problematic. On the one hand,        vious, however, that the first option would
the country is small, so such a market is sub-    achieve both of these results faster. However,
ject to high costs and unable to capture          either option is only likely to be viable in the
economies of scale. The structure of share-       distant future.
holding, mainly in the hands of insiders or
residual shares held by the government, does      Until a more permanent solution is found to
not offer an ownership structure that is con-     the foregoing problem, strengthening of the
ducive to the liquidity of such a market. Most    regulation of the market for securities must
important, the market signals received so far     follow the changes in international regulation
are that Macedonian firms see insufficient        standards within the IOSCO and of the rele-
benefits from listing their shares on the Mace-   vant EU directives. Moreover, it will be of key
donian stock exchange, and this suggests that     importance to ensure that the Securities and
the resources expended on the creation and        Exchange Commission, as a regulatory and
functioning of the stock market might have        supervisory body of the securities market, is
been more usefully expended on other insti-       both independent and competent. It is also of

                                                                             Blue Ribbon Report
      importance to increase the quality of financial     ing debts of local authorities, i.e., compiling
      reporting and auditing, which serves the pur-       and reporting correct information about the
      pose of increasing the information efficiency       true level of municipalities’ debts, and, after-
      of the securities market. Insisting on the dis-     wards, developing a credit rating of the po-
      closure of information, which is embedded in        tential issuers of such bonds. We discuss the
      the regulations adopted by the Securities and       conditions for issuing such bonds at greater
      Exchange Commission and the Macedonian              length in the chapter on fiscal decentralisa-
      Stock Exchange, is not enough, because the          tion.
      publicly available information will be of lim-
      ited use to the investors in securities without     3. Reforms of the Pension System
      good audits of financial reports. Progress is       The “first leg” of the pension system is the
      also needed in the application of international     pay-as-you-go component financed by gov-
      accounting standards. Currently two sets of         ernment revenues. The government needs to
      financial accounts are reported, one accord-        consider reforms to this system because it will
      ing to Macedonian standards and the other           increasingly come under pressure as pay-
      based on international standards. Also, the         ments are diverted to the “second leg”. In
      Audit law of 2005 requires an effective en-         particular, the government should reconsider
      forcement mechanism.                                the retirement age and examine whether it
                                                          should be mandatory.
      Both government bills and bonds have been
      issued and the development of the govern-           From the aspect of the financial system, i.e.,
      ment bonds market is important for the de-          the capital market, a new type of financial in-
52    velopment of the market for corporate bonds:        stitution, privately managed fully funded
      in general, the government bonds market is a        pension funds, has emerged for the first time
      benchmark for the rest of the bond market,          with the pension reform. These, in fact, are
      both with regard to the setting of prices and       the first investment funds in the Republic of
      yields and to the institutional arrangements        Macedonia. By their institutional form, the
      (for example, for settling transactions, etc.).     pension funds are defined by the law as
      The experience of other transition countries        open-ended investment funds managed by
      is that government bonds tend to crowd out          companies established to manage pension
      lending to firms, and thus we would encour-         funds. In this way, a new “industry” within
      age caution in determining the volume of            the financial sector has emerged: the industry
      government securities placed on the domestic        for managing financial assets. The key to the
      market. Some such bonds are useful, provid-         good functioning of this industry is regula-
      ing a solid asset for investors, but too large an   tion that is both legally well established and
      issue could starve the business sector of           effective. It is of particular importance that
      funds. Treasury bills and bonds have been re-       the regulatory body carries out effective price
      leased, and progress has also been made on          regulation with regard to the fees (commis-
      the regulatory framework in this area. The          sions) that will be charged by the pension
      pension reform will create a need for bond is-      companies, given the fact that in the initial
      sues as a regular instrument for financing          stages there are only two pension fund man-
      pension expenditures. In this context, the          agement companies, creating an insuffi-
      issue of the first sovereign Euro-bond of the       ciently competitive market.
      Republic of Macedonia should have a certain
      demonstration effect.                               The limits imposed on the classes of financial
                                                          assets in which the funds may invest, which
      The bonds issued by local authorities could         is a standard type of regulation for pension
      also be a viable instrument on the market.          funds, are included in the Law, whereas the
      However, a prerequisite for issuing “munici-        details are elabourated in the secondary leg-
      pal” bonds is the consolidation of outstand-        islation of the Agency, as the regulatory body.

     Blue Ribbon Report
In the future, depending on the development
of the national capital market, as well as on        Box 1. The Organisation of Pension
the possible measures for further liberalisa-       Funds: A Problem Caused by Insuffi-
tion of the capital account of the balance of                cient Globalisation
payments, there will be a need to reconsider
the limits for certain classes of assets, espe-   The current organisation and functioning
cially with regard to the investment in foreign   of the new private pension funds throws
financial assets (see Box 1.)                     into sharp relief some of the problems that
                                                  Macedonia faces in creating institutions in
Another important issue is the corporate gov-     a small and insufficiently globalised econ-
ernance of pension funds, i.e., pension com-      omy and the need for creative solutions to
panies. On the one hand, the regulation           these problems. First of all, any such pen-
addresses in an adequate manner issues such       sion fund is characterised by important
as the separation of the funds of the members     economies of scale. Even limiting the num-
of the Fund from the funds of the company;        ber of entrants into this industry to two
execution of the function of “custodian of as-    may already result in too small a fund
sets” for investing the money of the Fund in      manager size and result in high operating
securities of persons related with the com-       costs. In fact, the fees of the Macedonian
pany; the obligation to provide for external      funds, 1.8%, are higher than the fees of
audit, etc. In the future, account should be      similar funds in other transition countries,
taken of the most recent regulatory standards     in some cases by quite a wide margin:
in this area, such as the principles of corpo-    Czech Republic, 1%, Hungary, 0.6-0.7%;
rate governance of pension funds developed                                                          53
                                                  Latvia, 1.1% and Poland, 0.54%. Second, by
by the OECD. The existing legislation assigns     restricting the funds to investing no more
numerous and important functions and pow-         than 20% of their assets abroad, for exam-
ers to the Agency for the supervision of the      ple in the bonds of foreign governments or
capital-financed pension insurance. There-        in the shares of major global companies,
fore, it is of critical importance that the       the funds are severely limited in their
Agency have institutional independence vis-       choice of assets, resulting in a portfolio that
à-vis the executive branch of the government,     is very inefficient in terms of risk and re-
appropriate human resource capacity, credi-       turn. What might be seen as a prudential
bility and transparency of its operations.        regulation in a large country with a well-
                                                  developed capital market thus becomes, in
                                                  the Macedonian case, a mechanism for
                                                  raising costs and lowering returns to par-
                                                  ticipants in these funds. The entire organi-
                                                  sation of this part of the pension system
                                                  should be reconsidered by the government
                                                  as soon as the relevant legislation and con-
                                                  tracts allow, and the li ing of limits on in-
                                                  vestment in foreign securities should be an
                                                  integral part of the liberalisation of the cap-
                                                  ital account of the balance of payments.

                                                                            Blue Ribbon Report
      D. Creation of a Favourable Investment                 telecommunications, energy and transporta-
      Climate                                                tion services, further liberalisation is neces-
                                                             sary, for example through the entry of a new
      A favourable investment climate has a strong           operator in fixed telephony, entry of the pri-
      influence on the motivation of the firms to en-        vate sector into the generation and distribu-
      gage in productive investments, to create jobs         tion of electricity, etc., as well as raising of the
      and to expand their capacities. The invest-            quality and efficiency of the regulations, as
      ment climate focuses on the issues of institu-         preconditions for price decreases to the ben-
      tions, rule of law, stability of policies,             efit of businesses and citizens.
      administrative barriers, corruption, infra-            Corruption increases the costs and the risks of
      structure, taxation, financing of businesses,          doing business, deters both domestic and for-
      policies for attraction of foreign investments         eign investors and harms the international
      etc. Hence, the creation of a favourable invest-       reputation of the country. Therefore, it is nec-
      ment and business climate is a process that            essary to deal with corruption in a frontal and
      cannot be implemented unless it covers all in-         broad manner by: introducing an efficient ju-
      terrelated segments of the business environ-           dicial system; creating rule-based and non-ar-
      ment. Given that investments are based on              bitrary regulations; re-assessing the
      future expectations, the ability of govern-            discretionary rights of government officials;
      ments to maintain stability and credibility of         implementing the one-stop-shop system in as
      their policies are key elements in the creation        many spheres of regulation as possible;
      of a favourable climate for investments.               strengthening the position and independence
                                                             of bodies fighting corruption; increasing the
54                                                           transparency of public procurement; con-
      Good protection of ownership rights, the efficiency
      of the enforcements of contracts and the rule of law   fronting the practice of politicising important
      in general are the first precondition for the cre-     economic decisions, etc. In this respect, the
      ation of a favourable business climate be-             political will of the government to address
      cause they have the strongest influence on the         this evil is a crucial precondition for the elim-
      motivation of the firms to invest productively.        ination of corruption, and a strong and cred-
      This shows how important the implementa-               ible commitment to a quantifiable goal is
      tion of a comprehensive, competently drafted           essential. In addition to a developing, imple-
      and quality managed reform of the court sys-           menting and publicising a broad anti-corrup-
      tem is.                                                tion program, the government should set
                                                             concrete targets for achieving a major im-
      High-quality, readily available and inexpensive        provement in the country’s rankings in well-
      infrastructure has a strong impact on the cost         know international indexes of corruption as
      of doing business and is one of the basic pre-         suggested earlier in this Report.
      conditions for mobilizing domestic resources,
      for attracting foreign investments and for in-         E. Institutions for the Support and Reg-
      creasing the economy’s efficiency. Therefore,          ulation of Markets
      in the forthcoming period it is necessary to
      make special efforts to improve the commu-             Modern analyses of economic growth attrib-
      nications and transportation systems of                ute differences in the level of economic devel-
      Macedonia, to reduce the costs of these serv-          opment and in the speed and sustainability
      ices, and to support the process of rehabilita-        of economic growth between national
      tion, enlargement and modernisation of the             economies as reflecting the quality, efficiency
      local infrastructure and utility services. To          and credibility of their institutions.
      this end, it is necessary to use all possible fi-
      nancial sources: the state budget, the Road            The following four types of institutions are
      Fund, credits from international financial in-         particularly important for the processes of
      stitutions, concessions etc. In the areas of           economic growth and development:

     Blue Ribbon Report
   1.) Market-creating institutions, such as the ju-   agement and control mechanisms, along with
   dicial system, which protect ownership              a consistent enforcement of management
   rights, ensure the execution of contracts           standards in the judiciary.
   and the rule of law in general and have
   crucial importance for encouraging pro-             In regard to court procedures, reforms must
   ductive investments.                                provide easier access to justice, free court pro-
   2.) Market-regulating institutions such as          ceedings from unnecessary procedural for-
   agencies, commissions and other regula-             malities and create a more efficient and
   tory bodies in the areas of telecommunica-          unbiased system of legal protection. Judicial
   tions, energy, transport, environmental             procedures need to be revised to expedite the
   pollution, finance, anti-trust commissions,         resolution of cases. Furthermore, in the area
   etc., that mitigate market failures;                of criminal justice, the slow course of the pro-
   3.) Market-stabilizing institutions, including      ceedings can be removed by defining priori-
   the Ministry of Finance and the National            ties in the penal policy, simplifying the
   Bank as the most important macroeco-                regular court proceedings, applying sum-
   nomic institutions. Their credibility is most       mary proceedings and out-of-court settle-
   directly associated with their ability to           ment.
   maintain price stability and to implement
   macroeconomic policies that will support            The measures for improving the efficiency in
   the growth and the creation of jobs;                the settlement of disputes in the area of prop-
   4.) Market-legitimizing institutions, includ-       erty and contractual law are related to three
   ing pension funds, schemes for support in           levels. At the dispute prevention level, it is
   case of unemployment, health funds, etc.            necessary to encourage the participation of         55
Among other institutions, we particularly              trained individuals (lawyers, legal advisers)
emphasise the importance of the State Statis-          in the phase of negotiations for concluding
tical Office and the Cadastre. The Cadastre’s          contracts, with a view to stipulating clearly
records and their completion is a priority             the rights and obligations, thus avoiding later
need because it is directly associated with ef-        possible disputes. At the dispute settlement
fective investors’ and citizens’ real estate own-      level, there should be much greater possibil-
ership rights.                                         ities for alternative methods for settling dis-
                                                       putes. At the execution level, a huge load can
1. Judicial Reforms                                    be taken off the courts by transferring the
Macedonia’s court system is overburdened,              competency for the execution system to en-
inefficient in processing cases and regarded           forcement officers – private persons with
as corrupt. As such, it is a major barrier to the      public authorisation in that area.
development of the economy. Reforms are
under way and these need to be pressed with            Judges must exhibit the expertise, independ-
vigour, to be constantly evaluated and publi-          ence and impartiality that every person justi-
cised, not only among legal specialists but            fiably expects from the judiciary as a whole
also the public at large.                              and from every individual judge entrusted
                                                       with the protection of his/her rights. Judicial
The goal of the reform in terms of organisa-           expertise needs to be upgraded. Judges
tion is to adjust and restructure the judicial         should have one or several specialties in law,
bodies and services according to rational cri-         and cases in those specialties should be as-
teria. Changes in the organisation of the              signed to them. Advancement and retention
courts should adjust the number of courts              of judges should be based on merit according
and their jurisdiction according to an effi-           to these criteria.
ciency criterion. There is a need for a more
adequate regulation of the internal organisa-          Judicial reform, nevertheless, is not the only
tion of the courts and of the established man-         mechanism that can contribute to the creation

                                                                                 Blue Ribbon Report
      of a favourable legal climate for economic de-     international regulatory institutions be used
      velopment of the country. As mentioned else-       to provide regulatory oversight.
      where in the report, measures need to be
      taken to clearly define the system of registra-    F. Agriculture
      tion of real estate and to ensure its efficiency
      and transparency. Additional measures need         Agricultural output has stagnated in the tran-
      to be taken to improve the functioning of the      sition period despite Macedonia’s potential in
      registers for registration of pledge rights.       this sector. Agriculture in Macedonia will in-
      Measures should also be taken to improve the       creasingly and unavoidably face greater for-
      legal framework related to foreign invest-         eign competition in the future. Even though it
      ments in terms of improving the system for         is a sector that has significant potential thanks
      registration of trading companies.                 to the increased globalisation of agricultural
                                                         trade, this potential can be realised if and
      2. Market-regulating Institutions                  only if government policies and structural
      Regulatory institutions mitigate so-called         changes in agriculture can enable Macedon-
      market failures. The lack of tradition of such     ian farmers and processors of agricultural
      market regulation by the state and the inex-       outputs to increase their productivity and in-
      perience of Macedonian institutions in this        creasingly meet EU and world standards for
      area is a serious handicap for Macedonia that      quality, phytosanitary standards, etc. The ef-
      needs to be addressed. In doing this, it is es-    fective performance of the agrarian sector,
      pecially important that these institutions es-     just like that of industry, requires macroeco-
      tablish themselves from the very beginning         nomic stability and a business friendly envi-
56    as autonomous and independent institutions.        ronment. Hence, the recommendations for
      Given Macedonia’s desire to join the EU, the       improving the overall business climate in
      regulatory framework should be consistent          Macedonia developed elsewhere in this re-
      with EU practice, and we strongly recom-           port are critical for accelerating the growth
      mend that staff form Macedonian regulatory         and improving the competitiveness of the
      agencies be given significant opportunities to     Macedonian agricultural sector as well. In
      work at or to visit counterpart agencies in EU     this section we address the sector-specific
      countries.                                         policies and institutional improvements nec-
                                                         essary for strengthening the ability of Mace-
      The domain of electronic communications            donian agriculture to effectively meet the
      and radio broadcasting is key to creating a        needs of the domestic market and to compete
      sound business infrastructure, and particular      on global food markets in certain products as
      attention needs to be paid to developing a         well.
      regulatory framework that will support the
      development of this sector. A single regula-       1. Market and Institutional Improvements
      tory agency should be established in accor-        Needed improvements in the functioning of
      dance with the practices in EU countries, the      the markets for agricultural inputs and out-
      competencies of which will include, inter alia,    puts and of the institutions that support these
      the adoption of a list of universal services,      markets include:
      tenders for obtaining concessions in mobile
      telephony, specification of the conditions for     The Market for Land. A key barrier to the pros-
      linking telecommunication networks, etc.           perity and progress of the agrarian sector is
                                                         that it is dominated by small family farms
      Given Macedonia’s limited resources to staff       and by small and medium-sized food pro-
      regulatory agencies, we strongly recommend         cessing facilities. The efficient functioning of
      that ways be developed to make use of for-         the land market is the only feasible way to re-
      eign, and especially EU, regulatory proce-         solve the major structural problem of the sec-
      dures and that, where feasible, foreign or         tor    –    the     excessive     division    of

     Blue Ribbon Report
privately-owned agricultural land. In Mace-        plans is another important government func-
donia, the average farm has 2.5 hectares di-       tion that facilitates the transparent function-
vided into 6 non-contiguous plots. Such a          ing of the land market.
pattern of land holdings constitutes a major       As far as state-owned land is concerned, the
barrier to efficiency and to the introduction of   government needs to rethink its current pol-
modern technologies.                               icy of land leasing as the only mechanism for
                                                   disposing of state such land. Less than a
It is vitally important that Macedonia develop     decade after the existing policy was intro-
a market for agricultural land that encourages     duced, there is clear evidence that a single
the rational use of land by permitting the con-    disposal method, and the criteria used for
solidation of agricultural plots, the expansion    awarding lease contracts, have not generated
of successful farms, and the exit from agricul-    the desired outcomes. Much of the leased
ture of land owners who do not wish to work        land remains idle due to the ban on leased
their land. The market for private agricul-        parcel subdivision and sub-leasing and to
tural land, which accounts for about 80% of        the non-enforcement of the lease contracts.
the total, is overly segmented while the lease     There is considerable international evidence
market for state-owned land is dysfunctional.      that the gradual sale of state-owned land and
The Macedonian cadastral land registration         reliance on the market to determine econom-
system is in the process of modernisation,         ically feasible farm size is a superior model
with updating of maps and the introduction         for directing land into its best use. Therefore,
of new data storage technologies as well as        Macedonia needs to revise the Agricultural
verification of current land titles. This work,    Land Law by building on the best interna-
which is fundamental for the efficient opera-      tional land regulation practices and strength-     57
tion of the land market, needs to be acceler-      ening the capacity of the institutions for land
ated by employing additional budgetary and         management and administration.
donor resources. The sale of agricultural land     The Market for Agricultural Labour. The agricul-
to foreign persons, both legal and natural,        tural sector continues to provide employ-
should be permitted as soon as the revision        ment, though not in a very productive
of the land cadastre is complete. This liberal-    manner, to a significant portion of the labour
isation can promote the modernisation of           force. The contraction of employment oppor-
agriculture by foreign investors, and increase     tunities in the other sectors of the economy
the price of land, thus enabling farmers to        brought about early in the transition was par-
raise funds for the modernisation of their         tially mitigated by the agricultural sector,
equipment and buildings and for the expan-         which is now plagued by underutilised
sion of their land holdings.                       labour that only deepens rural poverty by
                                                   creating an illusion of employment without
Accelerating the consolidation of private land     sufficient income. This surplus labour and
also requires changes in inheritance legisla-      market uncertainties have pushed many com-
tion as well as improvements in the collection     mercial family farms into semi-subsistence
of the land property tax.6 The existing tax        farming. Thus the overall economic recovery
regime for agriculture land has brought the        and job creation in the other sectors of the
cost of land ownership to almost zero, and it      Macedonian economy are crucial for the ab-
thus eliminates an important incentive for the     sorption of the underutilised labour in rural
numerous landowners who have migrated to           areas.
the cities and abroad to lease or sell the agri-
cultural land that they do not use. Employing      It should be noted, however, that, despite the
public resources for setting up a national agri-   perceived low opportunity cost of unskilled
cultural land market information system is         agricultural labour, there are some labour-in-
also justified under the existing circum-          tensive types of agricultural production that
stances. Updating and enforcement of spatial       experience labour shortages during the peak

                                                                             Blue Ribbon Report
      farming season. There is recent evidence that       market. Quality control is also a concern, and
      labour mobility across the national borders in      farmers frequently complain about product
      the region is increasing, and many seasonal         forgery. Therefore, this market would benefit
      workers find summer agricultural jobs in EU         tremendously from less regulation, and
      member states. Thus, the pressures for raising      Macedonia’s EU membership ambitions pro-
      productivity and profitability in Macedonian        vide an excellent opportunity to adopt a “me
      agriculture and creating higher paying jobs         too” policy of applying EU standards and ap-
      are increasing as a result of regional labour       provals even before acquiring member state
      market integration.                                 status. Given that there are large regions
                                                          within the EU member states that have simi-
      In the given circumstances, the best course for     lar agro-environmental conditions as Mace-
      government policy is to improve the services        donia, this policy is relatively simple and easy
      that promote rural non-agricultural activities      to implement because it is based on the ra-
      by encouraging entrepreneurship through             tionale that “agricultural inputs that are good
      education and training, i.e., improving the         for the EU are good for Macedonia as well”.
      employability of the idle agricultural labour       This would require regulatory action for the
      force by developing and implementing re-            transposition of the EU’s plant/animal ge-
      training programs relevant to the needs of the      netic, plant protection agents and veterinary
      expanding private sector. The government            drugs registries into the domestic legislation
      also needs to address issues of rural poverty.      as well as the creation of new types of en-
      We believe that the better way to address           forcement capacity that would be focused pri-
      rural poverty lies in direct financial support      marily on preventing labelling fraud. The
58    to the rural poor rather than in subsidies to       early adoption of such policy would level the
      agricultural production. The latter would tie       playing field, as far as the agriculture inputs
      the rural poor to agricultural activities, even     and input-based new technologies are con-
      if these were not viable in the long run or did     cerned, for Macedonian farmers relative to
      not require as large labour inputs as was the       their competitors from the EU member states.
      case in the past, while the former would pro-
      vide more effective support for less money          Macedonia’s agro-processing capacity must
      while encouraging the natural movement of           be upgraded. Foreign direct investment in
      labour to other, more productive, activities.       this sector should be encouraged, not neces-
                                                          sarily by financial stimuli, but rather by com-
      The Market for Intermediate Inputs and Technol-     mercial diplomacy and publicity as well as
      ogy. Although agricultural inputs are gener-        though public education of farmers to enable
      ally available in the rural areas, this market is   them to meet the demands of modern pro-
      overly regulated for a country of the size of       cessing facilities. To this end, the government
      Macedonia where very few inputs are pro-            needs to reduce barriers to the activities of
      duced domestically. The cumbersome and              private farmers, of cooperatives and other
      time consuming registration requirements for        voluntary organisations for post-harvest col-
      plant and animal genetic material as well as        lection of produce and of marketing associa-
      for plant protection agents and veterinary          tions for processing and distributing them.
      drugs contribute to: (i) higher prices due to
      the substantial compliance costs that are ulti-     The Market for Rural Credit. Despite the weak-
      mately passed on to the consumers; (ii) post-       nesses of the banking sector that are de-
      poned penetration of new technologies               scribed in this report and the severe
      because of the delayed availability of the in-      contraction of agriculture credit post inde-
      puts that are necessary for the adoption of         pendence, recent government-backed donor
      those technologies; (iii) limited interest          programs have increased rural lending.
      among multinational firms to register their         USAID-sponsored micro-credit institutions
      new products for sale on the Macedonian             using advanced micro-credit techniques have

     Blue Ribbon Report
expanded their operations and have acquired       countancy Data Network as well as for pro-
the legal status of a financial intermediary      viding the necessary inputs for drafting a vi-
under the Macedonian Banking Act. Their           able Rural Development Strategy and the
rural lending portfolios are increasing and       associated plans that are important prerequi-
show admirable repayment rates. An IFAD fi-       sites for the timely absorption and equitable
nanced micro- and small-agriculture credit        allocation of the EU funding through the In-
facility based on loan refinancing principles,    strument for Pre-Accession Assistance (IPA)
where commercial banks bear the full lending      - Rural Development (RD) grants pillar.
risk and have access to matching capital
under favourable terms for agriculture credit,    2. Macedonian agriculture in a global setting.
has attracted the interest of the biggest Mace-   Globalisation has, and will continue to have,
donian banks and facilitated substantial com-     a major influence on Macedonia’s agricultural
mercial capital co-financing of small- and        sector. All Macedonian governments since in-
medium-sized agriculture investments.             dependence have drafted agriculture strategy
                                                  documents whose overarching objective was
An important contributing factor to the suc-      achieving self-sufficiency in food production.
cess of these rural credit schemes is the exis-   The efforts to translate such an isolationist ob-
tence of subsidised business advisory             jective into concrete agricultural policies are
services that help farmers and rural entrepre-    particularly troublesome in the light of SAA
neurs prepare business plans and loan appli-      and WTO agreements and lead to ad hoc gov-
cations.     Thus,    simultaneously      with    ernment interventions to mitigate the in-
improving the overall competition on the          creasing trade gaps for particular food
credit market and consolidating the banking       products, with milk and cereals being two           59
sector, the government needs to expand            egregious examples.
and/or replicate the existing rural credit suc-
cess stories in a way that does not distort the   Hence, both in keeping with our recommen-
credit market and channels funds for invest-      dations for the greater globalisation of the
ments to rural areas. A well functioning rural    Macedonian economy and with the need to
credit market is also one of the major precon-    formulate a realistic agricultural policy, Mace-
ditions for Macedonian farmers to be able to      donian policymakers need to abandon the
meet the strict pre/co-financing requirements     goal of food production self-sufficiency and
of the IPARD investment grants scheme that        embrace a more realistic goal of making
will become available to Macedonian rural         Macedonia a “net agricultural exporter”
residents by the end of 2007.                     while maintaining the environmental sustain-
                                                  ability of the agriculture resource base. Thus,
Information for Policy Making. Informed policy    Macedonia needs to carry out a fundamental
decisions need to be based on reliable up-to-     realignment of its national agricultural poli-
date information about the economic and fi-       cies and support programs toward helping
nancial performance of the sector as well as      farmers to produce commodities using effi-
about its resource base and structure. Much       cient technologies that they feel will be most
of the currently available information about      advantageous from a market perspective, for
the agrarian sector dates from 1981 when the      traders to move goods in the expectation of
last agricultural census was carried out.         profits unconstrained by uncertainty about
Therefore, all branches of government as well     government intervention, and for consumers
as foreign donors need to support the current     to be able to buy food at the lowest prices,
efforts of the Macedonian Office of Statistics    whether from foreign or domestic sources.
to secure funding for a new census. The new
census is an excellent opportunity inter alia     Such policy adjustments are long overdue
for setting the stage for the development of      given Macedonia’s commitments to reduce
an EU compliant Farm Registry and Farm Ac-        trade barriers under the SAA and WTO

                                                                            Blue Ribbon Report
      agreements as well as the forthcoming expan-       donia has very low rates of job creation, de-
      sion of CEFTA, and future EU membership.7          struction, and turnover compared to other
      By acquiring EU candidate status, Macedonia        transition countries at a similar level of devel-
      became eligible to receive investment grants       opment. This reflects the shortcomings in the
      for rural development under the IPA pro-           supply of financing for new activities and
      gram, and creating the administrative capac-       structural, economic and regulatory barriers
      ities for making effective use of these funds is   to new business creation. Job creation and de-
      an important task for the government. The in-      struction rates were around 1% per annum,
      troduction of EU and international standards       which is well below the average level in most
      regarding the origin, quality, health testing,     transition economies. These rates suggest
      and other components of food products, fresh       that, while it may be possible to improve the
      and processed, will become increasingly im-        unemployment situation somewhat through
      portant. Without their effective implementa-       labour market measures, the true solution to
      tion,      Macedonian        market-       and     Macedonia’s unemployment problems must
      export-oriented agricultural surpluses have        come from the creation of a more dynamic
      no real and sustainable prospects.                 private sector.

      G. Labour Market Reforms                           The data show that the private sector did a
      The persistently high level of unemployment        better of job creation than the public sector,
      in Macedonia is a major source of concern          even though more jobs in the private sector
      and the cause of serious social problems.          were destroyed than created. Furthermore,
      Consequently, unemployment has become a            the highest level of job creation is in small and
60                                                       medium enterprises. One of the crucial con-
      central issue. The unemployment statistics
      appear to be unreliable despite some at-           clusions from the analysis of job creation is
      tempts to improve the efficiency of collecting     that it is concentrated in the private sector.
      and disseminating the unemployment fig-            Job creation is the highest in services, such as
      ures. According to the National Human De-          education, real estate, and hotel and restau-
      velopment Report (2004), the unemployment          rant businesses as well as in wholesaling, re-
      rate was almost 37%, while other characteris-      tailing, motor vehicle repair, etc.
      tics of unemployment include the following
      related figures: young people (15-30 year old)     Macedonia has seen continuous increases of
      account for more than 40% of the unem-             nominal wages over the period 1996-2004,
      ployed, the long-term unemployment rate is         primarily due to the increase in the share of
      above 30%, those who finished 3-4 years of         the private sector in employment and the lim-
      secondary school account for 55% of the un-        itation on the increase of wages in the public
      employed, and female activity rates are much       sector imposed by the Law on Wages. Net
      lower than those of the men.                       wages paid out in 2004 showed an increase of
                                                         4%. Macedonia also shows relatively high
      The analyses of unemployment in Macedonia          sectoral and regional wage differentials due
      suggest some obvious factors that contribute       to the high level of centralisation of industry
      to the high unemployment rate: the decline of      and its labour demand. In Macedonia, the
      some sectors of economic activity combined         law requires that firms pay wages that are at
      with a lack of dynamism in the emergence of        least 65% of the average wage in their sector.
      new sectors; a low export-intensive economy;       This seems to help neither firms nor workers
      a low level of foreign direct investment; a        and does lead to inefficiencies. Macedonia
      large informal economy; inefficient labour         might be better served with a minimum wage
      market policies and rigid labour legislation;      law covering all workers, but one that pro-
      and weak law enforcement.                          vides for a minimum wage of somewhat less
                                                         than 65% of the national average wage. Given
      From the data available it is clear that Mace-     the high unemployment rates among young

     Blue Ribbon Report
workers, a high minimum wage could be an           formal sector or by other citizens for the sole
important barrier to the creation of entry level   purpose of obtaining access to health care
jobs.                                              services.
The large size of the informal economy gives       The wage-setting process should be clarified.
the wrong signal to labour allocation and un-      Wage policy should be established through
dermines the legal system. Some estimates          collective bargaining, primarily, at the com-
show that almost one-third of the labour force     pany level, unless there are compelling rea-
depends on the informal economy, including         sons for a broader agreement. The principle
seasonal work, temporary work and part-            of wage-setting should follow the established
time jobs. The wages in the informal econ-         European formula that real wage increases
omy are relatively low and in some cases this      should lag by at least one percentage point
helps businesses to survive since they reduce      behind productivity increases.
the “formal costs” of labour (see the discus-
sion on the tax wedge). Also, the informal sec-    One of the central problems of the current
tor is detrimental to the young population         wage policy is also the tax wedge that has a
and entrepreneurs because they develop an          direct impact both on the cost competitive-
“evasion philosophy”. Thus, for many, the          ness and on the scale of the informal econ-
informal economy has become a normal way           omy. To increase competitiveness –
of doing business, and it is tolerated by the      particularly of the manufacturing sector - the
local authorities and, in some cases, even by      taxes on labour wages should be reduced, al-
the state authorities.                             though this is a measure that has to be intro-
                                                   duced within the framework of the
The labour market situation is in a way the        introduction of the flat tax and a reform of the      61
“residual” of all other policies and their fail-   provision and funding of health care.
ures or inefficiencies, for example, because
the low level of law enforcement and ineffi-       Institutional capacities have increased but are not
cient tax collection have a direct impact on       yet sufficient. Labour market institutions’ ca-
the size of the informal economy. Thus, the        pacity should be expanded. First, the national
labour market situation can be indirectly im-      employment agency should play a major role
proved by many measures proposed in other          in promoting and operating active labour
parts of this Report. However, labour market       market measures. The agency should
measures introduced in this section can also       strengthen its technical, organisational, and
have a direct impact on labour supply and          staffing capabilities. It may be useful to es-
labour demand. Moreover, some of these             tablish job-points, disseminate information
measures can help to introduce a more trans-       about employment opportunities, and other
parent situation onto the labour market.           related activities. In 2005 the National Em-
                                                   ployment Agency (NEA) initiated a compre-
Labour statistics need major improvement: It is    hensive plan for reducing unemployment
necessary to establish a good system for reg-      with 27 detailed measures, including specific
istration of the unemployed through the sta-       instruments for unemployed youth. The ef-
tistical office and the Employment Agency. So      fectiveness of these measures should be eval-
far, the Agency has begun various activities       uated on an ongoing basis.
that will increase the reliability of the labour
data. The proper data collection, dissemina-       Beside the National Employment Agency
tion, and use are also crucial for adequate and    there are 15 licensed private employment
justified allocation of the unemployment           agencies. Their role as mediators has im-
funds. An important measure that is needed         proved in the last years, but they can have an
is the introduction of basic health care for all   even bigger role on the labour market
citizens in order to discourage the registration   through the establishment of temporary em-
as unemployed of persons working in the in-        ployment agencies, etc.

                                                                               Blue Ribbon Report
                                                            thus causing the incorrect expenditure of
      Labour legislation has been modernised but still      government funds, e.g., on social benefits.
      has some serious drawbacks. The new Law on            The reduction of the informal economy
      Labour Relations covers a number of basic             should be based on a mix of measures:
      principles, European directives and ILO con-
      ventions, including the provisions of the Eu-              Reduction of the tax burden on labour
      ropean Social Charter. The legislation has              and business activity and simplification of
      improved flexibility on the labour market in-           tax regimes;
      cluding the working time provision and the                 Simplification of the legal and adminis-
      information for workers on individual condi-            trative regimes by reducing time and cost
      tions. There are some provisions that do not            for registering new business/obtaining
      meet the requirements of the Acquis, such as            permits and licenses, etc;
      appropriate protection of workers in the case             Making property registration and land ti-
      of the insolvency of the employer. The en-              tling procedures easier and simplifying the
      forcement of the Law will be difficult due to           procedures required to register property as
      the judicial system’s unfamiliarity with its            collateral;
      provisions.                                               Addressing corruption on all levels;
                                                                 Ensuring strict law enforcement (i.e.,
      Active labour market policy: Employment pol-            harsher penalties for the lawbreakers, al-
      icy in Macedonia is being transformed into a            though an amnesty might be considered
      set of active labour market measures aiming             for those who register their businesses
      at promoting the creation of new job opportu-           within a certain period of time (maximum
62    nities, at activating jobless people, and intro-        6 months));
      ducing human resource management. Active                   Establishment of a national-level com-
      measures should be put together as part of              mission with private sector representation
      the national employment strategy, which                 to give advice on policies toward the grey
      should be the key document governing em-                economy;
      ployment in the country for the next five                  Enhancing access to capital by easing
      years and should emphasise active measures              banking regulations, etc.
      rather than passive ones such as unemploy-
      ment benefits. Active policy measures should          Moreover, there are some other measures that
      also include European directives and prepare          should complement labour market policies:
      Macedonia for the use of the European Social
      Fund (ESF), particularly for strengthening the            Management education is one of the key
      administrative capacity for management, im-             instruments for a major shift not only in
      plementation, and monitoring of active                  the labour market but also in the economy
      labour market policies. Also, active measures           as a whole. The possibilities include chang-
      should target some special groups with par-             ing school curricula, the establishment of
      ticularly high unemployment rates such as               new business schools, introduction of new
      disabled persons, young persons, and                    business courses etc.;
      women. Active labour market measures                      Introduction of best practice in human re-
      should also play an important role in dimin-            source management and taking a broader
      ishing regional differences in unemployment             view of labour to more fully embody the
      levels.                                                 concept of human capital and its develop-
                                                              ment would create a more competitive en-
      The informal sector is very detrimental to business     vironment and greater knowledge transfer.
      values. Informal activity accounts for 35- 40%          Particularly, the idea of identifying and
      of GDP, if not more. It undermines the rev-             publicising “national champions” in
      enue base of the Government, creates unfair             human resource practices is intriguing as
      competition, and distorts official indicators,          it would help overcome the “average is

     Blue Ribbon Report
  good enough” principle which is now           Notwithstanding the fact that the budget for
  widespread throughout the economy.            public expenditures is tight, a certain amount
                                                of public work could contribute to a reduc-
Because there are regions with particularly     tion of unemployment among the most vul-
high unemployment rates, it is necessary to     nerable groups and among the long-term
deal with unemployment through a regional       unemployed through temporary jobs, espe-
approach as well. The problem of income in-     cially for the recipients of welfare benefits of
security should be solved through measures      working age.
targeting the most vulnerable groups of un-
employed, while complying with the defined
criteria for receiving welfare, which would
provide a more equitable distribution of so-
cial transfers. In doing this, targeted meas-
ures need to be prepared, especially at the
local level.


                                                                          Blue Ribbon Report
      V. Making the Government of Macedonia a                above all that more room be provided for the
      Partner in Economic Growth                             employment and promotion of competent
                                                             staff through natural attrition and through a
      Macedonia’s government cannot, by itself cre-          more courageous rationalisation of public ad-
      ate prosperity or solve pressing economic              ministration. Remuneration and promotion
      problems. It can, however, by improving its            in administration must be determined by an
      functioning and the support it provides to the         objective merit system, and over time it is
      private sector through the provision of gov-           necessary to ensure convergence of the remu-
      ernment services, make a major impact on               neration in public administration to that in
      economic performance and on the lives of               the private sector, which will ultimately result
      Macedonian citizens.                                   in an increase of the reputation and prestige
                                                             of civil service employment. If all political
      A. Public Administration and the Politi-               parties have to rely on the same civil service
      cal Process                                            personnel to implement their policy pro-
      Public administration reform is a difficult and        grams, Macedonia can have a good civil serv-
      complex process. It presupposes qualitative            ice, but if parties can easily rely on their own
      changes in several segments that have to go            appointees to implement polices, then the
      in parallel and that are often contradictory.          civil service will be inefficient, demoralised
      First, there is a need for rationalisation of the      and corrupt.
      administration via consistent implementation
      of the already adopted medium-term fiscal              It is of importance also to depoliticise the ad-
      strategy agreed with the IMF, which offers so-         ministration, i.e., to separate the temporary
64                                                           political policy-making positions from the
      lutions in terms of reconsidering the number
      of employees and their utilisation and im-             permanent administrative staff whose job it
      proving efficiency through functional analy-           is to implement these policies. Thus only the
      ses of the most important budget users,                Minister and two Deputy Ministers in any
      through more courageous use of the method              ministry may be political appointees; the re-
      of full privatisation or privatisation of the          mainder should be civil service staff. The
      business in the budgetary institutions that are        conditions of the civil service should be cod-
      appropriate for such an approach – for exam-           ified so that:
      ple kindergartens, some institutions in the                1.) Entry into and promotion in the civil
      area of culture, some institutions addressed               service is on merit.
      in the project for structural adjustment of cer-           2.) There is a civil service commission es-
      tain budget users etc.                                     tablished to:
                                                                     ensure the independence of the civil ser-
      Second, the enforcement of the principle of                  vants from political pressure;
      equitable representation of Macedonia’s eth-                   independently verify claims of corrup-
      nic communities requires the selection of                    tion or abuse of power by civil servants;
      competent staff from diverse backgrounds.                      investigate on its own initiative corrup-
      Departure from the practice of government                    tion or malfeasance by civil servants.
      employment dictated by political parties is            The civil service commission should have two
      needed as it is detrimental to the effective           members elected by members of the civil
      functioning of public administration, be-              service and a member each from every polit-
      cause, instead of following the logic of com-          ical party that has seats in the Parliament.
      petence and professionalism, it follows the
      logic of political and pre-election manipula-          B. Making Public Administration Effec-
      tions.                                                 tive

      Third, the increase in the efficiency and in the ca-   1. The Evolving Concept of Public Adminis-
      pacity for action of public administration requires    tration

     Blue Ribbon Report
In addition to changing how the civil service       and services. The public administration re-
is organised and interacts with the political       form is comprehensively outlined in the
system, Macedonia needs to change its con-          Strategy for Public Administration Reform
cept of public administration.                      adopted in 1999 establishing the following
For public administration and services to           basic principles of the new public administra-
flourish in Macedonia, they need a degree of        tion system: rule of law, transparency, com-
trust and legitimacy for using their resources,     petence,         stability,      accountability,
processes, and services to create beneficial so-    predictability, equal treatment, efficiency, and
cial outcomes for society. They have to             ethicality. Whilst these are sound principles,
demonstrate they are creating public value          they do not entirely cover the main adminis-
for citizens, just as private companies have to     trative principles required by the EU in the
demonstrate the creation of private value to        process of accession: reliability, predictability,
their shareholders and investors. Public value      accountability, transparency, efficiency and
is not just an economic concept – it is also        effectiveness.
about the overall contribution to society in
economic, social and political terms that pub-      2. Public Value from Public Administration
lic administration and services make.               and Public Services
                                                    Public administration and public services add
Trust in government and its institutions is         value when they help to make life better for
very low in Macedonia, where almost 52% of          everyone. They do this not just by providing
citizens have no confidence at all in govern-       collective goods and services, but also be-
ment. Therefore, the concept that the public        cause people value the way in which these are
administration and services are creating a          provided. Citizens value not just the public         65
public value for citizens presents a shift from     services but the ”procedural” aspects of how
how the public administration is viewed by          they are delivered – especially participation,
the public today, with the corrupt seen as nor-     fairness, equity and probity. Markets also
mal, as well as a shift in the functioning of the   only function efficiently in states where the
civil and public servants themselves, who           rule of law and other supports provided by
continue to view themselves as mastering in-        the state, such as regulation, work efficiently
stead of serving the public. After introduction     and are generally accepted.
of the market economy, the Macedonian civil
service needed to develop itself along the          Different democracies have adopted differing
lines of performance management. Unfortu-           ideas about how big the public sector should
nately, all processes remained within the clas-     be, although nowhere is it insubstantial;
sical framework of bureaucratic, hierarchical,      about how centralised and decentralised or
periodic reporting, where budgeting control         how local or national public administration
remained the major method of control.               and services should be; about the exact con-
                                                    tours of the public services and what can and
Guided by its aspiration to join the EU, the        should be provided by voluntary or market
country has to articulate a clear vision of how     means; about how much they should be
the public administration and public services       based on law or not; and so on. But there are
will benefit society, create public value and       some broad areas of commonality in demo-
build capacity to equal not only the current        cratic approaches to public administration
quality of public administration across the         and services. They are expected to demon-
EU member states, but to meet expected fu-          strate:
ture service requirements as well.
                                                        their political neutrality, legitimacy and
Much of this vision already exists in various         accountability to democratic government
explicit and implicit approaches to the reform        and the people, and to seek the trust and
and development of public administration              cooperation of the citizens;

                                                                               Blue Ribbon Report
          that they properly, fairly and without cor-     The transition period has been marked by a
        ruption manage public resources;                  high level of unemployment, increasing the
          that their processes are fair and equitable,    pressure on the government to create new
        open to scrutiny and challenge, and effi-         jobs in the public sector while in a constant
        cient in the use of resources to deliver serv-    struggle for power and citizens’ votes, and to
        ices;                                             recruit party loyalists to these jobs. As a re-
          that the services they deliver are of the       sult, public sector employment is used as a
        correct volume, of high quality, are fair and     tool of patronage leading to an overstaffed,
        equitable and responsive to the real needs        inefficient public sector and a civil service
        and concerns of citizens;                         that is loyal to party officials and programs.
          and that these services lead to real and        The current system of civil service provides
        lasting benefits to society as a whole            incentives for such behaviour because it is a
        greater than could be achieved by any             predominantly position-based system. It is
        other means such as private or voluntary          open for entry at all levels, except the highest
        provision.                                        managerial level, to persons outside the ad-
                                                          ministration. Promotion within this system
      If public administration and services can sat-      does not follow rules of automatism or sen-
      isfy these criteria, they add real value to soci-   iority, as in the career systems adopted by
      ety. The model that forms the framework of          many Central European countries, but allows
      this section here has the following features as     new employment procedures and open com-
      its main principles:                                petition with applicants coming from within
          1. a greater focus on results and value for     and outside the administration.
66        money;
          2. devolution of authority and enhanced         Accountability is lacking in this system. The
          flexibility;                                    Law of the Civil Service does not mention ac-
          3. strengthened accountability and control;     countability (Law on Civil Service, Official
          4. a client-and-service orientation;            Gazette no.59/2000, no.112/2000, no.34/2001).
          5. strengthened capacity for developing         The only persons in the whole civil service
          strategy and policy;                            who are held accountable to the Parliament
          6. introduction of competition and other        for their work are the Director and Deputy
          market elements; and                            Director of the Civil Servants’ Agency. The re-
          7. changed relationships with other levels      maining civil servants are personally respon-
          of government.                                  sible only to the Minister or the Head of the
                                                          public body. This situation makes a great hi-
      C. Building Blocks of Public Value                  erarchy out of the Macedonian civil service
                                                          system, contrary to the principles employed
      1. Trust and Legitimacy                             in the EU member states, such as devolution
      Public Administration and Public Services           of authority and enhanced flexibility, coupled
      need to demonstrate political neutrality, legit-    with strengthened accountability and control.
      imacy and accountability to democratic gov-
      ernment and the people and to seek the trust        In Macedonia, strategic planning, policy
      and cooperation of the citizens. The current        analysis and impact assessments are not, as
      state of public administration reform in            yet, a generally accepted practice. The intro-
      Macedonia is characterised by a high degree         duction of performance measurement of the
      of formalisation of democratic institutional        civil service has started recently and is con-
      arrangements and attempts at technical im-          ducted on an annual basis. The introduction
      provement but a low degree of change man-           of the institutions of the Ombudsman, state
      agement and an absence of a clearly                 audit, the internal audit, and the new proce-
      articulated vision of the role of public and        dures in public procurement sets a solid basis
      civil services in Macedonian society.               for significant improvements of the operation

     Blue Ribbon Report
of the civil service and for increasing its legit-   ship and cultural change program across the
imacy. The process of decentralisation is also       civil and public services, starting from the
seen as one of the ways to meet the needs and        top. Anticorruption measures do not require
expectations of local satisfaction in the dem-       new laws limiting the work of the public sec-
ocratic government. However, the system has          tor, but rather practical steps to remove away
not provided for tools to monitor and meas-          some of the incentives and opportunities for
ure public satisfaction in the values received       corrupt behaviour of the civil or public serv-
from public services.                                ice.

Given the above diagnosis, we would pro-             In respect to proper and honest management
pose that the following additional initiatives       of public resources, a prominent problem in
be implemented:                                      Macedonia is the management of public fi-
     Amend recruitment procedures to create          nances. Therefore, the country should estab-
   a competent and politically neutral admin-        lish an effective and transparent mechanism
   istration.                                        through which available public resources are
     Move to a career-based civil and public         allocated in a manner that promotes eco-
   service system through comprehensive ca-          nomic growth and reduces poverty. The pub-
   reer development planning to increase             lic expenditure review is such a mechanism.
   professionalism and provide for effective         The national budget in Macedonia is cur-
   leadership.                                       rently prepared on an annual basis, taking
     Strengthen accountability and control at        into account only the revenues and expendi-
   all levels of the civil service system. Meas-     tures anticipated to occur in the coming year.
   ures such as the ‘employee of the year’, or       This provides a basis only for short-term           67
   ‘public service unit or department of the         planning and thus is not conducive to the de-
   year’ would promote professionalism and           velopment of long-term policies to create
   introduce competition among civil and             change. Government budgets must take into
   public servants.                                  account events outside the annual cycle, par-
     Set clear goals and objectives for the civil    ticularly macroeconomic realities, expected
   and public service in all sectors and pro-        revenues, and longer-term needs of programs
   vide concrete methods for measuring               and of government’s spending policies. A
   progress toward goals and enable early            medium-term, three to five year, expenditure
   warning if there are problems in achieving        framework (MTEF) consists of a top-down es-
   objectives.                                       timate of aggregate resources available for
     Introduce procedures and tools to allow         public expenditure consistent with macro-
   for citizens’ monitoring of civil and public      economic stability; bottom-up estimates of
   service performance.                              the cost of carrying out policies, both existing
                                                     and new; and a framework that reconciles
2. Public Value and Resources                        these costs with aggregate resources.
Public administration and public services
need to demonstrate that they properly, fairly       Given the history of corruption and ineffi-
and without corruption manage public re-             ciency in public services, the need for effec-
sources. Given that 90% of Macedonians be-           tive management and transparent accounting
lieve that the government, police, customs           for personnel policies cannot be emphasised
and courts are corrupt, individual legal ini-        enough. Citizens have to trust that public of-
tiatives, such as the Law on Prevention of           ficials are appointed fairly, on merit, and
Corruption and the Law on Free Access to In-         work without prejudice. So developing sound
formation, are to be applauded, as they inject       human resources policies and practices is not
anticorruption behaviours into the Macedon-          just an issue of efficiency and effectiveness, it
ian public sector. However, none of this will        also goes to the heart of people’s trust in gov-
really take root unless there is a major leader-     ernment.

                                                                               Blue Ribbon Report
      The key issues that need to be addressed in       3. Public Value and Processes
      the forthcoming period are:                       Public administration and public service need
             Comprehensively introducing MTEF           to demonstrate that their processes are fair
         starting with selected sectors and then ex-    and equitable, open to scrutiny and chal-
         panding coverage to all of government. A       lenge, and efficient. Furthermore, top-level
         MTEF involves a radical change in the          commitment is high and has shown consis-
         business of budgeting. Consequently,           tency over time. A considerable number of
         without political commitment, it has little    top managers support reform of public ad-
         chance of succeeding.                          ministration.
            Public expenditure reviews to be con-
         ducted by the government and not by in-        Coordination across Ministries at managerial
         ternational organisations such as the          levels has improved with the introduction of
         World Bank, as this tool provides useful       the General Secretariat so that reform policy
         evidence on the structure of governance        could become more comprehensive. This
         and the functioning of public institutions,    body was crucial in the process of prepara-
         as well as linkages between expenditure        tion of the answers to the Questionnaire of
         and policies in various sectors.               the European Commission. This coordination
             Participatory budgeting and budget         will facilitate co-operation and create infor-
         monitoring by citizens should be allowed.      mal peer pressure for setting higher stan-
         When the general public is directly in-        dards for the public administration and
         volved in making policy decisions and are      public policies in the process of European in-
         given an opportunity to allocate resources,    tegration. What is more, the coordination ca-
68       prioritise broad social policies, and moni-    pacity of the government will become a
         tor public spending, evidence shows that       priority when Macedonia becomes eligible
         public services are delivered more effi-       for EU structural funds.
         ciently and add greater value to society.
           In addressing corruption, the Macedon-       Considerable progress has been made in in-
         ian government should opt for a multi-         troducing new institutional arrangements to
         pronged anticorruption approach that is        facilitate development of policies. The depart-
         characterised by the following three fea-      ments for strategic planning, policy-coordi-
         tures:                                         nation, analysis and monitoring have been
           a) operations centred on an Anticorrup-      introduced with the promotion of the General
           tion Commission or an Agency that will       Secretariat of the Government as a body re-
           deal with investigations of corrupt be-      sponsible for public administration reform in
           haviour;                                     Macedonia. Policy analysis and monitoring
           b) prevention by providing policy advice     and evaluation departments ought to be es-
           to public and private organisations to       tablished in all line ministries to create an en-
           combat corrupt practices;                    vironment for change in policy in all sectors.
           c) community relations through a depart-     The decentralisation process also sets the pol-
           ment that educates the public, facilitates   icy development capacity of the local self-
           complaints and alerts the government to      governments as a high priority. This is
           reported corrupt behaviour.                  because, in a decentralised environment, the
                                                        local authorities govern key areas such as ed-
      This aspect is partly covered in the section on   ucation, health and culture.
      fiscal decentralisation, which sets out most of
      the principles and practices of good financial    In the context of European integration, Mace-
      management at all levels.                         donian public administration institutions and
                                                        courts must know the European law, policies
                                                        and the basic principles on which the Union
                                                        is founded and is operating because they will

     Blue Ribbon Report
become guardians of the treaties once the              Introducing the por-
country aligns its legislation with that of the      tal
EU.                                                    Better regulation of public enterprises
                                                       Decentralisation of provision of health,
Better regulation units (BRUs) should be es-         education and social services to the local
tablished, responsible to the highest political      government level
levels. These better regulation units should
ensure that regulatory reform is consistently     However, none of these addresses the central
pursued in all sectors and that the logic of a    problems of the organisation and manage-
service orientation is carried through into the   ment of public services to deliver high quality
operation of the whole range of regulatory        services, even if they do remove some obsta-
and support activities. Careful appraisal of      cles to addressing them. For those areas that
proposed and existing legislation should be       are and will remain in the public sector, and
undertaken as well as of the costs of new ad-     that are not public enterprises, it is difficult to
ministrative procedures. Special attention        find much reform effort focused specifically
should consequently be paid to the develop-       on the services they should be producing.
ment and application of the techniques of reg-    Nor should the scale of the problem be un-
ulatory impact assessment. Its objective is to    derestimated – developed democracies are
carry out regulatory reviews and to assess the    still engaged in continual attempts to reform
impact of regulations as well as to ensure that   and improve services. One of the key tenets
the points of view of SMEs, interest groups       of a “public value” approach is that the value
and civil society as a whole have been taken      of services is never fixed. What is deemed
into account in legislative proposals. In that    good by citizens today may be seen as irrele-         69
process, best practices should be identified      vant tomorrow, and, thus, public value in
and efficient tools and mechanisms for intro-     services has to be constantly created and re-
duction of the new regulatory instruments         created.
                                                  We propose a modest reform programme fo-
4. Public Value and Services                      cussed on services and drawing lessons from
Public administration and public services         successful service reform efforts carried out
need to demonstrate that the services they de-    in other countries. The approach proposed is
liver are of the correct volume, of high qual-    two phased so that: (a) new ideas can be pi-
ity, are fair and equitable and responsive to     loted and evaluated without a commitment
the real needs and concerns of citizens. The      to wholesale implementation, and (b) the use
reform of public services to improve their        of phasing allows the maximum leverage for
economy, efficiency, effectiveness and overall    scarce resources by concentrating on a few
quality of service has hardly begun in Mace-      ”early wins”.
donia. Much effort has been invested in creat-
ing some of the institutional environment in
which this can happen:                                 Review of 2-3 core services in each Min-
      Privatising those functions that do not        istry, Public Service organisation and at the
   need to be in the public sector and are bet-      local government level to assess their:
   ter provided for by private or voluntary              Quantity, quality and user satisfaction
   provision                                             Efficiency
      Introducing legal safeguards for the                The contribution that they make to
   rights of businesses and individuals and            achieving social outcomes
   provisions against administrative abuse               Value for money
   and corruption                                        Any consequent changes to the design,
     Introducing freedom of information and            production process and management.
   other means to ensure transparency

                                                                              Blue Ribbon Report
      This programme of rolling reviews would be         idence or analysis to support such assump-
      greatly strengthened by involving key stake-       tions. In the absence of such analysis and in-
      holders including parliament, service users,       formation, public and political debate easily
      personnel and partner agencies. Wherever           degenerates into stale exchanges of rhetoric
      possible, reviews should have an independ-         and ideological assumptions. Such analysis
      ent element and this could include the use of      cannot resolve the conflicts among values and
      “peer review” teams – small groups drawn           preferences that exist in any democracy, but
      from other public services and the private         they can lead to better debate and more in-
      and voluntary sectors.                             formed judgements.

      Another key component is setting service           Coupled with the service reviews suggested
      standards, monitoring users’ attitudes to          above there needs to be a system of regular
      services and providing mechanisms to re-           policy evaluations that look at the overall,
      dress grievances about services, which are         end-to-end, effectiveness and value of poli-
      often not covered in administrative com-           cies – from resources used to social outcomes:
      plaints processes that usually only address             Such evaluations should include regular
      the substance of a case and not the services          re-assessments of whether the services
      received.                                             achieve their designed social outcomes; are
                                                            still necessary; or could be better provided
          Developing an approach to setting pub-            elsewhere in the public sector or by volun-
        lished “Service Standards” that set out             tary or private means.
        what citizens can expect from all services            As evaluative capacity develops, the pos-
70      so as to create pressure for service im-            sibility of ex ante evaluations of proposed
        provement.                                          policies should be considered, including,
          Developing systematic reviews of user or          where possible, the use of external evalua-
        customer attitudes to civil and public serv-        tors – for example the State Audit Bureau.
        ices through a variety of quantitative and
        qualitative measures, again through pilot        6. Public Value and Leadership
        projects.                                        Civil and public service leaders need to offer
           Developing strong policies for cus-           transformational leadership to their organi-
        tomer/user complaints to be addressed by         sations. Transformational leadership means
        services, also through well designed pilot       leading by example; encouraging, developing
        schemes.                                         and empowering others; aligning the objec-
          Piloting solutions for promotion of pro-       tives of individuals, groups, organisations
        fessionalism in public services, such as         and the whole civil and public services; and
        “teacher of the year”, “doctor of the year”,     creating shared vision of the future. The atti-
        “event of the year”, etc.                        tudes and competences of the existing cadre
                                                         of senior leadership in Macedonian public ad-
      5. Public Value and Social Outcomes                ministration and services is a major weak-
      Public Administration and public services          ness. Whilst there is a lot of current and
      need to demonstrate that the services they         proposed training activity aimed at the whole
      provide lead to real and lasting benefits to so-   civil and public services, there seems to be lit-
      ciety as a whole greater than could be             tle or no activity aimed specifically at trans-
      achieved by any other means. Very little of        forming the senior leadership. This is a major
      the existing reform programs seem to be tied       omission.
      to a clear and explicit analysis of how public
      resources, processes and services lead to de-      Another issue is a generational one. The new
      sired social outcomes. Too much reform             employees are constantly being co-opted into
      seems to be of the axiomatic sort: if we do “A”    the existing culture of inefficiency and inef-
      then “B” will inevitably follow with little ev-    fectiveness present among many of the more

     Blue Ribbon Report
experienced civil and public servants, while       The implementation of the Ohrid Framework
the latter are not given the chance to transfer    Agreement requires the modernisation of the
their knowledge to their young colleagues.         public administration, a change of organisa-
There also appear to be structural problems        tional culture, and the reform of government
in relation to the coherence of the public ad-     service delivery procedures. This initiative
ministration reform program because leader-        has led to increased empowerment of com-
ship is shared by several state organs with        munity groups; has created opportunities for
some apparent coordination problems                citizens to express their needs; actively incor-
emerging.                                          porates the input of citizens into public deci-
                                                   sion making; delivers services that promote
For the reform program to be successful, the       the social inclusion of vulnerable popula-
exemplary commitment and involvement of            tions, for instance based on gender, cultural
the current senior leadership of Macedonia’s       diversity, age or disabilities; and has resulted
civil and public services as well as of the next   in a more client-centred service delivery.
generation of potential leaders is crucial. We
would therefore propose something like a           European integration sets the priority for
“Leadership for Public Value” program that         Macedonia to develop public administration
develops the transformational leadership           to reach the level of reliability of the Euro-
skills and attitudes of the most senior, and       pean Administrative Space and an acceptable
next generation of senior leaders, in Macedo-      threshold of shared principles, procedures
nia. This would focus on:                          and administrative structural arrangements.
                                                   There is a minimum standard of quality and
     Personal development of transforma-           reliability of public administration that can-     71
  tional leadership skills using action learn-     didate countries must attain.
  ing, 360 degree assessment, leadership
  assessment instruments and peer-review           Macedonia has achieved much since 1999,
  as well as international experience through      when the Government outlined its Strategy
  visits or courses.                               on Public Administration Reform, containing
    Organisational and team development            the main principles and priorities. The time
  for a collective vision of the future of Mace-   has come, however, to re-orient from the cur-
  donia’s public and civil services and indi-      rent focus on legal, institutional and systemic
  vidual        organisations,        improved     changes, which nevertheless remain very nec-
  team-working and cross-organisational            essary conditions. A much stronger focus on
  collabouration.                                  developing a vision and leadership capacity
    Developing action plans and strategies         is now needed, linked to a strong change
  for implementing this vision and better co-      management programme, one aimed at re-
  ordination of existing initiatives.              shaping the culture and behaviour of the civil
                                                   and public services in line with the new dem-
7. Conclusions                                     ocratic values of Macedonia.
The future of the Public Administration Re-
form in Macedonia is conditioned by three
processes: (i) the new democratic governance
and market economy, established since inde-
pendence; (ii) the implementation of the
Ohrid Framework Agreement and its effects
on the process of public administration re-
form and the process of decentralisation; (iii)
the European integration as an ultimate goal
of Macedonia.

                                                                             Blue Ribbon Report
      D. Fiscal decentralisation: a key element              partnerships, contracting out, concessions,
      of public sector reform                                etc. Local governments have the right to
                                                             establish partnerships with other local
      Implementation of reform of local govern-              governments to benefit from economies of
      ment in the Republic of Macedonia started in           scale.
      July 2005. The 2002 Law on Local Self-Gov-               The law stipulates that local economic
      ernment, the 2004 Law on Financing Units of            development is a municipal responsibility,
      Local Self-Government and the 2004 Law on              as is the identification of developmental
      Local Self-Government Territorial Organiza-            and structural priorities, support for small
      tion specify the legal status of local units of        and medium-size enterprises, and other-
      government, the public functions falling               wise realising the human and natural po-
      under local responsibility, the financial sys-         tential of municipalities.
      tem and the territorial units of local govern-           The law establishes a system of property,
      ment. Conceptually, these laws reflect the             establishes municipalities’ rights, and pro-
      basic principles of the European Charter on            vides for the creation of a comprehensive
      Local Self-Government, adopted by the                  local property registry.
      Council of Europe in 1985 and accepted and         The law prescribes the implementation of fis-
      ratified by Macedonia.                             cal decentralisation in two phases, depending
                                                         on the municipality’s capacity for assuming
      The Republic of Macedonia has retained the         its new responsibilities. The first phase began
      simple system of sub-central government or-        on July 1, 2005 within the scope of the Ohrid
      ganisation, without any intermediary levels        Framework Agreement. This phase of the
72                                                       transition process calls for the transfer of
      between the central and the local govern-
      ment, and, consequently, the municipality is       functional responsibility in a number of areas
      the only form of local government. The mu-         and of personnel and assets from the central
      nicipality’s inhabitants realise their self-gov-   government to local governments and the im-
      erning rights through democratically elected       plementation of local financing mechanisms
      officials, and, directly, through participation    to provide municipalities with the means to
      in the resolution of local issues. One the         carry out their service delivery responsibili-
      biggest challenges facing Macedonia is build-      ties – property tax, tax sharing, transfer for-
      ing an efficient central state while at the same   mulas, etc.
      time creating incentives for the development
      of local capacities.                               With the expansion of the public functions of
                                                         the local governments, the degree of decen-
      The Law on Local Self Government trans-            tralisation in the Republic of Macedonia,
      ferred a wide list of public functions from        measured by the share of local public expen-
      central to municipal authorities.                  ditures in general government expenditures,
           Primary and secondary schools; the net-       should rise to 16-18 percent after the comple-
         work of organizations and structures for        tion of the decentralisation process and con-
         primary health care and disease preven-         solidation of the new local government
         tion; certain cultural, athletic and recre-     system. This would be a decentralisation level
         ational centres and activities; the centres     equal to that of some European countries in
         for pre-school children, orphans, individu-     transition such as Estonia, Latvia, Hungary,
         als with social and educational problems,       the Czech Republic, and Poland. Currently,
         homes for elderly and the disabled.             the scope of decentralisation, measured by
           The protection of the environment, urban      the local expenditures as a share of GDP is
         planning and construction, as well as is-       rather low, only 2.7 percent, which means
         suance of construction permits. Local au-       also a low share of municipal expenditures in
         thorities are free to explore modes of          general government expenditures of 7.5 per-
         service delivery such as public-private         cent.

     Blue Ribbon Report
According to the provisions in the Law on         The private payments that are common
Local Self Government, the following princi-      throughout the social service system in Mace-
ples govern municipal finance:                    donia should be legalised and brought into
                                                  the open.
    Municipalities are financed by their own
  revenue sources, state transfers and other      Among local own revenues the property tax
  sources regulated by law;                       has the greatest potential. The USAID funded
    Municipalities determine their own tax        technical assistance project in Macedonia also
  rates, fees and user charges;                   focused on the property tax by establishing
    Municipalities, in compliance with their      pilot municipalities with higher autonomy
  responsibilities and legal obligations, are     under special rules.8 The results of this exper-
  free to dispose of their own revenue in an      iment should be carefully evaluated and the
  independent fashion;                            experience extended to other municipalities
    Municipalities have the right to enter into   if warranted. The real property tax is the tax
  debt both on the domestic and foreign fi-       revenue source that local governments are
  nancial markets, in compliance with the         best positioned to exploit. Property, unlike in-
  law;                                            come, cannot evade taxation through reloca-
    Municipal revenues should be adequate         tion.
  to carry out the responsibilities assigned to
  local governments;                              There are several basic local tax policy issues
    Municipalities adopt their own budgets,       that should be addressed by the national gov-
  which are not subject to prior or posterior     ernment in the immediate future. In thinking
  approval by the central government.             about these issues, care should be taken to        73
                                                  make the logic and design of local taxes as
On the revenue side of the budget, reforms        consistent as possible with the national tax
are needed in two areas: (i) increasing local     system. Taxing all real property can lead to
governments’ own sources of revenue; (ii) im-     double taxation where the use of taxable as-
proving the allocation techniques of intergov-    sets is also subject to VAT, as is the case with
ernmental transfers and shared revenues. At       rents on land or on plant and equipment used
a minimum, local governments and au-              for industrial or commercial purposes. Where
tonomous institutions must have full access       the property tax is concerned, the issues to be
to those revenue sources they are best            addressed include: specification of the tax
equipped to exploit, such as user charges for     base (residential property, all land and im-
local services and residential property taxes     provements, commercial property, etc.); the
to finance local government expenditures.         property tax rate design (higher on land than
Second, the central ministries must delegate      on improvements, the relative weighting of
greater spending authority to local govern-       land and improvements), and which level of
ments in every functional area of their re-       government administers the tax. Local gov-
sponsibility. Shared PIT and VAT are very         ernments should be free to set rates, subject
much controlled by the fiscal plans set at the    to reasonable limits, but property tax admin-
national level, but a large part of local taxes   istration is complex and in a country as small
and charges have to be spent for programs         as Macedonia, perhaps, best centralised.
and targets set outside the local governments.
                                                  The Public Revenue Office’s property records
1. Raising own-source revenues                    must be brought up to date. Currently they
Accountability requires that local govern-        are far from complete, and assessments are
ments should, whenever possible, charge for       missing or grossly inaccurate. Support is
the services they provide. Only where charg-      needed to ensure that these functions are
ing is impracticable should they finance such     properly carried out. This includes method-
services from taxes borne by local residents.     ological and technical assistance and im-

                                                                            Blue Ribbon Report
      provement of the organizational structure of       Report in its call for a flat tax at the national
      registration authorities. More reliable registry   level. According to the experience of many
      and assessment data would be a boon for            countries and according to tax theory, the best
      both commercial entities and the authorities,      solution for determining the municipality’s
      as such data are necessary for an efficient and    share of the income tax is to treat all income
      effective VAT as well as for property taxes        equally.
      and the creation of effective mortgage mar-
      kets.                                              3. Transparent and objective revenue sharing
                                                         and grant allocation
      2. Intergovernmental transfers                     The introduction of a shared Personal Income
      State transfers provide additional revenues        Tax (PIT) was an important innovation of the
      for municipalities. The five types of transfers    Law on Local Finances, even though it is only
      provided by law are: “shared taxes”, ear-          approximately five percent of local budgets.
      marked grants, capital grants, block grants        Despite this low scale, shared PIT has a
      and grants to support functions transferred        greater potential to link local tax policies to
      from central to local control. Unfortunately,      the development of the local economy.
      the allocation of these funds remains subject      Presently up to 3 % of PIT is shared with local
      to the central government except where             governments on a derivation basis. Direct
      shared taxes are concerned.                        linkages between local economic develop-
                                                         ment and the municipal revenue base can be
      Shared tax revenues are defined on two             improved by reforming the sharing mecha-
      bases:                                             nisms.
        a) up to 3% of the total collected value         In order to improve local governments’ PIT
        added tax (VAT) in the previous year;            rate-setting autonomy, they should have the
        and                                              authority to set the local personal income tax
        b) up to 3% of the of the personal income        rate. Similar models are used in Croatia and
        tax from salaries in the municipality in the     in the Scandinavian countries. This municipal
        current year and 100% of the personal in-        rate should be kept within specified limits, so
        come tax on earnings from handicrafts ac-        there will be a minimum level of PIT shared,
        tivity collected from taxpayers working          but too high local shares can be avoided by
        within the municipality.                         the maximum limit on such rates. This will
                                                         improve accountability through a revenue-
      We believe that the solution contained in the      neutral technique, as the PIT is shared with
      Law on Personal Income Tax Revenues of             local governments now as well. The planned
      Municipalities (Article 5), which comprises        flat tax rate would even make this sharing
      the two bases mentioned above, is inadequate       technique administratively simpler, as only
      both in principle and in practice. In modern       one local and one national PIT rate will be
      tax systems, the personal income tax should        used.
      be applied to all forms of income. The separa-
      tion of the tax to be paid on salaries and on      Among the shared revenues the Value Added
      handicraft activity by individuals in the mu-      Tax is a major local budget source. Up to 3%
      nicipality negates the essential character of      of VAT is reallocated to local governments.
      the personal income tax and is a return to the     VAT sharing creates a relatively stable and
      tax system where each separate income is           predictable revenue stream for local govern-
      taxed. These two revenue sources, as they are      ments. In Macedonia the shared VAT and the
      currently regulated by law, will complicate        various forms of transfers are the major rev-
      the calculation and application of the per-        enue sources of local governments. The tradi-
      sonal income tax and will contradict the sim-      tional “cap system”, which focuses on
      plification of the tax system proposed by this     legislated local government expenditure ap-

     Blue Ribbon Report
propriations will be completely replaced by a      row, including the issuance of guarantees for
formula based allocation mechanism. This           long-term loans. Short-term borrowing is al-
transition to a new transfer allocation model      lowed only within the country and for the
is the most important and urgent task for the      purposes of covering temporary cash short-
fiscal decentralisation reforms.                   falls; such loans should be repaid by the end
                                                   of the current year. In the long-term, the mu-
There is a need to support the further devel-      nicipalities can enter into debt within the
opment of the allocation formulas in several       country and abroad only for the purposes of
areas for the next budget. The planned crite-      capital investment, and the total amount of
ria for the block grants in education, culture     the annual repayment of these loans cannot
and social care should be further modified.        exceed 15 percent of the amount of the cur-
The strategic goals of intergovernmental fis-      rently operating municipal budget in the pre-
cal transfers are to reach three basic objec-      vious year. Municipalities are obliged to
tives: (i) a guaranteed minimum level of           obtain government approval before entering
services; (ii) horizontal equalisation between     into debt abroad.
local governments of similar type; and (iii)
providing local incentives for efficient use of    Hence, it is evident that long-term municipal
available funds. These aims should be              borrowing has not been fully liberalised. In
reached on both the expenditure and revenue        this phase of the implementation of the new
sides of the budget.                               local finance system, this can be justified, es-
                                                   pecially if the amount of the cumulative non-
For reaching these goals the planned block         regulated public debt of the municipalities
grants and VAT sharing mechanisms should           accumulated in the previous period is taken        75
be needs based (e.g., school age population)       into consideration. Similar limitations exist in
instead of service capacity based (e.g., num-      almost all European countries in transition
ber of pupils currently taught). Objective         and elsewhere. On one side, in many coun-
grant allocation criteria would increase trans-    tries the central government may be con-
parency and they could provide better incen-       cerned that the indebtedness of the
tives. These reforms should be implemented         sub-central governments could make it diffi-
gradually; otherwise local governments will        cult to sustain macroeconomic fiscal stability.
not be able to adjust to the new fiscal condi-     On the other hand, if municipalities wish to
tions. Block transfers appear for the first time   have access to credit markets, they must be
in Macedonia’s intergovernmental financial         credit worthy, which means that they, too,
relations, and their character and purpose are     have a strong incentive to limit their borrow-
determined by the need to avoid, in the first      ing.
phase of decentralisation, any potential diffi-
culties and misunderstandings related to the       Indeed, we propose a two-year moratorium
funding of the decentralised competences in        on all new long-term municipal borrowing
education, health care, culture and social care    and would permit it then only for those mu-
– spheres that entirely concern block grants.      nicipalities that have avoided arrears, have
These grants will eventually undergo a cer-        liquidated existing debt and are otherwise
tain transformation, and centralized alloca-       meeting their financial obligations. Neverthe-
tion by expenditure class should be relaxed.       less, it should be stressed that the develop-
                                                   ment of a long-term municipal bond market
4. Municipal debt                                  is a worthwhile goal. Where local govern-
The Law on Financing Local Self-Govern-            ments issue debt, regularly enough and in
ment Units regulates the rights of municipal-      small enough denominations to support an
ities to borrow from domestic creditors and        active secondary market, the discount or pre-
abroad and prescribes the terms and condi-         mium reflected in bond prices in those mar-
tions under which local governments can bor-       kets can be a highly informative independent

                                                                             Blue Ribbon Report
      indicator of the fiscal performance of local        issue of transferable warrants. These warrants
      government. Moreover, the bond market is            should be issued in standard denominations,
      the principal source of demand for sound            with standard maturity dates. The face value
      local budgeting and financial reporting prac-       of the warrants would reflect current obliga-
      tices. Bond holders, buyers, and sellers have a     tions compounded at an appropriate rate.
      real and an immediate interest in local fiscal      Their present value would, of course be their
      performance. Lacking a municipal-bond mar-          value for the discharge of current debts.
      ket, it is doubtful that sound local budgets or     At the same time the long term solutions have
      financial reports will be forthcoming. If Mace-     to be developed, as well, by stopping those
      donia goes too far in discouraging local debt       inappropriate procedures which lead to un-
      or permits the central government to under-         controlled local debt.
      write and control all debt issues, this benefit
      could easily be lost.                               5. Municipal Budgets
      The liquidation of existing municipal arrears       Each municipality has its own budget, which
      of EUR 43 Million to EUR 55 Million remains         is independently prepared, adopted and en-
      a major impediment to the regularisation of         forced. The budget is developed according to
      local finances. Practically all municipalities      a unique methodology, content and classifi-
      have some debt, either to construction com-         cation of the expenditures and revenues for
      panies, to the electricity supplier, to private     the central and local budgets prescribed in
      parties for the expropriation of land or prop-      the new Law on Budgets (03 August 2005).
      erty, as well as for salaries and supplies. How-    The financial plans for the public services that
      ever, ten municipalities owe three-fourths of       are provided by the municipality, and com-
76    this debt. This issue has produced endless lit-     pletely or partially financed by the munici-
      igation, some 155 pending cases by one esti-        pality budget, are attached as annexes in a
      mate. Consequently, local government                special part of the budget.
      accounts are frequently blocked for non-pay-
      ment, often for months at time, sometimes for       Uniformity in financial reporting requires the
      more than a year. This situation cannot be al-      adoption of common templates, standards,
      lowed to persist. Weighed against Macedo-           and activity classification structures. As the
      nia’s GDP, the inherited arrears issue is a         next step in this process, Macedonia should
      trivial matter. That it has been allowed to         require local governments to conform to in-
      delay the transition to decentralisation to the     ternational public sector accounting stan-
      degree that it has is unconscionable. These         dards (IPSAS). Initially, this should be on a
      debts must be expeditiously formalised and          cash basis. Annual published financial state-
      discharged.                                         ments should include a statement of cash re-
      A Working Group for Municipal Debt has              ceipts and payments, a statement of receipts
      been set up to deal with this problem. Unfor-       by fund classification, including proceeds
      tunately, there is a lot of uncertainty as to who   from borrowing, a statement of payments
      owes how much and to whom. Some of these            and expenditures by functions or activities, as
      debts appear to be the result of the central        appropriate, a balance sheet, and a cash flow
      government reneging on funding commit-              statement or sources and uses of funds state-
      ments, leaving local governments without the        ment. These reports should be made on a con-
      wherewithal to meet their obligations. Where        solidated basis, with an additional set of
      liability or the amounts in question are sub-       statements for each of the entities under the
      ject to disagreement, the issue should be           control of the municipality. The development
      promptly arbitrated.                                of cost-finding systems is also the first step in
      Once local governments’ liabilities, by             developing performance management sys-
      amount and creditor, have been determined,          tems.
      local governments should be permitted to
      discharge them immediately through the

     Blue Ribbon Report
The Law stresses that the budget revenues         regular servicing of the municipal debt or
can be used only for the purposes and in the      through the municipality exceeding its in-
amounts determined in the budget. The op-         debtedness limit, as well as in cases of contin-
erating budget should be balanced. The Mu-        uous blocking of the municipality account for
nicipal Council adopts the budget for the         more than 30 days. The Minister of Finance
following year not later than December 31 of      would then constitute a committee that con-
the current year. The Council also passes the     sists of representatives of the Ministry of Fi-
annual account and submits it to the Ministry     nance,      the     Ministry       of     Local
of Finance. The Mayor notifies the public of      Self-Government, the State Auditing Institute,
the annual account’s content. Together with       the Municipal Council and the Mayor, for the
the annual account, the Council adopts an an-     purpose of proposing a program of remedial
nual report on the municipality’s funds,          measures within 15 days. This measure is an
claims and liabilities emerging from the real-    attempt to solve a problem: to avoid bank-
isation of its investment program and imple-      rupting local government units and to avoid
mentation of the capital and block transfers.     the accumulation of arrears in their pay-
The municipality and the public services          ments.
funded by the municipality shall maintain ac-
counts according to the Law on Budget and         6. Representation and Rights of Ethnic Com-
Budget User Accounting regulations, which         munities
are obligatory at both the national and local     The Law on Local Self-Government contains
levels.                                           several articles that regulate certain issues re-
                                                  lated to the representation and rights of the
Taking into consideration the bad experiences     ethnic communities in the municipalities, in        77
from the previous period, an important meas-      compliance with the constitutional solutions
ure for the consolidation of the municipal        adopted after the signing of the Ohrid Frame-
budget enforcement and of the entire local        work Agreement.
government funding system is the strict pro-
vision specifying that all extra-budgetary mu-    First of all, the law prescribes the establish-
nicipal funds must be abolished and their         ment of a Committee for Inter-Ethnic Rela-
property and any pending liabilities and un-      tions in those municipalities in which at least
paid claims should be assumed by the newly        20% of the inhabitants belong to a certain eth-
founded municipalities.                           nic community. The Committee comprises
                                                  equal numbers of representatives from each
Abolishing municipal funds and establishing       community represented in the specific mu-
a unitary budget at the local level will con-     nicipality. The Committee considers issues
tribute to a more rational use of the municipal   that concern inter-ethnic relations and offers
financial sources and to more effective control   opinions and proposals for their potential res-
over their use. Ending the dispersion of mu-      olution. The municipal council is obliged to
nicipal funds into several independent fund-      consider the opinions and proposals and to
ing centres will reinforce financial discipline   make a subsequent decision concerning
and transparency and will contribute to the       them. The law also regulates the issue of rep-
consolidation of municipal finances.              resentation of the different communities in
                                                  the employment policy of the municipal ad-
There is also a procedure in the Law for tak-     ministration and the public services funded
ing timely measures to remedy any funding         by the municipality. Here, as the law pre-
irregularities and disruption of the municipal    scribes, the adequate and equitable represen-
financial stability. These measures would be      tation of the citizens of all communities in the
applied in cases where irregularities in the      municipality should be taken into account.
local financial operations are detected by the    According to the law, criteria referring to the
main state auditor or emerge through the ir-      candidates’ professional competence should

                                                                            Blue Ribbon Report
      be respected in employment decisions.               policy making and regulatory functions
      The law also contains provisions that refer to      might result in further decentralisation of
      the use of the official languages in the munic-     civil servants to the local level. At the mo-
      ipalities. The law states that the Macedonian       ment, local government employees are some-
      language and its Cyrillic alphabet is an offi-      how lower ranked than their counterparts at
      cial language in all municipalities. Further-       the national level because they do not enjoy
      more, it states that, in addition to the            the benefits and obligations of the civil ser-
      Macedonian language, the second official lan-       vants. Thus either a unified civil service sys-
      guage will be the language and the alphabet         tem that encompasses all civil servants,
      used by at least 20 percent of the municipal-       whether employed by municipalities or the
      ity’s inhabitants.                                  central government should be created, or a
                                                          separate system for local government em-
      7. Financial management                             ployees should be developed.

      7.1 External and internal audit at local gov-       7.3 Strengthening local government
                                                          The central government has a serious interest
      The direct supervision of local service deliv-      in preventing local corruption. One of the
      ery by line agencies of the central government      most effective bulwarks against corruption is
      and of local officials by central control agen-     a merit-based civil service system. The key
      cies is completely inconsistent with the devo-      point is that local governments must have
      lution of responsibility. With fiscal               considerable powers to appoint, and, where
78    decentralisation the purposes and functions         necessary, terminate public officials for cause.
      of external audit have to be transformed. The       But securing a high-quality, merit-based civil
      State Audit Office and the inherited supervi-       service system implies an important role for
      sory functions have to be modified towards          the central government in recruiting, training,
      building new supportive roles, based on a           and certifying career officials for service at
      risk assessment of municipal financial man-         both levels of government. Local govern-
      agement. The other way of lessening the ad-         ments should be free to set staffing levels and
      ministrative burden on the national audit           personnel requirements and to hire and dis-
      system is to develop internal audit capacity        miss individuals, but constrained to make
      at the municipal level. The first units of inter-   their selections from a national civil-service
      nal audit will be followed by other first line      list or registry.
      budget users and eventually by all local gov-       The newly created position of secretary of the
      ernments. An effective internal audit system        municipality provides the potential for pro-
      would require the harmonisation of the legal        viding support for developing the profes-
      base, setting up new institutions and signifi-      sional capabilities of these key civil servants.
      cant capacity development.                          The major weakness of the existing municipal
                                                          secretary system is that it is excessively dom-
      7.2 Improved staffing and management ca-            inated by the Civil Service Agency. The sec-
      pacity                                              retary must be selected by the democratically
                                                          elected council and serve at their will.
      Local government administration will be
      strengthened by transferring human re-              8. Fiscal Decentralisation – basis of a new ef-
      sources connected to devolved functions. At         fective local government
      the first stage only the Public Revenue Office
      staff have been moved to municipalities, as         The current process in the Republic of Mace-
      this was a basic stipulation of the legislation     donia of constituting a new, modern system
      on local finances. Modernisation of the na-         of local government, with decentralised pub-
      tional government by gradually developing           lic functions and local self-government, rep-

     Blue Ribbon Report
resents a complex reform providing for redis-        primary task is to separate local govern-
tribution of important public functions of the       ment expenditures from national budgets
state between two different levels of govern-        and to classify budget resources by func-
ments - the central and the local one. At the        tions. Functional classification should be
same time, this is a matter of a deep decen-         supplemented with performance indica-
tralisation generating new local responsibili-       tors. The current and capital budgets
ties in education, health, social care and           should be separated.
environmental protection. In addition, a new         2. Fiscal information and reporting should
system of municipal public ownership of real         increase municipal capacity to monitor
estate is constituted and real possibilities for     commitments, receipts, and outlays on a
improving the capacity for the economic de-          regular basis. Uniformity in financial re-
velopment of the municipalities are created.         porting requires the adoption of common
Fiscal decentralisation can make an important        templates, standards, and activity classi-
contribution to the improvement of the stan-         fication structures. Cash accounting is ad-
dards and quality of local public services, to       equate to meet local governments’
the strengthening of democratic processes            financial management, internal control
and to the participation of citizens in the or-      and internal audit needs.
ganisation of life in their municipalities, to the   3. Local authorities should be free to ex-
mobilization of human and natural resources          plore alternative modes of service deliv-
for the development of the local economy, to         ery. Full ownership of municipal assets is
increased employment and to a better social          a basic condition for developing effective
position of the citizens.                            forms of service provision. The regulatory
                                                     framework for private sector involvement         79
Local governments must be subject to the fol-        in public service provision would require
lowing operating principles: fiscal sustain-         legal and procedural changes (e.g., public
ability and a balanced budget; hard budget           procurement regulations, customer con-
constraints for financial interventions in the       trol).
economic sector; abiding by established bor-         4. Regional equalisation should target dif-
rowing limits and rules; financial discipline,       ferences in expenditures and municipal
transparency and accountability; inclusion of        revenue raising capacity. The most impor-
financial transactions of the local budgets in       tant task is to create a transparent system
the treasury system of the country.                  of equalisation, which could also support
                                                     solidarity among local governments. Na-
Willingness of the local authorities to cooper-      tional and local governments have to be
ate in a constructive manner with the central        prepared for planning, co-financing and
authorities is a necessary precondition for the      properly managing external sources of
establishment of a balance between the dis-          funding that will be available from the Eu-
cretionary rights and the autonomy of the            ropean Union.
local authorities on the one hand, and the           5. The municipal debt problem should be
need for maintaining a national macroeco-            resolved. Liquidation of indebted munic-
nomic framework and fiscal discipline on the         ipalities is a joint responsibility of the na-
other.                                               tional and local governments. Solutions
                                                     for non-payment have to be developed on
To better promote fiscal decentralisation and        a case-by-case method. The basis of any
local public service provision, the following        solution is an accurate register of local
specific recommendations are made:                   government debt. Possible solutions are:
                                                     (i) a case-by-case negotiation process on
   1. Fiscal planning rules and procedures           specific components of municipal debt;
   should be modernised with the reform of           (ii) setting up a special debt management
   intergovernmental fiscal relations. The           fund; or (iii) discharging municipal liabil-

                                                                            Blue Ribbon Report
         ities through the issue of transferable war-    E. Reforms in Education
         rants. This is the basic condition for devel-   Education has a key role to play in the efforts
         oping a municipal debt market with              to increase Macedonia’s human capital. By
         effective lending institutions and accurate     developing education and training, the gov-
         information on municipal creditworthi-          ernment supports the process of creating a
         ness.                                           developed and functional human capital
         6. On the revenue side, local governments       stock that can be the basis for the country’s
         should, whenever possible, charge for the       prosperity.
         services they provide. Among local own
         revenues, the property tax has the greatest     The following are considered as priorities in
         potential, but local governments have to        the areas of primary and secondary educa-
         develop appropriate tax administration          tion:
         and collection methods.
         7. Revenue sharing and grant allocation         Increasing the coverage of students. In the case
         methods should be made transparent and          of primary education, the policy should be fo-
         objective. Further improvement of Per-          cused on increasing the coverage in rural
         sonal Income Tax sharing mechanisms             areas and among populations currently un-
         should be a priority, with local govern-        derserved, such as the Roma. Full enrolment
         ments receiving limited autonomy in set-        of children in grade 1 can be achieved
         ting the local personal income tax rate.        through incentives and rewards, but also
         The future allocation formulas for inter-       through punitive measures against families
         governmental transfers should improve           and schools tolerating negative phenomena.
80       horizontal equity and provide better in-        The rate of coverage of students by secondary
         centives for local revenue raising.             education in Macedonia is still too low. Other
         8. In the area of municipal financial man-      problems include the high dropout rate of
         agement, the main tasks are to further de-      students and the poor vertical mobility to-
         velop external audit practices and to build     wards the higher levels of education. It is nec-
         internal audit capacity. These tasks re-        essary to overcome the belief that only
         quire the harmonisation of the legal base,      primary education should be compulsory
         setting up new institutions and systematic      and to promote the importance of the higher
         capacity development.                           levels of education through an aggressive
         9. Local government administration              publicity campaign and through a redesign
         should be strengthened by transferring          of curricula. In addition to the government
         human resources connected to devolved           and the non-governmental organisations,
         functions. The newly created position of        local authorities must also play an important
         secretary of the municipality provides po-      role in the efforts to increase the enrolment of
         tential for providing support in develop-       students in primary and secondary education
         ing the professional capabilities of            at the local level, through direct contacts with
         municipal employees. A high-quality,            families, state agencies, the private sector and
         merit-based civil service system would          educational institutions. Basic education will
         also help the fight against corruption.         become a local government responsibility. It
         10. The next phase of the decentralisation      is important to see that it is adequately
         process, and especially further reforms of      funded, and that local schools perform well,
         intergovernmental finances, requires co-        and that they maintain equal opportunities
         ordination, for which the policy making         and meet appropriate standards in terms of
         capacity of the government should be sig-       outcomes.
         nificantly improved.
                                                         Strengthening the quality and efficiency of the ed-
                                                         ucational process. In this context it is necessary
                                                         to modernise the curricula in line with the

     Blue Ribbon Report
standards in the developed countries and link        through the introduction of compulsory
them in a functional manner with the needs           training for administrative and managerial
of the labour market, as well as to Macedo-          staff of educational institutions. Moreover, it
nia’s economic and social needs and to in-           is necessary that the educational cycles be
crease the quality of the teaching staff as a        harmonised with prevailing European prac-
whole, and especially of the staff working in        tice.
the rural areas, by means of additional bene-
fits, to introduce forms of compulsory and           In the area of higher education, it is necessary
continuous assessment of the quality of the          to ensure significantly increased enrolments,
staff, as well as the introduction of a model        and to provide equal access for students to
for professional promotion of the teaching           the higher education facilities, to work con-
staff. Continuous education and re-education         tinuously on qualitative improvement of the
of teaching staff should be a given standard         curricula and syllabi, to increase the effi-
practice.                                            ciency of studying at a university, to establish
                                                     and comply with comparable criteria and
Curricula should be reformed to teach stu-           standards for teaching, assessment and pro-
dents about the European Union as well as            motion, to improve the availability of equip-
about economic and business subjects, even           ment, especially IT, and to strengthen the
in early grades. A population that under-            research function and improve the quality of
stands its global environment and the func-          the scientific and research work of faculty and
tioning of the economy will be better able to        students alike. Macedonia should adopt am-
adapt to new trends in the world economy.            bitious quantitative and qualitative targets for
Effective globalisation of the Macedonian            expanding the share of students who com-           81
economy also presupposes foreign language            plete a university education as well as on the
skills broadly disseminated throughout the           congruence of this education with Macedo-
population; broadened instruction in foreign         nia’s economic objectives. The Bologna
languages, and particularly in English,              process will have strong implications on the
should be encouraged.                                structure of the supply side, as well as on the
                                                     organisation, financing, quality control and
Strengthening the IT capacity of educational in-     certification of higher education. The Bologna
stitutions. The first precondition for this is the   process will also have important implications
modernisation of schools, setting clear prior-       for teaching methods, the content of the cur-
ities for the improvement and modernisation          ricula and the mobility of the students be-
of their IT capacity, introducing equipment          tween the faculties and to institutions of
for active teaching and introducing informa-         higher leaning in other countries.
tion technologies in the teaching process. In
this context, in addition to the budgetary           Therefore, Macedonian universities need
funds that need to be spent in a rational way        structural changes in order to define and im-
and in line with the priorities set, non-gov-        plement the obligations and the policies pro-
ernmental organisations, donations and               moted by the Bologna process. In particular,
sponsorships from international organisa-            they need to be focused on quality assurance,
tions and from the private sector should also        accreditation and diploma recognition. The
play an important role, and a national cam-          certification and recognition of foreign de-
paign to involve these non-traditional agents        grees and credits needs to be revised. Mace-
should be organised.                                 donia urgently needs graduates who have
                                                     global perspectives and experiences.
It is necessary to develop the capacity of ed-
ucational institutions in accordance with the        To promote the needed globalisation of grad-
needs for modern education, and to increase          uates, higher education institutions must
the quality of educational management                strengthen their mutual links and coopera-

                                                                               Blue Ribbon Report
      tion with peer institutions from abroad in          F. Reforms of Health Insurance and the
      order to adapt to the global environment and        Health Care System
      to benefit from the globalisation of higher ed-
      ucation. Although it is a relatively easy part of   The existing health care system in the Repub-
      complying with the Bologna process, the in-         lic of Macedonia, provides citizens with ac-
      troduction of the European credit transfer          cess to adequate medical care, but the
      system has not been completed yet. The diffi-       organization and financing of the health care
      culties are associated with the implementa-         system need rethinking and reform because
      tion of individual reforms, the depth at which      the current system appears to be financially
      they are undertaken and the priorities associ-      unsustainable and fails to provide appropri-
      ated with this system. More elective courses        ate incentives either to the providers of health
      need to be introduced and effective transfer        care services or to those who pay for and
      of credits between the faculties and also           utilise these services.
      among Macedonian universities and with for-
      eign universities needs to be made possible.        1. Organization of the Health Care System
      Macedonian universities need to establish           In 1991, Macedonia, inherited a health care
      ambitious goals for providing meaningful in-        system with good geographical coverage and
      ternational experience for both faculty and         few financial barriers to citizens’ access to
      students, and to develop mechanisms that            health care, as well as a long positive experi-
      make such experiences possible for a majority       ence with health insurance covering nearly
      of faculty and students.                            the whole population. The Law on Health
                                                          Care of 1991 established the organizational
82    The mechanisms for quality assurance must           structure of the system with the Ministry of
      aim at achieving international standards in         Health in charge of health policy formulation
      the development of curricula and evaluation         and implementation and the Health Insur-
      of personnel by introducing modularisation          ance Fund (HIF) responsible for the collection
      in order to make the system more flexible.          and allocation of funds and the supervision
      There is a need to introduce more courses,          of and contracting with health care and phar-
      more interfaculty and interdisciplinary pro-        maceutical providers. This law and a separate
      grams linked with the labour demand on the          Health Insurance Law established a system of
      local and the international labour markets, as      compulsory health insurance.
      well as shorter vocational studies.
                                                          Health facilities include health care stations
      Research and training for research are critical     and centres at the primary health care (PHC)
      for the improvement of the quality of higher        level, specialty-consultative and inpatient de-
      education. The financing of research, which         partments at the secondary level, and univer-
      is now modest, should be increased. The lack        sity clinics and institutes at the tertiary level,
      of new equipment and the limited time de-           with the latter also carrying out research and
      voted to research are among the main barriers       educational activities under the responsibility
      to the integration of Macedonia into the key        of the Ministry of Education. The last few
      scientific and intellectual developments at         years have seen considerable growth of the
      other European universities. The qualifica-         private sector, especially at the primary care
      tions at the Ph.D. level need to be fully har-      level. However, a comprehensive system of
      monised with the European Higher                    coordination and monitoring of the responsi-
      Education Area framework by using the re-           bilities for the provision and control of the
      sults-based principle. A key component of           quality of health care is lacking and needs to
      the Ph.D. program is the advancement of             be developed.
      knowledge through genuine research.

     Blue Ribbon Report
2. Funding Health Care Providers                     purchase of health services from providers,
Currently, health care institutions receive          regardless of whether those institutions are
funds to cover salaries and allowances for           public or private. It is also necessary to direct
employees, for drugs and other medical ma-           the reform of the financing of health institu-
terials, as well as part of their operating costs,   tions towards a methodology according to
thus providing the financial resources re-           which “money follows the patient”, instead
quired to cover the minimum needs of the in-         of providing a fixed amount that covers the
stitutions. Over the last decade, over 90% of        expenditures for the salaries of the personnel,
the HIF’s expenditures covered service deliv-        with minimal funds allocated for equipment
ery costs, while pecuniary compensation of           and supplies. In the system of public health
insured individuals, e.g., salary compensa-          financing, a form of “internal market” needs
tion for sick leave accounted for 6.5%. Spend-       to be established with a view to forcing the
ing on investments in the health sector was          health institutions to work more efficiently
0.7% of the HIF’s expenditures. So long as           and to attract patients. Barriers to the private
health care institutions’ budgets are based on       provision of health care should be reduced,
their past operating expenses and staff size,        and the HIF should not discriminate between
rather than on their actual contribution to the      state-owned and private providers of health
provision of health care, this expenditure pat-      services. Private health care is potentially an
tern is unlikely to change. This is problematic      extremely important segment of the system.
both because it limits resources available for       Conditions should be created for opening
investment and because, in the majority of           new private hospitals.
cases, the money given to any institution does
not directly reflect the type and volume of          3. The Health Insurance System                      83
health care services delivered. Financial plan-      The health care system is financed largely by
ning is further aggravated by the provision of       payroll deductions, which, in 2004, accounted
health services that had not been anticipated        for more than 95% of the public resources
beforehand by some institutions and the un-          available for health care delivery and other
derutilisation by patients of other institutions,    related benefits and activities. This way of fi-
whose budgets remain essentially un-                 nancing the health care system is neither an
changed.                                             efficient nor an equitable way of funding the
                                                     Health Insurance Fund, bringing about a feel-
In 2002 a capitation model of payment was in-        ing of inequality among insured persons.
troduced in primary health care for private          Contribution payments for private sector em-
clinics and in 2005 for private dental clinics.      ployees, including self-employed people and
In 2004 a budget allocation model was started        farmers, an area in which where there is both
in public hospitals, based on budget calcula-        under-reporting of obligations and evasion of
tions on the needs of the three preceding            payments, as well as for public sector em-
years as well as the projected types and vol-        ployees, foster a sense that those who do have
ume of services in the future. This is only a        deductions taken from their pay are support-
modest step forward, and it should be evalu-         ing many free riders. Moreover, many citi-
ated and revised as necessary, perhaps mov-          zens working abroad or in the grey economy
ing to a greater emphasis on more closely            fraudulently register themselves as unem-
relating the actual services provided by such        ployed in order to receive free health care be-
institutions to the amount of money they re-         cause, upon registration as unemployed the
ceive from the HIF. The HIF must be made ca-         individual receives a set of coupons which
pable of allocating its funds in a rational and      form the basis for health service delivery.9
transparent way to reflect the emerging,
rather then past, health needs of the popula-        The compulsory health insurance system pro-
tion. It is necessary to enable the Health In-       vides access to a very comprehensive range
surance Fund to be a strong negotiator for the       of health care services and thus is very costly.

                                                                               Blue Ribbon Report
      As a result both the HIF and individual           Any coverage beyond the basic services could
      health service providers are under financial      be provided by employers, if so negotiated
      strain while the system of financing health       under collective bargaining agreements, or
      care contributes to the existence of shadow       purchased by individuals from the HIF or
      employment and the growth of the informal         from consortia of health providers or insur-
      sector.                                           ance companies. Individuals receiving pen-
                                                        sions or disability payments could have their
      We suggest that these problems be resolved        coverage subsidised (but not covered en-
      by making basic health care a right of every      tirely), as could poor people. This would re-
      Macedonian citizen, and making additional         duce the total tax burden on wages and it
      health care provision a service for which peo-    would also reduce incentives for people to re-
      ple have to pay. The government should de-        port themselves as unemployed in order to be
      cide what medical services are parts of a         eligible for health care since the basic health
      package of “basic” health coverage and pro-       care would be provided to all regardless of
      vide these as a right to everyone who is a        their employment status. Coverage beyond
      Macedonian citizen. Such coverage might in-       the basic package would require outlays by
      clude basic immunization, periodic physical       individuals or their employers, which would
      checkups, emergency care, pre-natal care, etc.    encourage workers to press grey sector firms
      General tax revenues would finance this pro-      to become legal ones.
      gram, with fees to providers negotiated by
      the HIF. Health care institutions would thus      Finally, any reform of the finances of the
      receive some fraction of their budget based       health sector presupposes that the arrears
84    on their capacity to provide these basic health   that exist in payments between the HIF and
      services, and the remainder of their income       health service and pharmaceutical suppliers
      would have to be generated by providing           are promptly paid and that the payroll de-
      services beyond those in the basic package,       ductions due to the HIF from employers are
      for which they would be compensated on a          also promptly and effectively collected by the
      patient-by-patient basis.                         Ministry of Finance and the tax authorities,
                                                        even if such measures put some firms that lag
                                                        behind in their payments into bankruptcy.

     Blue Ribbon Report
  We do not provide a detailed analysis of Macedonian
                                                            Although politically sensitive, the agricultural land
trade policy because Macedonia has recently attracted     tax is a necessity in a market economy, and its collec-
considerable attention in the international community     tion and (partial) use can be delegated to the local gov-
due to its intentions to join the European Union. Such    ernments. The use of these revenues can be tied to
studies of the trade regime have been carried out by      agriculture land improvement investments such as ac-
the World Bank, NGOs, The Economist and various EU-       cess roads, flood protection, etc.
and USAID- sponsored activities. Additional informa-
                                                            An example of good practice in the region that details
tion was obtained from the WTO.                           the challenges as well as good policy responses for cre-
  See Mc Callum, J., (1995): National Borders Matter:     ating an enabling environment for the accelerated agri-
Canada – US Regional Trade Patterns; American Eco-        cultural sector adjustments required to meet the
nomic Review, Vol. 85, No.3, 1995, pp.615-23.             competitive pressures that stem from international
  EBRD (2005), Transition Report 2005: Business in        market integration is the recent Agriculture Sector
Transition, London: EBRD                                  Strategy      of    the    Government        of    Serbia
  Falcetti, Elisabetta; Sanfey, Peter; and Taci, Anita    (
(2003), “Bridging the gaps? Private sector develop-
                                                            Janevska, S.: Policy rationale for legislative changes
ment, capital flows and the investment climate in         and lessons learned from municipal property tax pilot
south eastern Europe”, EBRD Working Paper No. 80,         projects. FDI Policy Forum, Skopje, May, 2004.
London: EBRD
                                                            Co-payments have been introduced to counteract ex-
  Barth, James R., Tong Li, Sangeetha Malaiyndi, Don-     cessive use of health services or consumption of drugs,
ald McCarthy, Triphon Phumiwasana, and Gkenn              as well as to provide additional resources for financing
Yago, 2005 Capital Access Index. Miliken Institute, Oc-   the health care system. As might be expected, co-pay-
tober, 2005.                                              ments have not led to significant resource increases to
                                                          finance health care as they amount to only 3–4% of the
                                                          total fund revenue. Furthermore, the exemptions from
                                                          co-payments that have been introduced have served to        85
                                                          reduce the importance of co-payments as a revenue

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